Adrian Harrington |
Tuesday, 1 April 2008 8:00 AM |
The UK direct property market, once the standout on the international property investment menu, is now leading the global property market correction. This high profile collapse is even more notable for the speed at which the re-pricing has occurred.
The IPD Index, which has been tracking commercial property returns in the UK since the 1970s, shows UK commercial property values fell 2.0 percent in January after being down 8.7 percent in the December quarter 2007, and more than 16 percent in the past year. According to IPD, the December quarter recorded the largest quarterly decline in capital values in the history of the index – surpassing movements in the early 1980s and 1990s corrections.
There are many reasons put forward why the UK has been so badly affected. Clearly the UK markets were severely overheated, fuelled by a wall of equity from investors seeking assets that feed off debt supplied by banks fighting for market share at LTV levels much higher than we are used to in Australia. Hindsight is a wonderful thing – but a correction was inevitable.
However, the sheer velocity of change was driven by:
- Pricing signals from the listed market – UK REITs, which have only been up and running for a year, had been trading for most of their short life at 30 percent plus discounts to net tangible assets
- The IPD index is published monthly, giving a more timely snapshot of the market, notwithstanding it is appraisal-based
- The UK has a very sophisticated and growing derivatives market, which at the end of the day provides another pricing signal to sentiment in the direct property markets
- The large number of open-ended unit trusts owning property that had poorly conceived redemption facilities, which when sentiment turned and investors wanted out, forced many managers to place redemption freezes – intensifying the negative sentiment in the market.
As we are witnessing in the broader capital markets, sentiment plays a major role in investment markets and the property sector is not immune. Sentiment remains negative in the UK, although after the fall from grace in 2007, some leading market commentators are predicting a turn around in second quarter 2008. It’s a brave person to call that the bottom is near, but for those cashed up investors, some of the best buying opportunities in more than 20 years may be just around the corner.
UK debt – refinancing remains a risk
De Montfort University’s (DMU) six monthly UK bank lending study, released at the end of 2007, highlighted just how much the UK commercial property market became dependent on debt. Since 2003, outstanding debt secured against UK commercial property increased by a staggering 55 percent from £120 billion (A$264 billion) to £187 billion (A$411 billion).
Interestingly, the DMU survey estimates that 23 percent of this debt is up for refinancing in the next two years. Those borrowers who took advantage of plentiful and cheap short-duration debt, with the view to refinancing off higher property values, may well find themselves in zero or negative capital positions.
Property derivatives – a market on the rise?
Derivatives for direct property are a recent innovation in Australia, and I am sure not fully understood by many in our industry.
The UK has led the way with a sophisticated and now quite deep market in place. Recent reports in the UK put the volume of UK property derivatives trades in the UK in 2007 at more than £7 billion (A$15.4 billion), up from £3.6 billion (A$8.0 billion) in 2006.
In January 2008, almost £1 billion (A$2.2 billion) of property derivatives were traded. Clearly, either speculators are punting on when the UK recovery will occur or investors are seeking more sophisticated ways to manage the increasing risk in their property portfolios created by the uncertainty in the market.
With these sorts of volumes, property derivatives for direct property are here to stay. It will be interesting to see over time whether they become a hedge funds dream or a new market in which to wreak havoc – just look at their impact on the listed REIT sector over the past three to six months.
Australia’s safe haven status: on the nose?
As the fall-out in the northern hemisphere gained momentum last year, Australia was widely seen by investors in this part of the world as a safe haven. Our REIT sector was holding up (many of the REITs were trading at premiums to NTA and had strong growth prospects) and both our economic and underlying property fundamentals looked good.
How a few months can change things – D-day was December 17 when Centro shocked the market with its announcement that it was having issues refinancing its debt. All of a sudden, the Australian property market was not immune to what was happening around the world. The reaction of investors and hedge funds was swift – just look at the pressure the entire REIT sector has been under – down more than 20 percent in three months.
As one European pension investor, who has investments in both Australian listed and unlisted property funds, said to me recently “Australia has gone from one of my major ‘safe haven’ picks to a higher risk property market.”
His reasoning: capital has again started to think about the meaning of risk-adjusted returns. The fallout from Centro and other stocks such as MFS and Allco/Rubicon has savaged investor confidence, Australian banks are now on notice that they are well and truly exposed to the fallout from the credit crunch and will undoubtedly put tougher lending criteria in place, and with the RBA serious about further interest rate rises, pressure is undoubtedly going to be put on property cap rates, given Australian cap rates are now below the risk free rate.
While one pension fund investor does not make a market, if his logic is adopted by other global investors, then global equity and debt capital will become increasingly discerning about Australia, and I’m afraid we have yet to see the full fallout from this.
Adrian Harrington is chief executive officer, funds management UK and USA at Mirvac.
Adrian Harrington |
Tuesday, 1 April 2008 8:00 AM |
