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The first concrete signs of post-Brexit financial stress
Jul 6th 2016
THE first concrete signs of post-Brexit financial stress in Britain emerged
this week. The asset-management arm of Standard Life, an insurer, suspended
redemptions from its 2.9 billion ($3.8 billion) British property fund. It was
followed by a flurry of rivals: Aviva, Canada Life, Columbia Threadneedle,
Henderson and M&G.
The decisions highlighted the mismatch between the open-ended nature of such
funds allowing retail investors to buy and sell on a daily basis and the
illiquid assets they hold: office blocks and shopping centres. But the
announcements also reflected the shock to the property market caused by the
Brexit vote. London has attracted lots of businesses both because of its
perceived openness and because it provides an English-speaking base for doing
business in the EU; the vote has caused a reassessment of its attaractiveness
as a corporate home.
According to the Financial Times, German and Spanish buyers pulled out of
650m-worth of property deals in the week after the referendum. Russell Chaplin
of Aberdeen, another asset manager, says many deals had a Brexit clause
allowing purchasers to walk away if Britain voted to leave. This has happened
to Aberdeen s property fund in two cases: one buyer abandoned a purchase
altogether while another asked for a discount, which has not been accepted.
Mutual property funds tend to have monthly valuations (conducted by outsiders)
to determine the fair value of their assets. Given the uncertainties after
the referendum vote, valuers thought it prudent to apply a discount and
fund-management groups took their advice. Henderson reduced its fair-value
estimate by 4%, M&G by 4.5%, and both Aberdeen and Standard Life Investments by
5%.
The funds keep some liquid assets on hand in order to meet the kind of
redemptions they face in normal circumstances; as of May 31st, Standard Life
had 13% of its assets in this form. Some of these liquid assets will be stakes
in big property companies like British Land and Land Securities, so the big
falls in their share prices (see chart) may in part be a contagion effect from
funds meeting redemption requests.
There may be other knock-on effects. In a report on financial stability
published on July 5th, the Bank of England worried that forced sales of assets
by property funds may exacerbate the market s weakness; it has eased capital
requirements for banks to encourage lending.
Problems have been growing for a while. The Bank said that foreign capital
inflows into British property fell by almost 50% in the first quarter, perhaps
as investors waited for the Brexit vote to be resolved. The purchasing managers
index for the construction industry fell in June to its lowest level since
2009.
Mike Prew of Jefferies, an investment bank, has been predicting a
commercial-property downturn since last year. Two areas stand out. Central
London has been on a building spree, with 26m square feet of offices currently
being added (or refurbished) in a market with around 200m square feet of space.
Mr Prew thinks 100,000 jobs in London are at risk of moving to the EU enough to
free up 10m square feet. Office rents could fall by as much as 18% in central
London, he warns.
The second problem area is retail premises, to which the Standard Life fund was
heavily exposed (its five biggest tenants were all retailers). High-street
shops have been squeezed by the rise of the internet; BHS, a department-store
chain, recently went under. If the economy does slow in the wake of the
referendum, retailers troubles will intensify.
Comparisons with the financial crisis of 2007-08 are inevitable; that too saw
property-fund suspensions in its early stages. But they should not be overdone.
For a start, open-ended property funds do not borrow and own only around 5% of
British commercial property. Few investors are likely to have devoted a large
part of their savings to this asset; they will have known that they might lose
money. The systemic risk is limited.
Furthermore, with interest rates near zero and ten-year bond yields below 1%,
property funds still offer a decent income; even in London, prime rental yields
are 4-4.5%. Vacancy rates in central London are below the historic average,
according to Jones Lang LaSalle, an estate agent. A big sell-off would surely
attract some bargain-hunters.
Still, fund suspensions are not a good sign. At the very least, they should
make regulators question whether open-ended funds are suitable for property
investing. There is nothing liquid about bricks.