BREXIT – a gigantic special situation for the real estate market?
We speak with Dr Geza Toth-Feher about Brexit and the real estate market. He explains: “Brexit will not prompt the final sell-out of the UK, this process began many years ago. Therefore, I believe the UK will provide ample opportunity for foreign investors to buy opportunistically for the next eighteen to twenty-four months.”
In this insightful interview, he reveals what the impact of Brexit has been on the investment market and what the future looks like for transactions and FDI in the upcoming months.
What is the immediate impact of the referendum?
Last spring no member of the investment or financial community expected the people to ‘vote leave’. The referendum campaign was fought on the shallowest of levels, on both sides of the campaign trail. The arguments that were exchanged were ill-prepared to absurd, and the notion of an entire country plunging itself voluntarily into the abyss was just unthinkable. The representatives of the leave campaigns were perceived by many people in the finance and investment community as clowns, thriving on a neo-populist wave that rallies against everything that is modern and foreign and somehow not tightly controlled. Against this background, the decision truly came as a shock.
Therefore, the immediate aftermath of the referendum decision was dominated by turmoil in the financial markets and a major political crisis, which in my opinion, is still ongoing. To exacerbate matters, there was a legal vacuum. No one seemed to have thought this through or was prepared to show leadership. The public were confronted with details of the process only after the event and even then, the information given was scarce at best, often wrong, intellectually on mickey-mouse level.
The decision, ultimately born out of a Tory political backbencher quarrel that David Cameron simply could not quell, has thrown open largely unprecedented challenges, and it will take the United Kingdom some decades to overcome all of those. The technicalities of the referendum outcome and next steps are unclear, so are the solutions.
The UK negotiators, who will have to be trained first, are under massive pressure due to an ever-tighter timetable, set in motion by the article 50 notice. The fact that the 8 June 2017 election may have produced a minority government does not make this task easier. As a result, uncertainty about prevailing market conditions, as well as uncertainty about the political spectrum, as it now presents itself after the general election on the 8 of June 2017, prevail and affect investor sentiment.
How does the currency market affect real estate investments?
A prudent real estate investor will look at an investment not only with regard to its sector fundamentals, but also with regard to the currency in which the transaction is done, especially if the repatriation of returns (such as rental income or refinancing proceeds or sales proceeds) occurs into a currency other than sterling. For example, the famous (and fully let) Gherkin Tower had to enter receivership because it was financed in a multi-currency-structure, mainly made up of Swiss Francs Tranches. When in 2013/2014 the Swiss Franc rose, the loan amounted to roughly £644m, versus its original value of £396m.
The dramatic drop of the sterling against the two other relevant currencies (sterling came down from almost €1.35 to below €1.10, and from almost $1.45 to below $1.25) in the weeks and months following the referendum decision has sparked substantial trading activity on the currency markets. Furthermore, the US dollar and EUR property buyers are beginning to take advantage of the correction of the sterling value, which they perceive as being temporary.
In a way, the currency disaster provided some relief. It took some of the heat out of the Central London property market. The ‘Brexiteers’ never became tired of selling the currency development as a success.
However, the currency impact is of course relative, especially in commercial property investments, at least as long as rental income and other proceeds will be received in the same currency as the acquisition currency. Hence, real estate transactions will have an element of hedging and speculative currency trading as part of their normal risk profile. This uncertainty will eventually drive prices down.
It is unclear, what the long-term impact on sterling figures will be with: the Eurozone regrouping and reforming; France and Germany apparently able to defeat the ghosts of populism and isolationist politics, and the notion of parity between sterling and the EUR – and we have been close before – seems to becomes quite a likely scenario.
Has the referendum result sparked transactional activity?
It almost certainly has. Now, almost twelve months down the road from the original referendum decision, transactional activity has picked up and the paralysis that was seen in the days and weeks following the Brexit decision has lifted to some extent. The key element of uncertainty is the exact shape such Brexit is going to take. Is it a ‘soft’ or ‘hard’ Brexit, with additional uncertainty as to what exactly these terms mean.
It is difficult to have a comprehensive analysis of Foreign Direct Investment (FDI) into the UK, but Ernst & Young have compiled a report (EY’s UK Attractiveness Survey 2017: Time to Act) which is published on www.ey.com.
Looking at the statistics in that report, the UK has retained its top spot for FDI performance, ahead of Germany, with a 7% rise in total projects (1,144), the highest figure on record. It is also Europe’s leading beneficiary of FDI-related jobs, with a 2% rise to 44,665. However, this development was far outpaced by the increase across Europe as a whole, meaning that the UK’s market share of all FDI projects in Europe fell from 21% to 19%.
Aside from these numbers, the impression of most market participants is that there are lot of large-scale investors “kicking the tyres” on large deals in the UK. There are a number of very substantial property transactions under negotiation or under offer. One cannot help but feel that the interested buyers are more of the opportunistic, bargain-hunting nature, and that this is a first sign of an impending downturn, not from a healthy and functioning property market. We should not forget that the sector also suffers from the UK’s own home-grown problems, in particular the notorious shortage of affordable housing and the somewhat paralysed UK mortgage market.
Will the UK become a tax haven for offshore investments?
In the months following the referendum, it appeared that this might be the direction the government would take. By the end of 2016 it was widely expected and reported in the press that we would see a regime of falling corporate income and dividend taxation and a general relaxation of investment rules, the traditional cures for low activity and productivity.
Strangely, the government in its 8 June 2017 election campaign led by Theresa May, seemed to try to embrace a socio-economic approach, very contrary to what a stronger chancellor would be able to propose. With Philip Hammond gagged, the Tory party was suddenly becoming the champion of traditional new labour values. During the election campaign Theresa May refused to rule out tax rises.
