COMMENT: When investors buy overseas real estate, they inevitably take on foreign exchange exposure.
Normally, currencies do not fluctuate wildly, but forex volatility can escalate – often spurred by political events. The June 2016 Brexit referendum and September 1992 Black Wednesday sell-off are two major historical UK events that put currency risk in stark relief.
The resulting currency market dislocations resulted in near-term losses for investors, but also created attractive opportunities for investors to buy real estate exposure in the UK market using non-sterling currencies.
In the immediate aftermath of the Brexit referendum and Black Wednesday (as the market reaction to the UK’s withdrawal from the European Exchange Rate Mechanism is known), the values of non-sterling-denominated UK property portfolios shifted rapidly downward due to currency swings that had no direct relation to underlying real estate values.
To demonstrate the degree of currency risk faced by these cross-border property investors, we examined the total returns of the MSCI UK Monthly Property Index in the periods before and after both events. We then compared the index’s returns for sterling-denominated index investments and those denominated in four non-sterling currencies.
Opportunity knocks
Our analysis shows that currency risk led to opportunities. In general, the non-sterling-denominated MSCI UK Monthly Property Index outpaced the same index denominated in sterling in the years following both events.
After both major market-moving events, the sterling-denominated index’s total returns recovered quickly following the initial shock. But the same index denominated in one of the four non-UK currencies failed to bounce back, as sterling continued to depreciate significantly against the other currencies.
For example, from shortly before the Brexit referendum in May 2016 until December 2018, the sterling-denominated MSCI UK Monthly Property Index would have returned a cumulative 20%. By contrast, the euro-denominated index, over the same period, would have returned only 2.26%.
The same pattern held for Black Wednesday. A sterling-denominated index would have returned 38.23% from August 1992 until December 1995, whereas a US dollar-denominated index would have lost 10.79% over the same period — all due to currency exposure during a period of US dollar strength relative to sterling.
Of course, currency exposure cuts both ways for cross-border real estate investors, depending on their choice of currency denomination and investment timing. As a thought experiment, how did non-sterling-denominated MSCI UK Monthly Property Indexes fare in the immediate aftermath of the Brexit referendum and Black Wednesday?
From the October 2016 post-Brexit-referendum trough until December 2018, the indexes denominated in the Australian dollar and Japanese yen would have returned 37.48% and 32.8% respectively (versus 21.93% for the sterling-denominated index over the same period of time).
Black Wednesday presented a similar pattern: the sterling-denominated index saw a cumulative total return of 38.65% from the March 1993 trough to December 1995, whereas the euro- and Australian dollar-denominated indexes returned 50.94% and 41.44% over the same period.
The Brexit referendum, Black Wednesday and other hard-to-predict geopolitical events can have a major impact on currencies. And with the currency risk that comes with cross-border property investing, real estate portfolios can fluctuate in value like faster-moving, more liquid asset classes. Such volatility can offer both risks and opportunities.
Will Robson is global head of real estate applied research at MSCI
