By Emmanuel Lumineau, CEO and Thomas Schneider, CIO at BrickVest, the international online real estate investment platform
While investors paid little mind to political risk until recently, Brexit and the Italian referendum has made it a reality, and established a new paradigm in the realm of real estate investment. Evaluating political risk using qualitative and quantitative tools has now become essential.
As the largest market in Europe, London is traditionally part of any real estate investment strategy for international investors. Yet the lead-up to the referendum already froze approximately £1 billion worth of transactions, and investors today are not only still wary, some are in fact pulling out.
Having a dedicated risk rating for real estate is essential
Contrary to the bond market (which has much more sophisticated methods than its real estate counterpart for evaluating default risks), there is currently no structured, precise evaluation of political risk as it applies to real estate assets. This is hardly surprising, since it would involve considerable data collection from real estate markets in terms of demand (transactions, average square footage, rise and fall of rental rates), supply (rate of vacancy and unoccupied stock) and investment (volatility, ROI for real estate transactions). Establishing a tool dedicated to the political risk premium for real estate also requires access to data in real time, as well as demanding that information from different countries be normalised.
To date, the available real estate data has been supplied by private initiatives (Land Policy, owners, universities etc.) and concerns a very limited portion of the world’s markets. It is thus essential to avoid the conflation of real estate and sovereign risks. The Brexit referendum caused the UK’s debt rating to fall from AAA to AA, according to both Fitch and Standard & Poor’s rating agencies. But investors cannot effectively rely on such ratings to assess the change in real estate market risk, since real estate asset and sovereign risks are not always correlated.
The UK possesses one of a very few highly transparent real estate markets in the world, along with that of the US. Data collection initiatives, which are conducted by the Investment Property Databank (IPD), have been underway since 1986. In this respect the German and French markets remain murkier and data is harder to come by – something that is largely due to a lack of committed resources.
The first element of concern regarding political risk comprises real estate assets themselves. Relevant data available concerns transactions and yields, but also includes location-based rental risks. This data is now accessible, having been rendered public as part of the Open Data project: crime statistics, school density, neighbourhood economic activity, unemployment rates, turnover, etc. The key is using them to deduce the inevitable macroeconomic consequences that are a result of any social or political upheaval.
The second element associated with political risk concerns the business plan – these are risks associated with the investor and investment scenarios. Issues of taxation figure prominently, as well as performance, managers and so on. A particular risk profile depends on the type of investments planned.
In short, a political risk premium (or discount) may be assigned if a high level of risk is identified.
Since the 23rd of June it has become impossible to consider the Western European market as an integrated whole. As such, as we finished a year of significant turmoil across Europe, and indeed the rest of the world, with more likely to follow over the next 12 months, it is about time that the available data was aggregated to evaluate the political risks associated with real estate investments worldwide, emancipating them from sovereign debt ratings.
There is no doubt that such a risk indicator would prove extremely valuable both in terms of yields and for regulation. Data remains the golden goose of the digital economy, an environment that real estate investment is embedded in today.
At BrickVest, we understand the need for greater risk transparency. We have assembled a Board that includes European real estate research specialists. Earlier this year we announced an appointment of Remi Antonini (former head of European real estate research at Goldman Sachs and former partner & head of European real estate at Exane BNP Paribas) as the head of BrickVest Rating Committee.
Together with Remi, BrickVest is designing a proprietary algorithmic risk-based rating model, which will enable investors to classify real estate investments according to risk, using a similar approach as fixed income rating agencies. In this way BrickVest Ratings intends to make investing in real estate more transparent and comparable.