Financing Property 2011 Our 23 rd annual series of presentations - - PDF document

Financing Property 2011

Our 23rd annual series of presentations

Theme: “Two-tier market?” – Definitely not, multi-tier

Prime Secondary Tertiary

In the past, it has been a matter of misclassification

Financing Property 2011 - Presentation contents

• Three speakers (UK markets):

– William Newsom The Property Finance Market – Mat Oakley The Commercial Property Markets – Lucian Cook The Residential Markets

• Conclusions William Newsom

Note:

• 1. Sweepstake sponsored by

The Property Finance Market - Contents

• The market today
• Issues with existing loan books
• The outlook

Acknowledgements

Anglo Irish Bank HSBC plc Aviva ING Real Estate Finance Bank of China Investec Bank of Cyprus UK JC Rathbone Bank of Ireland Laxfield Capital Barclays Capital Lloyds Banking Group, BSU Citigroup Longbow Real Estate Clydesdale Bank NAMA Coutts & Co. Nationwide Building Society Credit Suisse RBS GRG Development Bank of Japan RBS plc Duet Santander Handelsbanken Société Générale HSBC Private Bank Wells Fargo

I thank all those listed below for their time when I met them during May 2011, as well as “all” the German banks with whom we have day to day contact

The mountain of debt is larger than usually stated

Source: All from DMU unless otherwise stated

Outstanding senior debt secured against commercial property *1 £206.9bn Ditto for social housing £18.7bn Committed but not drawn £25.9bn CMBS (S&P and BoAML estimate) £56.0bn NAMA debt (UK at 35% of €72.3bn) £21.8bn Lending not captured by DMU research (estimated at 10% of *1 above) £20.7bn £350bn Contributors to the DMU research do not include: Ahli United Bank, Bank Leumi, BNP Paribas, Citigroup Global Markets, Close Property Finance, Credit Agricole CIB, Handelsbanken (100 branches), OCBC/Bank of Singapore, Ulster Bank, Unicredit, Wells Fargo

How much of it is prime? What is prime? What is secondary? What is tertiary?

• Definitions ebb and flow. In 2007 ‘everything’ was prime. In

2009 ‘prime’ was a rarefied product

• According to the DMU research, lenders state that 38% of their

loan books are secured against prime property

• Surely, that is wishful thinking by the banks. I would say nearer

25%

• That implies that c£250+bn of the total loan book of £350bn is

secured against secondary or tertiary property

• Which is huge

There are various different strata of secondary and tertiary loans

Strata Description

Financeable? Proportion (est.) Good secondary Some but not all of these: good bricks and mortar, good lease, good tenant, good location, good

• borrower. Otherwise, it

would be prime Yes 25% Poor secondary Ticks fewer boxes Yes, selectively 25% Worse Tertiary Vacant grot Land The focus here should be

• n property fundamentals:

location, condition, sustainable lettability. Opportunities to add value? Potential for change of use? Never say never 50% (£100+bn)

• In amongst all this, there are some hidden gems

I am inviting lenders to have an open mind about ……

• Lending against secondary (but not tertiary!)
• Lending outside London
• Providing development finance – where there are strong occupational

markets, e.g. central London spec offices

• But remember, it is about understanding the fundamentals, sustainable

lettability and careful stock selection (no apologies for repeating this)

4.0 5.0 6.0 7.0 8.0 % 5 year swap and interest rate margin 2007 2009 2010 2011 2008

… because, now is a brilliant time to be lending I’ve said that before and it still remains true

• Property yields remain high …
• the cost of debt remains low …
• the margin between property yields

and the cost of money remains high ….

• and there is enough surplus income to

raise 90% LTV

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% UK Base Rate 20yr High Coupon Gilts IPD All Property Equivalent Yield 5yr Semi-annual Interest Rate Sw aps 3 Month LIBOR

2007 2008 2009 2010 2011

• 1.0%

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 1998 9 1999 2000 1999 2001 1999 2002 1999 2003 1999 2004 1999 2005 9990 2006 1999 2007 1999 2008 1999 2009 1999 2010 1999

IPD All Property Equivalent Yield Minus the 5 Year Swap Rate

3.50 4.50 5.50 6.50 7.50 8.50 9.50 2007 2008 2009 2010 2011 Swap Rate and IPD Yield % 30.00% 50.00% 70.00% 90.00% 110.00% 130.00% 150.00% Sustainable Loan to Value

IPD All Property Equivalent Yield -0.7% Sustainable LTV Cost of money (5 year swap + interest rate margin)

Sources: various

Where are LTVs and margins? Now and going forward?

