In his first budget, Alistair Darling tried to reassure voters that the UK economy is better positioned than the economies of many other countries to weather the effects of ‘economic turbulence’. His key message was stability and he presented a budget designed to cope with tougher economic times ahead.
Whether those tougher economic times are defined as ‘economic turbulence’ or a full-blown recession seem pretty irrelevant, because the effects are the same: the economy is slowing and consumer confidence is falling. Perhaps those of us who work in the financial services industry have felt the cold winds of change well ahead of other sectors, but there is little doubt that everyone will feel the effects of an economic slowdown soon enough.
Revisions
Even the Chancellor had to revise his economic growth forecasts downwards and acknowledge that 2008 may well be the weakest year for economic growth since 1992. The Chancellor is forecasting that the economy will grow by 2% during 2008 and 2.5% in 2009, which is a quarter of a per cent lower for each year than in his Pre-Budget Report, which was issued in October. If his predictions come true growth will be 0.75% below the 2007 budget forecast, but it will still put the UK in a better position than many of its international competitors.
Unfortunately, a number of economists don’t agree with the Chancellor, believing that his revised forecast is still over-optimistic. The consensus appears to be that growth will be 1.7% in 2008 and 2% in 2009, as the credit crunch makes its effects felt in the wider economy. The worry which many economists have is that with growth falling and inflation and unemployment rising, the Treasury is going to have to borrow more to balance its books.
Less revenue
A slower economy means less tax revenues from business and individuals. What’s more, a slump in the housing sector reduces government revenues from tax such as stamp duty and capital gains tax. Property related tax revenues are forecast to be £2.25bn lower in 2008/09 than forecast in the Pre Budget Report.
The net effect is that the Treasury will have to borrow £43bn next year to balance its books, with income totalling £575.2bn and expenditure rising to £617.8bn. This will be the highest annual deficit since 1996/97 and will leave the UK with one of the biggest budget deficits in the Western World, at 2.9% of GDP in 2008/09. However, if the economic turbulence turns out to be bumpier than expected, the Chancellor may have to consider raises taxes in the future.
What does all this mean for both the commercial property sector and the financial services market? You don’t have to be an economist to see that it isn’t good news. The commercial construction sector is forecast to cool considerably during 2008 and Capital Economics says that construction sector expectations are at their lowest level in 9 years.
Forecasts
Capital Economics has also downgraded its forecasts for commercial property rental growth to –2% in 2008 and –3% in 2009. It says office rental values in general will suffer from the effects of the credit crunch and retail warehouse rental values will also fare badly. It is forecasting that falling rental values will have a negative impact on capital values, which may fall by up to 25%. On the basis that capital values have already fallen by 12%, Capital Economics believes that the correction is only about half complete.
As far as finance is concerned, bank lending on commercial property in quarter 3 of 2007 hit a record high of £76 billion, but then slumped to £29 billion in quarter 4 as the credit crunch started to take its toll. This is below the quarterly average of the previous 3 years, which is £36bn. Unsurprisingly, economists believe lending on commercial property will continue to reduce during 2008. One of the key issues is that although demand for finance may still be strong, the illiquidity of the capital markets means that the finance simply isn’t available to satisfy demand.
Practical perspective
From a practical day-to-day perspective, commercial finance lenders and brokers have seen the very real effects of a slowing economy and capital markets which remain in deep freeze. Some lenders have closed their doors to new business, whilst others have tightened criteria and raised rates. Lenders want to lend and capitalise on the opportunities which still exist in the market, but with funds being less freely available and margins a lot tighter, lenders cannot afford to do business at any cost. As with any manufacturers, they have to be able to generate a worthwhile profit or they will go out of business.
During 2008 and 2009 those brokers who will be best able to cope will be experienced commercial mortgage brokers who have well established and strong links with lenders. Lenders will increasingly be looking to work closely with them to help control new business inflows and maintain credit quality. Residential mortgage brokers who are eying the commercial mortgage market as an additional revenue earning opportunity, may well end up being disappointed.
We’re in for turbulent times ahead and good businesses are feeling the effects through no fault of their own. It’s time to prepare for a rough ride.
