State of the Property Finance Market and Alternative Sources

When addressing our Lunch on 17th March 2011, Wilson Lee, Managing Partner of First Growth Real Estate Capital LLP, was confronting a topic of close interest to all his audience – how and when will the capital markets return to normal?

He started his talk with a resumé of how we got into this pickle in the first place. It might be summarised as a thorough exercise of what I paraphrase as 'due indigence': people failed to think through the inherent risks of domino effects in the structures that were being created, and didn’t build the contracts properly. When the music stopped, financial institutions across the Western World found themselves short of several chairs.

The political and fiscal responses, and uncertainties about what those responses might be, led, perhaps inevitably, to a capital market distorted in many respects. Banks are still in a state of flux. Whilst many US Banks have 'marked to market', that process is, in Wilson’s view, by no means complete in Europe; this implies more pain to come, and more reluctance to lend. In Europe, around £260bn of bonds fall due in 2011/12. Whilst some of these may be extended, there will be a very substantial pool to be re-financed in what will be a highly unfavourable climate. Wilson’s worry is that, as and when interest rates start to rise, lender tolerance will recede. This will lead to increasing defaults, cranking up the pain to the Banks. There are signs of this already as applications to the ECB for emergency loans have exploded.

Against this torrid background, investors crave liquidity and security; if both are not available, prices take a big hit. In property terms, we have moved from a position of the spread between prime and secondary property being too narrow during the bubble years to being too wide today; as an aside, Wilson thought that this might indicate some opportunities.

It was a testament to Wilson’s delivery skills and the value of what he was saying that, up to this point, there had been no suicides amongst members or guests. How will it all be resolved? Wilson was clear that there are more failures to come before the system is purged. There is, however, no shortage of capital in the world – witness, for example, Sovereign Wealth Funds. There is fear, and there is a mismatch between investors’ expectations and the returns that are actually likely to be available to them. Fear should recede if governments take steps to encourage wealth creation, both at the macro-economic level and in local initiatives. Wilson was also optimistic, I think(!), that Institutions will identify the opportunities open to them whilst the Banks occupy the Recovery Ward. In case that made us happy, however, Wilson suggested that we were not yet half way through the trough, if the previous upsets for capitalism were anything to go by.

Michael Mallinson, Scribe