• LTVs have been broadly static at 60%-65%

for the last 2.5 years. Margins have been broadly static over the same period, if not still moving upward

• I don’t see LTVs and margins changing

dramatically for the foreseeable future due to Basel III. Higher gearing would require more regulatory capital

• Also, banks arguably are more interested in

income to interest cover (ICR). Min 1.50:1

1.10 1.15 1.20 1.25 1.30 1.35 1.40 1.45 1.50 1.55 1.60 1.65 1.70 1.75 1.80 1.85 1.90 1.95 2.00 2.05 2.10 2.15 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 mid- year 2010 year- end Interest Cover (multiple) Prime Office Prime Retail Prime Industrial Secondary Office Secondary Retail Secondary Industrial Residential investment

90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240 250 260 270 280 290 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 mid- year 2010 year- end Basis points

Prime Office Prime Retail Prime Industrial Secondary Office Secondary Retail Secondary Industrial Residential Investment

Prime Office Prime Retail Prime Industrial Secondary Office Secondary Retail Secondary Industrial Residential Investment 60% 62% 64% 66% 68% 70% 72% 74% 76% 78% 80% 82% 84% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Loan-to-value ratio

Source: De Montfort University

LTVs

Margins

ICRs

With LTVs stuck at 60%-65%, where’s the equity going to come from?

• The world is awash with equity
• It comes in many different forms, obviously UK institutions, UK prop cos,
• verseas sovereign wealth, German open ended funds, etc.
• But not forgetting:

– long term debentures – private placements. REITs. Perhaps raised in the US – accumulated wealth, family trusts, straight cash – refinancing after purchase – profits from trading; selling (and buying) at the right time – opportunity and value added funds. Funds raised in 2008 largely have not

been deployed. £20+bn of purchasing power that has to be invested by

• 2012. Desperation?

– mezzanine finance (see next slide) Many mezzanine providers have sprung up. There is definitely a place for them

• Other mezzanine providers include: AgFe, Blackstone, Brockton Capital, Davon Capital,

Eurohypo, European Risk Capital, GIC, Maslow Capital, Och Ziff Capital Mgt, Partners Group, Pluto Capital / Mountgrange, Qatar Islamic Bank

Fund Capital raised LTV up to Target return Cairn Property Debt Fund £75m 75% 7-8% BlackRock £87.5m 85% 10-14% M&G Mezzanine Real Estate Fund £122m n/a 12% Matrix Commercial Mortgage Fund £50m 75% 12% Duet European Real Estate Fund £170m 80% 15% LaSalle Junior Loan Program £200m 75% 8-11% Longbow/Alpha £64m/ £100m 85% 15%/15-20% Pramerica Real Estate Capital 1 £492m 83-85% 12-14% TOTAL £1.35bn Range 65%-85% Range 7%-20%

Source: Longbow, LaSalle and Savills

The returns sought by mezzanine and equity providers will influence property values

• Mezzanine providers have a dilemma. Many seek IRRs in the mid to

high teens+. They also seek prime deals. However, prime yields have fallen, such that the figures do not always stack up

• What to do? Either reduce target IRRs (I have seen 8%), or venture into

secondary territory

• However, yields of secondary assets often are not high enough to

produce the returns that the mezz and equity providers seek

• Mezzanine and equity come in many different forms. Each will require its
• wn level of return
• If the figures don’t stack up? Secondary values may have to adjust (fall?)

to reflect the required returns

Issues with existing loan books

• The debt funding gap – estimated at £26bn
• LTV breaches – 80% in breach?
• Loan maturities - £100+bn over 2011/12/13
• Deleveraging - £100+bn (one third of the total loan book)

Notes from FPP 2010

• 1. The cost of unwinding swaps remains an issue, albeit less than it was
• 2. Obsolescence, lack of capital expenditure and lack of active

management where the equity is under water remain an issue, indeed a big one

The debt funding gap: is it a major cause for concern?

• DTZ report in May 2011 that the debt funding gap in the UK is c£26bn,

down from c£34bn in November 2010

• In the US, it fell from US$49bn to zero over the same period. Why?

