The UK commercial real estate sector will weaken over the next few months as investor sentiment has sharply changed following the vote to leave the EU, according to a report published by Moody's.
The rating agency says the good news is that UK banks are now in a stronger position to deal with the deterioration of the sector than they were during the financial crisis of 2008.
The report argues that large UK banks are more resilient to a weakening commercial real estate sector than they were eight years ago, because they have significantly reduced their lending exposure. Royal Bank of Scotland and Lloyds are the most exposed with £25 bn and £20 bn respectively.
'We estimate that the six largest UK banks have reduced their aggregate gross UK Commercial Real Estate lending exposure by around 40% to £84.6 bn at the end of June 2016 from £138.9 bn at the end of 2010,' said Andrea Usai, senior vice president at Moody's. 'Reduced exposure to UK CRE coupled with strong capital buffers means that large UK bank should be better positioned to handle a deterioration in the sector than during the 2008/09 global financial crisis.'
Despite their stronger position, Moody's warns that 'a severe stress would certainly erode capital, materially in some cases', leading in the worst-case scenario to losses of £12 bn across the UK's largest six banks.
The rating agency's forecast for the UK CRE sector is not positive: the base-case scenario is of an up-to-10% decline in CRE values, depending on type, quality and location. In a hypothetical adverse scenario, with the UK economy in recession, the decline in prices would be more pronounced, although it would not, according to Moody's, be of the magnitude witnessed during the financial crisis, when prices fell by 45%.
'Pressures on the market mounted in early 2016 amid uncertainty about the outcome of the Brexit referendum,' said Usai. 'Following the actual vote to leave the EU, we have seen the collapse of some large CRE deals, as well as the suspension of redemptions at some UK property funds. These events signal a sharp change in investor sentiment.'