The crisis in the financial sector and the rapid descent into recession of the UK economy in the past six months have reinforced the downward momentum in the property market that commenced in 2007.

The focus of the media has been very much on the collapse of prices and of the volume of transactions in the residential market where average house prices are now around 20% below their peak in autumn 2007. But arguably the state of the commercial property market is in an even more parlous state.

The findings of market specialists including the Royal Institute of Chartered Surveyors (RICS) paint a truly grim picture:

• Available commercial, property space is rising at a record level with Central London being the worst spot geographically and retail being the hardest hit business sector – particularly following the high profile demise of a number of high street chains.
• Occupier demand and enquiries are now running at their lowest levels for over 10 years
• Activity across all areas of the commercial property market is in decline and the deepening recession seems set only to accentuate this downward spiral.
• Property owners are having to offer increased incentives to secure lettings

In the good times, pubs borrowed money against their property

But this decline in the commercial property market does not just adversely affect those looking to let property space (whilst benefiting those looking for space).

In the boom years, supermarkets and pub chains became so-called ‘property plays’. In a rising property market, they could make easy profits from selling and then leasing back properties. But in a falling market, their share prices have because of the importance of property in the balance sheet. Particularly, as did the pubs, when they borrowed on the strength of their property portfolios.

Indeed, it is partly the leverage behind the pub chains which has led to 39 pubs closing per week! Both shareholders and the lending banks – and HBOS was a major lender on property development – have got their fingers well and truly burnt.

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Martin Upton is lecturer in finance at the OU Business School. Previously he spent 20 years in treasury management, including 12 years as Treasurer of Nationwide Building Society. Martin's particular interests are financial services, the housing market, financial markets and risk management.

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Money Programme

Get the facts behind the big business and finance stories from around the world – and down your street, in The Money Programme.

The motor industry and the financial markets have been transfixed in recent months as Porsche SE, the luxury sports car and utility manufacturer, has continued its move to takeover Volkswagen AG (VW). By early January Porsche had raised its share holding in VW to 50.8% and is expected to push this stake to 75% later this year enabling it to take formal control of the company.

But this is not just another takeover and industrial consolidation story. Porsche’s audacious move has had several astonishing and controversial angles.

First, the story has a ‘David and Goliath’ aspect to it. Porsche makes about 105,000 vehicles each year - a mere handful relative to the circa 6 million made by VW.

Then we have the amazing impact that Porsche’s acquisition has had on the stock markets. In the past two years Porsche has been building up not only its holdings of actual shares in VW but also in options positions which, when exercised, give it the right to further share holdings.

When Porsche announced in October last year that that it either owned, or had the right to, 75% of VW’s shares (with another 20% being owned by the German state of Lower Saxony) VW’s share price rocketed, rising over two trading days from €211 to €918. This made VW, temporarily at least, the most highly valued company in the world.

VW's share price rocketed, rising over two trading days from €211 to €918

This staggering increase in price was accentuated by the fact that a number of fund managers had been taking up ‘short-selling’ positions in VW - selling the shares in the expectation that their price would fall in the future. If this had happened the shares would then have been bought back at a profit. But Porsche’s announcement meant that only 5% of VW shares were not controlled by either them or by the state of Lower Saxony, where VW is based.

So confronted by this shortage of available shares the fund managers fought to cover their ‘short’ positions by buying VW shares. But this inevitably drove VW’s share price skywards. This resulted in huge trading losses for the funds that had engaged in short-selling.

Indeed the increase in VW’s share price has been great news for Porsche: in its last financial year it made circa €1 billion in operating profits from vehicle production but overall pre-tax profits were €8.6 billion, due largely to the €6.8 billion rise in the value of its holdings and options positions in VW shares.

Black Porsche Cayenne Turbo.

There have also been the regulatory controversies associated with the takeover - foremost of these being the fact that the Chairman of VW’s Supervisory Board is Ferdinand Piech, the grandson of Ferdinand Porsche, the founder of the Porsche company! Indeed the Porsche and Piech families have between them control of the voting shares of Porsche - although it has been many years since any family member has run the company. Some observers have questioned whether Ferdinand Piech’s position has given rise to a conflict of interests in respect of the takeover.

Another issue relates to Lower Saxony’s holding in VW. Under German law a shareholder with a holding of 25% or more of a company’s shares can veto its strategic decisions. But for VW the threshold for this power of veto is set at a 20% share holding under a special law passed in the 1940s.

The state of Lower Saxony, with its 20.1% stake, therefore has the right to block VW’s strategic initiatives. Given the lack of flexibility this gives to those running the company, Porsche, in anticipation of the completion of the takeover, is challenging this special law.

Then we have a Swedish angle! Now that Porsche has gained a majority stake it is statutorily obliged to make a takeover offer for the Swedish truck maker Scania, where VW owns 69% of the voting shares. This is unlikely to deter Porsche which will probably only make an offer that will be readily rejected by Scania

It is perhaps ironic that the economic backcloth to the takeover has been one of falling stock markets and plummeting car sales in Europe and elsewhere around the globe. Yet Porsche has made vast sums out of its share holding in VW and is poised to swallow a huge car manufacturer whose empire includes Audi, Bentley, Lamborghini, Seat and Skoda.

