The next landmine could be the property world’s debt deadlines

What is commercial property? An investor who bought up London several years ago called it “dreadful.” “Everybody’s risk-off. Static capital markets will exist, and I doubt anyone from the main lenders will write loans. There is a serious level of nervousness; nobody knows who they can trust.

The common question is “What will the next thing go bang?” Rapidly rising interest rates have caused crises in various parts of the financial system. This includes the liability-driven investments (LDI) that exploded in UK pension funds last Oct; and Silicon Valley Bank (SVB), this month. Credit Suisse was then shattered by shock waves following the collapse of SVB. They were swirling around Deutsche Bank, and other regional US lenders like First Republic Bank, late last week. What are the next landmines?

The margin calls, which resulted in the crystallisation mark-to-market losses on bonds government bonds, caused the LDI/SVB crises. They have plummeted from their lowly values due to rising rates.

Tightening credit conditions, drops in asset values against which loans are secured and other forms of margin calls could cause the next episode of distress. Refinancings are the trigger points. These are moments when a borrower must ‘fess up to what an item is really worth and see how a banker will lend it today.

These types of situations are more likely to occur in the unquoted space where private equity firms and others have invested huge sums of leveraged capital into low-yielding assets.

One good example is property. The warehouse or office building looked good when government bonds yielded almost nothing, and real estate was giving off 3 percent — and money wasn’t much. The bet could quickly go sour if the total cost of money spikes to around 8 per cent. Because the building is less valuable, rent may not cover new interest payments. The lender might also be cautious and give you a lower loan to value ratio for a lower valuation.

The prices have fallen by around 20% since their peak in various sub-sectors of the property market. This is a terrible reality that you don’t have the option of facing until refinancing makes it inevitable. Then, you realize that there is a gap between the new and old debts that must be repaid. You need to add more equity.

AEW has done some calculations on the extent of Europe’s problems. It estimated that there would be a gap of EUR24 billion (£21.1billion) in equity and expensive substitute debt in Europe over the next three-years. AEW increased that figure to EUR51 billion in January as money costs continued to rise.

The banks are much more resilient than they were during 2008-9, the last property crisis, and they have lent less in the past few year than they did in 2008. Last week, the Bank of England stated that forbearance would likely limit instances of keys being taken back and buildings being sold at bargain prices.

Despite this, banks were able to make bad loans disappear in the wake of the financial crisis. Real estate agents used the phrase “Extend and Pretend” a lot. Rate pressure will make it harder for them to hide this time. Lenders have other concerns about commercial property. Retail has been a disaster for many years, and there are growing worries over every office due to the WFH shift as well as the looming environmental regulations. In the tech boom, logistics assets (or “sheds” as they were used to be called) were selling at large prices. Latecomers may get burnt.

Property is an example I chose because I am familiar with the industry, having spent years writing about the Ronsons or the Sellars. These dynamics also apply to other areas in which leveraged assets purchased near the top end of the cycle face repayment deadlines. LDI, SVB were liquidity and investment crises. More old-fashioned refinancing crunches could be the next catalyst.

They will they have an overall impact on the system? This must be the central question.

Sir George Buckley accepted the lifetime achievement award at Thursday’s NED Awards ceremony. He said that business is like a Darwinian struggle. The bad news is that the winner gets your job.

This was a much more pertinent observation than most of the audience realized. Our Darwinian battle is between the FTSE (and the rest), in particular the US stock market, and private equity. The winner will have your companies and your talents. Smiths Group, the industrial conglomerate whose chairman is Buckley, is an example. There are higher valuation multiples in New York. This has attracted much attention. Pay is an important part of the equation. FTSE boards are disappointed by their inability reward top performers competitively. Investors are often guided by proxy voting agencies like Glass Lewis or ISS and, therefore, fearful of headlines. They shy away from large packages and those that depend on delivering high returns.

Smiths failed last year to reach a deal that would have allowed Paul Keel to earn up to £10million over five years to double the £6 billion market capital. Partly, Keel joined to work alongside Buckley, an industrial icon. Buckley, now 76, will likely retire from Smiths within the next few years. The US suitors may make Keel more open to poaching efforts after that.

Similar positions have been found in other FTSE companies for top talent. London is also falling behind in the Darwinian battle between stock exchanges.