I have been having a long look at the future of property development this past week. The industry has been through some tumultuous times and there is certainly more to come, but the development sector will not totally vanish. There is still a pulse, although it is very weak. I know some people out there would prefer to never hear from the sector ever again, and it will certainly be quiet for a few more years, but developments will rise again and new buildings will be needed as the economy grows.
When the current oversupply of property is dealt with (and this will take some years), the production of new buildings will lag behind demand because banks and their easy credit will be removed from the equation. In the past, property development was a very high-margin business, because land was cheap and credit was hard to get. This meant deals were tough to get done, but profits were high. I doubt the banks will be back in a hurry so this means carrying out any kind of new development is going to be challenging from a finance point of view.
These challenging financial conditions will drive down the value of land and drive up businesses' profit margins. This new dynamic will be the future for the business and the potential returns will be very attractive. It is also the way that most markets operate around the world.
With most developers wiped out, and the banks refusing to do any business, how will the business function in the future? What will change and how will it operate in the next phase? Who will the players be?
The latter years of the boom were significant in Ireland because the syndication of property deals became possible. Syndication allowed groups of people to come together and it facilitated some of the larger deals. We can see from the fallout that a lot of these deals did not work out. They failed because the market collapsed and because of the leverage involved, rather than because of any failures in syndication. The structure itself was very sound. The syndicate deals all carried generous equity, but clearly not enough equity to survive the storm.
The lesson here is to use more equity in the business, and to avoid any kind of land debt. Once the land for a project is owned outright with no bank anywhere to be seen, a project is safe and secure. Bank debt should then be taken on only to bridge the gap between the sales of the office building or apartments and the construction costs. This is how the property market tends to function in most of the world, and Ireland looks set to follow this path. It is a better way and it avoids the flood of liquidity that descended on the Irish market from 2006 until the crash.
I see the rise again of the property syndicate as the key to this new property development business. Returns of 15% to 25%-plus will be available to the brave investors who first step into the breach and come together on a deal. A lot of capital has been wiped out in Ireland and I think this lack of capital will drive people back to investing in deals to generate a high return.
'Safety first' is the current investment strategy for a lot of people, but this emotion will slowly fade and heightened risk appetite will return. It is difficult to accumulate wealth when you conservatively invest after-tax earnings. Ireland will emerge from this financial storm and the opportunities will appear in the good locations.
I see lots of opportunity for syndicates to form and buy land deals or other interesting parcels of property. The prices in general are still too high, but these will continue to correct as the banks realise the true value of their assets. The removal of bank credit from the market only serves to heighten the opportunity as values are driven down.
I expect many of these syndicates will form around the same developers who are now Nama-bound. The game will change but the players will probably remain the same with a few retirements to thin the field. This is always the nature of business. Donald Trump is a good example of this. He has restructured time and again but he stays in the game.
I also expect that the first deals will be small and very low-profile. Once the profits are delivered from these deals, word will spread and the investor base will grow. When syndicate investors roll their initial equity plus profits from deal to deal, the figures and numbers can grow very quickly.
Good business is based on trust and respect, and these initial deals will be built on this foundation too. The bust has shown us all the money we wasted on legal fees creating redundant structures that did not perform as expected.
The Glass Bottle consortium should have spent more time focusing on the fundamentals of the property deal, and less time on the personal guarantee from Bernard McNamara.
Strong teams can achieve more than the sum of their parts, and it will be the same for the successful property syndicates. None will want to end up like the French football team, arguing until the bitter inglorious end.
The French always show the path... (even for failure).