Their estimate of capital growth in 2010 was revised from

• 1% to +9%
• With property values in the UK improving (selectively), one can see the

debt funding gap reducing here likewise

• Although problems will persist at the secondary/tertiary end, I don’t see

lenders worrying about the debt funding gap

• I repeat: the world is awash with equity
• Definition of debt funding gap: where a property with existing debt secured against it has

fallen in value (and LTVs available in the market have also fallen), the debt funding gap is the difference between the existing level of debt and the level of debt that can be raised in the new market circumstances

Source: DTZ

LTV breaches – are we fussed?

• “Estimated that c.80% of loans issued after end 2004 are probably still in

LTV breach.” Source: PIA report, Jan 2011

• The banks I have talked to say, what’s new? We know there are LTV

breaches

• Banks are much more interested in debt serviceability
• They accept they are having to extend (more of this later)
• All of them are seeking a consensual approach, preferring to work with

their existing customers – who following the passage of time are more accepting of the situation; and are not seeking high LTVs

• Granted, there are greater challenges at the secondary/tertiary end?
• Granted also, CMBS is different ….

CMBS – the well publicised difficulties (high LTVs and “tranche warfare”) will lead to forced selling

• “The £6.2bn of bonds that mature in 2014 could translate into forced selling of £6.8bn of

UK property. We would expect to see most of this property to come to the market in 2012, two years before ….” (IPF Research, Feb 2011)

1 2 3 4 5 6 7 8

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Negative equity (£4.6bn) Estimated new equity Estimated new debt

£bn

• Note: Last year, I said it was a long term problem. The difference today is we are one

year closer, run off periods are shorter, the problems are better understood and special loan servicers are acting earlier

CMBS bond maturities

Source: Bank of America Merrill Lynch (Mark Nichol, Global Research)

Debt maturity is another big talking point

Source: De Montfort University and Fitch

2011 2012 2013 2014 2015 2016 to 2020 After 2020 £b n CMBS maturities Senior debt maturities £48.5 £36.8 £29.9 £25.9 £19.8 £29.4 £49.6

£115.2bn

• Over 50% of senior debt is due for repayment over 2011/2012/ 2013. Of that,

22% is due for repayment in 2011 alone. It is happening right now

Existing loan books: how well advanced are the banks?

• One of our competitors has suggested that “for non-prime markets, 53% of

lenders have not yet started dealing with distressed debt”

• Perhaps it is a question of definitions, but I don’t agree
• I have met “all the banks”, and they all say they have made good progress in

understanding what they have got, its value and the route out. They have had 2

• 3 years to do this
• Banks can see what is coming up, and are addressing the issues early. Loan

maturities for 2012 have actually fallen (from £33.4bn at year end 2009 to £31.9bn at year end 2010) because of this

• Initially, banks were “extending and pretending”. Today, they continue to extend

loan terms, but are doing so knowledgably

• They recognise that extending is inevitable. Investment loan extensions

average 2.2 years

• Conclusion: bankers still have lots of legacy issues; these are handled by

specialist teams; this is not holding back new lending ambitions; it is still a long haul; how long? ….

Source: Undisclosed and DMU

Deleveraging: many banks are seeking to reduce the size of their property loan books

• Broadly estimated at £100bn (30% of the £350bn)
• RBS, LBG and NAMA are the major contributors to this
• “The banks have the opportunity either to regulate the market or to blow

it up.” What will they be doing?

• Surely, the banks are not going to do anything to destabilise the market.

Provisions have been made. Hasty actions will not be taken?

• NAMA? Propose to sell €10.1bn of UK assets (63% is investment

property) by 2013

• For NAMA, it is still relatively early days. Still staffing up. 11,000 loans,

850 borrowers. A massive task

• But, this is less than 10% of total estimated deleveraging

Source: Savills and NAMA

Deleveraging: the art of portfolio selection

• My recommendation to banks seeking to deleverage is to package up

properties into saleable portfolios

• Well constructed portfolios are now achieving premium pricing
• What is the ideal portfolio size? Depends on number of properties,

blended initial yield, compatible mix of properties and not too many tertiary ‘dogs’

• But “everything is saleable at a price”. A portfolio of say 10 tertiary

properties with a good blended double-figure net initial yield could be highly saleable

• Careful portfolio selection gives banks the opportunity to take advantage
• f the available equity out there

In the meantime, there will be more provisioning

• Q: “Existing loan with 80% LTV covenant. You commission a valuation.

