Good pickings in the loan desert
27 Mar 08
Banks have cut lending to the commercial property and construction sectors, but cash-rich vultures can thrive
by Stewart McIntosh
When cash is king, the vultures circle over the market. A combination of the credit crunch and too many properties having been over-valued means that commercial property specialists are bracing themselves for a bumpy ride in 2008.
Having paid too much, too often, for too many buildings, major investors such as the pension and insurance funds have been deserting the market, selling some of their stock and leaving the field clear for those who can buy without needing to borrow. There are bargains out there – if you have the cash to snap them up.
“Investors who have cash are in a very strong position right now,” says David Murdoch, an investment specialist with property consultants Drivers Jonas. “Cash is king and those who have it are pooling their resources to snap up bargains. The vultures are circling and they can afford to be very particular about what they buy.”
The banks simply do not have cash to lend on commercial property acquisitions, their balance sheets having been hit by the double whammy of a drop in share value and general turmoil in the financial markets.
“The big squeeze is coming from the banks – they all seem to believe that their competitors don’t have any money to lend. As a result, it’s getting really hard for investors to get the cash they need to acquire new assets. Ironically, there are plenty of good deals around, but instead of a loan-to-value rate of 75 per cent, the banks will offer 65 per cent – and they’ll be looking for higher interest rates as well. Investors who have to borrow are definitely getting their wings clipped right now.”
He predicts that it will take until the summer at least before there is any relaxation of the current tough lending criteria. “It’s only fair to mention that deals are still happening, but I’d advise those who are offered bank loans to read the small print very carefully,” he says.
Roddy MacLennan, head of the property finance team at solicitors Tods Murray, confirms that many would-be investors are being held back by the banks’ reluctance to lend. It has also become very difficult for new borrowers to get access to funds.
“There is no doubt that there is less debt finance available,” he says. “The Scottish clearing banks are still in the market, but various European and US lenders have withdrawn. We know of one well-known lender who won’t take on new customers at all, no matter how good the deal – they will only lend to existing clients with whom they have a strong relationship.
“The shortage of debt finance comes at a time when there is a general slow-down in the market. After seven years of double-digit growth, there was bound to be a correction – and that correction is exacerbating the impact of the credit crunch. Unfortunately the new capital adequacy rules under Basle II [the international agreement on bank solvency safeguards] are also making it harder to borrow mezzanine debt.”
To twist the screw further, while the loan-to-value ratios are coming down, the price of borrowing is going up as lenders seek to increase margins charged.
“It’s now much more difficult to fund speculative office developments, although the residential sector is holding up fairly well,” says MacLennan. “On the interbank market, lenders are sometimes having to pay a premium if they intend to lend on UK commercial property schemes, putting 25 to 50 basis points on top of the LIBOR [London interbank offered rate] interest rate. Lenders will not bear that premium themselves and, if it cannot be passed on to the borrower, they may decline to lend.”
During a credit crunch, it is relatively easy for investors to pull out of the market and take their cash elsewhere.
Developers have a much more difficult choice. Press on with their schemes (if the bank allows) then keep their fingers crossed that there will be a buyer, or an occupier, ready to pay up when the building is complete? Or shelve the project and wait for better times? Companies may be locked into long-standing deals with development partners, funders, local planners, builders, building material suppliers and others that can make it very costly to call a halt.
Kevin Cassidy, senior manager – corporate business with Allied Irish Bank (GB) in Glasgow, says: “The credit crunch has certainly had an effect and it would be naive of any banker to suggest otherwise, but in my opinion Scotland is slightly more protected than the rest of the UK. In Edinburgh and Glasgow the over-riding criterion is supply and demand and there is a dearth of good quality grade A commercial property in each.”
Dan Macdonald, managing director of Edinburgh-based developer Macdonald Estates, and chairman of the Scottish Property Federation, says: “There’s no point in kidding ourselves, there has definitely been a downturn in development and investment. The good news is that we’re not as exposed in Scotland as colleagues elsewhere, mainly because the Scottish market is less volatile than that in the south east, for example.”
He is still working on projects that were already in his development pipeline, which means that Macdonald Estates is relatively sheltered from the yield shift that is threatening the viability of many recent schemes.
“The real issue for developers is how much they paid for the land. The developments we’re producing will have a lower end capital value than two or three years ago, because we’ve already done the land deal but property values have gone down,” he says.
“Our previous emphasis was on retail developments, but with the sector now looking rather gloomy we’re going for mixed use, a sector where we see opportunities despite the current situation.”
Rob Hill, a north-east
England developer, has just started construction on his first Glasgow project – the £35m Copenhagen building, a 54,000 sq ft Grade A office scheme on the city’s Hope Street.
He says: “Most of the gloom is caused by the media – if I believed half of what I read in the newspapers about the credit crunch and its impact on property I’d top myself,” he says. “I have every confidence that I’ll find tenants. There is a shortage of supply in the city and there’s a steady demand for quality space. At the end of the day, it’s the occupier who pays the rent; so where’s my credit crunch?
“Glasgow has come a long way over the last ten years – and it is not going to stand still. It is a major UK business centre. No matter what happens in the financial markets, that shortage of accommodation will still be there in early 2009 when our building is completing. So why would I put the development on hold?”
