Real Estate News
News analysis: Will distress depress European real estate pricing?
28 Sep 2012
Some say a new wave of disposals will drive down pricing. Shayla Walmsley investigates.
Threats to pricing are coming from all directions. The liquidation of remaining German open-ended funds (GEOFs) will bring assets worth €25bn onto the market. More will come from peripheral European governments, with the Spanish government already considering (in a bout of wishful thinking) discounts of as much as 20% of current values. Even if it weeds out the terminal cases from otherwise mildly infected portfolios, these discounts are what JP Morgan's Joe Valente and Charles Conrath describe as indicative of a "state of denial".
Above all, for banks, push has at last come to shove. Up to now, a small percentage of assets worth €200bn slated for disposal over the past two years has come to market. Yet Valente and Conrath's suggestion in a client note that big banks are finally becoming more realistic about pricing creates the basis for a new wave of disposals.
In Germany, at least, bankers see it coming. A Corestate survey of 24 bankers found 78% expected to see an upward trend in distressed transactions in 2014 compared with 48% in 2012. Compared with 33% who expected to see assets discounted by 20-30% in 2012, 45% expect to see discounts of this size in 2014.
The impact of assets flooding onto the market will be more keenly felt in some markets than others. Around 80% of GEOFs' stock-on-the-block comprises office assets in Germany and France, for example - though these markets' liquidity will protect them from a significant negative impact on pricing. In other markets, such as the Netherlands, where GEOFs hold significant secondary office assets, already mediocre pricing is likely to fall still further.
Banks have already begun to dispose of fairly hefty property loan portfolios. CBRE said this week it expected nine portfolios comprising loans valued at €11bn to come onto the market by the end of 2012, in addition to the €7.5bn already transacted this year. According to executive director Philip Cropper, it pays to be an early mover in the loan sale process to avoid deteriorating pricing. From the current situation characterised by good pricing and limited demand, a sudden increase could result in demand for ever-greater discounts.
A significant negative impact on property loan pricing in the UK could come from 'slotting', the sliding scale of collateral required for various risk-determined categories of commercial real estate loan. IPD simulations to gauge its likely impact suggest slotting could reduce the value of banks' current holdings - the UK currently has £212.3bn (€266.9bn) in outstanding loans - and force them to sell more assets to build up the additional required collateral.
In the report, the IPD's Malcolm Frodsham and Kate Gimblett said: "The result will be more forced property sales that will further depress the property market, thus creating a vicious cycle of further losses in loans secured by commercial property."
Although the Financial Services Authority (FSA) has backtracked somewhat from the slotting proposals on which the IPD based its simulation, there is no necessary reason to believe the version will escape some of the IPD's criticisms, including a lack of detail that would create perverse incentives and a likely dampening impact on lending.
There are a couple of cautionary postscripts to all this. For all the nautical adjectives - tides, waves and tsunamis - banks generally prefer trickles to floods, especially on less-than-totally toxic assets that may recover at least some of their previous value. At least they have so far.
Moreover, the new disposals will create their own opportunities. According to Valente and Conrath, some secondary assets - after a three-year period of suspended animation, during which neither buyers nor sellers have been willing to invest in them - have been wrongly labelled. They really aren't that bad. Given an injection of new capital and active management, whole swathes of them will even make the prime grade.
Author: Shayla Walmsley