Find LTV now is 120%. What level of provisioning do you make?”

• A whole range of different answers
• One said, provision down to 96% of Market Value
• Another said, 100% of Market Value less cost of disposal less cost of

unwinding any derivatives

• No one said, ditto less an allowance for the risk of not selling at reported

Market Value

• The majority said they would look carefully at loan serviceability, future

income profile, discuss with customer, restructure as necessary

• One said they would ask for a preliminary desktop, and if there were signs of

a LTV breach, “we would not commission the valuation”

• Conclusion in my view: there will be further provisioning

The forward view Solvency II gives insurance companies a positive incentive to lend against property

• Solvency II specifies the level of capital requirement behind different

categories of investment by insurance companies:

– equities (depending on whether listed or unlisted)

from 39%

– direct property investment

25%

– bonds (depends on date of maturity, etc.)

3% - 60%

– lending secured by commercial property

Nil

• Why nil for property lending? Because the borrower bears the first 25%
• f any fall in value. Thus, up to 75% LTV
• Will it remain at nil? Perhaps 2%
• Aviva is joined by others in this market
• May be extended to pension funds too

Source: Wragge & Co

Notes on Solvency II

• Solvency II seeks to protect insurance companies (and their policy

holders) against a 1 in 200 years shock. The regulatory detail is being worked on now. Likely to be effective from mid 2012

• There will be other asset allocation consequences as well
• Over many years Aviva/Norwich Union has been one of the few

consistently active insurance companies. Matching assets against

• liabilities. Longer term lending priced off the gilt. Recently lent Peel

£205m for 20 years. Similarly, Canada Life

• Aviva is now joined in the market by Axa (already lent £700m this year),

Met Life (done some significant deals this year), Pru M&G, Legal & General, Allianz (but not in the UK yet). Possibly Standard Life, Prudential of the US, Mass Mutual, ATP (Danish)

The CMBS market has staged a recovery

• The CMBS market in the US has ‘taken off’ again. Very strongly
• In Europe, CMBS AAA spreads have fallen by 25% since the start of 2011

200 400 600 800 1000 1200

2007 2008 2009 2010 2011

Europe CMBS AAA 5yr EUR UK RMBS AAA 5yr EUR Source: J.P. Morgan Securities Ltd

Spread bps

The scene is set fair for new CMBS issuance

• Step forward Deutsche Bank: £302m securitisation of the five year loan behind

Blackstone’s £480m acquisition of Chiswick Park, W4. Three tranches of notes. Guidance pricing for AAA notes is at 175 to 200 bps over Libor

• Marketing of the bonds is expected shortly (at 8 June 2011). However, a no-

names preliminary prospectus in November 2010 met with “enthusiastic” support from investors starved of sterling denominated bond issuance since 2007

• Many other finance houses are watching DB’s progress closely. We can expect

more activity in this market.

• It has to happen. One lender said, the key to the future of property lending,

particularly in view of Basel III, is “distribution, distribution, distribution”

• Any new issue needs to be simple, transparent, probably single asset, single

jurisdictional, as well as changing past features that have led to investor disillusionment

2 year view? – I’ve asked the bankers

• “It will be a better place.” “But only gradually improving”
• “The banks will still have much to do.” “The refinancing risk will remain a

hazard”

• “So much depends on what RBS and LBG are going to come up with”
• “The regulatory environment. More than just Basle III and Solvency II”
• “A few banks will go home, but others will arrive. That is the nature of

London.” “The insurance companies alone will not fill the gap”

• The size and timing of the inevitable increase in Base Rate. Higher cost of

money is coming. What impact will that have?

• Everybody says “London will power on”. “It will remain the financial capital
• f the world.” “A proxy for world GDP”

5 year view? – a whole range of comments

• “I have no idea. It is the first time in 20 years I have said that”
• “In the middle of a 10 year period of flat-lining.” “This is cyclical, the

market will come back”

• “I would like to think things will be better.” “It will be post Olympics. That

will bring a wave of optimism”

• “No one forecasted the impact of the internet. There is scope for new

innovations to come forward. To help emerging lenders.” Effect of internet shopping. Effect of social media

• “I very much hope the banks will not repeat the mistakes of the past. It

has happened before. We should consider creating a memorial to those that died!!” (wisdom from Max!)

