As at October 2008, the world had been hard hit by a once-in-a-century credit tsunami according to former Federal Reserve Bank Chairman, Alan Greenspan. Washed away in this wave were long standing names in the financial sector like Bear Stearns and Lehman Brothers. The year 2008 was also the year when global stock markets plummeted to record lows and government bailouts were carried out across the globe. At the time of writing this article a large number of financial institutions and investment banks in the US, UK and Europe had been partially or fully nationalised and the contagion was spreading to other countries including Mexico and Brazil. Iceland, with a population roughly the size of Barbados, had virtually gone bankrupt, the financial meltdown there meant that its banks owed the rest of the world over US$200,000 for each person on the= island. All of these factors led to a tightening of credit worldwide. Particularly, in the US where the problems began; credit that was once free flowing had all but dried up. It was only in 2007 that it was possible to borrow up to 90 percent of the cost of a major construction project. Today, banks are only prepared to lend up to 60 percent in most cases. This places a major hurdle for large commercial real estate projects that are internationally funded. Many of these projects have been put on hold because of lack of available financing. According to Kiplinger editors in Washington, deals are down 60 percent to 75 percent on 2007. Just over in Turks and Caicos, the collapse of Lehman Brothers led to the abandonment of a 175-room Ritz-Carlton, which was two months away from completion.
These factors will continue to affect commercial property markets in 2009. The question is how exactly will the local market be affected? Is then financial crisis really a problem for Barbados? If it is, how will commercial banks in Barbados deal with the fall out from the credit crunch and will funding still be readily available? These are some of the questions that are on the forefront of most developers’ and investors’ minds.
To answer these queries, one can begin looking at a recent report by PricewaterhouseCoopers and the Urban Land Institute entitled Emerging Trends in Real Estate 2009. This is an annual publication which surveys and interviews hundreds of professionals in the real estate industry from lenders, brokers, real estate firms and developers to get their view of the US real estate market. The 2009 report has predicted a difficult year in 2009 for those operating in the US; it suggests that it will be a slow recovery, hampered by risk aversion, constricted financing sources and a weakened economy. Vacancy rates are expected to rise as retail businesses close stores due to falling floor space as they shed jobs and scale down operations.
In Barbados, a quick survey of some of our local banks in October 2008 suggests that they too expect 2009 to be a challenging year. Bankers have seen demand for commercial loans either remain constant or decline from 2007 numbers. They also expect commercial rents and investment activity to decline during 2009. However, there is a silver lining as the general belief is that while the financial crisis and subsequent credit crunch is a problem; this will not have the same impact on local banks as it has had in the US. The view is that the majority of institutions were prudent in their investments and while there were some losses, it is not anticipated that there are significant enough to lead to the bank failures, or nationalisations we have seen in the US, UK and Europe. Barbados’ banks have been rated among the safest in the world. However, the main issue for Barbados will be the migration of the credit crunch to the real economy and the effects a slowing US and UK economy will have as it reaches our shores.
One interviewee from the Emerging Trends 2009 report suggested that everyone was so focused on the credit crisis that no one noticed the economy sneaking up to knock their legs out from under them, and to some extent this is accurate. In the case of Barbados, there is time to prepare and from meetings held with the Barbados Government and the Social Partnership in late 2008, the country had taken steps to prepare to weather the imminent storm.
It is expected that tourism revenues will fall as tourists from our major markets have less disposable income. They will holiday closer to home; in fact in the US the idea of a “staycation” is becoming more popular; this involves families doing activities in and around their immediate area. It is also expected that the revenues from the other major industry in Barbados will fall as some offshore banks close their doors and profits from those remaining decline. While the Central Bank of Barbados in the third quarter review of the economy was still expecting positive growth in 2009, it was forecasting much smaller figures from previous years. This is all assuming the US recession is not a long and protracted one.
A global recession will definitely impact how readily local commercial banks will make credit available. The question is to what extent. It is likely that those persons looking for 100 percent financing will soon realise this product is not as accessible as before. This was always a rare beast in the commercial real estate arena in any case. However, while there will be some tightening in Barbados, it is felt that this will be substantially less than that in the developed world. Mainly due to the fact that unlike their US counterparts, bankers in Barbados have been traditionally more conservative and will continue to adhere to current practices during 2009. When asked how to successfully secure financing during the tightened times in 2009, banks indicated that in general the same guidelines will remain as before.
It must be noted that every deal is different and each one has unique characteristics. Additionally, every bank is different and policies will differ from institution to institution depending on their appetite for risk. Most banks however, will still expect applicants to have some equity when approaching an institution for credit. If these applications are to be successful, the loan to cost ratio should be from 60 percent to 75 percent for new build construction deals. For commercial buildings a loan to value ratio of 50 percent to 60 percent would not be unusual. Applicants will need to demonstrate the potential to cover all additional costs of the project and overruns if any. They must have committed tenants on 3-5 year leases and if the project is a condominium or high end tourism project then strong pre-sales figures are a must. If the project is heavily reliant on pre-sales for cash flow and depending on the debt – equity ratio of the project, some institutions may require pre-sale levels sufficiently high to repay both the debt and cover any costs to complete the project.
Most banks will make their decisions based on cash flows and most institutions will want to ensure that these will cover the debt service. Therefore, some may ask for gross or net lease income cover of 120 percent to 130 percent of debt service depending on the project and the type of leases in use. Many institutions will also expect to receive well thought out, comprehensive business plans and/or feasibility studies. These could be deal breakers in the 2009 environment and hence prospective developers should seriously consider getting professional assistance in preparing these documents. There will finally be an expectation to have a valuation on a present value and fully completed basis carried out by a professional valuer.
This may seem like a long list but all is not doom and gloom when it comes to approaching banks for credit in 2009, there is still liquidity in the system and those looking for financing should do so now, as bankers also expect interest rates to fall. In late October 2008, the prime rate was around 9.25 percent to 9.8 percent. This was before the 50 basis points cut announced by the Central Bank in Review of the economy in October. Should interest rates decline more, it could be a good time to refinance loans for those capable of doing so. It is also apt timing for relatively new projects. Most real estate projects in Barbados have a developmental horizon of 2-3 years; these projects should consider continuing with their planning during the challenging times ahead if possible. This will mean that they will be ready to go to market, as the world economy is preparing to take an upturn. Also, if there is ability, buying and building in a downturn can provide opportunities to get good value. There are of course risks attached to this.
By all accounts, credit locally should still continue to be available, there is even consideration being given to allow foreign companies to borrow locally to finance projects in Barbados. This is good news as markets internationally are expected to remain frozen well into late 2009 despite the billions being pumped into banks by foreign governments. Barbados is well placed to take on some of these loans. Falling interest rates and a sound banking system makes it a great alternative for companies currently looking to the US or Europe for their financing.
Access to available credit has always been seen in Barbados as a major problem. The World Economic Forum in its 2008 Global Competitiveness Report considered it to be the third largest problem to doing business in Barbados. However, this time one should be content in the fact that local banks and our Central Bank were not as liberal as some of their colleagues. This fact, along with a strong economy capable of absorbing some shocks, places us in a good stead to ride out a recession.
It is often claimed that banks make their worst loans when the economy is booming. If the reverse holds true then 2009 could be a good year for both banks and those seeking credit.
Prepared for Terra Caribbean’s The Red Book 2009 Pink Pages by: Christopher Sambrano, Advisory Services, PricewaterhouseCoopers