To mark the 10th anniversary of the collpase of Lehman Brothers next week (September 15th 2018) here is an edited extract from BOOM, the first chapter of my book, Planet Property, published in 2013. It begins with a not-quite-so-jokey-now quote taken from the side of a mug distributed to clients by Harvey Soning, a well-known figure on the London property scene. Hindsight sometimes sharpens forsight. Read what was going on between 2005 and 2009. Spot the similaries and differences with present day behavior.
Planet Property begins…
“Dear God, just let there be one more property boom.
I promise I won’t piss it all away this time” – Harvey Soning, property veteran
Let’s start with a yarn from John Rigg of Savills, a tale too good to check. Picture the scene: it’s January 2007, and an American-born property financier employed by a global bank in London is lazing on a Caribbean beach. Let’s call him Hank. His mobile tinkles, and a glance at the screen reveals it’s his feckless brother Art calling from California. Hank answers, expecting to be dunned for another handout. Instead the out-of-work actor gives his sibling some “great news”: he’s bought a house. “How the hell did you manage to raise the money?” asks Hank. “Easy,” Art explains: “The broker got me a hundred percent mortgage.”
Passing over the obvious question – how you qualify for a mortgage without having a regular job – the puzzled banker moves on: “But you don’t have a steady income to make the repayments.” “Oh, that doesn’t matter,” answers Art insouciantly, “I’m not going to pay. The broker said it would take them at least nine months to evict me. Which is great – I get to live rent-free till fall!” he laughs, adding: “All of my friends are doing the same.” At this, banker Hank jerks upright on his lounger, alarmed. “Why are you telling me this?” he asks. “Well, I thought you might like to know,” says Art. “Your bank is providing the loans.” The great property bang of 2007–2009 began with whispers such as these.
SUB-PRIME? WHAT’S SUB-PRIME?
Alastair Hughes, then chief executive for emea at Jones Lang Lasalle:
I did a TV interview with a US-based financial channel at MIPIM in March 2007. I was told the first question was going to invite me to canter round the European property markets, so I didn’t feel particularly nervous. Instead the first question was: “No doubt you’ll have noticed yesterday there was a meltdown in the sub-prime market in the US. What implication will that have for European property?” I had heard the word “sub” and I had heard the word “prime”, but never in that order.
So I started drivelling on about the market, saying that as it stood it felt okay because there was quite a lot of demand and no supply. She said: “Yeah, but sub-prime: what impact?” I still hadn’t worked out what the hell it was, so I answered a different question. She asked for the third time, by which time I had worked out sub-prime wasn’t a good thing, and I could easily have said: “Ah, it will just wash away” – and would have been horrified to see that over and over again, given the fact that it kind of broke the world in half.
I think I managed to say: “Well, anything that affects America will eventually affect Europe. But here and now…” and went back to my script. So I just about got away with it, but it was a pretty alarming moment. I then spoke to a lot of people that day and evening to check I hadn’t missed something. And I would say eighty percent of the people had never heard of “sub-prime”. And the twenty percent who had heard of it thought it was something to do with lending too much money to Hicksville, America, to buy trailers.. That was the first time I remember hearing little alarm bells.
On 11th June 2005, a leader in EG – where I was then editor – took its lead from that raised eyebrow at the Bank of England as well as from a more explicit warning given by William Newsom, head of valuation at Savills.
Clear and present dangers exist for banks and valuers: for banks, the danger is lending on value, rather than price paid… an issue that comes into focus this week because the head of valuation at Savills has criticised banks for incautious lending in a market where prices may have peaked. The practice is an old bull-market game. The over-friendly valuer calls the open market value of Fawlty Tower at £20m. The over-clever buyer will say to his bank, “I’m doing an off-market deal and only paying £18m.” The overanxious lender will write a cheque for 90% of £20m – 100% of the £18m purchase price.
Last year, UK banks increased lending by 48% to £44bn, according to a study by De Montfort University. This year, 95% say they are “seeking to increase” the size of their loan books. Are they completely crazy?… There is a collective madness at work here: a madness driven by a desire for market share, a madness rooted in bankers’ bonus systems that reward the volume of money lent rather than the performance of the loan. Will this madness evaporate? Eventually, yes. But the sheer weight of money bearing down on the sector, means sanity may return later rather than sooner…
In 2006, the warnings intensified but continued to be ignored – even one from Hank Paulson, then boss of Goldman Sachs and later to become, as US treasury secretary, the man charged with cleaning up the mess. In April 2006, he warned Goldman bankers to curb their enthusiasm for property. Conversations with agents and developers during the spring of 2006 took on a darker tone; worry over escalating prices began to be expressed by many, but not in public. This EG leader published on 22nd April 2006 reflects that private mood:
Darker and Scarier
The accelerating rise in capital values, as tracked by the Investment Property Databank indices, has seen sentiment shift from bemused but grateful acceptance last autumn to a darker and scarier feel of an investment market now detached from the reasonable view that markets go down as well as up.
