Property deals aren’t pointing to a quick recovery

Early this year, the owners of the John Hancock Tower in Boston defaulted on a few loans. Foreclosure fast followed – the building was auctioned off in March. The price? $660m.

You might think that sounds like a perfectly reasonable amount of money. But it isn’t. The Hancock Tower is Boston’s flagship building, the tallest skyscraper in town. More important, it last changed hands for $1.3bn – back in 2006. So its value has fallen by 50% in less than three years (include the financing costs, and Broadway Partners – who bought it at the peak – have lost a lot more).

That must have made anyone holding commercial property as collateral against loans feel pretty nervous. But a sale has just gone through in Irvine, California that should make them feel even more nervous.

3161 Michelson Drive, a delightful-looking office block just a short drive from the Orange County airport has just sold for $160m, or about $300 a square foot. That’s 40% less than its construction cost: note we’re not talking about 40% less than its peak value but 40% less than the actual cost of the materials and labour used to put the thing up in 2007.

That’s beginning to look like the kind of deal you only see in very nasty depressions – the kind of deal we haven’t seen much of since the commercial property nightmare of the 1930s which ended in J. Paul Getty’s stunning bold purchase of the Pierre Hotel in New York: the hotel cost $15m to build in 1930, he picked up all 44 insanely luxurious storeys for a mere $2.5m in 1938. A reminder, were one needed, that, in a credit crunch, a building is only worth what someone with cash is prepared to pay for it.

There was only one bidder for the Hancock Tower and it doesn’t look like the new owners of 3161 Michelson Drive faced down much competition before taking possession either.

The fact that commercial property prices in the US are still coming down so fast, along with the fact that residential prices remain under pressure (nearly one in ten mortgages is in default and there is another wave of adjustable-rate resets still to come) matters.

It matters because the fate of the banks is inextricably linked to US property prices: as long as they are falling, we know the banking crisis isn’t nearly over. There has been much happy talk in the press recently about the healthy crop of “green shoots” and “the depression that never happened”. But, as Chris Wood of broker CLSA says: “Such celebratory talk is way too premature.”

You can see that in the US’s commercial property crash. You can see it in rising credit card defaults; in incredibly low manufacturing capacity utilisation (65% – the lowest level recorded in the post-war years, according to Graham Turner of GFC Economics); in increasingly tight lending standards; and in the fact that hours worked and earnings are on the way down in the US.

In Europe, you can see it in the nasty export numbers (down 20% in the last six months). And, in spite of the fact that we have seen some good data this week, you can see it in the UK, too.

Sure, industrial production rose 0.3% in April. But given how far it had fallen (nearly 13% in the 12 months to March), that shouldn’t have been any great surprise – nothing ever moves down in a straight line and the weak pound must have had some effect. However, the pound is strengthening again now.

So, with unemployment up at 2.26m, house prices likely to keep falling (hence creating a reverse wealth effect) and earnings growth pathetic, it is hard to see how we progress from here.

Policymakers are big on the idea that you can make things better by making people feel more confident. But what good is confidence to a consumer with no cash? Turner points out that one of Japan’s major problems during the 1990s was the fact that “by putting so much pressure on companies to dispose of bad debts and boost profitability, the Japanese government inadvertently sent wages spiralling down”, destroying consumption and any hope of domestic recovery as it did so. For more on this, see Turner’s recent book, The Credit Crunch: Housing Bubbles, Globalisation and the Worldwide Economic Crisis.

This brings us back to the question of whether the markets are in an extreme bear market rally or a new bull market.

I’m sticking with the view I expressed earlier this year: 2009 will be a surprisingly good year, but eventually the lack of economic recovery will undermine the market again.

The market seems to have stalled for now and it will probably need clear evidence of an actual upturn in the global economy to move upward again. I can’t think where it will get that from.

• This article was first published in the Financial Times