The scorching market for office and retail space seen only six months ago is rapidly cooling as developers and analysts see a slide turning into a slump
Some now fear that Britain is facing the kind of commercial property crash not seen since the early 1990s when Olympia & York, the main developer of Canary Wharf in London's Docklands, was forced into administration.
Until very recently the big banks were falling over themslelves to get a piece of such prominent office deals as the £1.1bn sale of HSBC’s headquarters and Citigroup billion-pound deal in Canary Wharf set new records. But they are now backtracking after the sub-prime fiasco and the wider credit crisis.
In 2007 new offices were being built in London at their fastest rate for 20 years but demand had already peaked. This has affected the capital value of commercial property, which dipped by about 4% in November and Capital Economics is quoting a fall of 15% from the peak in July 2007.
There may be further to go and the derivates markets are predicting a fall of 30% over the next three years which will be bad news for the UK’s beleaguered banks which have loans to commercial property companies totalling about £186bn (9% of domestic lending).
Recent weeks have seen the pipeline of commercial property transactions suddenly dry up and the first monthly drop in the volume of private-sector office developments for over 4 years.
Investment funds specialising in office blocks and retail developments are under increasing pressure. Friends Provident has suspended the right of individuals to take money out of its £1.2bn commercial property fund. Britain's largest such fund - administered by Norwich Union - has admitted its cash reserves to deal with sudden withdrawals has fallen from 17.5% to 7.5% of the fund value.
Investment bank Morgan Stanley has warned that the world's largest banks could have about £110bn of assets at risk of default as a result of the global contraction in the commercial property market and the slump in prices.
While there are widespread expectations that the residential market may be about to go into decline, investors in the commercial property have already started to desert the sector leaving big property developers watching declining share prices as their assets are revalued.
Prices in the commercial property sector had risen by almost half from the end of 2002 to the end of 2006 on the back of cheap credit and landmark buildings in London like 1 St mary’s Axe – the so-called "Gherkin" - were sold at a premium.
The investment bank Evans Randall bought the Gherkin for £630m as recently as February 2007 and Beacon Capital Partners acquired CityPoint for £650m in April just before the sale of 8 Canada Square in the Docklands set the new record of £1.1bn.
Savills Project Consultancy has reported that commercial property developers are pessimistic about the immediate future, with one in three anticipating a decline and retail developments are similarly dogged by worries about a serious fall in consumer spending this year.
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The odd thing about this situation is how obvious it was that it was coming. UK office prices rose at a rate of 10% per annum in both 2004 and 2005 and 17% in 2006.
According to financial data services company IPD rental yields fell below the cost of borrowing at the end of 2006, which should have sounded some warning bells.
And while developers were careful to ensure that they had tenants lined up before they started to build in the period 2000 to 2005, this year less than a million square feet of the 4.25 million in the pipeline in London is pre-let. The situation is even worse for just under 3.5 million square feet proposed in the Capital for 2009 with less than 250,000 sq feet pre-let.
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