Property dam about to burst
The crash in the office market will hit the banks hardest of all. Louise McBride, Nick Webb and Shane Ross tell how the carnage will play out
IRISH developers and banks are staring into a black hole of at least €10bn as the gravy train of shopping centre and office developments heads for what many believe will be a massive crash.
This black hole -- which will become a reality this year if, as Davy predicted in its report last week, the value of Irish commercial property dives 20 per cent from its peak -- will create unforeseen headaches for many.
Commercial property, which includes the offices, shopping centres and industrial parks that have sprung up around Ireland since the early 1990s, has had a "golden run" between 1993 and 2007, according to the Davy report. With commercial property prices almost trebling between 1993 and 2001, banks, developers and estate agents alike were quick to jump on the commercial property cash cow. But with stalemate in the market -- for the last nine months at least -- many are running for cover. The commercial property market was valued at about €50bn before the Irish property market started to slump in early 2007. There are therefore billions of euro at stake -- and these losses will spread far.
"As much as 25 per cent of a person's pension could be invested in commercial property," said Guy Hollis, managing director of real estate giants, CB Richard Ellis (CBRE). "Usually, between 5 and 15 per cent of a pension fund is invested in commercial, depending on the fund. Commercial property is also a huge provider of jobs."
The paralysis in the commercial property market has made it hard to get a handle on whether or not properties have dropped in value. But the downturn is happening. Over 110,000 square metres of office space were built in the first three months of this year. Yet the take-up of office space has fallen by 33 per cent over the last year, according to Davy. Only one in five new offices coming on stream in 2008 and 2009 has secured tenants in advance.
In recent years, rising employment has boosted demand for office space. The ongoing credit crunch, where lenders worldwide have tightened their belts to protect themselves from a mortgage crisis in the US, is already having an impact on financial services. The number of such firms taking up Dublin offices has fallen by about 54 per cent over the last year. Employment in Irish financial services "may well drop in 2009", says the Davy report. If casualties in this sector are high, those developers and banks that have poured billions of euro into office developments could certainly find it hard to keep their heads above water.
Banks are no doubt biting their nails. The largest player in the development market, according to Davy, is AIB, followed by Ulster Bank/Royal Bank of Scotland and Anglo Irish Bank. "We think Irish banks will tread softly in this market and do what it takes to help clients work their way out of trouble," said the Davy report. Davy however warned that a foreign bank could withdraw support from a large developer and that "this would create a domino effect across the market".
The steps taken by banks to protect themselves over the last few months speak words. "A few years ago, banks financed the full value of commercial property -- as well as the stamp duty," said Jim Stafford, managing partner of the Dublin liquidator, Friel Stafford. "Now, they're lending up to 60 per cent of the cost of the property. If a developer is trying to sell property today for €10 million, another developer will have to stump up €4m to buy that property because he'll only get €6m from the bank.
"But property developers don't have hard cash and a property developer certainly won't have €4m to hand. These guys are speculators."
Marie Hunt, the director of research with CBRE, said the amount of money that the banks were prepared to lend has "diminished considerably". "Irish banks are now much more cautious about who they will lend to, the types of property they will lend against and the terms on which they will lend," said Hunt. "The effect is stalemate with virtually no transactions taking place in the investment or development areas of the Irish or British commercial market at present."
Some believe that the key players in commercial property are unwilling to own up to how bad things are. "Estate agents often have acted in buying properties and no one likes to tell a client that they paid too much last year," said Bill Nowlan, chairman of the management consultants, W K Nowlan & Associates. "For an estate agent to admit to falling values is not good for executing existing business or securing new business and they badly need new business now. If a borrower admits to a fall in value, this could move them into negative equity. If bankers recognise that values have fallen, then it affects their loan to value ratios [the percentage of the property price borrowed by the borrower]."
Nowlan believes that some developers could be forced to sell their properties shortly: "There have been little or no forced sales of property in Ireland (yet) but eventually the dam will break and the truth will come out just as it did in Britain. A similar freeze happened in Irish residential property last year and when vales adjusted by 20 per cent, the market started up again."
The problems in the residential market, where many developers are finding it impossible to shift new apartments, could be the final straw. By last March, some 13 developers had reduced the price of new homes, according to the Davy report. These include Capel Developments, Albany Homes, Park Developments, Menolly, and Kingscoft. "We understand that many more builders have cut prices since then," said Davy. "The sensitivity of a builder's profitability to price cuts is all down to the price at which the land is bought."
Some believe the value of development land could fall by 25 per cent this year.
The slowdown in the residential market is also likely to feed into retail developments. "Retail parks have been more tied to the housing boom and are now exposed to the fallout," said Davy. "The developers of these projects made optimistic projections about future growth in the market."
But despite this, some are upbeat. "Prices will have to adjust a bit more to encourage buyers to come forward," said Hollis. "But the drop won't be as dramatic as expected. We are not in a blood on the wall situation."
Maybe not, but there seems to be plenty of sweat and tears on the streets.