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Wednesday, June 29, 2016

BREXIT: Finding clarity in murky waters

By Mark Rose (Toronto)

I was in London on June 23, the day the British voted to leave the European Union, when my taxi driver confessed: “I don’t know why I voted to Leave, but I wanted to vote for my country.” His remarks summed up the mood behind the “Brexit” vote that seems to have caught markets, politicians, business leaders and even much of the public so off guard. In just the past few days, we have seen a dizzying array of dire reactions in the U.K., Europe and across the globe, including dramatic plunge of the pound sterling and trillions of dollars in global stock market losses.

This short-term disruption is the natural effect of fear of the unknown. The market chaos that we are witnessing is due to people not knowing what leaving the EU will mean. The day after the vote, CNN reported that the most Googled search in the UK was- “What is the EU?” Visibility is low, and it is difficult to discern the guideposts, much less the horizon. While this situation is understandable, we at Avison Young cannot emphasize too strongly that no one knows how the U.K. vote to Leave will play out. A complex series of political and economic negotiations will need to be navigated over a long period of time before clarity is restored.

Yet, disruption is always a time of opportunity as well as a time of risk. Smart money will pause, assess – and then formulate new strategies. Brexit is not the death of the U.K. or Europe, and it is not the death of real estate investment, either. Our industry will bounce along as negotiations and rhetoric between the U.K. and the EU start, but global commerce is alive and well – and the U.K. is a big part of it. We may or may not be in the midst of a long-term trend, but business does not cease for long periods.

From a commercial real estate perspective, in the short term, we expect the bid-ask spread to increase as buyers and sellers jockey for position with very different views on value. This trend will lead to a slower investment pace and lower volume of transactions – although we would not be surprised to see a few large, bold transactions from smart-money investors. Similarly, for leasing, most multinationals will pause to assess the situation and chart a new course. We anticipate a slower pace and lower volumes among occupiers as well as investors in the short term.

The U.S. dollar is the big beneficiary and, thus, makes North American investment in the U.K. and continental Europe enticing as events stabilize. Europe is effectively on sale to North American investors due to currency losses. Previously unavailable opportunities may suddenly open up.

North America will continue to represent the best port in the storm. Core markets in the U.S. and Canada, in particular, become safe havens for commercial real estate investors, and New York, Toronto, San Francisco, Vancouver and Los Angeles could be a huge beneficiaries. The U.S. has largely been the world's core market over the past 24 to 36 months, with the most aggressive investors making acquisitions for capital preservation as much as for yield. The Brexit vote aftershock will amplify that situation, and we will see more markets and assets that are not traditionally viewed as core – but increasingly exhibit core characteristics – begin to trade as such. Expect the research-driven core funds to lead the way followed by separate accounts and offshore funds. In major markets, smaller assets that have the right characteristics will see pricing previously reserved for larger properties, due to lack of investable assets on the market.
The interest-rate environment, which was beginning to see signs of uptick, will remain stable to down over the next two years, possibly even the next three to five years – another ultimately positive factor for real estate investment. Brexit has clearly impacted interest rates and may have dealt a death blow to central banks interested in raising rates any time soon. Real estate as an alternate investment just became that much stronger.
Some short-term trends may promote investment opportunities; however, over the longer term, it will be wise to take the time to assess the strategic factors in play. It is simply not known yet how tariffs, import-export regulations, security agreements and movement of labor will be affected. The political and legal decisions that will shape the new relationship between the U.K. and Europe are, at this stage, opaque.
Europe’s broader political landscape will make exit negotiations quite challenging. Upcoming elections in Spain, France and Germany are bound to exert pressure on European negotiators, and some member countries will be in a hurry to be, or at least look, punitive. It is not unthinkable that Russia might make another move to test the nerve of the West.

On the home front, the U.K. has more than its fair share of homegrown problems. Scottish and Northern Irish voters, who strongly voted to Remain, are now rethinking their own alignment strategies. While the British economy has breadth and depth, according to The Economist, Britain sends more than 40% of its exports to Europe, while the EU sends only 7% of its exports to the UK.  Accordingly, Britain’s massive trade imbalance leaves it highly vulnerable to trade disputes.

Our advice to clients is to proceed with caution. History points to downward trends in the short term and a recovery in the medium term, but anyone who claims to know the details or the exact outcome over the long term is foolish. Brexit will play out in real time before us. The ending to this story is unknown.

With that said – although the emotions of this vote are high, the decline in markets around the world steep and the landscape one of uncertainty – capital flows have always found investable assets, and those who take advantage of the downturn will profit. Commercial real estate investment fundamentals remain very strong. At Avison Young, we encourage our clients to assess their situations carefully and develop a plan. Take time to pause and assess, seek out our experts. One thing is for sure- smart money has always taken advantage of disruptions in the marketplace.  

(Mark Rose is the Chair and CEO of Avison Young.)

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