‘How’s business?’ I asked the Mr Big of commercial property in a city somewhere north of Watford Gap last week. I won’t say which city, because this Mr Big is so big there – his logo is on office block after office block – that he would be instantly identifiable.
‘I’m a buyer for the first time in 18 months,’ he replied, rather to my surprise. ‘Prices have been at silly levels, but now they’re anywhere between 10 and 30 per cent off and we can see value. And before all this credit-crunch business the banks gave us a £400 million credit line at 20 basis points [that’s 0.2 per cent over the banks’ base lending rate or interbank borrowing cost] so frankly we might as well use it – if we were asking for it now it’d cost us at least 100 basis points.’
This was, I thought, a fascinating glimpse of the real-world real-estate market. ‘So who was buying at the silly prices?’ I asked. ‘Mostly property funds,’ was the answer. ‘And who’s selling at attractive prices now? ‘That would be property funds again. Their investors have got nervous and want cash out quick, so the funds have no choice but to sell – after all, no bank’s going to lend to them for liquidity at this stage in the game.’
‘And are you ever a seller, or do you just accumulate?’ ‘I suppose we’ll occasionally sell a property if it’s really bone-dry.’ ‘Dry?’ ‘If we’ve squeezed everything we possibly can out of it and there’s no hope of improving the rental yield.’ ‘So who’s prepared to buy from you in those circumstances. ‘Ah well, up to now it was usually property funds.’
Almost everything in that casual lunch-table conversation was confirmed by an excellent article by Jonathan Russell in this week’s Sunday Telegraph headlined ‘Property funds: the new liquidity crisis’. From 2003 until the end of 2006, commercial property prices were rising at 18 per cent a year, and everyone wanted a piece. Between January 2006 and September this year, more than £5 billion of retail investors’ cash poured in to vehicles such as Norwich Union’s Norwich Property Trust and New Star’s UK Property unit trust. But the estimated return for the sector this year is expected to be zero and in October cash started pouring out again – while at the start of this week New Star had to break cover and write £150 million off the value of its fund to reflect tumbling underlying values.
Now the sector is ‘seeing money haemorrhaging away at unprecedented levels’ – and faces an agonising choice: sell property fast, at any price, or plead with the FSA to allow them to restrict redemptions – that is, break their own promises of easy cash out. And the trouble is, it’s not just famous-name property funds that are caught in this mangle: we’re all office-block landlords nowadays.
How so? If your personal pension fund or your managed investment portfolio includes (as it almost certainly will do) fund-of-fund products, you can be sure that the commercial property element within them has increased significantly over the past four years and that they are now taking a corresponding hit. If your portfolio includes, directly or indirectly, shares in listed property groups such as British Land or Land Securities, as Jonathan Russell points out, you’re already looking at 40 per cent discounts to net asset values, ‘a clear sign that investors think either that [property] prices are going to fall or that they have already fallen and are not reflected in [balance sheet] valuations.’ And if you’re a holder of bank shares, let’s hope they’re not the banks that are most exposed to commercial property lending, which was the cause of billions upon billions of bank losses in the early-Nineties property slump.
So just when it was beginning to feel safe to get back in the water – interest rates down, the FTSE-100 back within range of its peak, that nice Northern Rock advertising for new deposit accounts – here indeed is the distant rumble of another potential ‘savings disaster’. Queues of elderly property-fund investors desperate to get their cash out, snaking past block after block of empty offices that no one wants to rent or buy? My Mr Big friend in the north certainly doesn’t see it that way: he thinks the current market is still more of an opportunity than a crisis. Let’s hope he’s right. But in the meantime, you might want to examine the small print of every clever financial product you own to see how much of it is invested in commercial property – and how quickly and securely you can get your money out.