Don’t even think about buying without 30%-plus deposit.
Bank credit policies are knocking commercial property players, from developers and building suppliers to brick-layers. Gordon Winning, explains why real estate owners can expect more conservative market values and why it is getting harder to sell.
Interest rate volatility
The prevailing macro-economic conditions suggest a slow down or a bottoming out of this downward cycle. The Reserve Bank recently announced a stay on the “repo rate”. Over the past 18 months we have witnessed extreme volatility in the bank’s prime interest rate, which up to this point has always been a key factor in the values of commercial and investment properties. With this volatility the commercial markets could hardly keep pace with the frequent changes occurring. No sooner had an Offer to Purchase been made when a change would alter the mind set of both the purchasers and sellers in the market. These interest rate peaks and valleys have recently resulted in a change in attitude to deriving value solely through the level of the banks’ prime lending rates.
Big deposits
Coupled with this, banks are now erring on the side of extreme caution, with significant increased levels of equity expected from the borrowers making it necessary to have some 35% of the bank’s value in the form of a deposit in order to procure the appropriate finance to acquire a potential investment commercial, retail or industrial property. This is now uppermost on the minds of buyers. The propensity for a buyer to commit to a deal is, as a result, adversely affected. The market value and the past means of determining reasonable or market value is lost in the negotiation process. The market at present does not have a definite formula for setting price and although the interest rates are a factor it is now not the only area of determination. Deals concluded vary from property to property.
Higher-than-normal cap rates
Hence, the numbers recorded for sales in the industry are plummeting. When deals are concluded they are for considerations at levels higher than the normal capitalisation rates. Capitalisation rates (or the “cap rate”) is the measure of the ratio between the net projected operating income produced by an asset (usually property) and its capital cost (the original price set to buy the asset) or alternatively its current asking/market price.
As a result, so more brokers and valuers are providing more conservative market values to property owners.
It would appear through our activity in the market that the expected cap rates are swiftly moving to a level equal to 100 to 250 basis points above the minimum banks’ lending rates for commercial property purchases (1% below Prime). In other words, this means with the minimum lending rate by the banks at 10%, the expected cap rate would be between 11% and 12.5%.
Factors such as position, condition, tenure, returns and available equity are the driving forces in the market. Buyers hold all the aces at present.
Cap rates will remain important because the market is driven by money invested and an expected level of return linked to borrowing rates. However, as the circumstances and the economic environment changes so does the demands for a changing formula to purchasing of commercial or investment property.