IPD judged in the month of March that capital values rose by 1.6% across its £40bn balanced universe of commercial property. Compound that up for the next nine months and you get a 15.5% rise on top of the 3.1% in the first quarter. In other words, capital values could rise by nearly 19% in 2006.… Now, that 19% figure is not a forecast – simply an extrapolation.
But the rise does look likely to again confound the 37 forecasters from the Investment Property Forum who, on 18 February, had a consensus forecast for capital growth in 2006 of 5.7%.… But it is not hard to hope that the IPF forecasters turn out to be right. If only because continued yield compression is also becoming a source of fear rather than wonderment.
The Jones Lang LaSalle prime yield figures published on 8 April showed the all-property yield at a record low of 4.71%. The office prime yield has fallen from just under 6% to around 4.75% in 12 months; sheds are down from 6.5% to 5.5%; and retail from 5% to just under 4.5%… there is talk in the retail sector of parks being offered at yields of 3%.
Is the world going crackers?… Yields have fallen so low it is more profitable to stick the money into an Abbey e-saver account, which currently yields 5.05%. Will capital values continue to rise? Nobody, frankly, has a clue. But it does not require much detective work to discover the prime driver: the lending banks. Only when they curb their enthusiasm for property will the acceleration of values slow. Right now, there is not a sign of that happening.
Few showed much wit over the coming year, with the exception of DTZ’s head of research, Joe Valente. On 28th June 2006, its annual Money into Property research was presented to three hundred clients over lunch at the Dorchester hotel. Valente revealed that UK purchases in 2005 had outstripped sales by £70 billion, triple the gap in the previous year – meaning that £70 billion of additional debt and equity had been raised to buy property in a single year. “Is this a bubble?” asked Valente rhetorically of a startled audience. “No,” he concluded. “But it’s the top of the market.” The DTZ researcher, who later went on to work at JP Morgan, rather spoiled the moment by adding, “At the moment, we believe investing in property is risk-free.”
Francis Salway, chief executive of land securities 2004–2012
I think the danger signs came in 2006. There were one or two instances where people failed to sell high-profile assets, and then re-financed them at very high loan-to-value ratios. That to me was quite a warning sign. What that tells you is that the market has shown there wasn’t a buyer at that price. But the banks still advanced even higher loans, as though there would be. So owners were able to take out an awful lot of capital through refinancing, even though they didn’t deliver a true sale.
During 2006 we were aware that we were finding it increasingly hard to find value in the market. We couldn’t find many properties that would generate a return above our cost of capital. We began to sell a bit. But we were holding back on a number of sales until the REIT legislation came in in January 2007, which would remove capital gains tax liabilities. In the first quarter of 2007, we started selling some secondary retail warehouse assets.
What came over was that investor demand was weakening and pricing was already falling away. So we sold at ten to twelve percent below book valuation, when the indices were saying the market was still rising. We also sold Devonshire House in Mayfair, which used to be Land Secs’ headquarters. That went for a yield of under four percent. And we sold a shopping centre we had just completed in Canterbury for a yield of just over four percent. We certainly made some good sales.
Chairman Peter Birch and chief executive Francis Salway struck a more cautious note in a joint statement accompanying the 2006 interims: “After an extended period when buyers of commercial property investments significantly outnumbered sellers, we are moving closer to equilibrium conditions, with less parties bidding for investments and an increasing number of properties being marketed for sale.
JANUARY 2007–AUGUST 2008: DOWN A STEEP’NING SLOPE
The first real distress signal had come in May 2007, with a sign that showed trouble had been quietly brewing throughout the previous year. Bill Maxted of De Montfort University published a survey of bank lending showing that the value of loans in breach or default had more than tripled between 2005 and 2006, ballooning from £1.2 billion to £4.2 billion.
Buyers soon started smelling a rat: on 11th August 2007, it was reported in EG that institutions had begun to “lose faith” in the values put on properties being offered for sale. The FTSE 100 index plunged seven hundred points that month, before recovering. Pension and life funds started to withdraw from the market. Frustrated agents reported that the UK’s largest property fund, Prupim, was “stalling, chipping or pulling out of deals and bids”.
In early November, DTZ director Robert Peto decided to speak out. The occasion was the Royal Institution of Chartered Surveyors valuation faculty annual conference at the Royal Society of Medicine, north of Oxford Street.
