What Lies Beneath?
It has been a turbulent 12 months, and you'd be hard pressed to find many companies that can say they have enjoyed the ride. But there are signs that we might have just turned a corner.
The first bit of good news for the real estate sector is that the banks are lending again. "We have done three purchases recently for a client, all of which were funded. That wouldn't have happened in January 2009," says Andrew Kinsey of Rosenblatt. Admittedly, there is a lot more caution. Whereas before, borrowers could borrow on 95% loan to value ratio, that has slipped to 65% and the banks are looking much more carefully at the quality of both the product and the borrower.
"The banks want vanilla deals with a significant chunk of equity per borrower," Kinsey continues. Fellow partner David Fairfield agrees: "Bankers are sitting on money and are under specific instructions to lend. But they are kicking the tyres harder." Their caution has opened the door to more entrepreneurial non-banking investors who are now circling the real estate sector with interest, and may yet dive in.
Caution appears to be the name of the game on both sides of the fence. Investors who would traditionally have bought lot sizes in the £50m plus bracket are looking in the £10m to £50m range in order to spread the risk of tenant default. Such is the popularity that Kinsey tells of a client who received 38 bids on one building, although he is circumspect, believing this may be a temporary bubble causing over-pricing.
In Short Supply
Figures support the view that there has been resurgence in the real estate sector. According to Thomson Reuters, the total value of European real estate M&A jumped 53% to August 2009, compared with the previous three months. Mat Oakley, head of commercial research at Savills, is not surprised. He estimates that there is £650m of office investments on the market in London, with £7.5bn of money chasing them. The imbalance between supply and demand is huge. Oakley's view is that the smart investment money is in non-prime property, where prices are not yet rising.
He believes that there a number of good grade B buildings where prices are significantly lower, whether as a result of short lease, partial vacant possession or secondary or tertiary location. "What has changed?" he argues. "These properties are based in the same town with the same catchment as existed in 2004 when people wouldn't have hesitated. The trick for the next couple of years is to rediscover those grade B assets," he says, although Kinsey cautioned that the banks may yet take some persuading to fund investment in those assets.
In the real estate sector, there is no doubt that investor demand is back and outstripping supply for prime properties, at least for the time being. For tenants with plans for growth and that are able to pursue them, now is the time to think ahead to future needs. With landlords focused on income protection and adopting "active asset management" techniques to minimise voids across their portfolio, there are some very competitive deals to be done in terms of rents, rent-free periods, length of lease, etc. However, with new developments having dried up, premium modern commercial properties will be in short supply. "2010 will be the year that the pendulum swings away from the tenant to the landlord," warns Savills's Oakley. Kinsey agrees saying that "while tenants may not realise it yet, the terms that landlords are negotiating now are not as pro-tenant as good quality tenants obtained last summer. For tenants looking for a good medium term deal, time is increasingly becoming of the essence".
Changes Afoot
There may be other changes around the corner that will impact the real estate sector. A number of CMBS (Commercial Mortgage-Backed Securitisations) totalling billions of pounds are due to be refinanced over the next couple of years – as much as £123bn, according to a recent estimate by Standard & Poors. There is a question as to who will have the appetite for this level of commitment. There are also a large number of Scuba loans, so called because the loan is "underwater" with the borrower technically in default, but still "breathing" because the bank has not stepped in to foreclose as the borrower is still servicing the loan.
"At the moment, the bank is staying with them and letting the borrower trade out until the market picks up. But mid-term, if the banks panic and start foreclosing and selling as soon as the market picks up, we could have another slump. It could depress the market by sheer volume of property. A lot will depend on how well the banks play their hands" says Kinsey. Adding in the index economic picture and the uncertainty that this year's general election may bring, it seems that going into the next decade, the only certain prediction is that uncertainty continues to lie ahead.
Media And Marketing
The general rule, as with all sectors, has been that those that have the funds can go forward. However, going into 2010, it seems likely that the rise of digital technology will mean the traditional print publishing industry will continue to struggle. The marketing services sector, on the other hand, has come out smiling.
"PR has been surprisingly resilient in the downturn," says Roddy Davidson, a senior analyst at Altium. "There is a structural change away from traditional blunt advertising towards areas where people spending the money can see more of a return. That is one of the driving forces behind corporates allocating more spend to marketing services," he says.
That has certainly been the experience of Frank PR, where income has grown 30% year on year, and earn-out targets post-acquisition have been easily met. "This business is about coming up with great ideas, and great ideas are always in demand no matter what the prevailing climate is," says Rosenblatt's Fairfield.
Similarly, in Davidson's view, companies providing good quality content will be attractive M&A targets. "Whether you're a TV production company or provider of business information, you have assets you can monetise no matter the delivery channel," he says.
Davidson believes that there is commercial logic for further consolidation in the sector, and that vendor expectations "have come down to more reasonable levels", which has increased acquisitive interest. He sees B2B as an attractive sector, as "it tends to be more profitable and cash generative with long-term relationships or subscription elements or both".
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