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Crunch time for family portfolios

With the current credit crunch shaking up the global economy, it is a tricky time for families who are looking to divest real estate. James Phillipps looks at some of those who are selling parts of their portfolio and offers some advice on the best way to do it

Family businesses can accumulate considerable amounts of real estate over generations and divesting properties has often been extremely lucrative. But with the credit crunch biting hard, choosing which properties to sell and when is becoming an increasingly difficult decision.

A lot depends on whether a business is a forced seller needing to raise capital or is rather looking to lock in any recent gains and diversify its asset mix. Lawrence Radley, a partner in law firm Reed Smith Richards Butler's property division, recommends family businesses first explore alternative routes before committing to selling, particularly in the current difficult environment.

"You need to first consider whether it is sensible to sell properties in the current market climate where sellers' expectations often do not quite match buyers' expectations," he says. "If you just need money you could instead use the property as collateral to raise funds and this would enable you to still benefit from any future capital growth." With interest rates generally falling worldwide and occupancy rates remaining robust, deferring the decision for a year or two, by which time the market is expected to have stabilised, could pay dividends, he says.

However, if family businesses are committed to selling, experts recommend that the individual family members develop a coherent, united strategy. Neville Pritchard, head of UK capital markets at property consultants King Sturge, says: "You are trying to achieve the best results possible but individual family members within the business can develop emotional attachments to assets, which can make the decision more difficult if they don't agree with the proposal."

This can be complicated further if different family members hold various assets under their own name, rather than all properties being held, for example, in an offshore trust structure by the business. In this instance, specialist tax advice should be sought to maximise the tax efficiency of the disposal.

Where there is agreement, the nature of the business, the types of properties owned and its international exposure are the key drivers in the selection process. "You need to analyse the portfolio and see where the opportunities are," Radley says. "If you have properties in a region or area that is not in crisis, there could be attractive selling opportunities. However, if you are selling in a hot area, you will lose the potential for future capital growth."

He says the credit crunch is affecting most developed economies with falling capital values and a lack of available credit stunting sales. Investment grade properties are the easiest assets to sell as many cash-rich potential buyers, such as pension funds, do not want to get involved in the development or turnaround of second tier properties.

Divesting the family way
Marco Spinner, who heads up the family-owned investment company Sigillum's real estate portfolio, says that this flight to quality has been evident in Canada, one of two countries in which the firm is an investor. "We are currently selling three properties in Canada and there the flight to quality is obvious," he says. "With one retail property in Edmonton we had to bleed considerably in order to attract buyers. It is too small for large institutional buyers and is quite old. The price we negotiated with the buyer for the purchase and sale agreement is 20% below our asking price."

Sigillum is proceeding with the sale as the firm expects the credit crunch to get worse before it gets better. Spinner adds that the deal is still providing considerable upside compared to the historic acquisition cost. Elsewhere, there are still pockets of value to be found and Spinner says that despite the difficult conditions, his firm has been able to achieve a strong price on a well-located prime industrial property in Vancouver.

Richard Owens, chairman of sixth-generation Australian family real estate business, ROI Property, says opportunism can still deliver excellent results. His firm recently sold a shopping centre to a national supermarket chain. The supermarket firm owned a larger, adjacent shopping centre and wanted to amalgamate the two. Owens says redeveloping his firm's shopping centre would have cost €15 milion and even a facelift would have required €3 million, with no guaranteed upside.

"We only buy property where we can add value because good stock is hard to come by. But we are opportunistic. We put several obstacles in their path and they paid €3 million above the market rate," he says.

The route to market very much depends on the skill set within the business. Owens says ROI Property is purely focused on its native New South Wales and its in-house team of six professionals carries out its disposals and acquisitions.

Sigillum takes a slightly different approach because of its international exposure with portfolios in Canada and Germany. "Since we live in Germany, we employ a real estate asset manager in Canada," says Spinner. "He oversees the individual property managers and negotiates on our behalf with brokers and buyers for a fee. In Germany I manage the portfolio myself and do the negotiating on behalf of the family. To source buyers I am employing real estate brokers."

Families without property management expertise can benefit significantly from using third party specialists, Pritchard says. In the current market, sales need to be more targeted and this is where experienced practitioner's contacts come into play.

Pritchard adds that sellers now need to be more patient than in recent times. "Properties are on the market for more extended periods than they were," he says. "A couple of years ago every vendor was pleasantly surprised with the price they received. Now a number of properties are being withdrawn because there is such little activity."

REIT or wrong
When the sale is completed, the business must then decide where to invest the proceeds. The US market is continuing to see companies more readily using REITs as a means of divesting properties. There are around 200 REITs in the US, enabling investors to access a whole range of niche property types as diverse as car showrooms and prisons.

However, the same cannot be said about the REIT market in the UK, which was introduced in January 2007. Only 16 have been launched since then and of these 14 were just property companies converting. The average REIT fell by 35% last year.

"We have a broad mix of clients across several industries and have seen absolutely no interest in REITs," says Radley. "Their performance since the regime has launched has been terrible and they are also unattractive because of structural issues, such as setting up costs and income requirements." What's more, with rental growth weak and capital values falling, Radley does not expect family businesses with property in the UK to consider Reits as a vehicle for divestment in the foreseeable future.

Phil Nicklin, a partner at Deloitte, says that even when the UK property market does recover, issues of scale that do not apply in the US could deter UK businesses from using Reits as a means to manage their property portfolios.

He says realistically, the minimum portfolio size for a REIT is €127 million, as the process of listing will cost around 4% of the value of the assets raised. Whereas a business in the US may hold sufficient specialist properties to consider a REIT, this is less likely in the UK where few businesses have property portfolios of that size.

Spinner says he is deliberately not reinvesting monies raised from property sales back into real estate because of his concerns about the state of the market. "We believe the downturn in this property cycle has at least a year or two to go, if not more," he says. "Capitalisation rates have fallen to levels that are not reflecting the risk inherent in property investing. We should see more of the highly leveraged buyers getting into trouble as mortgages roll over and banks require lower loan-to-value ratios or demand higher interest rates. Hence, we believe it is too early to buy and sit on the sidelines with regards to new property investments. Our sales proceeds currently go into liquid investments. There we prefer hedge funds and our cash position stands at 15% of total assets."

Similarly, Owens is sitting on a large amount of cash and says he is happy to sit on the sidelines in the short- to medium-term. But although Owens shares Spinner's concerns about the market, he is on the look out for distressed sellers, as he wants to buy a new corporate HQ for his growing business, a chain of off-licences, managed by his son. "We have now got a chain of 12 off licences under the Icebox brand and aim to develop this into a chain of 25 to grow market share," he says. Cash may be king in these uncertain economic times, but opportunities certainly exist both inside and outside real estate for those who know where to look post divestment.

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