• “It is so asset specific. You must get the tenants in”

Negative 67% Neutral 19% Positive 14% Negative 10% Neutral 16% Positive 74%

Lenders feel confident about the way forward

Q: Do you feel more or less confident that an year ago?

About your own business About the wider market

• These results arguably are contradictory. However, I interpret concern about the

wider markets as a reaction to wider uncertainty. What’s new about that?

• These results are positive in the context of my invitation to lenders to have an open

mind about lending against secondary (those hidden gems), lending outside London and providing development finance (including CL spec office)

Existing loan book: how long until it is fully sorted?

• There is still a lot of work to do on the legacy loan book:

London Is already sorted Major regional centres 2-3 years Good secondary 2-3 years The rest 5-10 years still

3 13 23 33 43

Quarters Time

60 80 100 120 140 160 180 200 220 240 260 280 300 320 340 360 380 400

Total debt mountain: how long until the bottom is reached? 1980s/90s – vs – 2000s/10s

Debt mountain 1984-2004 £bn Debt mountain 2004-2010 £bn

Peak Q4 1991 £40.0bn Peak Q2 2009 £254bn 1984-1998 2002-2015 Forecast Q1 1997 start of sustained recovery £30bn (25% down from peak) Q4 2014 forecasted start of next sustained recovery £191bn (25% down from peak)

‘87 – ‘89 ‘90 – ‘92 ‘93 – ‘95 ‘96 – ‘98 ‘84 – ‘86 ‘04 – ‘06 ‘07 – ‘09 ‘10 – ‘12 ‘13 – ‘15

Source: Bank of England and Savills

• The growth in the debt mountain in the late 1980s accelerated faster than in the mid
• 2000s. Will the market come back earlier or later? Forecasting the finance market is

a tough call

Annual lending activity: how much money will be available to be lent?

£0 £10 £20 £30 £40 £50 £60 £70 £80 £90

1 9 9 9 2 2 1 2 2 2 3 2 4 2 5 2 6 2 7 2 8 2 9 2 1 F

• r

e c a s t 2 1 A c t u a l 2 1 1 2 1 2 2 1 3 2 1 4 2 1 5 2 1 6 £83.7bn

Source: DMU and Savills

• 2010 saw more new money lent than forecast, but significantly fewer loan

extensions than forecast. Problem of classification?

• There will be a reducing level of loan extensions over time

Savills’ Forecast

Extended loans New loans

bn

Annual value of loan originations

£15.1bn £19.9bn £34bn £43.6bn

Who will be lending?

• The largest lenders are capturing increased market share. The top 12 most active

lenders wrote 82% of the new business last year (in 2007 the top 12 did 68%)

• Fine pricing of the Pfandbrief (10-20 bps)

gives German banks a big competitive advantage

• Basle III affects all banks, but some more

so than others

• There is less syndication between banks.

In 2008 32% of lenders did it; in 2010 that had dropped to only 14%

• New lenders? Yes. Insurance companies. Mezzanine providers. Far Eastern banks.

I have identified 20 “new lenders” since last year, but many are embryonic. And it’s sensitive info

• 20
• 10

10 20 30 40 50 60 70 80

2007 2008 2009 2010 2011

Pfandbrief 5Y swap -spread

Who is lending? My top 16 list of active, motivated bigger ticket property lenders

• Aareal*
• Aviva*
• Barclays Bank
• Bayern LB*
• Deka Bank
• Deutsche Bank*
• Deutsche Hypo
• Deutsche Pfandbrief*
• Eurohypo*
• Helaba
• ING REF*
• Landesbank Berlin
• Met Life*
• Royal Bank of Scotland*
• Santander
• Société Générale

9 are German, 2 are UK, 2 are life companies and 3 are other

• international. Those marked * may go above £100m in a single
• tranche. 6 are new to my top list since last year

If you think you should be listed, see next slide

Source: Savills

Who is lending? 16 further organisations that are active across a range of lending activities

• Axa
• BNP Paribas
• Citigroup
• Clydesdale
• Coutts & Co.
• Credit Agricole CIB
• Deutsche Postbank
• Handelsbanken
• HSBC PB
• HSBC plc
• Investec
• LBBW
• Lloyds Banking Group
• Nationwide BS
• Pru M&G
• The Co-operative Bank

5 new from last year. I can name many other occasional lenders (CBRE refer to a total of 56 ‘actively lending’), but in reality few others are actively motivated to lend new money to property. This is a subjective view. If you are not on the lists, get in touch!

