UK Real Estate: Amid Uncertainties, Longer-Term Prospects Still Attractive

For investors in UK real estate stocks, the Brexit vote has greatly increased short-term uncertainties. However, we see reasons to be optimistic about longer-term prospects—especially in London—and believe the market sell-off that immediately followed the referendum has created attractive buying opportunities in some high-quality companies.

While the market may have overreacted to the Brexit vote initially, there are some real short-term concerns. These include a higher risk of a recession in both the UK and continental Europe, which will likely put additional downward pressure on real estate stocks in both markets. In addition, we expect companies to delay decisions related to the size of their London office footprints. This will likely hurt the ability of office landlords to increase rents and may also manifest itself in lower property values. Additionally, there is a risk that some jobs could be relocated outside the UK.

Headlines about several large UK commercial real estate funds halting investor withdrawals added to the negative market environment in the days following the vote. However, it is worth noting that the troubles these funds faced were related more to how they were structured than to the long-term health of the real estate market. The funds involved invest directly in real estate. To satisfy investor redemptions, these funds must physically sell off buildings in order to raise cash liquidity. By contrast, funds that invest solely in publicly listed real estate securities, including ours, are a liquid alternative that do not face the same degree of liquidation pressures.

In the year leading up to the referendum, we trimmed our allocation to the UK market, reflecting our view that increasing office supply, specifically in London, could outpace demand in the short term and create a more challenging operating environment for office landlords.

However, the initial market reaction following the vote pushed some real estate stocks down more than 30% (over 40% in U.S. dollar terms1), leaving share prices out of line with longer-term valuations. Responding to this opportunity, we added to some of our high-conviction holdings in companies that we believe own excellent, well-located office buildings in London’s West End but that had fallen significantly on the news of the vote. These companies have solid balance sheets and strong management teams and, thus, should be relative outperformers over the longer run, in our view. The sell-off created an opportunity to increase our positions at a steep discount.

The post-Brexit environment could provide some additional benefits for real estate investors. Given the uncertainty in the UK, we believe it is likely that many planned real estate developments will be delayed or abandoned, improving the London office supply picture. A weakened British pound also should make UK real estate investments more attractive to foreign buyers armed with relatively stronger currencies, providing some downside support to real estate prices.

Brexit changes the landscape of the UK economy in the short term, and we will take a cautious, thoughtful approach as we look for investment opportunities. But London remains one of the world’s great cities, and we believe high-quality, well-located real estate assets there will continue to be in demand over the long term.

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