Robert Peto, director of DTZ:
The defining moment of my career was in November 2007 at the annual RICS valuation conference in London. As head of the RICS valuation faculty, my job was to tell valuers what I thought we were facing. I unloaded both barrels and said, “Guys, you are bringing us into disrepute. If you go on ignoring what’s actually happening in the marketplace, everybody will be the loser.”
I said values had fallen by at least ten percent since the summer and not the 2.5 percent being reported by the Investment Property Data-bank. I said it has to be at least ten percent. Did I believe it was ten percent? No, more. But there was a degree of politics involved. If I’d said the fall from the summer was twenty percent – which it probably was… You will lose your credibility if you take an extreme position; people will just think you are a bit of a loony.
What then happened to Bear Stearns jolted that confidence. The eighty-five-year-old US investment bank unravelled and collapsed between Monday 10th March and Friday 14th March – coincidentally the week of the MIPIM property jamboree in Cannes. Each year at the fair, Harvey Soning of James Andrew International holds a jammed party at the Majestic Hotel. That year, the property veteran gave me a mug emblazoned with the following prayer: Dear God, just let there be one more property boom. I promise I won’t piss it all away this time.
For Ian Marcus, the collapse of the American investment bank was his “Oh, shit!” moment. The head of real estate banking at Credit Suisse at the time says that “the writing was on the wall when Bear Stearns went in March 2008. Because there were enough organisations run in a similar style that you sort of think: unless they were complete crooks or completely stupid, neither of which is the case, then why should this just be a one-off?”
Alastair Hughes, then chief executive for emea at Jones Lang Lasalle:
We started out 2008 with reasonable optimism; by the end we were very pessimistic. For me the big turning point was MIPIM in March 2008. All the European property industry went there thinking it was one of these things that we just shrug off. We came back from that really worried, because MIPIM was full of bankers and Bear Stearns visibly shook them. Several bankers told me that this was really serious. I’m a member of an investment agents club; we invited some top investment banking people along and we just sat there in stunned silence as this very senior guy just quietly explained what the implications were.
Martin Gudgeon, head of restructuring at private equity giant Blackstone, said: “There are early signs of distress coming into the real estate market.” The banks began to get tough. More and more loans were falling into default as prices declined and loan-to-value covenants were breached. The wholesale transfer of well over £100 billion of land and property into the hands of the banks commenced in earnest in May 2008.
Schemes started to be shelved. In August, British Land announced that the seven-hundred-and-forty-foot Cheesegrater skyscraper at 20 Leadenhall in the City of London would be put on hold until 2012 – an accurate forecast by chief executive Stephen Hester, as it turned out. Right next door, the owners of the site of what was intended to become the City’s tallest tower – at nine hundred and forty-five feet – admitted they couldn’t persuade anyone to lend them the necessary £600 million: consequently the Pinnacle remained stalled until late 2012.
SEPTEMBER 2008–JUNE 2009: OVER THE CLIFF
The real “Holy shit, we’re doomed” period began with the fall of Lehman Brothers in September 2008, ending when the market finally touched bottom in June 2009. During those nine scary months, values fell a further twenty-six percent on top of the twenty-four percent fall between July 2007 and September 2008. That’s a monthly average decline of 2.9 percent – the fastest and steepest collapse in living memory, and almost double the monthly fall of 1.7 percent over the preceding fifteen months.
Gerald Ronson, chief executive of Heron International:
We were looking at Armageddon in the last quarter of 2008. If you were sitting on cash, you were scratching your head and saying: what bank is safe? So there was a rush here to open lots of new accounts – with Deutsche Bank, with JP Morgan, and with a whole range of banks. We’re not a big company, but Heron had something like £140 million of cash, and I suppose my family office had not too dissimilar a sum.
At that point, I was thinking to myself: we don’t want more than
£5 million and a maximum of £10 million with any one bank. Then of course you’ve got the people who owed the banks hundreds of millions of pounds. Some of them thought that that was the bank’s problem, not theirs. I spoke to some of them, saying, “You don’t seem to be particularly worried” – to which their answer was: “Let the f***ing bank worry.”
Lehman Brothers filed for bankruptcy protection at 1.45am on the morning of Monday 15th September in a New York court. Less than twenty-four hours earlier, Bank of America had rescued Merrill Lynch when the latter was teetering close to bankruptcy – a situation for which the drop in value of Merrill’s real estate mortgage portfolio was blamed.
Ian Coull, deceased, then chief executive of Segro:
The week of 15th September 2008 was the most extraordinary week of my life; I happened to be in New York at a property conference organised by Merrill Lynch. Lehman’s had gone bust; Merrill was taken over by Bank of America; AIG very nearly went bust. The financial world felt it was in meltdown.
