Banking on a better future

Often understanding what’s going on in the property market is about understanding where it has just been. In recognition of this, the British GRI 2010 event, held at the Intercontinental Hotel on Park Lane on 9 June, offered that opportunity for the gathered members of the property industry to reflect on the turbulence in the market over the past year and to discuss a wide range of the industry’s current concerns.

The event as a whole would reflect a cautious optimism for the future of the property market. Yet in terms of the financial outlook for the UK, keynote speaker Melanie Baker, UK economist for Morgan Stanley, summed things up with the title of her presentation ‘UK recovery hopes: Below par or worse?’ Providing an excellent overview of the current state of the economy, Baker expressed particular concerns over the possible impact of UK inflation and raised the possibility that the Bank of England may need to consider a revised inflation target. A fine balance would need to be struck however, as higher rates of interest would threaten to kill off the current fragile growth in the market, Baker explained.  

The greatest concern in the coming months is the performance of the European economies, Baker warned. The Greek financial crisis has resulted in economic unrest, with the debt levels and financial problems in Spain, Italy and Ireland still to be fully understood. This will sustain uncertainty in the fragile market.

The potential problems for the eurozone could, however, be much worse. If Spain were to need the level of financial aid that Greece has, the required bail out could bankrupt the European Central Bank and threaten the very existence of the euro. Nevertheless, the gathered audience were left with the distinct feeling that a ‘below par’ recovery is the best the industry can hope for in the foreseeable future, given the possibilities.

After the address, attendees to the conference broke off into open discussion sessions, led by a variety of industry figures. Attending the ‘UK property 2010: new asset bubble?’ session, it was clear that there is no clear path for future property investment. The discussion, hosted by Franck Ruimy, CEO of Aerium Finance, and Andy Taylor, head of UK property at Stenham Properties, went with a general consensus that prime property had shown the greatest recovery predominantly due to the lack of development. Though it was agreed values would remain strong while development gets going, it was thought that prime property has reached its peak for the foreseeable future.

For non-prime property, the overriding feeling of the industry figures was that values are still very much in the hands of the banks and that if the banks continue to hold on to assets then values would be sustained. It was considered unlikely that the banks would flood the market anytime soon either, only forcing sales when interest costs are not being met. The threat, however, of property flooding to market was clearly present in the minds of those gathered professionals.

The group also reflected on how far the market had dropped. At the low point it was possible to buy assets at replacement build cost with zero costs for the land, illustrating how badly the market succumbed to the bubble effect in values. Only secondary assets in secondary locations now offer such opportunities, as demand remains weak for this property. While this might provide potential for the brave investor, it was generally seen as a high risk strategy, as the cost of refurbishment is expected to rise for all buildings within the next five years as the increased demand from tenants for improved Part L and environmental considerations takes a hold.

‘Foreign investments in UK: Setting the pace of recovery or false dawn?’ explored the current interest in the UK market from overseas investors. Those gathered, including representatives from the  likes of investor Deutsche Pfandbriefbank, established that foreign funds currently felt under pressure to buy into UK real estate. The market is seen as a stable environment, with an established legal system to protect investors as well as leases that generally favour landlords.

The main problem remains the current lack of supply however. Relatively few prime assets are becoming available to purchase, while other classes of asset tend to be selling for low yields. As such, there was a feeling that there were more willing buyers than sellers, suggesting the market was ready to hold on to good assets. Again, it is the banks that are seen to be at fault for the lack of movement in the market. Indeed there was a general sense of frustration that banks are failing to offload larger volumes of property.

However there remain many incentives for investing in the UK property market. The favourable UK tax regime was noted, with capital allowances, income tax rates of only 20 percent for offshore investors, no capital gains tax and stamp duty mitigation proving incentives as well. It was generally thought that changes to capital gains tax or capital allowances, while not helpful, would have a limited impact for overseas investors.

In the context of the estimated £50bn of UK property assets expected to breach their covenants in the coming years, ‘Distressed Assets: Have we seen nothing yet or is the worst over?’ offered some important considerations for the future. The discussion felt that surveying firms had been overly optimistic in their estimation of rental growths, both now and prior to the crash, creating false values. It was felt though that the banks have had a reasonably benign effect so far, with the level of distressed property coming to market so far remaining a trickle. The long term situation will depend on interest rate policy, as while rates remain low, debt is currently being seen to be serviced.

With the bulk of market activity occurring in the capital, it seemed fitting to attend the ‘Central London Opportunities – Game over or has the fun just begun?’ discussion. Here, once again, there was a sense of frustration that financial institutions proved the obstacle to sales, through a failure to sell or actively lend. The result, many felt, was that the London market has descended into a state of stagnation.

In spite of this, the complaints of some representatives – that there were few great opportunities – seemed a little naïve. Investors can no longer make a significant profit by simply passing property on as prices in the property bubble rose, and owners must now invest more in buildings to see results. Opportunities now are riskier and hampered by the issue of finance. Most attendees to the event remained realistic about the prospects that remain in the London market.

Demand may be weak at the moment but in the long term London’s status as an important global city would pay off for property owners. New opportunities were also seen on the horizon, with the Crossrail project expected to create opportunities, particularly in mid-town, for price sensitive occupiers.

This GRI event offered a useful snap shot of the current feeling in the industry; optimism in the face of adversity. Though no one expected a miracle recovery or return to boom in the near future, there are some opportunities emerging.

Worryingly though, much of the growth the industry will depend on is currently under the control of the banks. They currently hold both the assets and the finance to kick start the industry – and seem reluctant to release either.

Only a change in fiscal policy or a strong legislative arm is likely to help release the industry from this vice grip. In the mean time, it is for property professionals to make the best of the market, however possible.