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Most businesses remain sound

Last month I reported that businesses were taking a more realistic view of their situation as well as appropriate action to remedy impending problems.

Two of the most notable effects of this are the shedding of staff and the renegotiation of rents for non-owner-occupiers, the result being that 2008 saw the largest recorded fall in the value of commercial property.

In its latest survey, the Investment Property Databank states that commercial property values fell by 26.4% in 2008 – the largest decline since records began in 1987.

Shops, offices and industrial buildings are now worth around the same amount they were in December 2001.

For owner-occupiers this is not necessarily bad news so long as loans are being serviced. But for commercial property investors and developers it is disastrous, as can be seen by the recent move by Land Securities which ann-ounced a deeply discounted £755.7m rights issue.

This followed landlords Brixton and Segro confirming they were considering cash calls after their share prices were hammered over expectations of imminent fund-raising efforts.

For a glimpse of how far the market sailed away from its fundamental value look no further than rent. In the seven years that capital values rose and fell 35%, rental values rose just 13% before falling back 2%.

This shallow rise and fall in rental values shows how little the boom had to do with the underlying economy and how much it had to do with the availability of loans.

From a servicer’s perspective this is a crucial issue as many sound businesses remain unencumbered by huge debts either because they bought their properties before the boom or because they rented. For more recent borrowers the situation could be markedly different, hence the reason that newer loans are now prioritised and monitored much more frequently.

In terms of business sectors, retail suffered worst with a 15.1% decline in value during Q4 2008 and a 27% drop across the whole year. Offices fell in value by 14.1% in Q4 and 26.5% over the year, while industrial buildings lost 13.7% and 25.7% of their values in the same period.

The figures from the IPD portray a pretty grim picture but having access to a large and varied book of commercial business I would argue that things could be worse.

The IPD collects its data largely from institutional property owners so the assets monitored tend to be of a different quality to the vast majority of the commercial property that dominates our high streets and business parks.

From a lender’s perspective this raises significant challenges as the secondary property market tends to be pretty specialist in nature.

This greatly affects the ability to find new buyers or tenants should loans default and repossessions of properties become necessary. The result is that bricks and mortar plummet in value dramatically as soon as they are left vacant.

It is therefore essential to look at the businesses you are lending to and figure out if their economics are fundamentally sound but temporarily strained due to the recession.

Having a business in place that is paying some interest may be better than crystallizing a loss.

This means that arrears teams have not only to be skilled at collections but also to have a sound understanding of the loans they manage and the businesses they look after.

Strangely, given the prevailing gloom, my outlook for this year is confident about the commercial sector because the fundamental economics of many businesses are sound.

High profile retail collapses will continue to dominate the headlines although most of these will be a reflection of an abuse of the availability of capital and more due to poor business sense than a fundamental failure of the wider economy.

Furthermore, from a servicer’s perspective these cases are easy to identify and resolve, albeit the remedies may require drastic action from the businesses concerned.

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