Source: Savills

The Property Finance Market - Conclusions

• The issues with existing loan books often are overstated
• There is a lot in the market to feel positive about
• ‘Prime’ is an over-populated place. Many lenders focusing on prime are

experiencing difficulty achieving their ambitions

• ‘Secondary’ – there are some hidden gems out there
• ‘Tertiary’ – there is a whole mass of it. Some properties are overvalued

by 20% or more

• Overall, it is a matter of understanding the property fundamentals. Over

to Mat ….

“Two-tier market?”

Outlook for the UK commercial property market

A three speed recovery (but are all of them slow?) Mat Oakley

Recovery underway. Time to take a more normal view of pricing, growth and risk?

• ‘The shape of the recovery revisited
• Underpricing and overpricing
• Where will the growth come from?
• Is it time to embrace a little risk, or continue to focus on expensive

security?

UK economic recovery will be weaker than those that came before…

• 5
• 4
• 3
• 2
• 1

1 2 3 4 5 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1991 1992 1993 1994 1995 2008 2009 2010 2011 2012 2013 GDP growth 4 year average

Source: OBR, Savills

• 45
• 40
• 35
• 30
• 25
• 20
• 15
• 10
• 5

5 Jan 2004 Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011

Consumer confidence

Consumer Confidence Avg confidence (1974-2011)

… primarily due to consumers in recovery denial

Source: GfK

Anatomy of the property cycle: Do the 1990’s give us a clue for the future?

• 25
• 20
• 15
• 10
• 5

5 10 15 20 25 30 1 9 7 1 1 9 7 3 1 9 7 5 1 9 7 7 1 9 7 9 1 9 8 1 1 9 8 3 1 9 8 5 1 9 8 7 1 9 8 9 1 9 9 1 1 9 9 3 1 9 9 5 1 9 9 7 1 9 9 9 2 1 2 3 2 5 2 7

Capital value growth %pa

Source: IPD, Savills Debt-driven boom No debt, values fall, activity low Tactical equity buyers re-enter market, some debt available for secure income deals Capital value growth stimulates

• ptimism and

return of speculative debt

And I predicted

• 30
• 25
• 20
• 15
• 10
• 5

5 10 15 20 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 %

Retail Office Industrial

Source: IPD, Savills Debt-driven boom No debt, values fall, activity low Tactical equity buyers re-enter market, some debt available for secure income deals Capital value growth stimulates

• ptimism and

return of speculative debt

The outturn was better (and worse) than expected

• 30
• 25
• 20
• 15
• 10
• 5

5 10 15 20 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

% Retail Office Industrial

Source: IPD, Savills

Is risk being priced correctly?

Average differential: 220bps. Current: 165bps

Source: Savills / Investment Property Databank

4 5 6 7 8 9 10 11 Jan 90 Jan 92 Jan 94 Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Yield % 50 100 150 200 250 300 350 400 Differential bps Spread Prime Average

Prime yields look correctly priced

4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10

Yield %

Actual Prime Equiv Fundamental Prime Equiv

Source: Savills

With some sectors having potential for further yield hardening

4.0 4.5 5.0 5.5 6.0 6.5 7.0 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10

Yield %

City Offices Actual Prime Equiv City Offices Fundamental Prime Equiv

Source: Savills

What about secondary?

• What is secondary?

– location, tenant, void? – not tertiary!

• Deals have been scarce, but an analysis of 2009-2011 shows:

– 280bps gap between prime and secondary – Comparable to anecdotal spread in mid-1990’s

The structure of buyers of UK real-estate indicates a reversion to acceptance of some letting risk

Source: Property Data, Savills

10 20 30 40 50 60 70 80 90 100 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 % of Purchases UK Institutions Prop Cos Non-Domestic Private Others

Could secondary assets now be a better buy than prime?

• Less competition and more stock to buy?

– Still a heavy investor bias towards risk aversion – Few reasons to sell prime, but more secondary assets will come to the

market

• More attractive pricing?

