The most positive remark in this article is about Bectonbut no...

The most positive remark in this article is about Becton
but no one wants to know


COMMERCIAL property is feared by the International Monetary Fund to be the biggest threat to the fragile world economic recovery.

It was a concern shared by the Australian government at least until the middle of the year. However, there are signs, locally, of the patient arising from its death bed. The Commonwealth Bank's property manager, Peter Barnes, commented last week: "There may be different sectors that will see more drop in values but the worst is over."

The listed property trust index has risen 75 per cent from a catastrophic low of just 550 points in March to 950 points, far outstripping the 50 per cent rise in the overall S&P/ASX index since then.

True, the property index had fallen much further and still sits 60 per cent below its 2500-point peak of mid-2007, but a number of trusts, including Stockland and Mirvac, are trading above their (much reduced) net asset value.

There are other vital signs. Macquarie Capital real estate strategist Rod Cornish says yields in the Sydney and Melbourne markets have either reached or risen from their trough. There has been a fall in the number of sub-lease properties on the market as tenants become more confident they can use the space.

Finance is starting to trickle back to the sector. The shopping centre manager, Macquarie Countrywide, last week issued $265 million in commercial mortgage-backed securities, the first such issue in two years. The listed trust sector raised $10 billion in fresh equity capital since the beginning of the year.

Louis Christopher, property director with Adviser Edge, says property trusts looking to acquire properties are getting more offers from their banks than they were, although it is all still expensive. He says the flow of funds from financial planners into the property trust sector is starting to revive. There are the first glimmers of takeover activity.

"At the beginning of the year, it was looking as bad as the early 1990 fall, but the problems are now not going to be that bad," Mr Christopher said.

The Reserve Bank's recent review of Australia's financial stability reported that commercial property was leading the rise in bank bad debts, with 4.5 per cent of their portfolio at least 90 days overdue on interest, up from just 1.5 per cent at the beginning of last year. However, this was much less than during the 1990s recession, when bad commercial property debts destroyed the state banks of Victoria and South Australia and nearly brought down Westpac.

It was the prospect of commercial property going into a tail-spin that was behind the venture known as "Rudd Bank", which intended to forestall fire sales of commercial properties caused by foreign banking partners in syndicated loans refusing to roll over their participation when loans fell due.

Jointly owned by the government and the big four banks, the venture was to have up to $30bn to spend.

The concern was that more than $70bn in commercial property loans would require refinancing before the end of next year, most of it syndicated debt. Foreign banks had been taking 60 per cent of syndicated debt and there was worry they would pull out. The venture was voted down in the Senate in June.

The Reserve Bank's financial stability review reported that the foreign banks have indeed cut back their exposure to the sector. However, the retreat has been effected by not originating any new deals, while their existing client base has been maintained.

There has been a handful of property groups go to the wall because of the banks' refusal to roll over debt, of which the Allco affiliate, Rubicon, which had raised $870m from investors, is the most notable. However, more generally, the banks have seen it to be in their interest to support their existing commitments.

This is a very different perspective to the one portrayed by the IMF in its reports on the global outlook last week, where commercial property was described as the biggest threat of a double-dip recession.

"Leveraged commercial real estate investors are likely to face difficulties in refinancing the loans that are coming due, and soaring delinquencies therefore have the potential to create a second wave of financial distress in exposed financial institutions," the fund said.

"The commercial real estate sector turned later than other sectors, but its deterioration is now in full swing.

"Rising unemployment and vacancy rates, falling property prices, and tighter lending conditions are contributing to distressed sales and delinquencies in the US, UK and Europe."

In the US, prices are down 40 per cent and still falling, compared with a 27 per cent fall in 1987-92. The IMF forecast that defaults would more than double from the present level of 7.9 per cent of all real estate loans.

Australia's commercial property market is still depressed, but there is no longer that sense of impending doom. Cornish says that in Sydney, office vacancies have risen from 5.7 to 8.8 per cent. However, they do not look like rising much higher.

In Melbourne, vacancy rates have barely moved, standing at 5.9 per cent. Cornish says vacancies will reach double digits in Brisbane because a lot of construction was started at the peak of the boom, whereas there is little new capacity coming on stream in Melbourne or Sydney.

During the five years to 2007, office rents soared by 180 per cent in Perth and 230 per cent in Brisbane, whereas Melbourne went up by only about 20 per cent and Sydney 50 per cent in that period.

Property owners are offering incentives to attract tenants, with the effect of lowering effective rents by about 27 per cent in Sydney and about 11 per cent in Melbourne. Cornish expects them to fall further in Brisbane.

No major prime office property has changed hands in Sydney since the crash, so it is hard to get a fix on the yield. However, analysts do not expect it to rise above about 7.5 per cent, against expectations earlier this year that it would top 8 per cent.

Meanwhile, residential property developers are going gang-busters. Two weeks ago, Becton took offers for land in a mixed public and private housing development at Bonnyrig, in Sydney's far west. This is the territory that the Reserve Bank has portrayed as the most troubled corner of the Australian residential real estate market. Becton's bankers were demanding 80 per cent pre-commitments, but the 100 lots sold out entirely within days.