Is the UK commercial property market on the verge of collapse?

A report by insolvency experts Begbies Traynor has highlighted a worrying trend in the UK commercial property market which could have serious consequences in the short to medium term. The company has issued a “red flag early warning report” which has identified 304 property companies facing serious financial problems which could result in short-term insolvency. This is an issue which has been ongoing for some time but what does it mean for the wider UK commercial property market?

Recent events in the UK commercial property market

While the Begbies Traynor early warning report has highlighted a number of potential problems relating to the sector, this is not a surprise to the vast majority of property analysts.  Over the last month we have seen Hammerson, Land Securities and British Land (some of the U.K.’s largest commercial property companies) all announcing deeply discounted rights issues to raise much-needed funds.

The fact that the rights issues have been deeply discounted to the prevailing share price at the time reflects the concern in the marketplace, concern in the property sector and the lack of investment funding in the UK. However, it seems inevitable that these three fundraising exercises will be successful because the companies will have “sounded out” their larger shareholders to see if they were willing and able to support the company in the short term.

Elsewhere the Begbies Traynor reports has highlighted 304 smaller property companies with a combined value of £1.1 billion (at their last published accounts date) giving an average value of around £3.6 million per company. While it seems inevitable that the smaller end of the commercial property market will suffer first, what are the repercussions for the wider market?

UK commercial property values

Even though there has been a significant fall in the value of UK commercial property over the last 18 months, many experts believe the worst is yet to come. Not only have we seen general property values fall because of the ongoing recession, reduced finance and reduced demand but a spate of company receiverships and administrations has taken many tenants out of the market.

While there is obviously a short-term hit for a landlord when a tenant leaves a property, with no rental income flowing, there are also problems even if the landlord is able to replace the tenant. The current market for commercial property is very depressed and as such there has been a marked downward lurch in rental values although some “lucky” landlords have been able to replace  tenants but at drastically reduced rental levels.

This reduction in rental income has placed enormous pressure on the ability of many companies to fund their ongoing debt payments with UK banks placing more pressure on those operating in the sector. There is also the fact that many loans are supported by other properties from a company’s commercial property portfolio and as these values have fallen many banks are requesting further collateral to cover current finance arrangements.

The short-term future

In the short term it appears that commercial property values will fall further, more tenants will disappear and rental income will be severely reduced. There are also signs that UK banks have “had enough” and are looking to liquidate or sell-on a variety of so-called “toxic assets” many of which relate to commercial property loans. If the UK government is able to give the UK banking sector a “way out” of the toxic mess then we could see more and more loans called in and more and more properties put up for sale.

The medium-term future

As more and more properties are sold at distressed prices this will exacerbate the ongoing fall in values and bring more and more companies into the bracket of those with “financial troubles”. As yet there seems little appetite for UK commercial property from overseas investors although there are hopes that with the fall in sterling, as well as property values, we should see the emergence of international interest in UK commercial property in the medium-term.

There are suggestions that UK banks have commercial property exposure which is approaching £300 billion, with a significant element in danger of default. The major problem now is that as more and more companies default and property prices fall we could well see medium-term credit lines squeezed yet again which will multiply the problem across the sector.

The long-term future

As and when the UK economy finally starts to recover we should see a growing appetite from both domestic investors and international investors (many of which will benefit from the fall in sterling). However, it is highly likely that investors will be selective in the early stages of a recovery as they may well be able to negotiate very attractive deals on leading UK commercial properties. The after-effects of the ongoing slowdown in the UK market will impact on many property companies, both large and small, for many years to come.

Government assistance

At the moment government assistance is focused almost wholly on the UK domestic mortgage market with reports of up to 200 repossessions each and every day. While an increase in general finance and credit lines will assist the wider commercial markets in due course, there may well be a time lag which will not help the situation. With the likes of Hammerson, Land Securities and British Land depending upon shareholders to bail them out in the short term there are concerns that further funding requirements in the short to medium term could see investors “run for the hills” and close this particular avenue of finance.

Conclusion

While the UK domestic mortgage market has taken much of the headlines over the last few months there are serious problems in the UK commercial property market. Property companies, both large and small, are struggling to meet their debt payments, property prices are in freefall and banks are not able or willing to assist in the short term. Many people believe the worst is yet to come for the UK commercial property market with concerns that many UK banks will use the government’s recent offer of transferring and liquidating/selling potential toxic assets as a means to call in many debts and push many commercial property companies to the brink of collapse.

The UK commercial property market has struggled over the last 12 to 18 months but unfortunately it looks as though the worst may yet be to come.


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