It appears that a compromise deal between Greece and its creditors has been reached. But it will be the nitty gritty of structural economic reform that will determine whether the country is to receive its third bailout. In the short term at least, this reduces the risk of a near-term exit from the single currency.
But significant hurdles must be overcome before the deal is finalised. And the negotiations over debt restructuring, which have been put off again, may yet prompt a Grexit. With this saga dragging on in a seemingly never-ending drama, it may be premature to start contemplating the implications for UK commercial real estate of other macro-economic affairs – or is it?
On the balance of probabilities, it is most likely that Greece will remain in the euro and that a long-term debt restructuring will be negotiated: something that is both inevitable and desirable. Politically, this would be a win for the Europeans, and you would expect to see a relief spike in the euro on the prospect of a definitive Greek solution ultimately being found.
But over time, and once the Greek risk is “priced out”, markets are likely to refocus on the ECB’s quantitative easing policy and its negative effect on the euro, particularly against the US dollar (as US policy is likely to normalise), providing further impetus for yield-tightening across European commercial real estate.
In the more unlikely event of a Grexit, the markets would add a risk premium to EU assets. However, with only 20% of Greece’s debt held privately and the general state of the European banks perceived to be in good health, the fear of a Lehman Brothers-type “contagion” is limited in scope and potential.
There will undoubtedly be a short-term bout of financial market volatility as a result of this. However, the higher yield will provide apt reward for property owners buying European real estate risk.
In the short to medium term, the fear of the bond markets trying to push other weak eurozone members out of the common currency is of little concern. Ultimately, the ECB’s QE mandate gives it far greater flexibility to stabilise bank markets and the Emergency Liquidity Assistance facility stands ready to respond to any potential bank runs. Also, the public finances of some of the peripheral eurozone economies, particularly Spain and Ireland, are in much better shape than they were earlier this decade.
Presupposing the view that this is a false assumption, and in fact the risk of contagion is higher than suggested, this would be incredibly positive for prime UK property, as there will be a strong shift, across all markets, to quality.
While the Greek situation has brought to a head many unknowns, and has forced the central banks to react, investors, by and large, have managed pan-European real estate assets proactively, and have continued to benefit from the QE programme.
As an investor, I am more concerned by the inherent weakness in the euro as a single currency than the underlying investment assets priced in that currency.
Ironically, whatever is the “final” outcome of the Greek affair, its real impact on UK property is limited – mainly the potential for prime to see some more yield-tightening.
The UK’s EU referendum, due by the end of 2017, is of much more importance to the UK real estate investor. Whatever its eventual outcome, the uncertainty leading up to 2017 will challenge the UK’s safe-haven status. The risk premium on sterling assets is more than likely to be challenged in the future.
Of even more immediate concern are the expected interest rate rises. As rates start to rise, all else being equal, the relative value of prime assets will fall dramatically. The “taper” tantrums we saw in the equity and bond markets in recent years highlight the inherent volatility that this repricing can have.
The stark reality is that the real estate boom is only as strong as its underlying lenders. Despite the growth in alternative lenders, property investors need to start questioning the robustness of the underlying lending market.
Pricing of UK commercial real estate must ultimately be based against the backdrop of lending availability – something that looks incredibly healthy and robust right now, but about which serious questions will be posed as interest rates start to rise.
Ironically, the UK-EU referendum may provide the foundation for rates to remain lower for longer. With the Bank of England not willing to raise rates during a period of heightened uncertainty, this may result in “real rental growth” justifying tighter yields and allowing the boom to last a little longer.
Michel Heller is fund manager at Gowers Investments
