Has Wheel Property Cycle Finally Come Off
Wednesday, 16 December 2009
Unlike the usual ten year boom to bust in the property market cycle, today's downturn follows an unprecedented 15 years of growth and does not show the hallmark traits required for recovery according to leading property expert, GVA Grimley.
A recent shift in the market has seen many bank clients in difficulty; requiring the restructuring of property debt. Where this has led to distress situations, many banks are holding onto properties in order to recoup losses in the medium to long term and also to avoid flooding the market and further depress values.
Property valuation expert Bruce Allan, from GVA Grimley's Leeds office, explains: "We have been through an unprecedented property cycle. As interest rates have fallen over the last 12 years, we have seen property values increase as yields have lowered. Provided there was a gap between interest rates and yields, then property looked attractive, particularly in a good economy. As demand for property grew so the traditional differential between different sectors narrowed.
"In mid 2007, all yields were close to the base rate - this left little room for increase in capital values unless there was certainty of rental growth. Combined with the financial crisis, this quickly left the property sector in turmoil.
"The pattern of this recession has not followed previous ones; we have not experienced the wholesale disposal of properties. Although we are experiencing low interest rates, funders are unable to pass on all the benefits. Quantitative easing and, so far, limited inflation has created unknown circumstances."
The UK is now entering the second year of decline in terms of property. Initially, most banks were not committing to providing any funding into the property market. However, many banks are now back in the market - but only lending on strict terms to the right borrower, on the right asset.
Allen adds: "Those quick to criticise the banks for not lending must consider that many banks need to adjust their total exposure to property. Also taking a balanced view, during a poor economic climate, any rational investor would ask themselves why lend on assets occupied by troubled tenants or on vacant buildings with little potential of being occupied, especially with the empty rates liability?
"To my mind, borrowers should adjust their expectations as well as the banks opening the doors to lenders. Years of cheap and easily available finance has distorted the market and attracted too many people looking for quick easy gains rather than a structured long term plan, with the ability to deal with fluctuations in the market and cash flow."
As the banks return it is under a new regulatory and risk-averse market strategy, based on a higher level of borrower equity, higher levels of amortisation and with most banks lending off purchase price rather than valuation.
Due to poor returns on cash and equities, risk adverse borrowers are chasing good tenant covenants and long leases. Similarly, funders are attracted by the same tenant and lease criteria. The same assets are therefore able to command better lending rates from the relatively few banks that are truly in the market, consequently yields in the prime investment market have improved.
Allan explains: "The reality is that this improvement is determined by a shortage of stock and a relatively good number of potential purchasers.
"Secondary and tertiary properties are not experiencing the same positive effects and I don't anticipate values will necessarily improve off the coat tails of the prime market. One reason for this is the empty rates liability, which is one of the most ill-timed taxes in history.
"If the Government thinks it has boosted its tax coffers at no expense it is sorely misguided. Landlords with vacant buildings are desperate to let them to avoid empty rates and letting the building at a lower rate has a direct impact on the capital value, which in turn impacts on the loan to value ratio with the funder.
"A lower income reduces the ability to pay interest and capital is diminished. Unless the borrower has other low-geared assets to balance the books, they are in a distress situation. Existing tenants unable to pay rents in full are further compounding the problem.
"This situation is not going to improve in the short-term. Any tenant coming to the end of a lease term is either going to negotiate for a better rental deal or relocate. Secondary and tertiary rents are under pressure from anywhere between 10% - 50%.
"We have had a yield adjustment over the last two years which appeared to have levelled. However, falling rents now have to be allowed for and this will impact once again on values.
"The jury is out as to whether the increased activity in prime property is a blip or sustainable. Much will depend on the funds, the level of cash in the system and the appetite from the banks. However, Secondary and tertiary property will continue to struggle for the immediate future with little good news on the value front.
"It would appear the old adage of 'there's no gain without pain' is proving unnervingly true. The gain of increasing property values has only been reaped by a small percentage. The pain is being felt by many."
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