Investors might have to move quickly to buy real estate assets, or companies with valuable underlying real estate, however, as the window of opportunity may be short-lived, some market participants believe.
A few already have cash earmarked for such investments. London-based private equity real estate fund manager Patron Capital Partners said on July 14 that it has raised €950 million for its fifth fund, which will target distressed property investments across western Europe, including property-backed corporate investments.
Real estate investment firm Madison International Realty plans to invest £1 billion in UK property due to be offloaded by struggling open-ended property investment funds that require liquidity to repay investors seeking redemptions, according to reports. Madison International Realty was unable to comment by the time of publishing.
Some foreign investors are also able to see past the short-term effects of Brexit, taking the view that a property investments will pay off in the long run.
Richard Hickman, director of investment and operations at HarbourVest Global Private Equity, who attended a London Stock Exchange conference in Asia in the week of the Brexit vote, said: “I picked up a mood of optimism among Asian investors. They saw this as an opportunity; they didn’t see it necessarily as anything to worry about in the long run… Property investments, in particular, Asian investors are very keen on.”
A range of assets could come on the market. Various open-ended property funds – including ones run by Standard Life Investments, Henderson Global and Aberdeen Asset Management – suspended trading in early July following a tide of redemption requests as investors feared markdowns on the value of UK real estate assets. Such funds are now expected to flood the market with property assets to sell to pay back investors.
However, declining valuations are complicating real estate deals, which could make selling assets more difficult. Keenan Vyas, a director in Duff & Phelps’ London office, said one £100 million deal that was negotiated to include a Brexit clause is now under dispute as the buyer is trying to get out following the June 23 vote.
Ryan McNelley, a managing director at Duff & Phelps, said there had been “a very, very sharp drop in deal volume in the real estate sector”, adding that funds are finding it tough to determine fair value for property assets post-Brexit.
Meanwhile, firms looking to monetise the real estate assets held by portfolio companies could soon be hit by a change in accounting rules. Sale and leasebacks – where an owner such as a buyout firm sets up a separate company, or propco, to hold and own property assets held by a business it owns, which are then leased back to the company via an opco – are due to be affected by an incoming change to accountancy rules.
While previously companies were able to record lease obligations under sale and leaseback structures off balance sheet, from January 1, 2019 a company must recognise all leases as a financial liability on their balance sheet, following concerns about the lack of transparency around such lease obligations. While the arrangements allow the owner to monetise the underlying property quickly they also create a rental obligation for the business.
The change to accounting rules is significant as it would make a company’s accounts look more highly leveraged, according to David Ryland, a partner at law firm Paul Hastings. He said: “Under these accounting rules they say the net present value should be treated as borrowing… You would be a more highly geared entity from an accounting perspective… At one level [sale and leasebacks] will be less attractive than [they were] because rents will be treated on their balance sheet from 2019, irrespective of whether it’s an operating lease or a finance lease.”
Long-term liabilities of the heaviest users of off-balance sheet leases were understated by 26% in Europe, based on a 2014 sample of 1,022 listed companies reporting under the International Accounting Standards Board or the US’s Generally Accepted Accounting Principles, the IASB found.
Potentially fewer sale and leasebacks could have a noticeable effect on the way buyout firms handle a range of deals, given that real estate has long been a sweetener for private equity deals. The underlying value of real estate in UK garden chain Dobbies, which Midlothian Capital Partners and Hattington Capital agreed to buy in June – fending off competition from the likes of Terra Firma Capital Partners – was about equal to the £217 million purchase price, according to one person who declined to be named. Dobbies and Midlothian Capital Partners both declined to comment.
Ryland said: “Real estate is quite often a very important part of what they are buying. How they [private equity firms] optimise the exit value will be a function of how they can get the best capital value when they sell. It’s all driven by valuations.”
Tristan Nagler, UK managing director at European mid-market investor Aurelius, added: “The whole market is going to have to respond to Brexit. Pricing will be impacted if underlying property values are down then sale and leaseback values will be down.”
- For comprehensive Brexit coverage, visit FN’s Brexit pop-up site