Although property investors and developers have only recently felt the bite of the credit crunch, the banking sector has been dealing with it since last year and is beginning to emerge from the worst, David Tannahill, of Anglo Irish Bank, believes.
“The situation is easing now and we’re quite positive about 2008,” he says. “We mainly lend to the person doing the deal and we have a list of trusted clients with whom we’ve worked before. The opportunities for us come from the opportunities spotted by our trusted clients.”
He argues that, from a cash flow point of view, investments are again “supporting themselves” and that the time has come to take advantage of the situation: “Yields are softening and it makes sense to get into property,” he says.
And investors who do so are likely to find that they can drive a hard bargain. Kelsey Gibson, a commercial property specialist with solicitors MacRoberts has noted a trend towards last-minute price negotiations.
“One impact of the current situation is that we’re seeing more price ‘chipping’ just before deals conclude,” she says. “The purchasers argue that their bank lenders insist on a reappraisal of values, but it’s interesting that the vendors seem to almost expect that kind of move. This doesn’t mean that the market is crashing, but it’s a sign that the market is adjusting to the new realities.”
She says she has investor clients who refuse to buy in the UK at the moment, waiting for prices to fall further.
“They prefer to buy in Europe where prices are softer, such as in France and Poland which offer better value than the UK at the moment,” she says. “Investors with cash are in control, but some of them are waiting until silly people get out of the market before they’ll buy in the UK.”
Vendors of Scottish properties must adjust their thinking to attract buyers from south of the Border, according to Fraser Smith of Glasgow-based property consultants Smith Cole Wright. With offices in Newcastle and Liverpool he argues that asking prices in Scotland may still be too high.
“Like for like, property is cheaper in many English cities compared with Scotland,” he says. “People from the south find that property up here is a wee bit expensive. The Midlands and the north-east of England have made price adjustments faster than we have, which implies that prices may have further to fall in Scotland. People who want to sell property in Scotland need to take account of that.”
STEWART McINTOSH is a freelance journalist specialising in property.
" THE FUNDAMENTALS OF SCOTLAND’S COMMERCIAL PROPERTY MARKET REMAIN STRONG"
Despite the uncertainties of the commercial property market, Barclays Bank recently set up a property finance division in Scotland, under the leadership of Graham McNaughton.
“We’re confident that the fundamentals of Scotland’s commercial property market remain strong – a good building, on a good location, will continue to attract good occupiers,” he says.
“Investors and developers are having to face up to two issues, the credit crunch and the correction of property values – and they’re both happening at the same time, which is why yields are being pushed out on prime stuff.
“Lenders want to re-price risk, which means that the cost of borrowing will continue to rise. While UK banks have been cutting back on their lending to commercial property, I’ve heard that new European lenders are coming into the market. Things should be much clearer by the middle of this year, once the full picture of bank exposure to the sub-prime market has emerged. Despite the uncertainty, there’s still a solid demand for property – if there was more stock available on the market, there would be more buyers and more deals.”
" A TOTAL SHUT-DOWN ON LENDING IS QUITE FRIGHTENING; I THINK IT’S AN OVER-REACTION"
Fergus McDiarmid of Macdonalds Solicitors sees no reason for panic in the commercial property investment market.
“The banks are still looking at investments and developments, but they are appraising them much more carefully than in the recent past. Some major lenders are refusing to deal with anyone except existing clients, which is rather a draconian step. A total shut-down on lending is quite frightening; I think it’s an over-reaction.”
However, he does see new deals beginning to work their way through the system. Currently he is working on a clutch of property purchases based on self-invested personal pensions. “Because they’re tax-driven, these schemes don’t depend on lending,” he says. “We’re also seeing a greater willingness among clients to buy at auction. In the past, the auction route was treated with suspicion, but now it’s seen as a good way to do a clean deal.
“Some investors are going in for ‘part development, part investment’ schemes, adding value to existing properties via refurbishment.”
INDUSTRY UPDATES
ICAS is holding its annual Construction Industry Conference on 12 June and its Property Investment Conference on 17 September.
The Construction Industry Conference has a reputation as the premier forum for all professionals working in the construction sector or acting as advisers to it, including accountants, lawyers, bankers and commercial and business managers. Delegates will hear an update on recent changes in the law and developments in taxation and accounting. They will hear leading industry speakers’ perspectives on current and future issues and be able to discuss issues of concern with speakers and other participants.
The conference, sponsored by MacRoberts, will be chaired by Gordon Henry, director, Neilstra, and will be held at the Radisson SAS, Glasgow. The cost is £255 plus VAT.
The Property Investment Conference will look at the trends shaping the property market in Scotland and the opportunities arising for clients or companies. Topics covered will include an overview of market conditions and an update on legal, tax and financing changes.
The event is intended for professional advisers, including accountants, lawyers, bankers and financial advisers.
The conference will include practical sessions and real-life case studies, with plenty of opportunities for discussion and questions. It is sponsored by MacRoberts and Anglo Irish Bank. and will be at the Hilton Edinburgh Grosvenor, Edinburgh. It will cost £180 + VAT.