Pressure force Have the US sub-prime affair and the Northern Rock crisis sucked the last fuel from the skyrocket of property value growth? By Estelle Maxwell
For poet TS Eliot, April was “the cruellest month”. However, in the world of real estate at least, where inter-bank lending rates hit a historic 6.26% high at the beginning of October, it seems that the “season of mists and mellow fruitfulness” might prove to be the most challenging for private investors and auctions alike.
Auctions have long been regarded as a barometer for the wider property market, and the September and October sales have been labelled an acid test of its tenacity under pressure. Falls in sale rates are closely observed by vendors and buyers as a tale of two halves emerged – rising rates of repossession fuelled sales and increased residential catalogue sizes. And commercial clients were urged to “get real” and adjust to a changing market place in order to sell riskier secondary stock.
Leading auctioneers have spoken frankly of the need for vendors to adapt to the full impact of the higher borrowing costs seen following the implosion of the US sub-prime market and after five interest rate rises in the UK since May culminated in the run on Northern Rock. This has all triggered speculation that, after a decade of spectacular growth, the market faces a potentially protracted cooling-off period, with the potential for valuations to fall below sale prices.
What the future holds
The growing evidence that institutions are quitting the market and that banks are moving the lending goalposts, has thrown up several questions about what will the effect be on those private buyers who emerged as a major force over the past decade, and what of those with less equity?
Will the current period of volatility be little more than a blip to be negotiated by commercial investors with a long-term perspective, and what are the prospects for the residential sector?
With yields moving out on secondary stock, margins tightening, and forecasts of “flight to quality”, added to a rise in repossession rates and demand for land reaching insatiable levels, the market is anything but predictable, especially on £1m-plus lots. Sales rates have fluctuated accordingly.
Jeremy Handley, Jones Lang LaSalle’s valuation advisory director, acknowledges that the current scenario is challenging. “It is a difficult period because both banks and investors are adopting a wait-and-see approach and are observing how things will be in the coming months. Private investors have generally relied heavily on bank finance, and there is no doubt that availability of finance is not as great as it was – which I suspect will continue for some time.”
He adds: “If private buyers are happy with the returns, and are willing to put in more equity, they can continue to deal. But in the private treaty market, there are fewer buyers. They are more cautious about taking on risk. It is not an easy market.”
Prices drop
Handley acknowledges that there is “a very strong current sentiment that prices are falling”, but he stresses: “It is not consistent, and varies from property to property. Prime assets are holding up better.”
He belives that investors want more profit for taking on more risk, and that is sensible. “It is important that a property has active management potential, that as a purchaser you have a robust business plan that you are confident can be delivered, and that you are getting enough compensation for taking the risk.
“It is difficult to make valuations in a slow market. There is evidence of deals falling by the wayside, indicating buyer’s sentiment, so it is important we stay close to investment teams to see what they feel is driving the market. I think, inevitably, at the moment, there are fewer purchasers. No one wants to buy now and see further price reductions in the next couple of months,” says Handley.
He goes on: “In terms of commercial buying, I feel that people are reassessing their assumptions on development. I think the banks are going to be even more cautious and want to see there is plenty margin for risk. Prelet developments are generally fine, I believe, because there are not so many about, but clearly the cost of finance will affect developers’ ability to put prices as high as they could some time ago.”
However, established buyers with long track records regard the current crisis, though serious, as nothing really new, with most expressing the view that the cool wind blowing through the market has introduced a badly needed note of realism.
Welsh private investor Richard Hayward, managing director of Richard Hayward Properties, acquired much of his residential portfolio through auction. He began investing in 1979, acquiring the Focus portfolio for £41.5m from ING Real Estate and a £160m portfolio from Lear Investments, doubling his holdings from £260m to £460m in August and September this year.
Hayward, also chief executive of AIM-listed Hawtin, takes a long-term view. He says: “The banks are looking for greater loan-to-value ratios, so you cannot borrow as much as you could just months ago. They are looking at 70% instead of 90%, and margins have moved out. It is a big issue for them all, and it is no doubt harder to get your hands on money than it was three months ago.”
He adds: “Many of the investors who have withdrawn cash are wanting to put it into property, and foreign buyers are also looking for similar deals because they feel their money is safer in the long term. Therefore I think the auctions will do quite well. There may be a bit of a slide in residential property prices where they rose particularly high, but not in London. Commercially, the yield has moved out a fraction, but it is not big money, approximately 0.25%. But who knows what may happen by next year? There is such a weight of foreign money pushing the market up.”
Feel-good factor
Trader, investor and managing agent Samuel Beilin, chief executive of TRB Estates, holds a £300m portfolio of residential and commercial property. He says: “We had a loan to draw on recently that was cut by £500,000 for no other reason except the Northern Rock panic, when the feel-good factor slipped away. Perhaps if we go back to them now, they will reconsider.”
