By Indraneel Karlekar, Mg. Dir. - Global Research and Strategy, Principal Real Estate Investors
A lot can happen in a day. In this case, over a 24-hour period, citizens of the United Kingdom (UK) recently voted to exit the European Union (EU) under a long-awaited referendum. As anticipated, British Prime Minister David Cameron resigned due to his failed attempt to convince constituents to remain in the EU. Mr. Cameron will be staying on until October when a new Prime Minister is in place. It's important to point out that in order for the exit vote to be binding, the UK government must give official notice of their intention to leave the EU, under the EU's Article 50 of the Lisbon Treaty, which could take up to two years for a British exit (Brexit). I think as the dust begins to settle on this unprecedented event, doubts and questions have begun to surface in how and when Britain will exit, potentially laying the stage for continued near-term volatility.
Since the Brexit vote, the full impact on different investment asset classes is yet to be fully understood with significant volatility impacting risk assets. Thus far, there appears to be minimal spill-over effect on U.S. commercial real estate because investors remain generally upbeat on occupier demand. (See related article: 24 Hours That Shook the World).
I'd like to point out that the initial reaction to Brexit by commercial real estate's public quadrants was pretty uneventful. For instance, while commercial mortgage-backed securities (CMBS) spreads have widened in response to risk aversion, demand for the higher quality tranches (AAA) seems to be holding up well. And even though UK real estate stocks have been negatively impacted, U.S. REITs have also held up relatively well. I believe that part of the reason may be the lack of immediate transmission mechanisms between the public quadrants of U.S. commercial real estate and the recent events affecting the EU's economic uncertainty. For example, U.S. REITs only derive approximately 4% of their net operating income from offshore. Part of this reason may lie in the continued search for yield - especially since global sovereign yields have declined.
For U.S. commercial real estate, the key point to understand is whether this dislocation will weaken occupier demand and investor appetite for the asset class. As the initial reaction by the public quadrants indicates, there seems to be a fair degree of confidence that U.S. real estate fundamentals won't be materially dislocated for now. And looking over the medium term, the path of U.S. real estate is likely to be determined by the following: relative global value, the outlook for net operating income growth, and the availability and pricing of debt capital.