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Shares in the property sector have been hit hard in recent months, even before the recent correction.
It’s no surprise. As the FT pointed out the other day, “analysts believe that prices for most commercial buildings in the UK are as high as they will get in this cycle.”
And last week, figures from the Investment Property Databank (IPD) showed that the monthly return from the sector in July was its lowest for a staggering 12 years. Average total returns, rent plus capital growth, came in at just 0.2%.
And there may well be worse to come…
The Sunday Telegraph reported that Norwich Property Trust – the UK’s biggest commercial property fund for retail investors – has quietly been putting out feelers about offloading some of its portfolio.
“Property buyers have been discreetly contacted about potential sales to boost the liquidity of the £4.1bn fund,” says the paper. The problem is that the chunk of the portfolio that is held in cash and shares has been dropping as investors pull their money out of the fund.
Since the start of August, it has apparently fallen from around 18% to 15%, “the bottom of the fund’s target levels.” It follows a change in pricing policy by many funds in the sector, from an ‘offer‘ to ‘bid‘ basis, “essentially penalising investors looking to exit and wiping millions of pounds off the value of investors’ funds.”
A spokesperson for the fund told The Telegraph that it was business as usual – “We are an active manager and continually review the portfolio.” But as the paper points out, given the time it takes to sell commercial property, further outflows could potentially lead to liquidity problems.
It’s not just Norwich Property Trust of course, though it’s one of the highest-profile fund in the sector. Commercial property – as we’ve been saying for a while now – looks like its glory days are behind it.
As The Economist reminds us, Stephen Hester, British Land’s chief executive, said earlier this month that he expects office prices to fall, as has consultancy CB Richard Ellis. With the yield on commercial property sitting at 4.8% at the end of June, according to the IPD, it’s not surprising – that’s way below the cost of borrowing.
That’s only been exacerbated by the problems in the credit markets. Banks are becoming much more wary of who they give money to, partly because of the fear inspired by the US subprime mortgage market debacle, but also because of the huge pressure on their balance sheets at the moment.
The banks have to be careful. With $300bn or so of private equity debt still to unload, and a constant stream of bad news from the commercial paper market (we’ll be discussing this in more detail in this week’s issue of Money Week – if you’re not a subscriber yet, click here for a free trial) banks can be forgiven for wanting to keep as much of their cash to hand as they possibly can. They simply don’t know where the next nasty surprise is going to crop up and make a claim on their capital reserves.
According to The Economist, prices of shops and factories “started to slip in July, according to IPD.” Meanwhile, “five of Britain’s biggest institutional investors have reduced their property exposure since the start of the year, reversing a five-year flow of money into the sector.”
The magazine also points out that although office prices have yet to fall, one of the traditional props under the market is no longer anywhere near as sturdy as it once was. Commercial property investors in the past were shielded from volatility in the sector by the fact that many tenants were locked into long-term contracts. But now, “this is no longer the case. Between 1995 and 2005 the average lease length declined from 13 years to less than five years. If demand falters, then rents, and property values, may tumble as quickly as they have climbed.”
And with the City currently looking like a decidedly risky place to be working, maybe companies will soon find that they just don’t need as much office space as they’d expected. The credit crunch isn’t just squeezing bank’s balance sheets – it’s making a lot of hedge fund and private equity operators brush up their CVs to get in before the redundancy packages and bonus cuts start doing the rounds (see last Thursday‘s Money Morning for more: One sector to avoid as the City jobs market slams shut).
All in all, we think commercial property will have plenty more rough months ahead.
Turning to the wider markets…
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In London, the FTSE 100 fell back from earlier highs to end Friday 23 points higher, at 6,220. Positive broker comment boosted heavyweight miners including Rio Tinto, Xstrata and Lonmin, whilst software stock Sage topped the blue-chip climbers following an upgrade from Merrill Lynch. For a full market report, see: London market close. (The London market was closed yesterday for the Bank Holiday.)
On the Continent yesterday, the Paris CAC-40 lost 8 points to close at 5,590, whilst the Frankfurt DAX-30 was 4 points lower, at 7,507.
On Wall Street, stocks closed lower on Monday after data was released showing the count of unsold homes hit a 16-year high in July. The Dow Jones lost 56 points to end the day at 13,322. The tech-heavy Nasdaq was 15 points lower, at 2,561. And the S&P 500 was down 12 points at 1,466.
In Asia, the Nikkei fell 13 points to close at 16,287 as the stronger yen weighed on exporters such as Nissan and Sony. In Hong Kong, the Hang Seng fell by as much as 85 to 23,492.
Crude oil futures had edged up to $72.10 this morning and Brent spot was at $70.76.
Gold was up to $667.00 compared with $666.40 in New York late last night. And silver was last at $11.75.
Turning to the currency markets, the pound was at 2.0052 against the dollar and 1.4699 against the euro this morning. And the dollar was at 0.7326 against the euro and 115.45 against the Japanese yen.
And in London this morning, Barclays denied claims made in The Financial Times that it had provided funding for the investment unit of troubled German public lender Landesbank Sachsen Girozentrale. A spokesman for Barclays said that claims that it had ‘exposure’ to debt units worth hundreds of millions of dollars, as reported by the FT, were ‘inaccurate’. Shares in Barclays had fallen by as much as 1.3% today.
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