UK: RPs Suffering In The Property Market Crash

Last Updated: 5 November 2008
Article by Emma Brett

We look at the effect the downturn in the housing market is having on RPs' accounts

As property sales plummet, what measures can RPs take to minimise the impact?

The global credit crunch has hit the UK property market hard, with Nationwide and Halifax stating that house prices have fallen nearly 11% in the past year. Lack of mortgage availability and a fall in consumer confidence has led to a downturn in the housing market, the effects of which could be far worse than those encountered in the 1990s. The demise of Lehman Brothers, HBOS and Bradford & Bingley has also added to the misery.

Many larger registered providers (RPs) are increasingly financially dependent on the sale of property (via outright sale or shared-ownership) to make their business models work, and until recently, few RPs had assumed that there would be any downturn in their anticipated revenue from property sales.

Predicted effect on RP accounts

Property sales

The sector's reliance on property sales is clearly illustrated in the global accounts published by the Housing Corporation, which show an increasing deficit before tax and property sales for the years 2005 to 2007. In 2007 the surplus generated from the sale of properties was £542m, compared to the overall surplus before tax, £270m.

The balance sheet

RPs have been developing to a greater extent over the last few years and are likely to be holding properties on the balance sheet that have experienced impairment.

In addition, RPs trying to sell properties, either through shared-ownership, HomeBuy or outright sale, will be holding significant amounts of property on the balance sheet as current assets. These assets are valued in the accounts at the lower of cost and net realisable value, and RPs may need to make significant write-downs to these assets to reflect the reduction in the achievable selling price. Also, contractors are increasingly facing financial difficulties and taking longer than planned to complete developments – making matters worse in a market where prices are continuing to drop.

The global accounts in 2008 and 2009

The 2008 global accounts are yet to be published, so we have made some simplistic assumptions to show how the 2008 and 2009 global accounts might appear when taking into account the effects of the slowdown, impairment of housing stock and increased interest rates.

The assumptions we have used for 2008 are:

  • an increase in rental income of retail price index (RPI) of 0.5% plus 3% for growth
  • an increase in operating costs of RPI of 2% plus 3% for growth
  • RPI at 3%
  • an increase in interest payable of 0.5% to reflect rises in the London interbank offered rate (LIBOR) plus 6% for growth
  • impairment of housing properties of 0.1% of assumed 2008 net book values
  • growth of 20% in surplus on fixed asset sales
  • all other items in the income and expenditure account remain the same.

Fig 1: Predictions for the 2008 and 2009 global accounts

The assumptions for 2009 are as follows:

  • an increase in rental income of RPI of 0.5% plus 1% for growth
  • an increase in operating costs of RPI of 2% plus 1% for growth
  • RPI at 5%
  • an increase in interest payable of 1% to reflect interest rate rises plus 6% for growth
  • impairment of housing properties of 5% of net book values at 2007 plus 10% of net additions for 2008 and 2009
  • no surplus on disposal of fixed assets
  • all other items in the income and expenditure remain the same.

The housing property additions for 2008 and 2009 have been assumed to be the same as in 2007, based on the movement in the global accounts.

These assumptions are highly speculative. However, the results in figure 1 are highly alarming and would be likely to result in a number of RPs breaching covenants.

The ability to meet cashflow requirements will become even more critical in the future, particularly as significant levels of cash are likely to be already committed to ongoing developments.

Mitigating the risk

For existing shared-ownership and outright sale schemes, the first step is to assess whether the asking price for properties is reasonable given the current market conditions. For some schemes a small downward adjustment will secure property sales; for others, it is possible that despite discounts and strong marketing strategies, the properties will still not sell. In these circumstances, it is likely that the best option will be a change of use to rental rather than sale, taking advantage of the recent Housing Corporation dispensation on these areas. However, this may well crystallise an impairment (since value for rental properties is usually much lower than for sale), and is likely to have adverse VAT consequences (please refer to our article 'VAT adjustments for temporary lettings').

For schemes in progress, careful monitoring should ensure developments are completed to timescale. Perform regular reviews of contractors' financial viability, and prepare contingency plans in the event of insolvency. Properties should be marketed as soon as possible and preferably prior to completion.

Planned shared-ownership and outright sale schemes may now not be viable in current market conditions. Development appraisals should be re-worked on revised assumptions in relation to property sales.

Business plans should also be adjusted, for at least the short term, to ascertain what effects the slowdown will have on an RP's financial position, and to work through arising potential problems.

Most crucially, RPs should check carefully that all loan covenants will be complied with even under pessimistic assumptions. If there is any doubt, urgent discussion should take place with lenders. As a general principle, lenders will now be more demanding of information. Nearly all RPs are now more reliant on gaining the trust of lenders, so it will be essential to support their needs.

Do not assume that impairment provisions can be added back in the same way that depreciation changes can. This should be checked, and if in any doubt, confirmed with the lender.

It's not all bad news

We cannot predict when the property market will start to pick up, although our expectations are that prices will continue to fall through 2009. However, others have predicted that by 2012 house prices will be worth 15% more than their peaks in 2007. We can only hope that the events of the past 12 months may soon be a distant memory. However, our view is that the market will take a long time to recover and sentiment will remain cautious for a number of years. We hope we are wrong.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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