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London’s commercial property feels the blues

The “leave” vote has forced global investors to have second thoughts on exposure

Gulf News

Uncertainty remains pervasive in the UK financial markets and that has knocked the legs from under the commercial property sector. Call it a Brexit aftershock that has many pondering if indeed there’s much more of this to come.

In a span of five days of trading, the market witnessed more than a handful of sizeable asset managers freeze funds with exposure to the commercial real estate market. This is a manifestation of the sharp correction of the British pound, which plummeted from a pre-referendum high of 1.50 against the dollar down to a 31-year low.

The worry for property investors is that while a 20 per cent correction is significant, the percentage loss is less than half of what the world witnessed during the 1992-93 exchange rate mechanism (ERM) currency crisis or the 2008-10 global banking crisis.

The funds are heavily exposed to offices and other prime commercial property in the UK that can’t be unloaded quickly enough when nervous investors want their money back. By their very nature, property is not a liquid asset and Bank of England Governor Mark Carney called the current phenomenon a “liquidity mismatch”.

While giving his twice-annual report on the state of the economy, he noted that commercial real estate transactions had fallen by 50 per cent from their peak last year.

All told, six funds froze nearly $19 billion of assets after pressure from investors to liquidate their holdings. While that drastic measure triggered some alarm, property strategists suggest there was little choice when panic started to grip the marketplace.

“The nature of the beast is that open-ended funds are always at risk stemming from the uncertainty money will move out of the funds and that it is difficult to square with their illiquid nature,” said Liam Bailey, Global Head of Research for Knight Frank.

Bailey suggests if this level of selling continues, we could be faced with a shortage of office space in Central London over the next two to three years. On the residential side, Knight Frank research indicates prices dropped just 1.4 per cent since the end of 2015, but that was before the shock of a “Brexit” vote.

After multiple conversations with investment fund managers, private equity players and even black cab taxi drivers, there are two camps forming here in London: those waiting and hoping for some sort of EU trade agreement that will stabilise the pound and those who see a currency correction as reason enough to move on property purchases.

Edward Mermelstein, Co-Founder of the property law firm Rheem Bell & Mermelstein, said Gulf investors and their counterparts in Asia will likely, as a whole, wait for the political dust to settle before re-entering the market.

“Obviously they’re very nervous, a larger portion of their portfolio is located in the city of London for the most part and when the value of that portfolio drops 20-30 per cent in a month or two month period, you become more nervous about what will happen next,” said Mermelstein.

One of the current unknowns is finding a business-friendly successor for David Cameron at 10 Downing Street. A common theme often arising during the push for support from the party membership has been the effort to reduce CEO pay and close the gap between the upper 1 per cent and everyone else.

What investors in the UK want to hear is if whether what is arguably the world’s most international financial centre will remain open to the outside world. The current Chancellor of the Exchequer, George Osborne, convened a group of top executives from international banks who publicly said they will continue to support London, but there was a noticeable absence of any firm commitments or new investments.

Meanwhile, British banks and development companies remain under intense pressure. Their stocks have seen corrections of 30 per cent or more since the “leavers” secured their victory.

At this stage, the credit rating agencies are beginning to issue warnings over the potential fallout from the vote. “In our view, the leave result in the UK’s June 2016 referendum on EU membership has increased the risks of adverse economic developments in the UK. As a result, we now see a negative trend for UK banking industry economic risk,” said S&P in a statement.

The agency added, “The UK economy has now entered into a correction phase”.

So most of the people I spoke with believe this shakeout has just begun. Building a reputation as one of the most influential city-states — in the spirit of New York, Hong Kong, Singapore and Dubai took decades; rebuilding that role after the shock will not happen overnight.

The writer is CNNMoney’s Emerging Markets Editor.