For weeks now, all the talk in the commercial property market has been of green shoots, bottoming out and fresh investment.
That optimism was given a harsh reality check on Wednesday after Land Securities took the largest valuation writedown in the history of the sector and warned of further pain to come.
Although its operating performance was in line with expectations, the £4.7bn drop in the value of its portfolio shocked the market. More worrying was the company’s clear suggestion that the market has suffered from over-exuberance in recent months and the prediction that the real estate slump – already the worst on record – was not over yet.
Over lunch at the company’s London headquarters on the Strand, Francis Salway, the measured and softly spoken chief executive, shook his head when reflecting on the natural tendency of the property market to overreact.
“The market has swung from being excessively gloomy to being too optimistic in the space of months,” said Mr Salway, referring to the recent share price rally on the back of this tangible sentiment shift. “I think schizophrenic is the word.”
At the beginning of the year, few saw any reason to be cheerful, particularly as the big property companies dived into hugely dilutive rights issues to correct balance sheets at risk of breaching banking agreements as asset values tumbled.
More than £3bn was then successfully raised by the sector, parking most of the majors in the safety zone. This, alongside signals that price declines were slowing and sales activity was picking up, caused some in the investment community to call the bottom.
The shift in sentiment most publicly manifested itself in a rally that saw the UK real estate sector rise by more than 50 per cent in weeks. Land Securities benefited, rising 64 per cent from a multi-year low in March.
Several real-estate investment trusts began trading at near parity or even premium to spot net asset values – remarkable given discounts of more than 30 per cent a few months before – leading to a suggestion from Morgan Stanley last week that they could raise additional equity now with little dilution.
New money is already being raised by those who see the opportunities emerging, should this be near the bottom of the market. Nick Leslau, the millionaire property entrepreneur, on Tuesday launched a new Aim-listed investment company called Max Property with a plan to raise £200m, while there are a number of other large unlisted opportunity funds prepared for launch in the next few weeks.
However, the share price rally at least appears to be over, with Wednesday’s measured statements from Land Securities nailing the lid closed. The company’s shares fell 13 per cent yesterday, while the sector slid by almost 8 per cent.
Land Securities has not abandoned its central forecast of a peak-to-trough fall in the market of about 50 per cent. But, given the decline of about 42 per cent since the peak in 2007, this means that there is still a further move downwards to come.
Mr Salway is not without some optimism, however, suggesting there were signs of stabilisation in parts of the market. The value of about £1bn of its properties has stabilised, or even slightly risen in value, showing that there are signs of a two-tier market appearing.
There is a resurgence, said Mr Salway, in property let on longer leases to good tenants, offering investors a decent long-term rental income. This sort of return looks attractive to cash-rich investors, but the market for properties without these characteristics looks dicier.
The move to “defensive” properties pinpoints the key threat to the real estate market this year. Even as investment yields on properties begin to stabilise, rents being collected have only just begun to fall and vacancies will rise as the recession hits occupational market.
Land Securities is shifting from a capital to an income preservation strategy, according to Nomura’s Mike Prew, indicating the increasing risk of earnings pressure. There is a lag for property owners as the fall in rents only shows up as new deals are struck when leases come up for renewal.
For Land Securities, which owns a portfolio of well positioned properties, rents fell 9.3 per cent last year while like-for-like voids rose to 4.6 per cent, from 3.5 per cent. Mr Salway expects rising vacancy rates and weakening rental values – and so further pressure on income.
Rents, he said, are linked to the economy, and so are only likely to turn when economic growth also turns positive. Even so, he is confident enough to suggest Land Securities could return to development next year, given the time needed to build for economic recovery.
Mr Salway is bullish on the opportunities in the market for a group with £1.6bn sitting in its coffers. But, he cautioned, there needed to be patience while the market downturn runs its course. The money could also be used to pay down some of the company’s debts.
The biggest opportunity, he believes, will be when the debt behind property investments comes up for renewal or maturity, and banks or investors need to find a well-capitalised investor as an exit route. He can see Reits raise new capital from the market to fund large acquisitions if necessary.
Land Securities’ “cold dose of reality” – as KBC Peel Hunt called it – looks likely to be a sobering influence on the market for some time.
via FT.com / Companies / Financials – LandSecs finds weeds pulling up green shoots.