London’s commercial property shock reverberates around the world
Friday, January 11, 2008/
The dramas in the London property market have global implications that could rival the US sub-prime crisis. And the combination of sub-prime and London property is sending alarm bells around the world – though apparently less so at the Bank of England, which did not cut interest rates this month. It is likely to move in February.
Australia may not be in the front line, but our property majors Westfield and Lend Lease are global property investors and some of our capital finance sources come out of the London pool, so we will not escape some of the fallout.
In Britain we have three events taking place simultaneously cutting the values of both office and some retail property. The first is, of course, the sub-prime crisis itself, which is restricting the supply of money and increasing its cost. Property values in all markets are determined partly by the supply and cost of money.
The second event is concentrated in the office sector where for years developers held back after the last crash. This changed gradually, however, as the people who remembered the bad times left the industry and the youngsters were allowed a free hand. As their organisations did 25 years ago, they began undertaking office developments that had no tenants.
A huge number of new office developments without tenants are in the pipeline, which will flood the market just as demand is contracting because of the effect of the sub-prime capital curbs fallout on lawyers, banks and accountants. In fairness to the developers, they were being lavished with money by young bankers who had no concept of risk or the need for tenants to allow the buildings to generate income to pay interest. It was hard for the property executives who also had never seen a big downturn to say “no”.
According to The Economist, office property values are already down 9% from the peak and are likely to fall 30% over three years. The experience in the Australian slump of 1990 would indicate a 30% cut is a conservative estimate because the inevitable forced sales depress the market further. Britain may see a re-run of Australia in the 1990s when Westpac and ANZ sailed very close to the wind.
The third force, the growth of online shopping, focuses on retail property values. Internet shopping has been seen as a potential threat to retail property values for a decade, but only now has it started to materialise in the UK. According to a Dow Jones comment published by Business Spectator yesterday, UK non-food shoppers are buying online on a much bigger scale, thereby weakening the pricing power of retailers selling goods that have become readily purchasable over the internet.
Accordingly, in the British Retail Consortium shop price deflator data, food prices rose around 4% in November/December but non-food prices actually fell 0.4% in both months. Marks & Spencer has been hit hard.
In the latest data from the US overnight, cold weather and nervous consumers are being blamed for bad December sales of many non-food items but almost certainly online purchasing has worsened store traffic and put similar pressure on prices.
Clearly there are some nasty global events ahead. We are going to see significant UK bank losses, which is one reason why British bank shares have fallen sharply. But the losses will spread to the capital markets because many of the loans have been sold to pension funds, which have already been stung by sub-prime.
That will cause the supply of money for property to dry up. Banks suffering big losses every couple of decades is not a new story, and doubtless after the present crisis has passed and we are in the 2020s, they will throw the risk book away again.
By contrast, any switch in demand from retail property to online is an entirely different development.
Lend Lease and Westfield are in the process of creating modern Australia-US type shopping malls in Britain, which may fare better against the internet than the old type stores because they are areas of entertainment. But once internet buying gathers real momentum they are more likely to be affected.
Westfield feared this event 10 years ago but concluded the internet would be a small player. But broadband has changed that. It is still not taking off in food items.
Australian superannuation funds have already seen a big fall in the values of their listed trusts, which everyone blames on Centro – but then Centro’s problem is money and its food stores are insulated. The real threat for Australian superannuation funds is the long-term internet effect, if any, on shopping malls.