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By David Stevenson, MoneyWeek
20 November 2008
While we’ve all been fretting about the value of our houses, another much more vicious property bear market has been underway.
House prices have dropped almost 15% year-on-year, according to the Nationwide and Halifax indices for October. And of course the “real” prices, at which any rare deals have been done, are some way lower again.
But homeowners desperately seeking a bright side have one small consolation to cling to. The declines in the residential market are still absolute peanuts compared with what’s been happening to commercial property...
Commercial property values are down a staggering 28% from their June 2007 peak, says the Investment Property Databank. The fall has come as over-extended investors have been forced to dump their holdings due to the rising price of bank loans.
And if you need any more confirmation of how grim things have been for the big “quoted” property companies now known as REITs (Real Estate Investment Trusts), British Land provided it yesterday.
London's largest office landlord, the owner of a string of high profile sites such as Broadgate in the City, as well as the Glasgow Fort shopping park, has had to slash its net asset value (NAV) per share by a massive 38% over the last year.
No wonder former chief executive Stephen Hester has jumped ship (though as he’s turned up at the Royal Bank of Scotland, we can hardly accuse him of seeking an easy life).
Recession fears have already done some serious damage to the big landlords’ corporate egos. British Land has been forced to delay its biggest-ever development - the 47-story Leadenhall Building otherwise known as the Cheesegrater - while other major developers have had to shelve similar schemes.
But what’s really going to keep the property barons awake at night is what’s still waiting in the wings. And this is why property stocks, despite their massive fall from grace - the sector is down 43% over the last year compared with a 36% slide in the FTSE All Share Index - are still not worth buying yet. One phrase on page 13 of the latest British Land six-monthly report just screamed at me. It said: “occupancy is exceptionally high across all sectors”. To put that into numbers, the company currently has tenants for almost 97% of its properties.
That’s really scary, because it means the real recession fallout hasn’t kicked in yet. So there’s only one way this figure can go - down. And that’s before we even start to consider the extra space due to come onto the market from development schemes being completed within the next few months.
The biggest threat to property companies is jobs - or rather, the lack of them. Last week’s UK unemployment figures rose by the most in 16 years, with the headline jobless rate hitting its highest (5.8%) since the start of the decade. But this is just the beginning. Companies have embarked on a ferocious firing spree, with the CBI this week forecasting that unemployment will reach 3m next year compared with 1.8m now.
For property companies, that means more vacant space. Whether it's the City, Canary Wharf, industrial sites in the Midlands or shopping centres in Glasgow, job losses spell fewer tenants. And the way that UK high street sales are going, there might be quite a lot fewer tenants, as retailers could soon be going bust in droves.
By itself, that equals less income. But there’s another damaging effect, too. Already, in “hedge fund alley”, we’re seeing how crumbling demand for office space is hurting. Office rents in London’s Mayfair and St. James's areas, the natural habitat for hedgies, are dropping for the first time since 2005. The annual cost of renting office space fell by 6.5% in the six months to 30 September, according to Jones Lang LaSalle. Throw in incentives such as rent-free periods, and the effective rent per square foot falls by another 10% or so.
Translate all this into property values, and then factor in the gearing (the part of the portfolio bought using borrowed money - British Land is 78% geared), and NAVs still have a long way to fall.
In what’s set to be a “downturn exceeding the slump of the 1970s and 1980s”, Capital Economics reckons that capital values could slump by almost another 24% over 2009 and 2010. For a business that’s 78% geared, that adds up to a further NAV drop of over 40%.
So the property companies may be talking a good game, and continuing to churn out flashy-looking pictures of their flagship sites. And some of the valuation damage is already built into property share prices.
But don’t get tempted yet. There’s a lot more pain to be endured before it’s time to buy UK REITs again.
