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Commercial Question

Real Estate Reality

updated on 04 March 2008

Question

What impact will the credit crunch have on commercial property?

Answer

In recent years commercial property has proved one of the most popular forms of investment, with billions of pounds pouring into the sector including a wall of money from Asia and the Gulf States. However, following the collapse of the American sub-prime mortgage market last summer, the contagion from the credit crunch has spread to the UK commercial property market.

But the credit crunch was just the proverbial nail in the coffin - the sector was already over-valued and fuelled by an era of low interest rates and the availability of cheap credit. America sneezed and the United Kingdom caught a chill.

As a result, the volume of commercial property transactions has fallen and values have been on the slide. At the blue chip end of the scale, major property companies have seen billions of pounds wiped off the value of their portfolios. For example, British Land recently revealed the extent of the property downturn after admitting the loss of more than £13 billion from its portfolio.

The slide has also spread to the fund management sector with investors reacting by withdrawing hundreds of millions of pounds from commercial property funds such as AXA and New Star Asset Management. Additionally, FTSE 100 property shares remain among the most ‘shorted stock’ (a technique used by traders placing bets on further price falls of stock) as positive fundamentals such as high occupancy rates and rent increase continue to be ignored because of fears they will reverse.

As property's fortunes are to a large extent linked to those of the wider economy, the current outlook for commercial property is uncertain. The credit crunch has made it harder to raise debt and interest rate cuts are not necessarily being passed on by commercial lenders. Occupier demand and uptake would suffer if the economy was to tip into recession, affecting some more than others. For example, Moody's (the rating agency) has warned that the City office market is most at risk due to the high number of financial service jobs that could face the axe in the wake of the credit crunch, as well as the number of completions in the City scheduled over the next 24 months, which are expected to exceed occupier demand. In contrast, the West End is said to be less susceptible owing to its diversified tenant base and a smaller construction pipeline.

Also, in an attempt to combat the credit crunch and to spread their risk, developers of mixed use schemes are rescheduling and changing the mix of existing schemes. Housebuilders such as Taylor Woodrow are thought to be mothballing their land banks until an end to the downturn is in sight.

However, in spite of the above, many property companies view times such as these as a period of opportunity. Nick Leslau’s Prestbury Group for example is set to acquire a £220 million London office portfolio, while Laxey Partners - a well-known activist investor - is floating a property share fund on AIM with a potential war chest of £500 million to invest in underperforming property shares.

Although the commercial property market is facing uncertain times, the current market might be best described as a correction or realignment as opposed to a complete meltdown. Further interest rate reductions would be welcomed by the sector, although the Bank of England has to balance a slowing UK economy with rising inflation. Also, as the property industry follows the lead of the broader economy, the investment market may have to wait until the credit crunch plays out and a balance returns to the global money markets.

One thing is for certain, the credit crunch will sort out the men from the boys.

Greg Rosen is a trainee solicitor in Weightmans' property team.