Stress Test

In the aftermath of the subprime meltdown, how are property-sector CFOs coping?

“We are in the eye of the storm,” says Simon Melliss, the long-serving finance chief of Hammerson, one of the UK’s largest property groups. This particular storm started last summer after the US’s subprime mortgage meltdown, and is battering companies like Hammerson as property values plummet and funding, not to mention investor confidence, dry up. Hammerson’s share price, like those of many of its competitors, has already been hit hard, falling more than 40% over the past year.

But unlike the sector’s last dramatic downturn, which brought developer after developer to their knees in the early 1990s, Melliss says most of Europe’s property companies — contrary to popular belief — are financially fit to weather this storm. “The problems in the 1990s were in the trade and development type of company — buying and selling, buying and selling,” he recalls. “They had overstretched themselves in development, particularly in central London, they had little cash flow and they couldn’t finance themselves.” While he accepts that some property companies “have confused the [recent] bull market with genius” as others have done in previous market booms, he reckons that a big difference between the two downturns is that “in the early 1990s the property industry caused the financial crisis; this time round, it’s the banking world that is causing the property crisis.”

Whatever the cause, it’s not just Melliss who is feeling more confident than one might expect. Europe’s property companies today are large, diversified, less leveraged companies with investment portfolios that provide steady income, according to Tony Key, professor of real estate economics at Cass Business School in London. “Their CFOs are feeling a lot more relaxed than they once would have been,” he says. A report published in December by FitchRatings notes that well before the turmoil began last summer, CFOs’ treasury teams “showed good anticipation” of low interest rates and frothy property markets when carrying out bank refinancing and new bond issues.

Yet most concede that it could get worse before it gets better. A report in May by Morgan Stanley warned that UK banks are poised to “pull the plug” on some highly leveraged property companies. Its analysts believe this will lead to “distressed sales of properties and hence another upward lurch in property yields.” They forecast a further fall of 25% for a basket of European property companies’ share prices, with no recovery until the end of 2009.

Shortly after Morgan Stanley’s report, Moody’s Investors Service declared that “the fundamental credit outlook for the European real estate industry is negative,” with costly, scarce credit “creating a dearth of investor demand and causing property prices to drop.” But despite such bearishness, Moody’s analysts point out that not all parts of Europe’s economy are hit by the US fallout equally, and asset values of the sector’s investment-grade players can still withstand a significant drop over the next year or so without experiencing permanent damage.

So why don’t Melliss and other property CFOs believe that they will see a repeat of the 1990s downturn? Stronger balance sheets, for one. Gearing at Hammerson, for example, is in a “comfortable” 50%-to-60% range, says Melliss, while the firm’s weighted average maturity of debt is approximately nine years. What’s more, as of the end of December, the firm had access to more than £3 billion (€3.8 billion) in cash and other facilities.


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