Jeremy Warner: Commercial property takes a terrible bath

Outlook A couple of years ago, when it looked as if we were app-roaching the top of the cycle, I asked a number of property companies how they expected to cope in a downturn. Remember, many commercial property developers had been completely wiped out in the recession of the early 1990s.

The mass insolvency of the property world was neatly summed up by the then chairman of the British Property Federation who, introducing his guest speaker at the annual dinner, Andrew Buxton of Barclays Bank, asked members to bid a warm welcome to a man "to whom we owe more than we can, er, ever repay". It was a good joke, the more so as it was absolutely true. It was commercial property lending, not asset-backed securities, that nearly sunk Barclays in that downturn.

Yet this time around, it was all going to be so, so different. The property world had learned from past mistakes, companies were well financed, speculative development had been kept to a minimum and tenants were locked into long-term leases. Of course, it hasn't worked out that way, and we are now seeing a string of distress rights issues across the property sector.

What went wrong? Most of the above was in the round largely true, but nobody had banked on the severity of the downturn, which according to Francis Salway, chief executive of Land Securities, puts the early 1990s in the shade and is possibly the worst peace-time fall in commercial property values in nearly 90 years. Figures from Investment Property Data Bank show that, over the past 18 months, commercial property has crashed nearly 38 per cent. Property derivative markets point to a peak-to-trough decline of some 55 to 60 per cent.

These are extraordinary numbers which even worst case-scenario planning had failed to anticipate. The commercial property bubble of two years ago was obvious to all, particularly in London. Everyone knew it had to end. There was also general resignation to the likely fallout of a recession – insolvent tenants, vacant properties and falling rents.

But nobody had anticipated the extent to which credit to the commercial property world would be switched off. In any case, many banking covenants are based on loan-to-value ratios. Most of these looked hugely conservative two years ago. Lots of them are now perilously close to being breached.

The possibility of a firesale of assets and a vicious downward spiral in prices is only too apparent. Those who can are therefore moving fast to tap equity markets for more capital in the hope this will protect them from further downside and enable them to take advantage of the weakness of others as the cycle bottoms out. Land Securities managed to get a £755.7m rights issue away relatively easily yesterday, though the massive, 50 per cent-plus discount plainly helps. Others may not be so lucky.