ECONOMIC MADNESS: The commercial property balloon

It would be hard to imagine a more dangerous investment: here is a type of property which (apart from a few engorged egos buying ‘trophy’ buildings right at the top end) finds itself threatened by very high local taxes, a depressed retail economy, and the arrival bigtime of the internet as a cheaper and more convenient way to buy than physical shopping.

But the institutions allegedly looking out for your future pension are piling into this investment sector as never before: even though the signs – throughout the EU – are of an enormous balloon about to be pricked with a loud bang.

Let’s start with beleaguered Ireland. In Dublin is the site of the former Irish Glass Bottle factory. The 24-acre docklands plot, which before the bottle factory arrived served as Dublin’s main municipal waste tip, was bought in 2006 for €412m (£355m) and earmarked for a swanky development of up-market apartments and glitzy shops. Investors were promised the city’s future “best postal address”.

Today this stretch of wasteland is officially valued at €60m.

And so on to England. At the height of the retail property boom in 2006, Shrewsbury’s shopping centre was sold for £118m with only six of its 135 units lying empty. Four years on, 29 units are empty in Shrewsbury’s centre.

It was sold last month at a price roughly half of the 2006 figure.

In the UK, negative equity is widespread in the whole of the commercial property sector. Industry estimates suggest it could be as much as £50bn. Property consultancy Savills thinks that represents 25% of the entire lending book of UK banks.

And you’re still wondering why UK banks aren’t lending?

Mark Rawstron, regional senior director of GVA Grimley, says:

“The subject of empty rates and the rating system as a whole remains a political hot potato. Labour has pledged to maintain the existing empty rates tax, which is a damaging move. The belief that a tax on empty property will encourage proprietors and owners to let more space has proven to be incorrect. In reality, it just stifles development and regeneration.”

Talk to anyone in the on-licence trade in Britain, and they will tell you that brewers simply cannot get publicans to take on pubs. A combination of high business rates, severe drink-driving laws and recession make almost any undertaking a non-starter for the pub entrepreneur.

But throughout metropolitan Britain and corporate Europe, the go-for-its are busy chucking vast amounts of speculative money into the sector. And the mood is one of ridiculously unfounded hysteria.

MERJS, one of London’s leading commercial property letting agencies represents a classic example. Get this release from one of the sector’s leading websites last week:

‘Colin Becker, Equity Director for MERJS, said “We are delighted to announce this successful letting to RelianceMedia, demonstrating that contemporary Soho office spaces are still in demand amongst media companies….It’s a fantastic, lively location, right in the heart of the vibrant Soho area, “The Reliance Media staff will be spoilt for choice in terms of restaurants as there are so many nearby”. It’s all a bit breathlessly 1980s…yet with no discernible boom data to underpin it.

In mainland EU Europe, there is now a 3:1 ratio of capital chasing available product. Large, multi-country portfolio deals went gangbusters in 2010’s first quarter, with Corio agreeing to purchase a shopping centre portfolio in Germany, Spain and Portugal (developed by Multi-Corporation) for 1.3 billion Euros. Unibail Rodamco acquired a 50% share of a trans-Europe shopping centre portfolio for 715 million Euros.

It’s all very well for cash-rich conglomerates to buy into a sector that’s going nowhere except down the toilet. But when pension and assurance providers start doing the same thing….well, you know two things are coming: balance sheets riddled with sub-prime retail business loans; and credit default swaps backed almost entirely by worthless retail property as security.

Take the Munich-based insurer, Allianz. In the first three months of 2010, it has been one of the most active investors in retail schemes and property developments. Why? Who are these people telling their managements that, under a dark, cool and cloudy sky, they should be buying bikinis?

Fund managers are increasingly active, once more targeting new ground-up builds with freshly raised capital. Which person in their right mind today has failed to notice the Western household pulling in its horns, repaying debt, and steadfastly refusing to play ball with a capitalist economic form totally reliant on unaffordable debt for growth?

One thing, however, is for sure. Come the implosive collapse, the corridors of Westminster, Brussels, Moscow and Washington will be inundated with politicians swearing blind that these outcomes were unforeseeable.

And the syndrome really as widespread as those varied capital cities suggest. Russian banks in particular have balance sheets weighed down with bad debts secured by massively overvalued retail and corporate properties from the boom years. And the retail collapse in the States looks set to be even more punishing than here in the UK.

What is it about Homo sapiens, I wonder, which allows it to believe that only when the train has left the station is it time to start speculating in tickets for that journey?