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A look ahead: Palmer Capital

Leverage is likely to be a contributor to the next property downturn but not to the extent it was last time, according to Palmer Capital’s Nick Cooper.

Although debt will play a part in Europe’s next property downturn, it will by no means take on a crucial role, said Nick Cooper, deputy chairman of London-based private equity and venture capital real estate firm Palmer Capital.

“It’s beyond the bounds of reasonableness to expect that leverage won’t play a role in the next property downturn when it comes. In a low return environment, investors, manager and bankers will get very tempted by the allure of higher returns that leverage can deliver. Memories become short and judgements get cloudy,” he said.

Cooper added: “However, the banking market is operating under different controls today. The rules around capital adequacy and the internal cost of capital for illiquid assets such as real estate means that the volume of lending to the sector is actually reducing.”

As highlighted by the De Montford University research on the UK market, there are few banks that are actually in the market, and those that are have a very restricted sector appetite and pretty low loan-to-value thresholds.

But, in the same vein, what will likely contribute to leverage becoming a potential problem in the future, according to Cooper, will be hedging arrangements put in place to protect both borrower and lender against interest rate movements.

“Real estate investors don’t have a great track record in this area. Ill-timed swaps with high breakage costs can cut right across rational real estate decisions and will be, as they were last time, a contributor to future problems,” said Cooper.

He added: “There is a caveat, however, that in a world of low interest rates, another recession could see a return to negative yields and that will definitely throw up a whole new set of issues on pricing and breakage costs. Hopefully internal risk management teams will be across the problem before it becomes a reality.”