There were fifty or so property company chiefs at Merrill’s offices over two days, along with a hundred or so investors. The mood was one of total amazement at the speed of events. I came down for breakfast and saw an American real estate guy I knew and said: “Have you seen the FT this morning?” He said: “No, I’m not interested in that; it’s yesterday’s news.”
Every hour there was a new revelation that just shocked us. People were feeling suicidal. Everybody had travelled to the New York conference feeling we were through the worst – then suddenly these cataclysmic changes were occurring. I sat on a couple of panels;
I talked to a lot of investors who were also shocked at what was going on. People were shell-shocked that week.
Nick Thomlinson, then senior partner at knight frank:
I can remember being on summer holiday in August 2008, worrying this was the year it was going to slow down. We had already begun to reduce costs: it wasn’t just people, but all the marketing side of things that runs away with you in the good years. We put a clamp on opening new offices. I think by then we probably thought a slowdown was inevitable. Then I went on my wedding anniversary break to St Tropez in September. We were in a hotel, totally oblivious to what was going on in the rest of the world – until I saw a paper on the breakfast table, probably the International Herald Tribune, with a headline saying: “Lehman’s Collapses”. And the rest, as they say, is well-documented history…
Everywhere, the world just stopped. September, October, November, December: no one did anything. “If we’ve any money left in the bank, we’re certainly not going to go and spend it” was the view. So we moved very quickly to cut costs: in the end we cut just under twenty percent. Yes, it was mainly people, sadly, but it was also a frightening amount of waste which had crept in, and things that were jolly nice to have and nice to do. Frankly, you suddenly realised you didn’t need to do them. If you were making people redundant, it would have been positively obscene to take clients out for expensive meals. Even if you wanted to, which we didn’t, it would have looked utterly wrong – and it’s frightening how much money you can save by not doing so.
Property venture after property venture collapsed. More and more land, half-built developments and over-leveraged investment stock fell into the hands of the banks. A fresh and larger wave of layoffs swept through the major agents and property companies. By then, the rot had spread around the globe. “After September 2008, all the EMEA markets became seriously affected,” says Jones Lang LaSalle’s Alastair Hughes, “apart from Dubai and Russia. Russia was big business for us – then Russia just went. All international investment capital headed for the hills; all international occupiers stalled all decisions. Very shortly after that, Dubai went.”
HOW FAR AND HOW FAST?
On 5th November 2008, I chaired a session at the Royal Institution of Chartered Surveyors’ annual conference of valuers at the Royal Society of Medicine, the very place where, a year earlier, Robert Peto of DTZ had warned the audience that values needed cutting hard and fast. Nearly two months on from the near-collapse of the banking system, there was more inclination to take a pessimistic view. Prices were in freefall. I asked for a show of hands among the two hundred valuers: “How many think values will fall five to ten percent next year?” A few hands. “How about ten to fifteen percent?” More hands. “What about fifteen to twenty percent?” A sea of hands rose.
The consensus in the room was that the bottom of the market was roughly twelve months away, in November 2009, with values halving from the 2007 peak by late 2009. Close: the floor turned out to be seven months away, in June 2009, and the overall drop in values forty-five percent. Deep cuts in interest rates played their part: they fell from 4.5 percent in October 2008 to just 0.5 percent in March 2009.
Then, the early turn
Early 2009 turned out to be the right time to snap up bargains. The year opened with the news that veteran investors Raymond Mould and Patrick Vaughan had bought a block of a hundred and seventy thousand square feet at One Fleet Place in the City for £74 million – at a yield of 7.75 percent. Legal & General had been trying to sell the offices at a reported £100 million for twelve months.
Santander spent £115 million buying the freehold of its own headquarters, two hundred thousand square feet on the Marylebone Road, from British Land. King Sturge partner James Beckham said at the time: “With yields now at historic highs and rents falling steeply… there is now great potential for tenants to buy into ownership at economic levels.”
Morrisons felt the same. The supermarket chain spent £120 million purchasing property that it had previously been renting. In March, agent Atis Real (which became BNP Paribas Real Estate) called the bottom of the market, with its investment head Paul Griffiths declaring that yields had stabilised. Of an Atis Real survey suggesting that two-thirds of investors saw the market bottoming out in the next six to nine months, Griffiths said: “The research indicates real optimism within the market and that investors are now seeing opportunities for real estate investment again.”
