The news from the commercial sector is far from good and while the government is attempting to stop the rot, lenders must prepare for the worst. Foreclosures are now a fact of life and lenders need to plan for maximising their internal rates of returns when the inevitable happens.
The scale of the problem is, in truth, unknown but the signs are not good.
PricewaterhouseCoopers recently estimated that one in five retailers could close by the time the economy recovers. Meanwhile, the British Chambers of Commerce has warned that business results for Q3 2008 will be “exceptionally bad and a key bellwether of risk”.
The insurance industry is already withdrawing some types of cover, as can be seen by Atradius, one of the largest trade credit insurers, pulling facilities from 12,000 businesses.
The announcements in the pre-Budget report will help some businesses, especially those that are bordering on profitability. The ability to spread VAT, corporation tax and national insurance contribution payments over a longer time period will help, as will deferring the rise in corporation tax from 21p to 22p – planned for April 2009. Likewise, offsetting tax repayment schemes for previously profitable businesses up to £50,000 of losses will help.
However, while these measures will help some businesses, many more will be beyond saving. And as the size of the problem escalates, many more lenders will have to pull in resources from third parties to support their internal teams. However, our experience shows that this is often done in a haphazard and unstructured manner, with not enough focus on measuring the performance of sub-contractors.
One of the business areas most typically outsourced is third party asset management although this is the one that can have the biggest impact on companies’ bottom lines. Ironically, it is also an area that few lenders research enough.
The appointment of estate agents needs careful consideration in the current market because many are struggling financially.
Mystery shopping is essential prior to appointing an estate agent as it is true that some, albeit a minority, are in the pockets of property developers. We would therefore recommend asking a few simple questions, which should be verified in writing, such as – what properties of a similar type and location have been sold, how many sales are at asking prices, and the number of viewings in first 10 days of properties being listed.
With regard to the last point, as a rule of thumb, less than three and the property has been valued too highly and more than five and it’s too cheap.
Warning signs that an estate agent is less than honourable when mystery shopping include a reluctance to do viewings, a refusal to state whether bids have been received, and worse, stating that properties have been sold.
The same rigorous testing should apply to the appointment of surveyors. As with estate agents, they should be decided upon depending on their geographical knowledge or sector specialism, the latter factor being much more critical for certain types of commercial property.
It is also important to remember that unlike their residential counterparts, commercial properties are not valued based simply on bricks and mortar, but also with the success of the business in mind.
Given the Bank’s warning about commercial property lending, a better approach to managing risk in any portfolio would be to undertake regular valuations of properties. Although most lenders revalue properties at commencement of loan, less than 10% do so annually.
Thus, lenders need to be more creative with their borrowers’ exit strategies should repossession be necessary, as keeping a business running until or close to point-of-sale will realise approximately 15% more than a vacant unit.
Besides, failure to make an accurate and regular valuation of a property could not only signify a greater risk of default but also land you in court for negligence.
Furthermore, many borrowers will be cash-strapped at this point and so unable to afford legal costs or estate agency fees, which is where lenders can step in because the cost will be covered by the increased sale price.