Six reasons to steer clear of UK commercial property
There’s been an upturn in the commercial property market recently, but prices are still well below their peaks. Is it time to buy back in? David Stevenson thinks not – here’s why.
"Buy like hell".
That was the advice from one investment veteran last week.
He wasn't talking about shares, bonds or commodities. He wasn't even talking about some wacky new product thought up by the City's black box brigade.
No, he was telling punters to pile into good old boring British commercial property. And you can see why he might be tempted. Despite a rally in commercial property prices over recent months, values are still a long way below the peaks of three years ago.
So is his advice right? Or should you wait a while longer?
UK commercial property prices are rising
In November, UK commercial property prices ticked higher, but hardly enough to get landlords cracking open the champagne. Prices rose by just 0.2%, according to real estate adviser CB Richard Ellis.
Let's put this into perspective. Although prices overall have now risen by 15% from their summer 2009 lows, they're still down by over 35% since their mid-2007 highs. That's three times the fall from the peak seen in house prices (have a look at our new UK house price page on the MoneyWeek website). And it's enough to get one or two putative buyers looking for a bargain.
Such as Mike Slade, the investmentveteran mentioned above. Slade is the boss of the property development and investment company Helical Bar (UK: HLCL), where he's been for 26 years. Over that time he's developed quite a reputation for calling the commercial property market right. His company has just raised more than £28m in new equity. So when he advises people to "get on the train before it leaves the station", it's at the very least worth listening.
But we've been bearish on this market for ages. So should we now think about changing our tune?
Buying now could be too soon
I still think buying now could be too soon. Why? Here are six reasons.
First, if you see what else Mr Slade is saying, like "we're talking about the South East here, outside is a bit of a worry", he's not quite as upbeat as you'd think from the headlines.
What's more, he's looking at vulture' stuff. With his new cash pile he'll be able to pick and choose the tastiest morsels from over-borrowed private property firms and institutions clearing out their portfolios. These aren't the type of deals that are likely to be available to private investors. And they could take a good while to come right.
Second, the get in now' stance isn't widely shared by his industry colleagues. The respondents to this year's fourth quarter Investment Property Forum Consensus in other words, a panel of experts expect a 6% gain in all-property capital values overall this year. But they reckon prices will fall by 2% next year. Sure, taking the contrarian view generally works out in the long run. But you run the risk of buying in too early.
Why banks are wary of commercial property
Third, the banks surprise, surprise just don't want to know about lending on commercial property. In fact, they're getting even more wary of it. Net lending in the sector was minus £0.8bn in October, the seventh negative month in a row, say Bank of England stats. Over 2009's firstten months, net lending was minus £0.9bn. But in 2010 to date, it's a negative £7bn.
Indeed, looking at the wider picture, the state of property lending is starting to look really quite nasty. "Banks have retreated from the commercial sector for the first time in more than a decade as lenders attempt to rein in their huge exposure to troubled property loans", says Daniel Thomas in the Financial Times.
De Montfort University began monitoring the market in 1998, since when lending has risen over four times. But its latest report shows outstanding debt on commercial property dropping to £215bn. Compared with last year, that's a 6% fall. De Montfort has never seen this happen before. "Alarmingly", says Thomas, "about £42.8bn of this debt is either in breach or in default of its lending terms".
In other words, the banks are so deeply mired in toxic property loans they'll take ages to extract themselves. So they won't be upping their lending to the sector for years. And that means that buyers will lack firepower.
Which leads onto the fourth reason. Lenders could now start getting much tougher with property borrowers who are unable to service their debts. There's "anecdotal evidence that some lenders are starting to call time on the delay and pray' approach" that is, turning a blind eye to defaulters "of the past few years", says Kelvin Davidson at Capital Economics. That could lead to another wave of forced selling at fire sale prices.
Commerical property prices look set to fall again
Fifth, the UK economy still has plenty of hurdles to jump. Some of these are set to depress commercial property prices further. For example, government cutbacks will mean less cash sloshing around. This will hurt high street spending and lead to more shops going to the wall. In turn, that will increase the amount of spare retail space which will be bad for both rental levels and yields.
Further, as the state looks to raise as much money as it can it, it will flog off any surplus property it can find. That's set to hit a market already under price pressure.
And now the sixth reason. Government bond yields are now climbing again - fast. This matters because the value of a property, just like the price of a bond, is determined by its yield. In the current climate, it's unlikely that overall rental levels will increase. So if yields rise, values must fall. And if bond yields surge, property yields could follow which would result in prices being pushed down.
The bottom line? Add this lot up, and I for one won't be tempted into British commercial property. Not yet, anyway.