The UK’s commercial property sector is far less indebted than it was on the eve of the 2008 financial crisis, which should limit the damage caused by a drop in values.
Average loan-to-values (LTVs) across deals funded with debt have crept up in recent years, reaching 48% in 2014 and 55% last year, but they are nowhere near the pre-crisis levels of 70% in 2006 and 80% in 2007, according to CBRE (see above).
During the last crisis, the high levels of debt meant that even small changes in values threatened lenders with losses and owners with loss of control. They should be more immune to such dangerstoday, suggested Graham Barnes, executive director in CBRE’s capital advisors team.
“The dynamics of the last downturn and its aftermath were in large part driven by the consequential effects of the high levels of indebtedness,” he said.
“Current market levels of borrowing do not have this characteristic; at say 55% LTV, the asset value would need to fall by more than 30% to reach the 80% LTV starting point for a typical 2007 loan.”
The listed property sector has been especially prudent. After almost all companies in the sector were forced into emergency rights issues in 2009, partly because of excessive gearing, they are much more conservatively leveraged today.
Average LTV levels among REITs are little more than 30%, and, among the big names most exposed to London offices, which is considered one of the most vulnerable sectors after the Brexit vote, leverage levels are typically even lower. Great Portland Estate’s LTV is 19%, Derwent London’s is 18% and Land Securities’ is 22%.
Data from Morgan Stanley Research (see bottom) also shows that debt levels in the listed property sector are much lower than they were before the crisis and that interest cover has risen consistently as well, meaning that companies are able to service their debt much more comfortably.
“Balance sheets are a lot stronger than they were,” said Kames Capital UK equity fund manager Douglas Scott.
“Land Securities, in particular, is looking quite smart. It has degeared, got through the majority of its development programme and increased the quality of its portfolio.”
Interestingly, the Morgan Stanley data shows the rest of the stock market has become more highly geared in recent years.
Scott attributed this, in part, to the collapse in profits in mining and energy sectors, and the appeal of the low cost of debt which has encouraged firms to pursue share buybacks.
“Borrowing costs are low and companies have been able to borrow cheaply and buy back more expensive equity, enhancing earnings,” he said.
The upshot is that 35% of dividends paid out of the FTSE 350 companies are not covered out of income, Scott added.
However, if the uncertainties caused by the Brexit vote push the UK into recession, growing debt levels could heap pressure on corporates facing declining profits.
For the property industry, that could have the negative knock-on effect of limiting demand for space.