U.S. banks have placed billions of dollars of loans into the British property market, betting that London will boom with European unification at hand.
But as last week's bankruptcy filing for Olympia & York's Canary Wharf illustrated, the boom has been a bust so far. Last year, London experienced the first decline in property values since World War II, prompting fears that lenders could suffer huge losses.
"So far, the banks are playing down this risk, but some estimate problem loans could exceed $8 billion" for all the banks, said Stewart Forbes, president of Colliers International, a consultant based in Boston.
U.S. Exposure: $4.8 Billion
Although British banks hold nearly two-thirds of the $93.5 billion of loans on U.K. property and construction, U.S. banks also are among the victims of overly optimistic lending, with some $4.8 billion outstanding, according to Savills, a London real estate manager.
Citicorp, which has placed $279 million of a $380 million exposure to Olympia & York Developments Ltd. on nonperforming status, also lost $120 million on loans to Randsworth Acquisitions Ltd., a British real estate concern that failed last year.
BankAmerica Corp. was listed in The Wall Street Journal as among the banks financing Heron International PLC, an investment company based in London that is attempting to reschedule more than $2 billion of debts.
Chemical Banking Corp. has $125 million in Olympia real estate loans, including $100 million at Canary Wharf, for which the company hinted it has already set aside reserves.
Tenant as Well as a Lender
In addition, it is set to become a rent-paying tenant under a lease due to take effect next January, bank officials said last week.
Citicorp and Bankers Trust reportedly have lent money to Mountleigh PLC, a property company placed in receivership last week. It owes $732 million to a lending syndicate led by Barclays Bank.
London was the favorite in the race to become the financial capital upon unification of Europe's economy, due to take full effect by the end of the decade.
Bankers figures London's access to the Continent would be enhanced by a new tunnel under the English Channel; that the city's universally spoken language would offer another edge; and that its superior infrastructure would attract global banking and finance companies.
Completion Date Unclear
However, the tunnel is reportedly in technical default on its financing, and one of its developers has publicly broached the subject of a bankruptcy filing, which could delay completion well beyond target dates.
Another problem is that capitalist Europe's borders have stretched eastward. The collapse of communism has moved London further from the geographic center of the economy.
And the world financial community has become more cost-conscious, putting expensive London real estate at a greater disadvantage against such better-situated competitors for tenants as Frankfurt.
To be sure, Greater London's immediate problems are not nearly as severe as those faced at Canary Wharf. The success of the Olympia & York project was partly predicated on government leases and favorable tax provisions that have yet to be approved.
Whereas Canary Wharf's 4.6 million square feet of completed space remains 43% vacant--and some prospective tenants are reconsidering plans to move there -- the overall London vacancy rate is about 15%, according to a survey by Colliers.
Richard A. Buck, senior manager of Arthur Andersen & Co.'s real estate services group in London, noted that while there are problems, "everyone in the market is committed to maintaining London's position" as the preminent office market in Europe.
In one positive sign, he said the European Bank for Reconstruction and Development, a new institution created to spur economic growth in eastern Europe, is based in London.
Mr. Buck and managing partner David Sproul at the Arthur Andersen office argued that bankers who tried in vain to renegotiate $2 billion of debt on Canary Wharf faced obstacles far beyond those in the market at large.
Equity Source a Surprise
First, they were irked to learn that what they thought was Olympia's equity in the project actually came from the proceeds of financings on other properties in North America.
Moreover, there proved to be hidden costs underlying some of the big leases in the project, he said. For instance, Olympia had arranged to lease about 300,000 square feet of space at Canary Wharf to American Express Co.
But when the cost to Olympia of assuming American Express' former lease in downtown London was weighed against revenue from the new lease, it turned out the deal would actually cost the developer $16 a foot.
"There's a feeling that the banking community is very supportive" of the market at large, Mr. Buck said, "because if the market goes down, the bankers go down with it."
Mr. Buck noted a downtown building recently was let at $98 a foot, a sign that space still can command a top price, despite Olympia's troubles.
Preference for New York
But high costs for space can also be seen as a negative for the market, said one banker, who acknowledged a bias in favor of New York, where high-quality space is being "given away."
London rental rates declined an alarming 20% last year, but they remain the highest of any city in Europe or the United States, at about $75 a foot, according to Colliers.
Washington was the most expensive city in the United States, at $43 a foot, and New York space commands only about $33 a foot, Colliers said.
Among more direct competitors for European supremacy, rental rates in Frankfurt rose to about $54, from just over $30, while space in Paris rose slightly, to about $61 a foot.
Terms Getting Softer
Also upsetting lenders' high hopes that the London market would outperform U.S. markets, the British 25-year leases under which rentals can only increase are falling by the wayside, the New York banker noted.
Now American-style concessions to renters are the norm, and once-binding leases have "escape clauses."
Londoners still expect their market to remain the preeminent market in Europe, Mr. Sproul said. But he added: "I think there's a little more concern about whether there will be growth."