He adds: “From a psychological perspective, the credit crunch is very damaging. But the most significant thing is the number of increases in interest rates, which encourages private investors to keep money on deposit. If you are getting 7% on your cash, you are not going to buy investment property when the base rate is 5.75%.”
David Pearl, chairman of Structadene, recently assembled a portfolio of stock in Islington for around £40m. He says: “It is a changing climate, and the market has to readjust. For larger buyers it is a good time, because it gives them the opportunity to clean up their portfolios.”
He adds: “We are not buying anything like as much as we were three months ago. We are still completing on lots of acquisitions but, as for new investments, I am not as keen as I was six months ago. We are still getting the money we want, but many people are finding it more difficult. Anybody could make money in the past 10 years – you could buy anything and make a profit. Now, it is the experienced ones who are left.”
Arv Soar, director of Nottingham-based Property Investment Portfolio, invests through Northern auctions. He owns a portfolio of more than 200 mostly residential properties in regeneration zones, acquired over 10 years and valued in excess of £20m with 70% gearing.
He says: “You can see some of the deals are coming back into the room at auction. We are trading, but what we cannot sell we will keep. If the market drops, we will hold, and if it turns, then we will sell. Either way, we cannot lose.”
Fergus Walsh’s Burwood Properties portfolio, valued at £230m, began in 1991 with the purchase of its first three-bed property in Paddock Wood, Kent, for £35,000. It now owns around 800 residential properties in the county, with around £100m of equity and LTV gearing of 65%.
Walsh, a former maths teacher, bought three houses at a Barnard Marcus auction in September, but says: “Most people are not going to expand their property portfolio. Everyone is talking about a drop in the property market, but I have not seen it yet, and there was a need to cool off prices. Over the past 14 years, property has generally doubled. Over seven years there has been an increase of 13% pa, and probably that is a reasonable level to aim for.
Walsh addes: “But it will be a great place for auctions. Every time there is a market drop and repossessions go up, it is good for landlords. It is an ill wind which blows landlords good. They will be buying, and repossessed people need to rent somewhere because they need somewhere to live.”
Stephen Conway, managing director of Galliard Homes, bought via auction before moving into developing in the early 1990s: “I think it is the most turbulent time for 34 years, but no-one has ever gone wrong taking a long-term view on the UK property market.
“In the current climate, business risk will be revalued and people will look for higher margins. Anything we have taken to the market now is not for completion until 2011, and we are not seeing signs of falling values. Our stock is continuing to increase.
Conway concludes: “Last month, we launched our New Capital Quay site in Greenwich, a mixed-use, 8-acre development with 630 apartments and duplex suites. Buyers queued from 7am to purchase apartments, and more than half the units – £150m worth of property – sold by the end of the day, which was a great sight at a time when people have been waiting to take their money out of the banking system in the wake of the Northern Rock crisis.”
What do auctioneers think?
Jones Lang LaSalle’s auctioneer Richard Auterac says: “Though there is little money available for lending, many of our buyers have been borrowing for years and are probably not hawking around their debt package looking for the best deal. So I suspect we are not going to see a huge credit problem, although our market is not immune from what is going on in the wider arena.
“The quality of stock at auction has increased, and the reasons for buying now are no different from before the summer. I am very hopeful it will be a good three to four months for auctions, and believe it will be one of the few markets that will be working. But you cannot predict the unpredictable.”
John Barnett, auctioneer at Barnett Ross, says: “There are still people who have not completed on lots they bought in July, because they were affected by the sub-prime shake up in August and September and by the Northern Rock crisis. Vendors are being advised that yields on secondary stock must be opened up in order to sell.
“But it is not easy to get finance since the banks have restricted new loans. Consequently, the whole of the secondary market is constricted, and it is a domino effect. There is less liquidity at the bottom, where the more amateur investor who bought and then experienced a drop in value cannot make their repayments, so they try to sell in a market where people want to pay less. It is like pass the parcel, but no-one wants to be holding it when the music stops.”
Auctioneer James Cannon predicts that, although Savills’ October commercial sale was its biggest auction by 70%, Q4 would not be as straightforward as in the past few years. “But people still perceive opportunities,” he says, “and returns are there for the right sort of property – although purchasers in the middle 4.5% to 7%, the ‘twilight-zone’, will need to show they have the means to raise returns through active asset management.”
Cushman & Wakefield’s auctioneer John Townsend says: “At the lower capital value end of the market, I think it will be business as usual, though regulated buyers may be a bit more discerning. And in some respects, it is a good reason for people to buy property, rather than go into equities – provided pricing is right. It will be insightful to see how the £1m – plus lots will be received. My gut feeling is there will be strong interest in them.”
Allsop’s commercial auctioneer Duncan Moir says that the commercial sector is still experiencing a strong appetite for stock. But he adds: “A lot of loans have been changed before anything has been signed. It is not a surprise that banks are looking to reduce their loan sales, but it will be interesting to see how much this pressure will influence how they start changing their terms of business.”