– Increasing dissatisfaction with low prime yields, leading to low potential

returns

• Rental growth prospects?

– Secondary is not tertiary – rental growth is likely – Do lower capital values enable the new owner to drop the rent to a

lettable level?

• More opportunity to add value?

– Development remains hard to finance – Is refurbishment the new redevelopment?

Hunting for growth – Time to look at more than just prime?

• Offices

– Central London continues to lead – 2011 and beyond will see the re-emergence of growth in Birmingham,

Glasgow, Edinburgh & Manchester

– Secondary towns with strong private sectors and non-existent supply

pipeline will also deliver

• Retail

– Central London continues to hit record highs – Upward rental growth now being seen in the “sub 5% towns” – Shortage of large units in good towns represent an opportunity in-town

and out-of-town

• Logistics

– M25, Heathrow and West Midlands remain “core” Conclusions & Challenges for investors in 2011/2

• The recovery will be slow, the challenge will be targeting ‘slow

growth; over ‘no growth’

• Economic and sentiment volatility still an issue
• There is mispricing out there, but some of it can be capitalised

upon

• Prime remains supportable and popular…
• … but it is time to rediscover the joys of Grade B:

–

rental recovery is about to start

–

less investor competition

–

more opportunities to add value

“Two-tier market?”

Agents’ cliché or inconvenient truth?

Residential Property Outlook

Lucian Cook

The Abnormal Equilibrium

• 60
• 50
• 40
• 30
• 20
• 10

10 20 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 00 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11

balance of opinion Supply of Secured Credit Cost and Availability of Funds

i

Supply of credit remains constrained

Source: BoE credit conditions survey

• 8.00%
• 6.00%
• 4.00%
• 2.00%

0.00% 2.00% 4.00% 6.00% 8.00% May-05 Nov-05 May-06 Nov-06 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 3 mth on 3 mth house prices

• 100
• 75
• 50
• 25

25 50 75 100 Balance of opinion RICS Nationwide Halifax Land Registry Source: Nationwide, Halifax, Land Reg, RICS

Prices coming through a second slip

Mortgages affordable for now

6 8 10 12 14 16 18 20 22 24 26 Q 1 2 1 Q 3 2 1 Q 1 2 2 Q 3 2 2 Q 1 2 3 Q 3 2 3 Q 1 2 4 Q 3 2 4 Q 1 2 5 Q 3 2 5 Q 1 2 6 Q 3 2 6 Q 1 2 7 Q 3 2 7 Q 1 2 8 Q 3 2 8 Q 1 2 9 Q 3 2 9 Q 1 2 1 Q 3 2 1 Q 1 2 1 1 Mortgage payments as a % of Income

Interest as a % of income With capital repayments on 5 year fixed rate mortgage

Source: Savills / CML

The Geographical Divide

50 100 150 200

Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Monthly transactions ('000s) UK Mortgage Completions UK Transactions Source: HMRC, CML

A partially functioning market

2010 transactions as a % of the 5-year average to Q307

• 30% to -15%
• 35% to -30%
• 40% to -35%
• 45% to -40%
• 50% to -45%
• 55% to -50%
• 72% to -55%

5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 H2 1982 H2 1984 H2 1986 H2 1988 H2 1990 H2 1992 H2 1994 H2 1996 H2 1998 H2 2000 H2 2002 H2 2004 H2 2006 H2 2008 H2 2010

Mortgage possessions Mortgage possessions Sales of Repossessions Source: CML

Repossessions high in low transaction markets

Possession claims leading to orders per 1,000 households Q1 2011 1.0 & above 0.8 to 1.0 0.6 to 0.8 0.4 to 0.6 0.3 to 0.4 0.1 to 0.3 0.0 to 0.1

Application to London

• 25%
• 20%
• 15%
• 10%
• 5%

0% 5% 10% 30% 40% 50% 60% 70% 80% 90% 100% 2010 Transactions v Pre Crunch Q1 2011 Prices v 07 Peak House Price Islington K and C H’smith & Fulham Camden Newham Barking & Dagenham

Leaders and laggers revert to type

• 16%
• 12%
• 8%
• 4%

0% 4% 8% 12% 16% 20% 24% 28% 32% 1 9 9 5 1 9 9 7 1 9 9 9 2 1 2 3 2 5 2 7 2 9 Annual House Price Growth Top 10% 10% - 20% 20% - 30% 30% - 40% 40% - 50% 50% - 60% 60% - 70% 70% - 80% 80% - 90% 90%+

