As we grind our way to the end of a tough year, a new tremor of uncertainty can be detected rippling through the commercial real estate industry. Not, we hasten to add, from the broker community, disturbing numbers of whom are buying readily into the notion of an imminent return to ‘normality’.
Perhaps it’s understandable – transactions, after all, are the life blood of the brokerage and advisory industry. But an up-tick in trading volumes in the third and fourth quarters of this year is no basis for assuming that property prices have reached a new equilibrium, and it’s upwards from here. We are uncomfortable, too, with the now widely accepted notion that, since the wave of distressed selling in Germany has been conspicuous by its absence, it no longer poses an immediate threat.
No, not an immediate threat, perhaps. But the pernicious nature of the current market serves to hide a multitude of deceits, whose effects are debilitating rather than instantaneous. Headline-grabbing announcements of new financing deals provide some distraction from the cold reality being experienced at the coal face of property investment by those with their own skin in the game. Banks and governments’ attempts to prevent ‘distressed’ selling are promoting the wide spread side-effect of stanching the flow of credit for investment, and postponing the day when losses are realised. Their hope is that capital values and LTV ratios will float magically upwards so that they can re-finance and somehow escape the hangman’s noose.
It’s a vain hope, and has resulted in a market that is constipated, with few laxatives in sight. Any ‘normality’ that is hoped-for is one at a permanently lower price level, certainly for several more years. In the early 1990’s, despite far more moderate price declines, panicking banks dumped their distressed property in a heartbeat, rather than convulse themselves by trying to stomach the indigestible. Many of today’s most successful US REITs got their start at that time, and went on to build up sizeable businesses. But today’s collective climate of government bail outs, bank restructurings, and paralysis in the face of the wave of CMBS maturities coming down the turnpike from 2011 onwards – put at ?€13.5bn for Germany alone for 2013 – will ensure that any market clearing will be slow and protracted.
It’s the banks who are ‘managing’ the risk now, since many investors have been nominally wiped out. But since investors are disinclined to leave the party while their hosts hold out the prospect of another drink, this could all take some time. So long as investors are servicing the interest on their loans, banks will turn a blind eye to breaches of loan covenants, which are now widespread. We expect defaults on interest payments to become much more common next year, and banks to take a harder line as they reduce their whole exposure to the property sector. They still won’t want to book losses, and buyers still won’t want to pay over the odds, but the high margins and fees on new property business will help the banks to get their creative juices flowing again.
As always, rental incomes and replacement cost remain the fundamentals of property valuation. We see both of these pillars remaining under steady pressure in Germany next year. The current infatuation among investors with prime CBD office properties in Germany clearly provides a degree of support for the top end of the market, to the exclusion of the middle and lower divisions. With rising vacancy rates and a still very uncertain outlook for employment in Germany next year, this will put disproportionate pressure on office rents in second and third-rate properties. Tenants re-negotiating leases in all but the primest of properties will remain in a strong bargaining position throughout 2010.
We are assured by Axel Weber of the Bundesbank that there is no credit crunch for ‘real’ companies in Germany, i.e. companies that actually produce and export things. That’s comforting to hear, although we doubt its veracity, and it doesn’t tally with our anecdotal evidence from businesses outside the real estate industry. Given sufficient security, however, there’s plenty of credit available even for property lending, as the healthy state of the German residential market can testify. And as cash rich equity funds can attest when contemplating buying commercial property. Sufficient security, of course, is the rub.
The German market is not in dire straits – quite the contrary. But German business es are dependent to a high degree on the financial well-being of their neighbours and key export markets, and we see little sign of major upturns elsewhere, in a manner that would lift the uncertain cloud hovering over German employment prospects.
Perhaps this very uncertainty about business prospects has partly underpinned the sizeable capital sums flowing into German residential property this year and, as we expect, next year as well. The fundamentals of residential investment in German urban conurbations are on a much sounder footing. The market for alternative financing in the sector is growing rapidly, with a broader range of refinancing options open to investors. The capital markets, too, are showing confidence in the sector and a willingness to respond to cash calls. This augurs well for the German listed property groups, who have learnt much from their dalliance with foreign private equity investors.
Related posts:
- Anybody out there NOT looking for prime, core-plus, fully-let, to blue-chip tenant…?
- JLL’s Quint sees Germany benefiting as larger economies are favoured
- Owls to Athens, Coals to Newcastle
- When I hear the word “Sustainability”, I reach for my revolver
- When Masters of the Universe resort to Jingle Mail, listen up
