Corporate Finance Associates Blog

The following article is reproduced from The Telegraph Online

Investors pile into commercial property as Isas sales hit record levels, say the IMA

Commercial property was the most popular sector in October as investors renewed their appetite for Isas, according to the Investment Management Association.

By Paul Farrow
Published: 2:29PM GMT 01 Dec 2009

Investors have renewed their appetite for commercial property having endured dreadful returns for the best part of three years.

According to the Investment Management Association, the property sector was the highest selling sector in October, accounting for £367.6 million of net retail sales – the highest since May 2007. Property funds have seen positive net retail sales for seven consecutive months. It is in stark contrast to last November and December when property was the lowest selling sector.

The IMA added that gross Isa sales (£965m) were the highest ever for any October – and the highest monthly figure outside the Isa season since June 2000.

The demand for property has coincided with an upturn in performance. British commercial property posted the third consecutive monthly capital growth in October, at 1.9pc, according to the IPD UK Monthly Index. Since the market’s upturn, which began modestly in August, UK commercial property has produced a compounded 3.2pc capital growth. This has reduced the fall since the trough in July 2009 to -42.4pc, as measured by the IPD UK Monthly Index.

Tens of thousands of investors were persuaded to buy into commercial property at inflated values in 2006 and 2007, only for prices to come crashing down. Many funds fell in value by more than 40pc.

Funds that invest in actual bricks and mortar are not exactly the most liquid of investments, as the credit crisis showed. The crisis brought property deals to a halt, causing liquidity to dry up. Falling fund values triggered a rush for the exits as investors tried to withdraw their cash. Many funds imposed “exit fees”, suspended trading or introduced a notice period to stem outflows.

But investors appear to have put the turmoil behind them and money has been pouring in. So much so that last month it emerged that Hermes Real Estate and Threadneedle Property Investment were staggering cash inflow into their open-ended institutional property funds so that fund mangers were not under pressure to invest.

Billions of pounds, many of which is coming from overseas, is targeting UK commercial property after a sharp fall in asset values since summer 2007. However, investors have been left frustrated by a lack of quality assets on the market as cash-call bolstered property companies avoid selling into a distressed market and banks take their time to unwind distressed portfolios.

This had caused Threadneedle to halt new allocations to the Threadneedle Property Unit Trust, which grew from £310m at the start of the year to more than £400m at the end of the September. The fund had reached its maximum liquidity limit of 20pc, and therefore new cash will not be taken until the fund has made acquisitions.

“All the money that went out of the fund has come back,” said Don Jordison, managing director at Threadneedle Property.

©www.telegraph.co.uk

We are asked on a regular basis to arrange funding for those building developers out there that are still keen to get on with residential and commercial builds, but the reality comes as a shock to many of them, that despite the “supposed” masses of money the banks are lending they see none of it, and indeed are unlikely to, at least at anything near the terms that used to exist.

In the pre-Credit Crunch days there were two essential ways to finance a development project, go with a bank who would usually lend up to 65% of the land value and up to 65% of the build costs drawn down in stages as the development progressed, or secondly go with a specialist lender who would lend up to 60% of the Gross Developed Value (GDV),  often resulting in less input from the borrower and very often 100% of the build cost covered.

In the former case, it was great if you had the funds, most developers didn’t as their money was still tied up in the last development that was now being sold, in the latter case, these forward thinking lenders made development funding a much easier proposition.

Well we have the Credit Crunch, and a lot of the GDV lenders either closed their books (some of them having Icelandic parentage) or took a step back to see what the market would bring, and the high street banks just refused to sanction new deals at all, but would not announce to the marketplace that they no longer had an appetite for this sector.  Out of all this however there remains some specialists who still know what they are doing and can still help with the smaller projects.

We are now 2 years on and after the spate of large developers shedding completed stock, by bulk sales or heavy discounts, and closing up other “in progress” sites after making them wind and water tight, we have seen a gradual return, as in certain parts of the country work is starting once again.

The lending climate has changed however, the GDV lenders are few and far between but will look at smaller residential deals (very few lenders at all are looking at commercial builds unless they are either pre-sold or pre-let to a reputable end user) up to say £3m.  They limit their total advance to about 50% of the GDV and expect the developer to exhaust his own funds first before drawing on theirs.  Interest rates are higher often 9% p.a. and if the interest is to be rolled into the deal rather than separately serviced, the 50% limit has to allow for payment of these  as well.

The banks are still there in a minor way but are not keen to lend in excess of 50% of the land costs, and a similar amount of the build costs and there will always be the need to jump through an extensive array of “hoops” first, so don’t expect them to be major players for quite a time to come.

We are seeing green shoots, and the demand will always be there for housing stock to satisfy the British desire to own their personal bit of real estate, but unless the deal represents a very attractive return, there will be challenges for quite a while to come.

If you have a development project you would like our input on do let us know and we can point you in the right direction.