The issue that has been exercising banking and property advisor’s minds is how to deal with the overhang of property related debts. There are broadly 4 options; firstly a restructure of the existing debt with the borrower in place; secondly, a consensual sale of the asset; thirdly enforcement action with the appointment of LPA Receiver or an Administrator or finally the sale of the debt. Clearly the starting point is a review of the property and this, frequently involves an external property adviser. Traditionally the question most frequently asked was about the value of the asset. However, lenders increasingly require a much more sophisticated product which encapsulates anticipated market movements, material cashflow events, sale strategy, asset management and crucially the time to complete these.
Where is the asset relative to the competition?
The heart of the matter is assessing and articulating what are the issues relevant to a property. For example if it is worth £10 today could that move to £15 – and if so how would that be achieved – or is it more likely to head towards £5 in which case what steps can be taken to mitigate or avoid the decrease. In order to address these issues the advisor needs to deal with both the strategic and tactical aspects.
Establishing the value of property in today’s terms is the first step. This provides an understanding of not only the current value and prospects of a property but also the future potential. To do this there needs to be an analysis of how a property sits in the local market but also how it relates to the wider market.
In simple terms this analysis at the ‘micro level’ will assess the quality of the property in terms of location, building and tenant quality (if occupied) relative to its peer group as well as the supply and demand side issues.
Red flag events
Having established the base point the interesting bit is to see where a property looks like moving on the value/pricing gradient. DTZ looks at each property to establish whether there are any ‘Red flag’ cashflow events such as lease expiries, tenant break options or likely tenant failures which would lead to vacancy. Crucially by involving leasing experts to advise on reletting timescales, likely lease terms including rent free and capital contributions. This enables a detailed cash flow analysis to be constructed which can be sensitised to enable scenario development. Clearly the length of time a space is vacant will determine the amount of income foregone but also results in operating income shortfalls as the owner is required to fund the empty rates and the unrecoverable service charge. The cost of refurbishing the space also needs to be considered not only from the aspect of cost vs rental return but also whether in fact it is a necessity in order to achieve a letting ie it is required as a defensive measure rather than as a value enhancing tactic. Decisions that flow from this includes those on timing, whether find a tenant and then do the works, do a show suite and then market or any other viable market strategy. Advice should include input where necessary from building specialists.
Getting the right advice on planning
When we are looking at sites or where alternative uses are being considered, getting advice from specialists is essential particularly against a changing planning environment. Understanding the possible vs the fanciful is important in order to arrive at a conclusion regarding the strategy for the site and it is at this point that the bank may be reaching initial conclusions regarding the borrower. In providing this advice, sensible attempts to quantify the likelihood of success should be articulated in order to enable an assessment of risk against reward. Timing and the cost of the planning process are also essential items – these drive requirements relating to extensions of existing debt facilities. In reviewing sites where we have been involved we have sought to provide a range of scenarios related to the potential alternative outcomes and the impact these have on potential exit prices but also the timing of these. Viability of the schemes needs to be assessed – planning being only part of the issue. There is no tactical or strategic sense in getting consent for an office building for which there is no demand either due to location, existing supply overhang.
Protecting the cash-flow
We recognise that the protection of the cashflow generated by a property is essential not only in terms of servicing the existing loan but also for protecting the longer term value of the property. The preparation of detailed cash flows with the ability to flex the inputs in order to demonstrate the potential impact of multiple scenarios provides banks with the opportunity to understand the impact on loan servicing over a range of scenarios. This also provides the opportunity to identify asset management opportunities or ‘must do’ initiatives. The latter relates to items that need to be executed due to the sensitivity of the cashflow to a particular event such as lease expiry or reletting following refurbishment. Key is determining future capex requirements how that will be funded whether it is a defensive spend or income enhancing. Experience suggests that there are some borrowers who clearly have the skills to act on these initiatives while others do not or have other priorities.
Identifying when to exit
Timing a sale to maximise proceeds is in the forefront of the minds of banks where the loan exceeds the value of the property. It is important to assess the decision in the context of the anticipated direction of travel of the market will move. The appetite of purchasers and their mindset is a very clear influencing factor and the inclusion of the investment agency team provides valuable insight in this respect. As indeed is their advice regarding the method and approach for sale.
In the short term hold scenario with a view to sell inside 12 months one of the options to consider are the preparation of a disposal pack to include:
• Report on title
• Detailed planning report
• Environmental report
• Site plans
The advantage is an accelerated due diligence process for bidders and reduced costs thereby encouraging a wide pool of potential purchasers to assess the property.
Where sites are being sold where there is potential higher values alternative uses, advice provided should address the merits of a straight sale vs retaining some overage position or whether a joint venture would provide a solution.
In the longer term hold scenario the key focus is on the initiatives that need to be executed in order to get the property ‘oven ready’ for sale. This might include some or all of the following:
• planning applications to be made and consent granted
• lease re-gears
• letting of vacant space
In order for these to represent a valid business plan each action point needs to have a timeline attached to it. This enables a consistent basis for monitoring progress and to act as an early warning if key dates are missed.
Conclusion
Secondary market properties dominate banks loan books and what is absolutely true is that each property has to be reviewed on its own merits. Generalisations can frequently be misleading. In order to make a difference to the final outcome you need a team with an understanding of the issues and who can provide commercial but well reasoned advice. The team needs to draw together all the relevant strands but also crucially have experience in providing this advice and understand the issues. It is important for the bank to assess the relative merits of the available options and the only way this is possible is for the advice to be provided to not only be comprehensive but also assumption explicit.
About the author
Charles Smith MRICS- Head of Valuation, London, DTZ
T: 020 3296 4411
M: 07768 065 419
E: charles.smith@dtz.com
T: 020 3296 4411
M: 07768 065 419
E: charles.smith@dtz.com