In late January 2009, Helical Bar raised £27 million; chief executive Mike Slade explained why: “We believe that the exceptional market conditions we are currently witnessing will present buying opportunities that arise only once or twice in a property career.” But the most compelling evidence of a change of mood came from the auction rooms, when Allsop held a two-day event in London’s Cumberland hotel around the middle of February. The Ocean Suite was overflowing with prospective bidders, and nine-tenths of the four hundred and twenty-eight lots were sold, raising £56 million. Auctioneer Gary Murphy declared: “Property is back. I have only seen a room like this in extreme boom conditions. It is clear buyers perceive that, for the time being, the market has stabilised.”
By then, falling values had by then wrecked the balance sheets of most of the large property companies. The top four saw billions wiped from the credit side of their balance sheets in just a single year. Land Securities’ investment properties had been valued at £12.3 billion at the end of March 2008; a year later, largely the same portfolio was valued at just £7.9 billion. After writing off another £800 million, a record loss of £5.2 billion was declared for 2009. Over at British Land, gross assets shrank over the same period from some £13.5 billion to £8.6 billion, forcing the declaration of a £1.6 billion loss. Hammerson meanwhile took a £1.6 billion hit, and Segro (formerly known as Slough Estates) suffered a £1 billion loss.
The quartet moved fast to repair their balance sheets in 2009. Each created more shares, then sold them at a huge discount to the price of the existing shares. “All the majors were forced into raising capital to prop up their balance sheets,” says City analyst Alan Carter. “Hammerson were the first to see it, hotly pursued by Land Securities and British Land and Segro. But they all raised equity at prices which gave away years of value creation. They were forced to sell shares very cheaply. Existing shareholders were furious at the dilution of the value of their holdings.”
While this was going on, Hammerson chief executive John Richards organised a dinner for a handful of chief executives from the listed property companies. It was in my honour, because a few weeks earlier I’d announced my intention to retire from EG at the end of February 2009. Ian Coull of Segro was among the diners, still working on his rights issue. John Richards was more relaxed, having got his away. As we stood around having drinks, a call came through from Francis Salway of Land Securities. Always the gentleman, he had sent his apologies.
We all knew what was keeping him away, even though his rights issue was supposed to be a secret: the lawyers were clearly keeping him late. My memory of the night is of a mood of hesitant optimism: an odd, unidentifiable feeling among the group that this was its darkest hour and that the worst would soon be over. The next day was cloudy for me; John Richards and I had shared a final bottle of red after the other guests had left. But the earlier mood and the good news from the Allsop auction coloured my penultimate EG leader that week:
When the Darkest Clouds Are in the Sky
Fidelity is making cautious noises about buying real estate. That would be nice. But perhaps the brightest little sunbeam emanates from the auction room. Allsop has just experienced packed rooms and high success rates in both commercial and residential sales… but best not get overexcited, for there are plenty of thunderclouds still around.
The stack of property companies announcing rights issues has depressed property stock prices to ridiculously low levels. You could buy Land Securities, Hammerson, British Land and SEGRO for £5.8bn at this week’s share prices. These four companies have net assets of £10.8bn, for heaven’s sake. In two years’ time, those buying the discounted shares may well have a bargain. But, for now, all the City can see is clouds.
The clouds soon began to clear. Office values still had another six percent to fall, through the first six months of 2009, before they finally hit bottom in July. At that point in 2009, the IPD index of office capital values stood at 100 – the figure at which the index first commenced in 1986. In other words, you could buy an office block for the same price as you could have done some twenty-three years earlier. The FTSE reached its nadir slightly sooner, bottoming out at 3,530 on 6th March 2009. Then the stock market began to recover. The FTSE had moved up from 3,500 in February to 4,400 by July 2009. The index went on to gain another 1,100 points to reach 5,500 by the end of the year. The summer of 2009 turned out to be the turning point in the worst downturn in property history.
All that was left to do was clear up the terrible, terrible mess. That was still under way in late 2012.
Gerald Ronson… a final word.
Unless we get a dose of inflation it will take the banks ten years to work through their losses. Even if you dump everything in the toxic bin, it’s still going to have to be sorted out. When it comes to sorting out big, complicated, problematical deals, there aren’t hundreds of people in the business who are capable of doing that.
There are people who have survived. But a lot of people have been very severely burnt. Anybody who had leverage is bombed out altogether. The school that I came out of is that you had a responsibility, and if – God forbid – you did have a problem with the banks like we did in the Nineties, you sit down with the banks and work it out, eat a lot of humble pie and work together to maximise the value.
These people didn’t want to do that. Not having given personal guarantees, I suppose they felt they didn’t have to. They felt that the bank should be privileged for giving them the money. The degree of arrogance in the property business is higher than in any other industry I know.