A declining pound splits debate on the UK’s attractiveness

While a 25% currency discount is a lure for some international bargain hunters, the institutional attitude has remained largely circumspect.

Just hours after the pound collapsed to a historic low following the UK government’s tax-cutting ‘mini-budget’ of September 23, perceptions of the country’s real estate market had already significantly shifted.

That day, Andrew Cummings, head of prime residential at broker Knight Frank’s Dubai office, was live posting to his 1,500 Instagram followers: “20 percent discount on UK property today for dollar buyers.” He added a currency screenshot demonstrating four Emirati Dirham to the pound, down from five earlier this year.

Cummings’s comments were focused on the UK’s prime residential market. But such an extreme reaction was in keeping with sentiment elsewhere in the UK real estate market in the aftermath of UK chancellor Kwasi Kwarteng’s policy announcement. That was followed by a Bank of England statement that it would “not hesitate” to raise interest rates as much as needed to tackle inflation and an adjoining bond-buying program designed to “restore orderly market conditions.”

The response to this quickfire sequence of events from government and central banking officials around the world was negative, with the International Monetary Fund and the US government among those warning of the economic consequences.

But the impact of this on the pound alone has forced a dichotomy of perspectives about the short-term attractiveness of a European property market long considered a staple of any institutional-level portfolio. “This makes things crazily cheap for those of us pegged to the dollar,” Cummings said. “Lots of my clients based here are now interested. For them, it’s a case of buy now and wait until the dirham gets back to five to the pound to make 25 percent on currency alone.”

A similar understanding has developed in pockets of the UK commercial real estate market too. Three days after the Kwarteng’s budget, Clearbell Property Partners, the London-based private equity real estate manager, and Augsberg, Germany-based manager Patrizia announced the sale of The Bower office in Stockley Park, West London for £74 million (at press time: $84 million; €85 million) to Sidra Capital, a Saudi Arabian investment firm.

Manish Chande, senior partner at Clearbell, told PERE: “The fall in the pound against the dollar implies that international investors can effectively acquire an asset for 25 percent less. This not only applies to US investors, but any originating from a country with a currency pegged to the dollar, including much of South America and the Far East.”

Chande said currency as a buying reason would likely remain relevant for the next year to 18 months. “You would expect funds to be taking advantage of prices over that period. International investors must be eyeing the situation with interest.”

Spread of views

Not everyone is convinced. Positions on UK attractiveness on currency weakness vary by organization, with more conservative institutional investors among those staying circumspect. Isabelle Scemema, global head of French insurer platform AXA Investment Managers – Alts, is more interested in repricing for distressed reasons.

She said: “We won’t make a decision just on currency; we have to be comfortable with the fundamentals. What I am seeing in the UK market is more volatile today. There are big issues triggered by the currency, including margin calls which have to be matched. That triggers distressed sales on the liquid markets, but, for the moment, we haven’t seen distressed sellers on direct real estate in the UK.”

Charles Baigler, head of acquisitions for real estate at Geneva-based manager Pictet Alternative Advisors, stressed the importance of getting comfortable with the UK economy over buying on its weak currency: “While the UK now looks extremely cheap for a dollar investor, it’s also materially more risky with three-year gilts at 4.7 percent as we speak – that is 25 percent more implied risk than Italy. And there is limited debt.”

Indeed, according to PERE affiliate Real Estate Capital Europe, UK residential lenders, including HSBC and Santander, responded to the pound’s decline by suspending deals to new customers and, with economists predicting UK interest rates could top 6 percent by next spring, commercial property lenders are finding it increasingly challenging to price new loan issuance.

Nicole Lux, senior research fellow at London’s Bayes Business School, and author of its bi-annual UK commercial property lending report, argues rapidly changing interest rates are making it difficult for lenders to assess the potential risk of falling property values.

“Public debt markets have already reacted to increasing interest rates with a sharp drop of new bond issuance, while private debt residential and commercial mortgage providers have been busy running stress tests to consider any additional capital required to cover risks on their lending books,” she said.

In such circumstances, a common wisdom is prevailing: besides for short-term opportunistic, but long-term holding investors, which are able to invest without financing, major institutional outlays should remain thin on the ground until inflation has been curtailed.

Pictet’s Baigler says: “Nobody can call the bottom of a market, but the current thinking is it’s going to get worse before it gets better. The UK is not a ‘buy’ yet, but I’m sure it will be.”