Meanwhile the fund managers who have incurred huge losses by betting the wrong way on the price of VW’s shares may find themselves having to trade in their Porsches - perhaps for a VW!

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About the author

Martin Upton is lecturer in finance at the OU Business School. Previously he spent 20 years in treasury management, including 12 years as Treasurer of Nationwide Building Society. Martin's particular interests are financial services, the housing market, financial markets and risk management.

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Credit Crash Britain

In a series of special reports the Money Programme team investigate the issues that are affecting all of our bank balances: Credit Crash Britain.

In 1979 I needed a £500 loan from my bank (with whom I had been a customer for 18 years) to buy a distinctly dodgy second hand car. At the time I was a Lecturer at Aston University. To get the loan approved I had to meet the manager of the bank branch. I put on my suit, prepared my ‘case’ and yes I got the loan – but not before the manager had got to know his customer a little bit better.

Today, as a Lecturer at The Open University, I could, if I wanted, turn on my computer click the mouse half a dozen times and get a loan for £18,500 (equivalent to over £5,000 in 1979 money) without talking to anyone. And I thought we were in the middle of a ‘credit crunch’! Oh well, it saves on dry cleaning costs!

Credit card.
[Image © copyright AbleStock.com]

Of course the intervening 29 years may have changed the assessment of my credit worthiness ..so perhaps we are not talking about a like-for-like comparison. But during the intervening years there has been a ‘sea change’ in the access to and availability of credit. This change has had a hugely influential impact on the economy, on the housing market and on people’s lifestyles.

So how and why did the credit environment change, and are the recent developments in the financial services sector now threatening to take us back to the years of more considered and tighter credit?

The increasing availability of credit can be traced back to the so-called ‘liberalisation of financial services’ in the 1980s. This much used term relates to the changes in the financial services industry, prompted in part by government legislation that encouraged financial services providers like banks and building societies both to expand and diversify their activities, and to become more competitive in their operations.

Changes occurred quickly. Prior to this ‘liberalisation’ you were normally expected to save with a building society before applying to it for a mortgage. Even if you were granted one you had to queue - mercifully not literally - for the funds. Relationships with banks and building societies were long term and people did not tend to flit from one provider to another as they do now.

Prior to this 'liberalisation' you were normally expected to save with a building society before applying to it for a mortgage

Post ‘liberalisation’ the financial services providers competed on price more competitively and marketed their products more keenly (witness the ‘junk mail’ we still receive). The benefits for the consumers during the sustained boom from the early 1980s until the past year (interrupted briefly, and with some pain, by the slump in the housing market from 1991 to 1994) have been obvious.

Readily available credit fuelled a boom in house prices, making all home owners feel wealthier. New entrants into the financial markets – particularly the credit card market – provided a further dimension and scale to the growth in personal indebtedness sustaining in its wake a consumer boom throughout the country. In past fifteen years the level of personal debt in the UK has ballooned from £400 billion to nearly £1,500 billion - a staggering £1.5 trillion of outstanding mortgages, loans and credit card debt!

For the providers of financial services business was good. With credit booming profits rose whilst the credit exposure to the borrowing was (and is) contained by the growing value of property against which the vast majority of the debt (currently 84%) is secured.

A love affair was in place: the public loved the lifestyles that cheap and readily available credit could provide. For the lenders the expansion of credit meant growing balance sheets, growing profits and growing pay for those running the businesses.

A love affair was in place: the public loved the lifestyles that cheap and readily available credit could provide

So how and where did it all go wrong? The immediate source of the current problems was the collapse in the sub-prime mortgage market in the US. This did not directly impact on households in the UK - rather it meant that the funds UK financial institutions relied on to finance their lending dried up as banks became more reluctant to lend to each other.

The drying up of funds pushed up the cost of credit and triggered a fall in house prices – since availability of credit is a key house price driver. The fall in house prices has made households feel less wealthy and so discourages consumer spending. The fall in the price of property, against which most personal debt is secured, has made lenders more cautious about their lending policies.

For those borrowing - or seeking to borrow - the current environment is the worst for decades. Lenders have tightened their lending policies and increased the cost of borrowing - for example by ‘risk-adjusted' pricing on higher risk loans.

The impact of the debacle in the financial services industry - particularly the demise of HBOS and Bradford & Bingley - has also diminished the volume of credit available to households. The capacity to meet credit repayments has also been squeezed by the impact on household budgets of rising fuel and utilities prices.

For those lending - and there is not much sympathy for the institutions whose lending policies are deemed to have fuelled the boom-bust in the credit markets - there is the prospect of arrears, bad debts and losses. The weakest will lose their independent existence as HBOS,  Alliance & Leicester, Bradford & Bingley and Northern Rock already have.

Having spent nearly thirty years in love with credit many households and lending institutions are now left ruing their financial relationship.

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About the author

Martin Upton is lecturer in finance at the OU Business School. Previously he spent 20 years in treasury management, including 12 years as Treasurer of Nationwide Building Society. Martin's particular interests are financial services, the housing market, financial markets and risk management.

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