Source: Savills / Land Reg

Leaders and Laggers Ranking Top 10% 10% - 20% 20% - 30% 30% - 40% 40% - 50% 50% - 60% 60% - 70% 70% - 80% 80% - 90% 90%+

5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 Q 1 2 Q 3 2 1 Q 1 2 3 Q 3 2 4 Q 1 2 6 Q 3 2 7 Q 1 2 9 Q 3 2 1 20% 25% 30% 35% 40% 45%

English New Build Completions % London and the SE

Source: CLG

The development industry response

Greenfield Urban All

• 45%
• 51%

SE

• 35%
• 46%

Eastern

• 45%
• 60%

Western

• 36%
• 53%

Northern

• 61%
• 71%

Scotland

• 47%
• 46%
• 25%
• 20%
• 16%
• 12%
• 8%
• 4%

0% 4% 8% 12% 16% Q193 Q194 Q195 Q196 Q197 Q198 Q199 Q100 Q101 Q102 Q103 Q104 Q105 Q106 Q107 Q108 Q109 Q110 Q1 11

• 120
• 100
• 80
• 60
• 40
• 20

20 40 60 80 Land prices: Quarterly change (lhs) Developer's sales expectations (rhs) Source: Savills Research, Home Builders Federation

The implications for development land

The Sector Divide Deposit issues for FTBs and second steppers

• 20,000

20,000 40,000 60,000 80,000 100,000 120,000 140,000 Q1 90 Q1 91 Q1 92 Q1 93 Q1 94 Q1 95 Q1 96 Q1 97 Q1 98 Q1 99 Q1 00 Q1 01 Q1 02 Q1 03 Q1 04 Q1 05 Q1 06 Q1 07 Q1 08 Q1 09 Q1 10 Q1 11 Deposit 5 year price growth 10 year price growth Source: CML / Nationwide 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 Q1 90 Q1 91 Q1 92 Q1 93 Q1 94 Q1 95 Q1 96 Q1 97 Q1 98 Q1 99 Q1 00 Q1 01 Q1 02 Q1 03 Q1 04 Q1 05 Q1 06 Q1 07 Q1 08 Q1 09 Q1 10 Q1 11 Deposit Income Source: CML

First Time Buyers Home Movers

Valuing Britain - The power of equity

200 400 600 800 1,000 1,200 1,400 1,600 Total Value Stock Total Equity

£bn

16 to 24 25 to 34 35 to 44 45 to 64 65 and over

Source: Savills 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

£ bn 55% 60% 65% 70% 75% 80%

O/S debt Equity in Housing Equity %

Source: Savills / Bank of England

Value of UK Housing Stock 2000 – 2010 (Debt v Equity) Distribution of Owner Occupied Housing Wealth by Age

A new market profile

§ High tier equity rich markets driven by owner occupiers delivering capital growth § Mid-low tier markets include some equity loan, shared equity and co-ownership § Low tier markets dominated by renting amongst the equity poor with returns dominated by income yield

The rise of the rental sector

10,000 20,000 30,000 40,000 50,000 60,000 Q1 07 Q3 07 Q1 08 Q3 08 Q1 09 Q3 09 Q1 10 Q3 10 Q1 11 Increase in no. o/s BTL mortgages

Source: CML

50,000 100,000 150,000 200,000 250,000 300,000 350,000 2 2 1 2 2 2 3 2 4 2 5 2 6 2 7 2 8 2 9 2 1 Increase in no. o/s BTL mortgages UK Increase in PRS households England

Source: Savills / CML / CLG

The Outlook

Overall conclusions

• They are multi-tiered markets – but that is normal
• The last five years has been a period of abnormality
• There still remain many areas of uncertainty. However, the fear we saw

in recent years in the property lending industry has passed

• Lenders have had 2-3 years to analyse existing loan books, and it’s not

holding back new lending ambitions

• The market is reverting to a historical model (1950s/60s/70s) where

higher levels of equity are required

• But that is fine, because the world is awash with equity, including lots of

mezzanine

• Each area of the market is also multi-speed, so it needs to be properly
• understood. Savills ……