UK REITs could be poleaxed by funds’ famine

LONDON: Britain’s real estate investment trusts (REITs) may have to sell assets and cut expansion plans in 2008 as a bearish market and cautious lending slashes their spending power and ups pressure on capital reserves.

Those which this year have invested millions of pounds in share buyback initiatives, such as British Land and Land Securities, or which have resorted to higher-risk debt packages to finance deals, could face a backlash if difficult funding conditions continue.

“With the equity market shut, debt facilities tightening and permafrost in the investment market, REITs have to worry more about sourcing capital than asset value preservation,” Lehman Brothers’ property analyst Mike Prew said.

Some experts fear capital-starved companies could be forced into firesales to raise quick cash to service more demanding and expensive borrowing terms, further diluting their appeal to shareholders and deepening a slowdown in UK commercial property.

Bank of England data released last week showed the amount of outstanding debt owed by real estate investors rose by six percent to 186 billion pounds ($388 billion) in the three months to end-September.

But other evidence shows lenders’ confidence fading fast. Banks have scaled back loan-to-values (LTV) and increased margins on loans issued even to experienced and creditworthy investors.

“Where we used to see lending at 90% LTV levels — we may now see 75-80% LTV,” said Seth Lieberman, managing director of real estate finance at UBS.

“These terms have been chipped away by competitive market pressures but lenders realise the risks are growing and they want to be paid properly for taking on risk.”
Bankers also said lending margins to property investors had broadly doubled to a minimum 110 basis point spreads over LIBOR.

Tighter credit conditions have encouraged some of the UK’s biggest property firms to negotiate defensive finance terms.

“In this new, more circumspect lending environment, getting new leverage for any property deal is tough,” Ian Coull, chief executive of Segro, one of Britain’s biggest REITs, told Reuters.

“But almost 90% of our debt is at fixed rates with an average maturity of just under 12 years.”

However, some investors have probably left it too late to fix their debt, and those who structured deals at high LTVs hoping for a quick resale at a profit were now vulnerable.

Max Sinclair, head of the UK division at Eurohypo, said such buyers risked being forced to sell assets they cannot refinance into a depressed market and now needed to inject more equity into deals to boost their bankers’ confidence.

“Conditions are getting tougher and banks are only going to lend against deals they consider will offer them long-term safe returns,” he said.

“We’re sticking to relationship clients and we’re only going to do business if it’s good business.”

Extended falls in REIT and property share prices have also eliminated opportunities for companies to raise fresh equity by issuing shares, heaping more pressure on capital reserves.

The quoted property sector has been dramatically de-rated since then and some stocks are trading at 20%-plus discounts to net asset value.

Prew said firms like British Land and Land Securities could live to regret recent capital-intensive share buyback programmes, which provided little support to weakened share prices.

Compounding concerns of a funds famine, analysts said firms would find it increasingly difficult to boost capital reserves by selling properties as market conditions worsened.

Until the commercial mortgage backed securities (CMBS) market recovers, Royal Bank of Scotland analyst Michael Cox said REITs needed to ration capital to protect themselves.

“REITs are getting hit on all sides and on top of all these issues, they have to distribute 90% of profit under the REIT regime,” he said.

“It’s an incredibly tough situation for them and it will put pressure on their resources and ability to purchase and development property,” Cox said.