The Truth about the Property Crunch Current Market Conditions

Transcription

1 PROPERTY UPDATE MAY 2008 The Truth about the Property Crunch Current Market Conditions Presented by Peter J Memmott BA (Hons) FRICS FNARA MCIArb Senior Director Fairweathers Chartered Surveyors Presented to: THE TURNAROUND MANAGEMENT ASSOCIATION Head Office: Kingfisher House Headley Park 8 Woodley READING RG5 4SG Tel: Fax: FAIRWEATHERS info@fwsurveyors.co.uk Web: London Office: 33 St James s Square LONDON SW1Y 4JS Tel: Fax:

2 INTRODUCTION: GENERAL STATE OF THE RESIDENTIAL AND COMMERCIAL MARKETS MAY 2008 There is an old Chinese saying: May you live in interesting times. That certainly sums up the residential and commercial markets at the present time. We are in a period of adjustment; values are fluctuating and confidence is ebbing and flowing. This has created considerable uncertainty. To give you an idea of the speed at which events are currently overtaking us, six weeks ago I gave a similar speech, at which point I indicated that it was my opinion we were moving towards the edge of a precipice but, provided the base/libor gap started to close and public confidence remained at a reasonable level, I thought we would not go over the proverbial edge. In the subsequent weeks there has been a material deterioration in public confidence which is not only affecting the residential market, but is affecting the economy generally. The Governor Bank of England has gone from being cautiously optimistic to slightly pessimistic, aided by voluminous press articles. The effect of the Press should not be ignored. Headlines sell newspapers and the public will be inclined to believe those headlines if they are repeated sufficiently frequently, thereby making them self-fulfilling to some extent. In any property correction, there are winners and losers. Most people present this evening are Turnaround or Insolvency Practitioners and are undoubtedly experiencing an increase in the volume and quality of cases being referred to them as market conditions continue to deteriorate a trend which looks like it will continue for the remainder of 2008 and possibly, as far as levelling out and correction is concerned, into the first half of This is not a re-run of the 1990 s recession but, as it continues, inevitably some of the characteristics will seem similar. We are, to some extent, in uncharted water.

3 Residential Market 2008 Factors which Determine whether we Face a Short-Term Correction/Challenge or a Longer Term, More Serious Situation 1. Public Confidence This has changed markedly over the last month for the worse. The barrage of press articles reporting a deterioration in the housing market have, to some extent, become self-fulfilling. Up until the end of March 2008, estate agents valuations had generally shown a level market. It became increasingly clear that there was a gap between vendors and purchasers expectations. Many vendors have withdrawn their properties from the market after failing to achieve what they believed to be an acceptable price. Estate agents with whom Fairweathers have spoken are increasingly reporting that offers are being made below asking prices and vendors are reluctant to accept. In our opinion the situation changed between March and April Now properties priced below Ñ500,000 are generally seeing offers at 5% below asking prices and those priced above that threshold are generally having to consider offers 5%-10% less. This is a serious market adjustment driven, I suspect, by estate agents who are having to educate vendors that, if they wish to sell their property, they have to make a substantial reduction in the asking price and hope that is similarly reflected in the property they will purchase. Public confidence tends to fluctuate in line with the state of the UK housing market; if the housing market becomes worse and the extent of the price correction becomes greater, it will affect confidence in other areas. In the last month, the situation has deteriorated dramatically. First-time buyers have generally not been in the market for some considerable time, thereby causing structural issues and preventing chains forming. Estate agents with whom I have spoken over the last few weeks are, bluntly, scared witless. They have finally accepted that adjustments to asking prices are warranted in current market conditions and have talked to their vendors, negotiating price reductions, but nothing is happening. A very well respected and successful estate agent I have known for many years was selling between 20 and 25 houses per calendar month last summer. They are now selling an average of 2 houses per calendar month and are seeing increasing numbers of applicants pulling out or vendors withdrawing their properties from the market. Those individuals who have already sold and are in rented accommodation are in an excellent position to make a purchase. They are looking, but are not buying at present. Anecdotally, agents report that they expect further price deteriorations throughout 2008 and are therefore awaiting developments. To sum it up, we are in a period of correction and have gone over the edge of the precipice, but are nowhere near seeing conditions stabilising and people regaining confidence in the housing market. I expect this period of uncertainty to continue over the summer. It remains to be seen whether the market will stabilise in the Autumn. 2. Bank Funding Crisis There are a few signs of a gradual easing of the crisis, however Lenders have adopted an extremely conservative approach to both residential and commercial funding. The number of new residential mortgage products is falling consistently, margins are getting tighter and percentage advances are falling back in the expectation of price falls in the residential housing sector. The commercial banking sector is holding on to liquid cash assets. The continuing gap between LIBOR and the Base Rate is having a detrimental impact on the market. There is a

