DBRS Takes Several Rating Actions on U.K. CMBS

DBRS Ratings Limited (DBRS) has completed its review of all DBRS-rated transactions with collateral in the United Kingdom (U.K.). In this review, the rating agency assessed to what extent U.K. commercial real estate price (CRE) declines could negatively affect the creditworthiness of the rated transaction. This impact analysis has been done on a deal-by-deal basis and is based on the assumptions described below.

On 23 June 2016, the United Kingdom voted to leave the European Union (E.U.). As a major member leaving the E.U. is an unprecedented event, the referendum marked the start of an economically uncertain period, as it will need to be established when and on what terms the U.K. will leave. This uncertainty resulted in a falling exchange rate, with the sterling falling to a 31-year low earlier this month. The U.K. CRE market was also affected, as shown by the price development of U.K. commercial real estate companies’ shares, and when increased redemption requests led to several U.K open-ended real estate funds either closing for redemptions or otherwise gating their funds by reducing the redemption price. While still early in the process, these developments indicate that U.K. CRE could have entered a downward trend because of the expected weakening of the economy affecting occupational markets and increased risk premiums affecting the investment market.

The London office market could be particularly affected amid a strong development pipeline and the uncertainty to what extent current occupiers will need to relocate staff into the E.U. This will ultimately depend on the terms on which the U.K. will leave, and could be a longer-term process. In the short to medium term, this negative trend could be at least partially offset by increased office demand from the U.K. government, which will have to hire staff and advisors for its exit negotiations. The sterling exchange rate should also be positive for U.K. prime real estate, London in particular, considering that the recent decline made U.K. CRE more attractive to overseas investors. Several real estate research firms have published research on the possible impact of the E.U. referendum on the CRE markets and generally have a negative view: for example, Green Street Advisors LLC forecasts that London office values could fall as much as 20% within three years of Britain’s leaving the E.U. In DBRS’s view, the downward adjustment of U.K. prime real estate values will likely be sharp, but the continued attractiveness of U.K. real estate and especially the exchange rate could result in a quick stabilisation and even recovery. All in all, DBRS does not expect the correction to be as pronounced as following the financial crisis in 2008/09.

The performance of secondary and tertiary CRE markets across the U.K. will likely be the most affected by the macro-economic development, including investment and consumer demand. In addition, lending standards could tighten. This will likely result in declining tenant demand and rents and higher-yield requirements for domestic opportunistic investors, resulting in value declines. All in all, DBRS expects non-prime U.K. CRE values to decline as well, potentially to a lesser extent than prime. However, for these markets, the speed of stabilisation and recovery will likely be slower than for U.K. prime real estate.

Of the six outstanding U.K. CMBS transactions rated by DBRS, the ratings of two could be vulnerable to an economic decline – consumer spending in particular – coinciding with a downturn in CRE investments and values. This vulnerability is expressed by the assignment of a Negative trend for the Taurus CMBS UK 2014-1 Limited and Debussy DTC plc transactions. Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS’s trends and ratings are monitored. DBRS confirmed the ratings of four transactions: Mint 2015 Plc, INDUS (ECLIPSE 2007-1) plc, Westfield Stratford City Finance PLC and DECO 2012-MHILL Limited. Individual press releases for all transactions are available on www.dbrs.com.

Notes:
All figures are in GBP sterling unless otherwise noted.