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CRUNCH TIME


It is very likely that 2009/10 will be crunch time for distressed property. After unsuccessful attempts by customers to realise asset sales through normal marketing campaigns in 2008/09, this year financiers will be taking a much more influential role in deciding the fate of their customers. With tight debt and equity markets, many in the market are expecting to see a raft of forced sales as banks take control through receivers and managers. Is this the best course of action to take? Several factors suggest that, under certain circumstances, it most certainly is not.

At current estimates, Australia has $30 billion of commercial real estate for sale. The expected swoop of Sovereign Wealth Funds has failed to materialise. Many superannuation funds, already exposed to property, won’t consider further property investments at present. Even if investors are interested, poor credit availability means it’s difficult to obtain financing for commercial property transactions.

The few potential buyers of the increasing swag of property assets on the market are the limited number of cashed-up private investors and small developers. And these lucky few will be looking to take full advantage of the lack of competition by making opportunistic offers.

Given Australia’s current low interest rates, it may be worth holding an asset until the market improves rather than disposing of it at a deeply discounted price. However, how do you know when that is the case? Clearly, holding onto a property requires the anticipated growth in the value of the asset to be greater than the cost of holding it over a specified period. This value will be determined by the net income of the asset and projected capitalisation rates. Two key factors to consider:
  1. The net income position of the property over the next few years
  2. How long it will take the property market to bounce back from the global financial crisis
Unfortunately, neither is easy to estimate accurately. The first is tricky and the second impossible because no one actually knows when the crisis will end or how the markets will behave following the downturn.

Other risks may come from, for example, the nature of tenant contracts. You should consider the mix of tenants - whether a tenant represents the majority of contracted rents or is from the one industry – and take this mix into account from a credit outlook perspective in terms of the rent roll.

Capital expenditure also needs to come under scrutiny. Does the capital expenditure budget for the anticipated holding period include any major expenditure items, for example, refurbishments upon lease expiry or any other outstanding incentives? Is there a contingency plan for any unexpected capital expenditure that could arise over the holding period?

And finally, you need to consider the more obvious risk that market conditions may not improve over the projected holding period, with capital values taking longer to return than you anticipate.
 
Source - Roger Dartnell, Partner for Ernst & Young

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CRUNCH TIME

It is very likely that 2009/10 will be crunch time for distressed property. After unsuccessful attempts by customers to realise asset sales through normal marketing campaigns in 2008/09, this year financiers will be taking a much more influential role in deciding the fate of their customers. With tight debt and equity markets, many in the market are expecting to see a raft of forced sales as banks take control through receivers and managers. Is this the best course of action to take? Several factors suggest that, under certain circumstances, it most certainly is not.

At current estimates, Australia has $30 billion of commercial real estate for sale. The expected swoop of Sovereign Wealth Funds has failed to materialise. Many superannuation funds, already exposed to property, won’t consider further property investments at present. Even if investors are interested, poor credit availability means it’s difficult to obtain financing for commercial property transactions.

The few potential buyers of the increasing swag of property assets on the market are the limited number of cashed-up private investors and small developers. And these lucky few will be looking to take full advantage of the lack of competition by making opportunistic offers.

Given Australia’s current low interest rates, it may be worth holding an asset until the market improves rather than disposing of it at a deeply discounted price. However, how do you know when that is the case? Clearly, holding onto a property requires the anticipated growth in the value of the asset to be greater than the cost of holding it over a specified period. This value will be determined by the net income of the asset and projected capitalisation rates. Two key factors to consider:

1.      The net income position of the property over the next few years
2.      How long it will take the property market to bounce back from the global financial crisis

Unfortunately, neither is easy to estimate accurately. The first is tricky and the second impossible because no one actually knows when the crisis will end or how the markets will behave following the downturn.

Other risks may come from, for example, the nature of tenant contracts. You should consider the mix of tenants - whether a tenant represents the majority of contracted rents or is from the one industry – and take this mix into account from a credit outlook perspective in terms of the rent roll.

Capital expenditure also needs to come under scrutiny. Does the capital expenditure budget for the anticipated holding period include any major expenditure items, for example, refurbishments upon lease expiry or any other outstanding incentives? Is there a contingency plan for any unexpected capital expenditure that could arise over the holding period?

And finally, you need to consider the more obvious risk that market conditions may not improve over the projected holding period, with capital values taking longer to return than you anticipate.
 
Source - Roger Dartnell, Partner for Ernst & Young