Stock market giant Morgan Stanley has announced that it expects the share prices of the top UK property companies on the stock market to fall by around 42% over the next 12 to 18 months. This is a major call for the company and if correct there will be large problems on the horizon for the UK property sector.
The worrying thing is the fact that Morgan Stanley has recently been fairly downbeat on the UK property market and this further critical analysis, if correct, could see some of the U.K.’s best-known property companies go under. So why do Morgan Stanley feel the sector is ripe for a further fall? What is the reasoning behind this?
Background to the UK commercial property sector
When Morgan Stanley look at the UK property sector this is more centralised upon the commercial property market such as office as oppose to the more domestic properties which are more in the headlines today. We are talking about companies such as British Land, Liberty International, Brixton Estates, Land Securities and Derwent London. These are all major UK property companies often used as a barometer for the sector as a whole.
There are a number of issues to consider when looking at the commercial property market which include:-
Finance
While many of these property companies in question have assets worth literally billions of pounds many of them will also have substantial debt in the form of bank loans, overdrafts, debt market instruments and general lending capacity. In the good times it is very easy to use the assets of the company to raise more and more finance for bigger and better ventures but in the bad times the situation can become critical very very quickly.
As the value of company property continues to fall, the asset backing which has probably played a major part in raising capital in the past starts to erode. We then have an issue with banking covenants whereby assets which had once comfortably covered the debts in question slowly begin to depreciate and the margin of error which the banks face great faith upon slowly becomes more worrying. This can lead to short-term financing issues and a number of property companies have in the past attempted to reorganise their assets and their liabilities in troubled times.
UK banking sector
The UK banking sector is currently going through one of the worst downturns in modern-day history. Governments are having to step in to save banks all around the world, there have been many knock-on effects, assets values have being wiped out and the banks are literally running scared of lending any more money to anyone or any company connected with the property market. While many people believe we have seen the worst of the so-called toxic loans linked to mortgages around the world there may well be some further fallout in the commercial property sector.
Until the UK banks are able to get their commercial property loan books in order there is very little chance of significant finance being afforded to the UK commercial property market. This reduction in liquidity will in due course see some properties put up for sale and in the current market, with the lack of buyers and finance, what price these assets would bring is very much open to debate. We also have the issue that many assets are linked directly to debts via banking covenants and collateral agreements thereby placing more pressure on the companies involved to raise cash as soon as possible.
UK economy
While it has not perhaps received the media interest it deserves there has been and continues to be a major slowdown in the UK office market. This is the market in the likes of British land, Liberty International and Land Securities operate, as well as the vast array of retail shopping centres throughout the UK. Both of these particular asset classes will be hit very hard over the next 12 months and the pressure which the companies are feeling today is likely to be magnified significantly over the next year.
As we see more and more businesses companies hit financial trouble there is likely to be a reduction in rental income for the property companies mentioned. For example, if a tenant were to ask for a rental holiday or some kind of reduction there is very little the landlord could really do – if they say no, the company may go under and they would need to find a new tenant which would likely see a rental income reduction anyhow.
The stock market
Any company which has debts or property exposure has been hit hardest over the last few months as investors continue to look for the next troubled sector. The UK commercial property sector brings together these two elements which is why we are seeing the likes of Morgan Stanley forecasting substantial share price falls over the next 12 to 18 months and other investment houses suggesting yet more difficulties. This all adds to the doom and gloom of the sector and also places more pressure on the banking sector because if the banks push too hard and some property companies go under they will be left to write-off substantial loans which may not be recoverable in full.
Recovery
It is far too early to suggest a timescale for a recovery in the commercial property market because the scars left after the current downturn will be very deep. Balance sheets will also be under great pressure, predators may be looking to acquire companies on the cheap while traditional investors will be waiting for a sustained period of improved performance before even considering an investment in the sector.
While we have seen downturns hit the property market in the past the current downturn also needs to accommodate a substantial reduction in finance for the sector which is placing more and more pressure on property company directors. The names that made headlines in the heyday of the property market have in some situations made a comeback but for all the wrong reasons and we are seeing less and less interest in the former up-and-coming property TV sector.
The long-term recovery in the sector will be slow and very difficult with many casualties along the way.