4 clear gap between prospective clients expectations (coloured no doubt by the rates that were available last year) and the credit terms that are on offer currently. Generally, the percentage advance has fallen back and 70% is becoming increasingly the norm. The cost of finance has increased and generally Lenders are being extremely conservative. This is impacting both on new transactions and property re-financing. The number of lenders in the residential and commercial markets and the products on offer are decreasing week by week. Arrangement fees are rising significantly in the field of residential development; a 1.5% - 2% arrangement fee is becoming the norm. The cost of finance has gone from 1.25% - 1.5% over base to generally 2.0% - 2.5% over base, reflecting the lenders concerns about development and the prospect of price falls in the residential sector. The cash injection by the Bank of England appears to have had little impact; if anything, over the last month our commercial lending clients are tightening up their criteria, raising their charges and looking increasingly carefully at any new proposition being put to them. From what we see, it is getting worse, not better. This is particularly good news for Insolvency Practitioners who will see increased volume and, indeed, increasingly large ticket items; but a cause for concern for Turnaround Professionals who are reporting increased difficulty in obtaining bank support and, indeed, appetite for new propositions. 3. Volume of Residential Transactions Prognosis: These are continuing to fall; the impact varies significantly from location to location. Semidetached and detached housing in good areas is holding up far better than residential apartments. Increasingly, price reductions are being seen in outer London. The Central London market and the better areas are still holding up reasonably well. Agents are reporting that offers are increasingly being made; applicants expect to acquire property at below asking prices and vendors are taking time to adjust to the new reality if you want to sell in this market, you are, almost certainly, going to have to take a hit. This is not necessarily a bad thing for individuals moving up into more expensive property, the gap between their existing property and the property they are purchasing is decreasing. Falling residential values in the remainder of The situation has clearly been worsened by the substantial gap between the Bank Base Rate and the LIBOR Rate. Much depends on the influence of the Bank of England. Residential mortgage providers continue to tighten their credit criteria and the situation may worsen still rather than improve. Public confidence is currently shaken. The Bank of England is clearly taking action to try and improve the availability of funding for residential property transactions, but we have yet to see any sign of this having an impact.

5 Residential Development Regional and national builders are slowing down construction rates and are laying off staff. They are generally reporting that applicants are reluctant to enter into contractual commitments in what they perceive to be a falling market. New residential development not under way but contemplated is virtually at a standstill. Local and regional builders are increasingly mothballing their operations, trying to sell off sites (particularly for town centre residential flat developments, where demand has fallen significantly). Given the lack of appetite of the main Lenders, it is becoming difficult, if not impossible, to fund the construction cost. If you look in the main surveying magazine, The Estates Gazette, there are large numbers of adverts for sites for sale with consent, principally for flat developments or sites in the less well regarded areas. Local builders still need to earn a living and cannot afford to do nothing. They are looking increasingly carefully at transactions and only progressing the more straightforward propositions with a relatively short construction period. Confidence is extremely low and we are seeing niche developers experiencing difficulty selling even well-specified, well presented, well located units. Generally, however, they may be realising slightly less than they anticipated, but the detached and semidetached properties are still selling. If the volume of new units constructed continues to decrease for the remainder of 2008, as appears likely, the lack of supply may help prices to level to some extent. The profit margins on residential development are quite large and can normally accommodate 5.0% % falls in sales. Builders are increasingly looking to improve their profit margins and insulate them from potential price falls. Profit margins of 20% rather than the 13%-15% seen last year are becoming more frequent amongst cases we have seen. To some extent this is dictated by the requirements of the main lenders, who are increasingly looking to be safeguarded from potential price falls, requiring greater cash injections, thereby making lower percentage advances. The number of residential repossessions is starting to increase markedly. There have been and will be retail chain casualties and large numbers of individual problem cases, but the middle ground is currently somewhat quiet and cases are relatively few in numbers. That having been said, the amount of monitoring and investigation work has generally improved significantly and, with the number of cases being referred to Insolvency Practitioners and Turnaround Specialists, there will inevitably be more volume. We expect the number of insolvency cases to rise in the summer and autumn of 2008 as market conditions continue to worsen. However, there is a change in the attitude of the Lenders. They have not taken action to realise assets as they did in the 1990 s, unless it is absolutely necessary. They are expecting the majority of their customers to ride out the proverbial storm. We believe this has resulted in fewer insolvency cases - the Lender s margin has yet to be eroded. Particularly insofar as development sites and residential flat developments are concerned, there is increasing Lender monitoring.