With the result of the general election being as it is, the chancellor’s hand appears strengthened again. At this stage, no one can exclude yet another U-turn in this never-ending tale of political miscalculations.
Of course, the reality is that the United Kingdom, and with that one means the Greater London area, the commuter belt with good transport links to London, and maybe the powerhouses in the North, still provides investors with an investment market of considerable breadth and depth. Taxation is one factor an investor should consider but it cannot or at least should not be the main investment driver.
What is the impact of the referendum results on the fund and hedge fund industry?
The fund industry dislikes change. The hedge fund industry usually thrives on it. Change prompts transactional activity and returns. Of course it brings risks – a lack of certainty in the fields of taxation, of cross border dividends post Brexit, the absence of a unified approach to the regulation of the industry, and a drain on the UK based pool of human capital and talent.
Where the immediate impact of the referendum, at least legally speaking, is non-existent, during the Brexit negotiations the funds regulation will have to change and quite fundamentally. This applies not only to funds, but also to financial services, insurance and other regulated industries.
It is entirely unclear which regulator regulates what in the future. As an example – if a fund is located in Luxembourg, within the EU, but does investments in the United Kingdom, will there be a double layer of regulation, one coming from Brussels and one from Westminster? These questions need answering and fast.
How have you adjusted your investment strategies?
We are generally opportunistic in our approach, as are our investors. We, therefore, see opportunity, not without challenge, in these difficult market conditions. The main issue for us is not so much the worsening of the general outlook but the extreme volatility. Market sentiments and economic outlook on the world, post Brexit, change on an almost weekly basis, with a few U-turns here and there.
As a result of our fluid outlook, we at CBE Trapp & Co. have adjusted and solidified our investment strategy. We continue looking at the investment fundamentals. The market conditions are what prompts the activity that promote a transaction and pressure points. However, we try not to fall into the trap of doing a deal just because of that.
We look for those deals where a good asset is caught in a market-driven special situation and is therefore, artificially and temporarily, undervalued. We prefer solid and tangible value, capital growth and income growth in defendable positions, but not necessarily with a long-term view.
Investments have become larger and the composition of investors has changed. We see large institutional amounts piling into the UK and we are now, more than before, keen to secure large scale portfolios or platform transactions, where the assets will be worked on by an experienced management team.
How concerned are you that organisations will move to cities such as Paris or Frankfurt?
Banks and financial institutions have always been toing and froing between Frankfurt and London. In my personal career, which I started in Germany, Frankfurt became a boom town for some years in the 90s, then the sentiment swung towards London, then back again. A new phenomenon of the post Brexit area is the wooing, with Paris and Berlin sending clear – almost shameless – signals to the talent pools in the UK to try and attract them away from London. This may work well for the start-up industries (and generally for ‘hipsters’ working on ‘projects’) in Berlin, and for natural sciences in France. However, people forget that London is a metropolitan city with enormous attractivity for families and young professionals, and they do not – and often simply cannot – just move over night.
I believe that talent will always seek the best place of employment and opportunity, and we will see more people commuting between London and Paris. In a way, these two cities have almost merged into one Pan-European unit.
I am also convinced that Paris will have political difficulties in offering ‘sweetheart’ deals for bankers, this may be different for other talent such as technological, pharmaceutical or the academia.
How is the banking and lending market affected by the referendum results?
The banking and lending market reacted as all institutional markets first did, with paralyses. Lending became scarce and the availability of debt finance for commercial and real estate transaction was limited. The markets have since relaxed a little bit and we now find bankers, if not bullish, but at least willing to participate in the natural course of business.
The hurdles for any bank to make a lending decision have become higher. Once the decision in principle has been made, lending values, LTV and repayment terms are just as aggressive as they were ten years ago.
The European banks, in particularly those with a license to issue German Pfandbrief as a means of refinancing, are taking a large share of the markets, together with their US counterparts, who now benefit from a massive competitive advantage in that the US is beginning to deregulate its banking system under the Trump administration.
What is your prognosis for the future of the real estate market in the UK?
As I said before, the UK remains a property market with quite considerable breadth and depth. I would firmly expect to see a temporary correction, with a lot of influx of foreign investment capital into the UK, and I would not be surprised if some of the landmark buildings around town and some prized companies and infrastructure assets were changing hands.
Mini Questionnaire – ‘Food for Thought’:
What do you want to achieve in 2017?
We would like to achieve further growth in our property portfolio and we would also like to add more partners to the firm.
Do you have a mantra or motto you live by when it comes to helping your clients?
Nice and simple: focus.
How do you measure your success?
On the returns achieved for us and for our investors.
My name is Geza Toth-Feher. I am the Managing Partner of CBE Trapp & Co Ltd., London, a multi-family office with German, Swiss, Austrian and UK investors and co-investors. The firm acts as lead investor and operating partner for multinational private equity transactions. Additionally, we provide advisory support, usually in special situations, restructurings and/or recapitalisations. The firm invests in commercial real estate in the UK, Germany, Austria and Italy with prime emphasis on special situations or particularly complicated structures. The firm has recently been involved in one of the largest commercial real estate transactions post Brexit in 2016. We co-arranged the sale of a property portfolio of Marks & Spencer retail outlets to Fortress and funds managed by Fortress, Los Angeles.
Dr. Geza Toth-Feher Lord of Kennal
Managing Partner of CBE Trapp & Co Ltd.
4 St James’s Place
London SW1A 1NP
United Kingdom
Tel: +44 2074 994 596
E-Mail: gtf@cbetrapp.com
