Just how much further will values fall? Are we three-quarters of the way there?
I recently tested the views of investors, developers, agents and bankers at MIPIM, and there was a clear consensus that commercial property values have further to fall. The investment market has already seen prime yields soften by 75-100 basis points – suggesting falls in value of 15-20%.
The softening in yields for secondary property has been more dramatic, although the precise level is highly dependent upon the sector, lot size and location.
The question is, how much further will values fall? Some observers have expressed the view that we are perhaps three-quarters of the way there. Others are more pessimistic.
There is no doubt, reading the newspapers, that there are many negative factors in the wider markets. The US is probably in recession and there are fears that the UK economy is heading in the same direction. There is turmoil in the banking and finance industries, and concern as to the extent to which it will feed through to the real economy.
However, there are also some positive factors. Wherever I go, I seem to meet investors setting up vulture funds – there’s no shortage of capital, arising from 15 years of economic prosperity. Another type of investor waiting to pounce is the kind who has been investing in Germany and Europe over the past couple of years, instead of the more expensive UK market. They are now poised to return to the UK, because it is starting to look like good value.
The real problem in today’s market is that investors are still sitting on their hands. Institutions are not short of funds but, because they mark to market and values are expected to fall further, they will not return to the market until the perceived bottom has been reached.
So far, forced sales have been largely restricted to property funds with liquidity issues. We have seen few instances of banks foreclosing on properties after loans have gone wrong – but that may change as more lenders are forced to refinance. By and large, at least for the time being, tenants are not going bust and investment cash flows remain solid.
In the debt markets, it is not true to say that property financing has dried up. Of course, the problems of the conduit lenders are well publicised. However, there are the large branch networks of Abbey, Barclays, HBOS, HSBC, Lloyds, RBS, Bank of Ireland and Unicredit (9,000 branches in Italy), plus Nationwide and other building societies, that are taking in the all-important cash deposits.
Lenders pursue profitable business
One commentator recently said to me that “the balance sheet lenders are making hay while the sun shines”. While those lenders are active, it is not in pursuit of market share but in pursuit of profitable business. Obviously, margins are far higher and loan-to-value ratios lower than nine months ago – when we were in a markedly different era.
I track approximately 100 lenders, of which 78 say they are still lending in the UK (and 42 say they are lending across continental Europe). Of those, 50 say they are prepared to lend to new customers. This includes a dozen German banks and five private banking arms of major banks, which say they will lend to new customers with whom they can form a good relationship. That is key in this new era: a borrower will find it far easier to secure debt finance if they are respected by a bank.
But it remains true that property lending is going through troubled times, not least because half of the banks I track are experiencing difficulties, partly with their existing loan books.
The majority of loans granted over 2006 and 2007 are probably in technical breach of their loan-to-value covenants, which may yet drag further banks into a downward vortex.
However, half of the banks that I track are still doing good business – but on cautious terms that reflect the unique market circumstances we are in. I am praying for a turning point. If it does not come soon, then it could turn nasty out there.
William Newsom is head of valuation at Savills
