Brexit 3.0 – Commercial Property
As I am sure you are aware there has been much post Brexit debate surrounding the effect on UK property prices, both residential and commercial.
Much of the commentary so far has been contradictory, on one side there are industry experts who are predicting a 10%[i] drop in values and on the other there are those insisting that the fall in sterling has made UK property cheaper and much more attractive to overseas investors.
In the past 48 hours three Open Ended UK property funds (Standard Life, Aviva, and M&G) have closed their doors to redemptions. It’s important to note that these fund suspensions are currently limited to Open Ended Investment Companies (OEICs), these fund structures are not the most effective vehicle for holding property because they offer unlimited liquidity while holding an illiquid asset. The result, when investors want money out on mass, these funds have to close their doors.
Around £35[ii] billion is invested through similar fund structures, which accounts for between 5-7% of the UK commercial property market. These funds are equity in nature buying hard property assets such as retail, industrial and offices, but they do maintain limited cash reserves in order to offer investors liquidity.
In May, the month before the referendum, retail investors withdrew approximately £360m[iii] (1%) from these funds in the anticipation that a leave vote could have a negative effect on prices. Post referendum the demand for withdrawals has snowballed and has all but exhausted the limited cash reserves. In response, the funds have implemented withdrawal restrictions, allowing fund managers the ability to offer assets for sale in a timely fashion thus retaining value rather than a fire sale. This suspension mechanism is not a perfect scenario for investors but was one designed into the fund structure intending to cope with shocks like these in the market.
It’s too early to tell whether properties about to be offloaded by these funds will be met with sufficient demand from overseas investors, to whom these assets look like remarkably good value. With the expectation that the Bank of England will be forced into one or two interest rate cuts before the end of the year, these sales will also offer investment opportunities to yield starved UK investors.
Unlike investors in the previously mentioned funds, Proplend Investors have invested into the debt part of the capital structure and therefore have an equity cushion sitting ahead of them to absorb the short term market noise and price volatility. Proplend offers a property backed fixed income investment, not an equity investment. Our unique Tranching model allows investors the ability to decide how much Loan to Value (LTV) risk they are willing to take. For example, investors in Tranche A (0-50% LTV) invest in the knowledge that a property would have to fall in value by more than 50% before their principal investment was impacted.
At Proplend we believe we have taken a cautious approach to underwriting. Currently, our loan book sits at a comfortable average of 64% LTV. We have just completed an internal stress test and re-analysed our existing borrower and tenant profiles, at this stage, we are comfortable that there are no red flag exposures. We will continue to closely monitor existing loans and how the market reacts over the coming months. New loans will be underwritten with the same strict criteria, and if deemed necessary, we will increase that equity cushion, by reducing the maximum LTV level.
[i] Write down on property OEICs and general market assumptions
[ii] Data from the Investment Association
[iii] Data from the Investment Association