One of the most critical components of a downturn in property values is a fall in liquidity. Bank lending has been the largest component in market liquidity for a long time in the UK, usually leading institutional investment and independent equity (frequently from overseas investors, but often with a component of bank loans involved). So a decision to ‘ turn off the tap ‘ by banks is a major factor in a market turndown, as well as an accelerator of a fall in values.
This may seem an obvious statement, but few appreciate all the reasons for this, particularly the banks themselves. Banks tend to see themselves as ‘ lenders to the property market ‘ rather than realising that they are an integral part of it. Their actions affect not only other players in the market, but often also harm themselves.
Before the creation of APB, I would regularly address meetings of creditor banks to point out that precipitous action in liquidating property companies would harm the market and cause presently secure loans to become risky. On one occasion, a colleague pressed me back in my seat as I rose to speak and announced “Can we take it as a given that Richard has made his ‘responsibility to the market ‘ speech ?”.
It was then that I decided I had to go ahead with the creation of APB – an idea that had been in my mind for years. If the message had become routine – and therefore in danger of being ignored – another way of making it had to be found. Whilst there were a number of reasons for starting the Association of Property Bankers, one of my intentions was to make the banks understand their involvement in property markets and therefore to consider carefully their actions when fuelling a boom and exacerbating a crash. It has to be said that I have failed, but I still live in hope.
So what is it about ‘ turning off the tap ‘ that causes problems ? Consider these reasons:-
It makes new purchases difficult .
The obvious one. It is what most people think of when one talks about liquidity and severely restricts what Economists call ‘ real demand ‘. Less credit available means less organisations able to buy property investments or owner-occupied property.
Banks finance both supply and demand.
The often forgotten one. Buildings are primarily a factor of production and have a secondary function as an investment product. Before banks face financing the purchase of them as an investment, they finance their construction and also lend to the companies that wish to occupy them. A halt to new building arising from a restriction of available finance may eventually help counterbalance a downturn in values, but any cut-back on general lending immediately affects the ability of occupiers to take new space and may even threaten their ability to pay for the space they already occupy. Tenants going out of business is not uncommon in a recession, affecting returns and undermining confidence in the commercial property sector.
Borrowers are unable to refinance existing loans.
The generally unappreciated one. Most commercial property loans are for 3 to 5 years and sometimes 7 years. When they reach maturity, the borrower can find the bank is unable/unwilling to renew the loan and alternative sources of finance are unavailable. This can force investors to sell at the weakest time in the market and perfectly stable property investment companies can become vulnerable. Furthermore, since past increased market activity produced a lot of new lending, loan maturities can come in large clusters, forcing a lot of property on a market at a time when there are few purchasers, tipping a falling market into periods of freefall.