Here we are in the middle of a recession and you’d expect me, a commercial property auctioneer, to be far too busy selling distressed stock to write this article. The fact is, though, that I’m not.
A quick look at auction statistics produced by Essential Information (eigroup.co.uk) confirms that my market has seen some substantial reductions. Over the 12 months to the end of September 2010, the commercial auction market has raised just 43% of the amount raised in the equivalent period 2006-7 (in my opinion, the peak of the market). Meanwhile, across the same respective periods our success rate has dipped, from 80.1% to 71.7%.
So where are all those bargains you’d normally expect to see in auction catalogues as a result of loan defaults and debt recovery processes?
Hitherto, there have been very few high-profile instances of property lenders “pulling plugs” on loans that are in breech, unless interest payments are not being met or the borrower has proved to be unreliable or uncooperative. The reason for this still remains unclear to those of us outside the banking world, but it feels almost as if there is a great inter-bank decision not to crystallise losses on loans where the value of the asset against which the loan is secured has dropped markedly. At any rate, banks have avoided revaluing these assets to establish a true current value, adopting what appears to be a “head in the sand” attitude toward technical breaches of covenant.
Of course, this is not the case where interest payments are not met. And yet how often does this happen? Tenant defaults and the consequent lack of rental income are the usual reasons for a borrower to default on interest payments. Fortunately, this recession has yet to witness widespread business failure and, thus, the levels of defaults are not as high as predicted by some as the recession unfolded.
However, property loans don’t last forever. The vast majority are cast in five-year terms, after which they must be either refinanced or paid back in full. In pre credit crunch times, refinancing was much easier than it will be today. And, counting forward five years, it is easy to see that the loans made in the absolute boom times of 2006 and early 2007 will be maturing across the next 24 months.
What will happen? The banking system has neither the means nor, frankly, the appetite to refinance all those loans. In some cases, the banks may have to opt for a brief extension of a year or so (this is happening already on some earlier maturities). Other banks, such as West Bromwich Building Society, have already announced their intention to wind down over time their property lending side altogether.
Most recently, this problem loomed for Norwich-based property investor Targetfollow, whose plug was finally pulled by their bankers last week with a reported £700 million of loans overdue and no sure way to repay them. What happens to the Targetfollow portfolio over the next few weeks and months may well be a pattern for what is to come.
The problems will be most acute where asset values have slipped considerably from the levels ascribed at the time the loan was granted. This is very likely to happen in the case of a secondary investment property that was purchased during that boom period of 2006 – 7, unless its value has been somehow enhanced in the meantime through adroit asset management. Whether banks can afford to keep such devalued assets as security seems less likely in the wake of Basle, leading one to the conclusion that the banks may end up – whether they like it or not – in charge of a lot of property that they will then have to sell.
You will gather from the above that, whilst I may not be as busy as I would like at the moment, I am expecting to become very much busier from about this time next year onwards. Before then, I will still have time to suggest a few ways of finding bargains in the auction rooms and also how to avoid pitfalls that can lead to expensive mistakes. But that will have to wait until next time.
Felix Rigg is a partner and principal auctioneer at King Sturge LLP
www.kingsturge.co.uk
