Afternoon:
10°c
An economist who specialises in property has a chart he delights in showing to investors in the sector.
It records commercial property prices over the past 30 years from the late 1970s to a few months ago, and his question for those listening to him is what they think the average annual rate of return has been for the asset class, after stripping out the effects of inflation, over that period.
Most people guess the answer lies between 5% and 10% per annum, and that is the point. Most people are wrong. The correct answer is less than 1%. The commercial property industry has created almost no value for the past 30 years.
People need to remember this when they get excited about the so-called recovery in the sector, which has been the subject of much PR hype this week. Investors can make money in property but they need to remember two rather important things.
First, in common with most equities, the gains come from riding the cycle, buying in a trough and selling in a boom.
Second, even these gains rely on very heavy gearing, and are just not going to happen when debt is in short supply.
People say the sector is on the mend, but that is taking a lot on trust. Canary Wharf has in effect gone bust again and been refinanced but it does that in every recession, so that is just par for the course.
More interesting, and some might think a bullish sign, is that British Land can sell half of its stake in the Broadgate office development by Liverpool Street, and Land Securities can sell its slice of the Bullring shopping centre in Birmingham, within a few days of each other earlier this month.
But others might think these were some of the better properties in their portfolios. Normally, a relaxed seller tries to unload the rubbish not the jewels. It is a sign of a seller under pressure when the good stuff is tossed overboard — whatever the PR spin about not wanting minority stakes. It is a sign of pressure too when the values are as pitifully low as these were.
How anyone can call the turn in the market at this stage is bizarre. Not only are rents falling as tenants go bust and occupancy drops but this will continue for some time, particularly in the financial sector where some of the most expensive properties lie, even if we have a recovery.
That is the pattern of business cycles. However, the trading outlook appears relatively benign when set against what is happening on the asset side, where there is a veritable mountain of distressed assets. Someone recently described the banks as property companies in disguise because they are sitting on so much of the stuff — or soon will be when the borrowers default, and they have to call in the properties they hold as security for the loans. There is apparently £185 billion of property-related debt on the books of RBS and Lloyds together with the Irish banks, and the bulk of that comes due in the next three to four years.
In addition, according to Standard and Poor's, there is some $200 billion (£123 billion) in commercial mortgage-backed securities that will have to be refinanced even earlier.
So it is really not at all surprising that CB Richard Ellis should publish a report this week that estimates the sector needs £150 billion of equity to recapitalise. Set against that, the amount raised so far in rights issues is minute — which is why when property companies first came to the well earlier this year, this column observed that like the banks they would probably have to come back for more before the deleveraging cycle had fully run its course.
One hope now, as then, is that this is too gloomy a view. But if you accept the numbers that are plainly visible in bank balance sheets, or objectively from industry experts such as Richard Ellis, you also have to ask where that money is going to come from. The fact the banks have thus far found ways to avoid confronting the full and awful truth does not change the underlying reality. At best, it simply defers the day of reckoning.
It is all too easy to picture a time, not too far off, when the market is totally swamped by distressed sellers and there is barely a property company in the country that can keep its head above water.
This after all is exactly what happened in the 1970s, the period from our history that most resembles the conditions we are now in. The story of that decade was one of painful, remorseless deleverage after a frenzied credit boom. Not only did the deleveraging bring down lenders, property companies, property investment funds and most things in between, it also took years to unwind.
It was well into the 1980s before the market returned to anything like normal, and even that only happened after massive support from investing institutions such as the Prudential and Norwich Union, which worked for years to try to stabilise the market. This was a rescue chronicled in an excellent book by John Plender, which should be required reading for those who don't understand what deleveraging means for industries that live on debt.
The short answer, for those who don't want to read the book, is long and continuous pain.
