In Part One we looked at the tribulations of the commercial property market in the light of what is now an entrenched resistance on the part of banks to lend into this market for anything other than absolutely prime locations. One indication of just how severe bank withdrawal of credit to the sector is can be seen from the way two of the biggest lenders, Commerzbank's Eurohypo and Société Générale both decided to cease new lending towards the back end of 2011.
Eurohypo's importance to the European property market is considerable, particularly since it is known for lending on larger projects. Commerzbank was told by the EU as a condition for the EU agreeing to the German government bailing out the bank that it would have to hive off Eurohypo for sale by 2014. In fact the EU has now agreed to a modified plan that will enable Commerzbank to fold some of the Eurohypo lending book into its own operations and to cease property lending in all but certain key markets. The point here is that taken along with Soc Gen's decision to withdraw from the property lending market, this represents a very significant pull back in available funding for the European property market. As PwC puts it in its review of the prospects for European property in 2012:
"So, once symbols of a recovery (in the global property market), Eurohypo and Soc Gen now represent the market's fragility, demonstrating how quickly sentiment can reverse in the current climate and how what the industry [now] faces is so much more complicated than first thought."
Inevitably, as the banks withdraw partially or completely from the property market, other lenders, including the big insurers, will come in, but they are looking only at funding premium deals at the highest rates. Lending on "secondary" or "tertiary" property - the two categories that are really cluttering up and over-burdening bank property loan portfolios - is almost non-existent.
On top of all this, as PwC notes, Europe is currently in the throes of an economic crisis "that is wreaking havoc with no map or direction". No property market benefits from massive economic uncertainty. One of the interviewees surveyed in the PwC report is reported as saying:
"We thought that the outlook was uncertain in 2009. But we did not understand what the definition of uncertainty was back then. Now we do. Even the economists admit that they don't know what is going on. We are in a truly unique time."
The "flight to quality" and the two speed property market
Not surprisingly, the general response of the property sector to all this uncertainty has been to sit on its hands and do nothing while property companies and investors wait to see how the political dimension in Europe unfolds. Business is still being transacted and deals are still being done, but the vast bulk of the deal-making is being directed towards premium quality assets. As always when economic conditions get tough the whole sector witnesses a tremendous flight to quality. In its Global Market Perspective: Global Foresight Series 2012, the property specialist Jones Lang LaSalle says that the flight to quality is taking the form of investors "pivoting" towards core assets in the major global cities that have strong economic fundamentals or safe-haven characteristics, or both.It also means that property investments are being firmly divided into premium quality property, such as grade A office space in the top cities, and secondary property which is either older stock or is located in lower ranked cities. Pricing for premium quality property is holding up extremely well. There is basically not enough of it coming on to the market and with everyone chasing quality, any that does come onto the market attracts a fair cohort of potential buyers, driving the price up. This is often taken to mean that the property market is recovering. It is, but only for premium properties. Everything else is languishing in the doldrums and will continue to do so until growth regenerates and companies start demanding office space again. Not every company can afford to lease premium quality office space and demand will eventually re-awaken for cheaper, secondary and tertiary property. Since there is very little renovation of such property going on at the moment it is not impossible to see the same sort of demand spike in the secondary and tertiary areas at some point in the future, as we are currently witnessing for premium grade properties. However, that day continues to look a long way off, with the UK now officially confirmed as in recession again, and with European GDP also set to contract through 2012. What all this adds up to is that it still looks as if it is going to take at least a decade for the banks in the UK and Europe to manage down their bloated property portfolios. That too, is going to be a drag on the economy but there does not appear to be any faster way of doing things on the horizon. The commercial property sector is having to dig in for the long haul, with no short cuts in sight.
Further reading on "real" assets:
- Inverse Stagflation and the Global Economy: When Real Assets and Paper Assets Part Company by Renée Haugerud
- Real Estate Industry - Sector profile on real estate
- Asset bubbles: to act or not to act, by Anthony Harrington
- Commercial real estate heading for a deep freeze- Part 1 of 3, by Anthony Harrington
Tags: asset bubbles , commercial property , European property market , property investment , property market , property price , real assets , real estate , real estate industry , secondary property