— By Sunny Sajnani
In late June 2016, a historic referendum was voted on approving the British withdrawal from the European Union (EU). The immediate reaction was a short-lived dive in world stock markets, which immediately rebounded a week later. Investors of all assets classes have come to realization that Brexit will result in a long-term transition for the UK, rather than an immediate change. So what does all this mean for commercial real estate in the United States? Why does the UK decision to distance themselves from other European nations affect us?
Bexit is likely to have a short-term positive effect on commercial real estate in the United States, especially in large gateway cities and in the office market. “We’re probably going to see more foreign capital push into the safe haven that is the United States. The greatest effect will probably be in the office markets of U.S. cities that are points of entry for international travelers,” said Suzanne Mulvee, director of research at CoStar, a commercial real estate analytics company.
The longer-term effects of the vote and Britain’s actual withdrawal from the EU are less clear. “Brexit is one more in a series of shocks to the global economy that will have uneven implications for the U.S.,” said Christian Redfearn, professor of real estate at the University of Southern California. “An exit from the EU could signal the beginning of the end of the EU experiment and a lot of uncertainty about one of the major drivers for the world economy.”
Gerard Mildner, director of the Center for Real Estate at Portland State University, said Brexit will probably have little immediate impact on the U.S. economy or commercial real estate markets, but could be part of a larger shift in the nature of the global economy. “The risk is that other countries will copy Britain and impose trade barriers. The most exposed U.S. sectors will be export businesses (e.g., aerospace, agriculture, technology), port-related industrial property and the financial industry.”
US Treasury rates have tanked since the Brexit vote. The 10-year US Treasury rate has fallen from 1.74% on June 23, 2016, to 1.37% on July 5, 2016—a reduction of 37 bps in 2 weeks. Also note, when the energy market was at its low at the beginning of the year, the 10-year treasury rate was 2.24%. A drop in rates comes as investors flee to the safety of the 10-year treasury note that serves as the benchmark for mortgage interest rates, creating a “Brexit benefit” for lenders and borrowers. For purposes of new financings, this is a huge benefit for borrowers that are locking in long-term rates especially compared to the price of capital only 6 months ago.
These drastic rate decreases don’t benefit everyone. Brexit drastically affects Defeasance Costs and Yield Maintenance for borrowers that are trying to unwind and payoff CMBS debt (and other permanent mortgage products). The cost to defease a CMBS loan has become substantially more expensive due to the decline in treasury yield. Since most CMBS loans being defeased now are maturing within a couple of years, the cost is more correlated with short-term yields. As yields rise, the cost to defease is cheaper; however, as they drop, the cost increases. As an example, the yield on the 2-year note has dropped from 91 basis points at the beginning of June to 58 basis points at the beginning of July. Thus, many borrowers are being surprised at the jump in the cost over the past couple weeks.
The Principals and Senior Directors at MCA are preparing for surge of financing requests to lock in long term rates given the current environment. Please reach out to us if you have questions on how your deal will place in today’s credit markets.
The author, Sunny Sajnani, is a Senior Director in the Dallas office of Metropolitan Capital Advisors. Please contact Sunny Sajnani at firstname.lastname@example.org or visit the Metropolitan Capital Advisors website at http://metcapital.com.