Boom to bust for syndicate members

The credit crunch has brought the commercial property market, and the involvement of syndicates, to a halt, writes Fiona Reddan.

WITH THE commercial property market in the doldrums, property syndicates are facing a challenging time. Falling prices, rising loan-to-value ratios and a dearth of transactions mean some syndicate members are facing negative equity and, in some cases, bankruptcy.

During the property boom, the rewards were great. Last October, members of the syndicate that bought La Touche House in Dublin's International Financial Services Centre for more than €82 million in 2002 saw the value of their investment increase when the loan was refinanced by Barclays Capital for in excess of €100 million. The syndicate members shared a €7 million payout.

In January 2005, Quinlan Private sold the Savoy Hotel in London, making an estimated profit of €60 million in just eight months.

Times have changed, however. The global credit crunch has brought the Irish commercial property market, and the involvement of syndicates, to a halt.

"We have seen very little activity for syndicates," says Marie Hunt, director of research at CB Richard Ellis.

"A syndicate would typically require a number of different investors putting money into a deal, but at the moment investors are very nervous of all asset classes, including property. They have also seen evidence in the UK market that values have fallen sharply and, while there is no evidence of that happening here yet, that is their suspicion."

Earlier this month, IIB Bank succeeded in raising €14.2 million from its private clients for two separate property deals in Dublin and Brussels. However, such property transactions are few and far between as investors shy away from the uncertain market. And with banks battening down the hatches, funding sources have dried up and financing of more than 80 per cent is no longer available.

Michael Gilmartin, head of commercial banking with IIB Bank, says the bank's property syndicate deals in Dublin and Brussels were arranged in February, ahead of the recent slowdown, and were able to benefit from financing of 80 per cent and a margin of 1.25 per cent.

"We wouldn't be able to avail of that now," he says. "It would be more like 70 per cent financing and 1.5 per cent margins."

Moreover, as commercial property prices continue to fall, some syndicates have begun to slip into negative equity.

"Investors who entered syndicates over the last 12 months will undoubtedly have seen their investment decline," says Hunt.

But by exactly how much they have fallen is difficult to gauge.

The Jones Lang LaSalle Irish Property Index for the second quarter of 2008 showed that the index was down 9.9 per cent in the first six months of the year. However, the real decline may be greater than this.

"It is extremely difficult to say by how much prices have fallen because no transactions have taken place really in the Irish market in the last few months," says Hunt.

"Commercial property is priced on yield calculations and, as there are no transactions taking place, we have had to call them ourselves, based on sentiment. But investors will only crystallise their loss if they get out now, which would be a really foolish thing to do. Most people will sit tight and ultimately, like the stock market, commercial property will recover, but it will take some time."

For some, however, waiting out the downturn is not an option.

Privately managed syndicates, which often consist of several friends or business acquaintances coming together in an informal partnership to purchase property by putting down the minimum cash deposits, are most at risk in the current environment.

There is "absolutely no question" that some of these investors joined syndicates without realising their full implications, according to Jim Stafford, managing partner of Friel Stafford Corporate Recovery.

"These syndicates tend to be highly leveraged, with investors taking out a second mortgage on their home in order to put a 10 per cent deposit down on a commercial property, which is often in a poor location, without a tenant in place," he says.

Stafford says problems have begun to intensify for such syndicates since Easter, when the credit crunch really started to bite.

In some developments, the loan-to-value ratios have increased above the levels specified in loan covenants and banks have begun to step in to seek additional funds, with syndicate members expected to make up the deficit.

As syndicates are personally guaranteed by syndicate members, these cash calls mean some members are facing bankruptcy, as they do not have the cash to meet the bank's requirements.

And the option of selling the syndicate's properties does not exist in the current climate.

"There is no grey market for these investments," says Stafford. "You can't go on to a market like AIM and simply sell it on."

IIB Bank's Gilmartin points to land deals as being particularly problematic, and says there have been one or two examinerships of land-focused companies. "Some of these syndicates are now under the water and there are refinancings taking place. No one is financing land and it is very hard to get a valuation on it," he says.

Nevertheless, the market has not yet seen much forced selling.

"You won't see many people having to sell," adds Hunt. "You would imagine that by now there would be some distressed selling, but people still aren't under pressure to sell, because they have done very well over the past few years."

Moreover, for investors who are not strapped for cash, as long as the rental income can match mortgage payments, then falling prices are not a major issue. But if property values do not recover, investors may lose their equity investment.

CB Richard Ellis is taking the long view on a return to form for the commercial property market, and expects the market to stay negative into 2009.

"The only difference with this downturn is that we don't have liquidity. Normally, values deteriorate, then hit a floor and then take off again. In this cycle, however, while all the ingredients are the same, you don't have liquidity so it might take longer to come out of the downturn. It completely depends on the credit crunch and the availability of funding," says Hunt.

In the meantime, professionally managed syndicates are changing their strategies. In May, Quinlan Private raised €725 million from Irish, US and UK investors to purchase European property, with the expectation that it would avoid poorly performing markets in western Europe and concentrate up to 70 per cent of its activity in central and eastern Europe.

CMC Capital has reacted to the new economic reality by offering investors 100 per cent capital guarantees with one of its funds, while IIB Bank's recent Brussels transaction also offered investors a guaranteed return. This reflects the fact that investors are not willing to take the risks of previous years.

However, IIB Bank remains in the market looking for deals. Gilmartin says there are opportunities out there and "investors should be a bit bolder".