The massive injections of cash into the financial system have not brought forward a recovery in commercial real estate markets, as Lynn Strongin Dodds reports
In the wake of the sub-prime crisis, banks exerted extreme caution in their lending practices. Activity, though, has practically dried up following the recent financial meltdown this past autumn. The fall of the venerable Lehman Brothers as well as bailouts of other major lenders, including Germany's Hypo Real Estate, the UK's HBOS and Iceland's Kaupthing, sent shivers through the banking community.
The big question now is whether the various rescue and stimulus packages will be enough to kick start the liquidity flow. Over the past few weeks, governments and central banks across the world have been frantically devising different solutions, both individually and collectively, to encourage banks to start lending to each other and their customers.
According to industry estimates a staggering $3trn (€2.4trn) plus has been so far committed to bailing out the financial sector. The US was first with its treasury's troubled asset relief programme (TARP), which provides up to $700bn to buy the bad loans on banks' balance sheets. However, the US and several other industrialised nations are in the process of pursuing the UK's far more reaching £50bn (€62.5bn) plan as a blueprint. The difference with the UK plan is that it not only provides capital for banks but also offers additional infusions of money to keep markets liquid, guarantees transactions between banks and enhances protection for customer deposits.
As for the impact on property, Philip Cropper, executive director at CBRE Real Estate Finance, echoes the sentiment for many. "So far we have not seen any increase in lending since the injection of cash into the system. I think the purpose of the government actions is to instil confidence, encourage banks to start lending and to prevent the economy turning into an even larger recession than the one we are likely to have. It is aimed at the corporate world and consumer spending, including the residential market, but will take some time to filter down to the commercial property sector."
Milan Kharti, chief economist at Aberdeen Property Investors, says: "The contraction in lending has been substantial across Europe. It is difficult to estimate a figure for loan to value (LTV) ratios because there are so few transactions but they are around 50%, if not less. Not surprisingly, margins have increased substantially and, overall, lending criteria has become tighter. This is not just for property but it is reflection of the overall economic conditions."
In fact, figures from the Bank for International Settlements revealed that the value of lending by banks plunged by $1.1trn in total outstanding loans to $39.1trn during the second quarter of 2008, the biggest quarterly contraction on record. The decline in interbank lending accounted for almost a third of this figure. The largest previous reduction occurred in the second quarter of 2001 after the bursting of the dot.com bubble, and in the fourth quarter of 1998, following the demise of hedge fund firm Long Term Capital Management.
Banks are going back to basics and relationships are now key. A recent report on global real estate by UBS notes that the emphasis today is on high-quality firms and assets. Even still, only a handful of players are quoting loan for property deals in each region. While UBS believes that the situation is likely to improve as the immediate crisis fades, conservatism and cash flow will remain the watchwords for the foreseeable future.
Underwriting is likely to have LTV ratios with a maximum of 55-60% with a 1.2 times debt service cover ratio - which is used to analyse the amount of debt that can be supported by the cash flow generated from the property. Also on the criteria list will be a short to non-existent interest-only period, as well as considerable reserves.
Looking ahead, some market participants believe that covered bonds might become more prevalent. Popular in Germany, the Pfandbrief, as it is called, has been a main financing tool until recently.
Herbert Spangler, head of structured finance at Invesco in Munich, notes: "Activity has dried up in the past few weeks but I do not think this is permanent. The main attraction of covered bonds is that risk is with the property and not the financial state of the banks. Unlike securitisation, they are much easier to understand, more transparent and have fewer tranches."
For now, though, lending and deals are likely to be limited, with many participants not expecting to see the start of recovery for another year to 18 months. Khatari says: "I think we are looking at 2010 before we see any signs of a real recovery. If you take the property collapse of the early 1990s as an example, lending did not come back fully for several years. This did not mean that the investment market was paralysed for that whole period. The biggest drop in outstanding loans was in 1994 but the UK property market turned around by 1993 followed by the lending market by 1997."
Spangler adds: "Transactions have dropped substantially, especially in September and October, and the deals that are being done are funded through equity rather than debt. One of the problems is that there is still an expectation gap between sellers and buyers in terms of price. However, sellers may be willing to accept lower prices going forward due to market conditions."