A growing number of property entrepreneurs are talking about now being the time to get back into the market.
Among the latest is Nick Leslau who now plans to raise a total of £600m (£200m on the stock market, plus £400m borrowed, reports the Evening Standard) to spend on offices, flats and retail developments over a five-year period. Max Property is listing on Aim at the end of this month.
So should retail investors follow him in yet? We’re not so sure…
There could still be worse to come for commercial property
Commercial property prices have already fallen hugely. The most recent data from Investment Property Databank (the industry benchmark) shows that the average UK commercial property price in April was 42.7% down on the market’s peak in June 2007.
So it’s no wonder that some people are starting to sniff opportunity. But there could still be worse to come for commercial property.
Lending is unlikely to relax much this year for one thing. Kelvin Davidson at Capital Economics points out that the De Montfort University review of UK commercial property for 2008 suggests that new lending last year totalled $49bn, down from $84bn in 2007.
Meanwhile, about nine out of 10 lenders had non-performing loans in 2008, “double the proportion” of 2007. Almost half of these loans were “non-performing” because of breaches of maximum loan-to-value (LTV) arrangements. In other words, falling property values mean that in percentage terms, there’s a lot less equity and a lot more mortgage on many buildings than lenders agreed to initially finance.
Now if you fall into negative equity on the home you live in, the bank won’t turn around and ask you to top up the equity. But that’s not the case for owners of commercial property (or buy-to-let landlords for that matter). If you breach the agreed LTV, the bank can ask you to make up the difference, or it can repossess.
Plenty of anecdotal evidence suggests that this is happening to some unfortunates. However, for now banks are seemingly largely choosing to overlook LTV breaches as long as borrowers are still paying their mortgages, reports Davidson, which “is surely helping to keep forced selling to a minimum”.
But this cosy situation won’t necessarily last forever. For one thing, about £40bn of loans is due to be refinanced this year, but De Montfort reckons lenders might only make £20bn available. More to the point, with economic conditions remaining weak, conditions for commercial landlords are just going to get worse.
Arguably there are too many shops and too many offices in Britain, and not enough capacity to fill them. That adds up to falling rents, more tenants being unable to pay rent, and more reluctance by banks to finance any businesses or projects that depend on rising consumer demand within the next few years.
That’s not an attractive outlook for the commercial property sector. And regardless of how tolerant banks are of LTV breaches, if a landlord can’t actually make the payment on his mortgage, they’ll have no choice but to repossess. That in turn means asset fire sales (not to mention more pressure on bank balance sheets as they have to write down their commercial property loan books).
I suspect it’s the prospect of picking up bargains at these fire sales that are dragging old hand property investors back to the market. They’re raising money just now to take advantage when the real carnage comes. But for retail investors I wouldn’t be keen to get back into the sector now, particularly not via those property funds and real estate investment trusts (Reits) that were still investing at the height of the recent boom.
Some interesting investment opportunities
If you are dead keen to invest in commercial property, there are more promising prospects abroad. Cris Sholto Heaton wrote about prospects for the Singaporean Reits sector in his MoneyWeek Asia free newsletter recently – to sign up for his weekly email, click here.
Another interesting area is in the US. Commercial property in the States is in just as deep a mess as it is over here. Last month, General Growth Properties, the country’s second-largest shopping mall operator, filed for bankruptcy protection. It’s been described as the biggest real estate collapse ever seen in the US.
However, as Alex Seagle points out in The Contrary Investor newsletter, one sector might be worth a look. The healthcare Reits sector – companies that own properties catering to doctors, care homes and the rest – should see long-term demand maintained for all the usual reasons associated with the health sector. Western populations aren’t getting any younger and they’re prepared to spend increasing amounts of money to offset the ageing process. Of course, they’re still weighed down with debt, so you have to choose carefully, but there could be some decent opportunities out there. We’ll take a closer look at the sector in a future issue of MoneyWeek – subscribe to MoneyWeek magazine.
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