British Land warns credit crisis is spreading to commercial property

The sub-prime crisis is slowly spreading to the commercial property market, the chief executive of Britain's second-biggest real estate company warned yesterday.

Stephen Hester, of British Land, said that while his company had posted strong results for the second quarter, investors in the sector had become increasingly anxious about the impact of a liquidity crunch on credit markets.

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Mr Hester warned: "We are in a period where investor concerns on the macro-environment are reflected in industry stock prices but not, to date, in actual business results."

British Land said yesterday that its net asset value per share rose 3 per cent during the second quarter, with the company posting underlying profits up 7 per cent to £76m. However, while Mr Hester said the company's investment returns were ahead of the average figure for the commercial property market, British Land has been unable to escape negative sentiment towards the sector, with its shares down from a high of above 1,700p in January to 1,206p last night.

British Land's trading update followed figures published on Wednesday by the Investment Property Databank, which warned the sector was at its most depressed for 12 years.

IPD said the average commercial property investment recorded a total return - combining capital growth and rental income - of just 0.2 per cent in July. It warned that property revaluations lag behind actual sales by several months, suggesting the sector's problems may not be fully reflected in company results before the end of the year.

Even before the current sub-prime mortgage crisis, shares in commercial property companies had fallen sharply this year. The valuations of companies that took advantage of new regulations enabling them to convert to real estate investment trust (Reit) status on 1 January initially rose, but the sector is now 30 per cent below the high-point recorded at the beginning of the year.

Analysts now fear a serious slowdown in the sector as property companies find it increasingly difficult to borrow to fund new investments.

Much of the boom of the past five years has been fuelled by cheap borrowing. Figures from De Montfort University show debt secured on commercial property rose from £49.8bn at the end of 1999 to £172.5bn by the beginning of this year. However, the sub-prime crisis threatens to choke the supply of borrowing, and the cost of the debt that is available has already risen above the yields available on property. The average yield in the sector has fallen to a little over 4.5 per cent, while the cost of borrowing is now running at above 6 per cent.

"Property shares have clearly not been a safe haven in recent months - the sector has in fact been one of the most volatile," a report published by Merrill Lynch warned. "The correction in equity and debt markets signals that investors are increasingly focusing on risk as a key investment consideration."