Will Brexit necessitate more creativity in portfolios?10 Apr 2018
The ever-present Brexit juggernaut continues to roll on. Richard Hansford, Ocorian’s Director for Alternative Investments, ponders the impact of the transitional period on the private equity and real estate markets.
The market should be used to Brexit uncertainty by now, and the transitional deal released last month by the negotiating parties of the UK and European Union has done little to dispel nerves.
We now have a transitional period agreed - set to last from 29 March 2019 to December 2020, just a little under two years, and intended to smooth the path to a future permanent relationship - and that agreement includes provision that the UK would no longer participate in EU decision-making. It also says the UK would be bound by its laws in that period while maintaining all the advantages and benefits of the single market and customs union.
There has also been an agreement between both parties on the post-Brexit rights of the 4.5m EU citizens in the UK and the 1.2m UK citizens in the EU, including giving EU citizens arriving in the UK during the transition the same rights and guarantees as those who arrive before Brexit.
The latest version is colour-coded to reflect areas of formal agreement, areas of political agreement where further clarifications are needed, and areas of continuing disagreement. Those areas still under discussion include the governance of the agreement itself, plus geographical indications for food products, data protection and automatic recognition of judgments. Likewise, the Northern Ireland border remains an issue of contention, and is unlikely to be resolved swiftly or cleanly.
Markets to remain accessible through transitional period
As a plus for the UK negotiating team that is so focussed on the trade implications, the UK will be able to negotiate and sign trade deals with other countries during the transition period. This was initially frowned on by the EU Brexit negotiation party but they seem to have conceded here. The UK itself has conceded by agreeing to continuing status quo on all four freedoms - goods, capital, services and labour - in order to keep access to the single market while things are figured out.
It is hoped that both parties will be able to focus on a permanent future relationship, with a deal hopefully to be agreed by the autumn to enable all member states to review before the transitional period commences.
Regardless of the UK’s ability to negotiate its own trade deals, managers are still concerned about single market access. Yes, the UK’s managers will continue to have access to European markets during the transitional period, but it remains to be seen if this will remain the case post-transition.
To help prepare for any outcome, managers are now looking for optionality, sizing up the markets of Luxembourg, Ireland, Jersey, Guernsey and London. This has been the ongoing question since the referendum vote, and each of those EU markets are vying for the businesses looking outside of London just in case.
What will the exit deal mean for UK PE and RE?
The final shape of an exit deal will be fundamental to the short-term attractiveness of UK businesses and real estate. On the Monday following the referendum vote, investment manager TH Real Estate cut the price of its own fund by 5%, meaning it believed Brexit knocked the average value of UK commercial real estate by 5%. But that was June 2016, and things change fast in real estate and private equity.
These are very international sectors by nature, and we have seen many managers in recent years diversify away from their core strategy - whether this be office in prime London to regions, major cities or diversifying into other asset classes - to take advantage of new market trends and opportunities. We see no reason why this will change in the transitional period.
We have also seen the sectors diversify into completely new industries, such as debt and infrastructure, by having greater diversity within their portfolio - and diversification will certainly reduce the impact of a hard or soft Brexit on these markets.
In the immediate aftermath of the referendum vote, people were concerned about investing in office blocks across the City as the market was concerned that Brexit would have a heavy impact on financial services business and the demand for offices. This has not necessarily been the reality; while offices have not achieved the same levels of growth such as PRS, student accommodation or logistics, the market continues an upward trend thanks to sterling’s depreciation.
London remains vulnerable
Yet political volatility is set to continue as negotiations continue. The impact of uncertainty on investor sentiment has, overall, been surprisingly minimal. There is uncertainty, yes, and the UK real estate market has certainly slowed in the last year or so - but the impact on pricing has been limited. Outside of London, the markets are actually holding up better than expected.
Of course, London remains the most vulnerable to Brexit, whether it’s in terms of financial services decamping to the continent, or in terms of its large skilled European population heading home. The City requires access to Europe and beyond to maintain its position as one of the world’s dominant financial centres. If that changes, not only would property in London become less attractive, but the loss of revenue would have a massive impact on GDP and government coffers.
Similarly, foreign investors who have invested in London property, considering it a safe haven, may reconsider their options - and the impact of that would be huge for the market.
Still, private equity and real estate people can be very creative in uncertain times - it is when they are at their best, able to spot an opportunity and exploit it. We’re sure they’re watching these negotiations as they continue to unfold, hedging their bets and keeping one eye on the alternatives. We likely won’t even know who won this bet until long after the deal is signed.
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