6 Commercial Market The commercial Lettings market, whether it be shops, offices or retail, is holding up remarkably well. The credit crisis means it is unlikely that there will be large amounts of new commercial development undertaken in Generally, office and industrial rental values are rising. In some areas, indeed, there has been a significant recovery in office rental values and we are starting to undertake rent reviews. Retail The retail market situation is continuing to worsen; it is being hit be a combination of increased finance costs, rising utility bills and rising rentals. This is not being helped by a decrease in turnover. A number of national chains have gone into liquidation. The Consumer has been responsible for the buoying up of the retail market for several years. Anecdotally we are told that consumers are increasingly putting off spending on large items. This is clearly impacting on retailers turnover. As a response to decreasing turnover, profit margins have been slashed to try to improve volume. As is ever the case, this will benefit the consumers who are prepared to spend they will see some more attractive bargains on offer. Office Market The Financial Services market is clearly contracting; additional offices are coming to the market, particularly in Central London. Quoting rentals have fallen back in reflection of the increased availability of stock in Central London and investment yields have moved out significantly during the first half of The regional office market is in rather better shape; it is getting increasingly difficult to pick up good quality offices in the size ranges between 2,000 and 10,000 square feet. The general over-supply of office buildings is starting to reduce and selective redevelopment of new high quality offices is taking place, for example in Reading and Maidenhead. Rental levels are improving and tenant s inducements are falling back. The situation is significantly worse in the secondary office market. Many of the 1970 s and 1980 s buildings are functionally obsolete. It is not economically viable to refurbish and upgrade these buildings and many have been taken off the market and the sites redeveloped for residential purposes. We expect this trend to continue. Industrial Market The industrial market is relatively level. The available supply of stock is relatively constant, and rents are still edging up slightly. We are not seeing any major problems in respect of the leasehold market. The situation is somewhat different when one looks at the numbers of small business industrial units which were constructed for the self-invested Pension market. The value of such units tends to change in line with the economic conditions. The increased cost of funding and the higher deposits required have adversely affected this market. We are seeing significant price reductions across West London and throughout the M3, M4 and M40 corridors. The number of transactions from distress sales is still relatively few, and these have been cases where people cannot hold on any longer and have to sell. To take a local example, and without naming the developer, in the Spring of 2007 they were achieving prices for new Industrial at about Ñ175 psf. The majority of the units went, but there were a few left. If you know the right agent and have the right evidence, they can be picked up for between Ñ135 and Ñ150 psf at present. Is it a market crash? Yes and no. Prices went forwards too quickly but we are now back into a normal market and a period of adjustment is inevitable.

7 Investment Market Once again, there is a gap between vendors expectations and the prices that purchasers are prepared to pay. Many investment owners have decided to hold on to their properties in the hope that conditions improve in the latter part of On reviewing the auction catalogues, other than the sale of the bank investments, there is very little good quality investment product currently being sold through the auction houses. The investment market is being adversely affected by the credit crisis. As investment funding is increasingly linked to LIBOR rather than base rate, the cost of funding has generally increased. This is preventing many highly-geared purchasers from undertaking transactions. Investment yields have moved out, particularly in respect of the larger lot sizes in excess of Å5,000,000. The impact on lots less than Å5,000,000 has been less significant, but purchasers are still experiencing difficulty in finding and securing good quality pension investments. We have seen significant numbers of transactions on investments commanding prices higher than that which one would normally expect in this market. We would interpret this to mean that, in a competitive purchase situation, investment yields have not moved out significantly. However, if the vendor is deemed to be in a difficult situation and wishes to sell for reasons of liquidity, as one would expect, acquiring agents are taking advantage to the best of their ability. We believe that Insolvency Practitioners will see significant numbers of investment portfolio cases in the latter half of This will be dictated by two factors; firstly unwillingness of many Lenders to rebank investment portfolios where client s equity has eroded markedly and, in some cases, disappeared; secondly, a decrease in appetite for new property transactions generally being seen across the Lending market. Lenders are picking and choosing and being far more careful; the question arises what happens to those cases where the Lender is not prepared to support further. We are seeing increased signs of investment clients having to insert additional assets, cash and other security but, generally, Lenders are currently not taking action to liquidate assets in order to recoup their advances. If you test the logic, it is somewhat bizarre the Lenders loans in 2007 may be coming under increased pressure but, if they made new loans in presents market conditions, because of the writedown that has already occurred, such propositions should be regarded as being somewhat safer. We are seeing little evidence of this attitude being adopted. If the funding crisis does not ease and, particularly the Base Rate/LIBOR margin decrease, and the availability of finance continues to fall back, we are likely to see forced investment sales in the latter part of Generally investment yields tend to follow base rates; if interest rates fall (although possibly not as far as has been suggested previously) there may be an element of yield correction. If, for argument s sake, a base rate of 4.5% % occurs, residential and commercial property investments are going to look very attractive. Much will depend on purchasers relationships with their Lenders. This is becoming increasingly important in current market conditions. Prognosis Good times for Insolvency Practitioners are already on the way and will become better. More challenging times for Turnaround Professionals with new cases testing the strength of their relationship with Lenders. Increased care is required on presentations Lenders are looking increasingly carefully and are only prepared to support the better propositions. Inevitably therefore, I would suggest that more turnaround cases will not succeed and more Administrations may fail. I should make it clear that the comments made are entirely my own opinion and not representative of the Royal Institution of Chartered Surveyors.