Commercial property is in free fall and NAMA is built on a false floor

THE August bank holiday weekend is one of the high points of my year. It falls between Galway race week and the Dublin Horse Show. As a horse lover, I appreciate the best of equine talent. Whether two-year-old blue bloods on the flat, a Galway Plate winner, international show jumper or Connemara pony – all horses gleam in their summer coats and epitomise natural beauty.

Throw in salad days, balmy weather, top GAA matches in Croke Park and a national holiday mood. The summer has reached a high point of official relaxation and an entitlement to “get away from it all”.

Like all else, 2009 is different. Officially we’ve had the wettest July on record. The past week has seen an apex of activity in trying to grapple with our burst bubbles of property and credit.

The publication of the NAMA legislation has raised more questions than it answers. The enormity of the proposal is truly awesome. NAMA is entitled to take on up to €90bn of toxic impaired loans, borrow a further €10bn to complete construction projects and issue €60bn worth of Government bonds.

These are IOUs from the taxpayer which can be encashed at the counter of the European Central Bank. It will be the largest property company in the world. Our successors will underwrite this gamble.

We won’t know until September 16, at the earliest, what approximate valuation we are going to pay for these property assets. Apparently, we are going to start with a current market value and then add on an expectant premium to reflect future prospects. That may sound plausible, but its fiction. Nobody knows what future property prices will be, when they might recover and to what extent. After almost two decades since the Japanese property crash, valuations are still 40% off their peak levels there.

If we take one component of the commercial property market, we can see the perils of trying to guess future values. I refer to the corporate office sector. This is the most important aspect of commercial property. Right across all our cities there are floors of empty office blocks, old and new. The vacancy rate is heading for one in four units. Experts reckon it could take more than 10 years to clear this unused space.

Rental income on new property is dropping sharply (by at least 50%) because demand has disappeared. The only buoyant tenant has been the State through the myriad of quangos looking for new homes. Bord Snip is most likely to achieve success in rationalising this area of public administration, relative to other recommendations. The exodus of commercial clients to low tax zones is evident. Financial services were the other big occupier. They are facing massive downsizing. Previous valuations on these properties were based on repaying the principal cost over 20 years. Now they can’t even service interest repayments.

The elaborate legal complexity of NAMA can’t conceal its fundamental flaw. Its architecture and structure is artificial. However well-meaning in attempting to restore bank liquidity and solvency, it seeks to dispense with market realities. How apt that on the day after the publication of the NAMA bill, the real world exploded into life through Judge Peter Kelly in the Commercial Court last Friday.

The best reform of the entire court service over the past decade has been the establishment of the Commercial Court. This component of the High Court has performed admirably. The criteria for admittance include commercial disputes in excess of €1m. Civil High Court cases, such as libel and defamation proceedings, have taken “forever” to determine. Monica Leech’s verdict came four years after the articles were written. In stark contrast, Commercial Court cases are usually held within a year.

In November 2006, a group of Irish bookmakers took a case against the British Horseracing Board over data charges for British horse racing information. We sought to avail of an EU court ruling on a data protection directive. I was the first witness before Judge Peter Kelly in a two-day hearing, before the case was settled. The essence of his style was no nonsense, a stickler for detail and a superb grasp of the business world. On a daily basis he arbitrates on the most complex, protracted and even bitter commercial disputes.

In one judgment, he cut through the false fog of waffle on NAMA. He exposed the fantasy of Liam Carroll’s Zoe Group’s financial plan. He didn’t accept that a €1bn loss today could be turned into a €300m profit in three years.

He asked: “What market is there likely to be over the next three years for the sale of sites even with planning permission and the sale of residential, commercial and retail units”? He rejected the pretence that he was dealing with anything other than insolvency. He concluded there was no viable rescue plan.

Judge Kelly’s refusal to extend court protection and the appointment of an examiner to this property group must force the Government to reflect on its bailout of Irish banks. Exchanging bad loans for government bonds has the superficial attraction of providing liquidity without upfront cash outlays by the State. A period of NAMA portfolio consolidation, followed by orderly market disposals, is highly desirable but illusory. My interpretation of Kelly’s judgment can be summarised succinctly: “The emperor has no clothes”.

The Supreme Court will adjudicate on the Carroll appeal next week. It has to choose between the Commercial Court’s extensive examinership experience of solvency prospects and the trinity of bankers, developers and politicians who still live in a fantasy world of denial. If Judge Kelly’s verdict prevails, he will have performed sterling service to the taxpayer. He has shattered the edifice of false valuation of NAMA assets.

LET us not forget the preemptive warning about NAMA by our most experienced public servant. The NTMA boss, Dr Michael Somers, publicly expressed fears that NAMA will be a legal minefield in the Four Courts. This legislation provides enormous new legal powers to the State to carry out a number of functions.

These include compulsory land acquisition, vesting powers to enable NAMA to pursue any assets of developers, appointing a receiver to other parties in default over a loan and participating as a litigant in bank proceedings.

The bill seeks to prevent legal manoeuvres by disgruntled parties. These include the refusal of injunctions, limitations on judicial reviews and rights of appeal to the Supreme Court. Constitutional challenges to the legislation seem inevitable. Property rights are deeply embedded in our constitution. President McAleese should have the Council of State on standby. NAMA may not become operational until next year due to this legal quagmire. This might allow a real market to prevail for impaired property assets and loans.

All of these momentous political and judicial considerations have almost succeeded in disrupting our annual high summer respite. Before the daylight disappears from our evenings, let’s enjoy what’s left of the holiday season. God knows between budget blues, Lisbon lectures and strike chaos, our winter of discontent will be upon us long enough.