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Archive for April 17th, 2011

What is a fire sale?

Apparently it’s something that you want to avoid if you’re managing assets, particularly in NAMA and the State-controlled banks. It’s also a term routinely bandied about by the Irish media in a way which suggests we all should know what it means. The entry examines the meaning of the term and how you can tell the difference between a fire sale and a “distressed sale” and a “normal sale”. It also examines how the concepts might have applied to the sale of 84 properties at auction at the Shelbourne Hotel on Friday last.

There is some dispute about the origin of the term “fire sale” which seems to be a couple of centuries old. The most credible claim for its origins that I have come across is the sale of fire-damaged goods by a retailer who is otherwise going out of business as a result of said fire. Thanks to a paper on fire sales referred to in a comment by Professor Karl Whelan at the irisheconomy.ie website, I am taking the working definition of a fire sale to be “a forced sale in which high-valuation bidders are sidelined, often due to debt overhang problems afflicting many specialists simultaneously” (Shleifer and Vishny, 1992) Or to put it another way – “a fire sale is a forced sale at a price regarded by the market as low because potential buyers can’t get credit”

So the three elements are

(1) forced sale – The Schliefer and Vishny paper on fire sales implies a definition of “forced” which suggests “necessary for the seller so that the seller can pay creditors”. So if your creditors are about to foreclose on you and you sell your property as a result of those circumstance so as to pay your creditors, then that is a forced sale. What about the auction last Friday? Were the banks forced to sell those properties? Arguably not – they might have decided to sit on the properties for another year in the hope that the prices might have recovered.  Banks though are not in the business of sitting on property and will generally want to quickly sell foreclosed assets. So the banks mightn’t have been truly forced and might have been able to wait a little longer but their own corporate objectives might have effectively forced the sales. Better examples of forced sale however might be the requirement on the State-guaranteed banks to deleverage by 2013, presumably with some intermediate targets before then. In these cases the banks will need to sell if they want to continue receiving State support, so that would seem to fit more with the concept of “forced”. If NAMA gets a ministerial instruction to sell, then that too, might give rise to forced sales. On the other hand, NAMA has a 10-year lifespan and could decide to sit on assets for some time in the hope that they might recover. So was the auction on Friday a forced sale? I’d tend to say no and that the bank had the discretion to wait another year before disposing of the properties.

(2) low price – it is the “market” which gives rise to the perception of “low” and “high” prices. And the “market” comprises actual and potential buyers and sellers, sources of finance, valuers & auctioneers, the media and commentators, the government and others. You can use all sorts of “hard” methods to value property, rental yields where you take the monthly rent and multiply that by a number that reflects the current yield rate (134 months for the ~9% “yield” suggested by the auction last Friday), average gross income multiples for the area, affordability (presently we spend an average of 13% of our take-home income on paying for our home), cost of land and construction, demand:supply equilibrium which tries to look at the amount of vacant and for sale property with the demand. These are “hard” methods but as we all know, during the boom these hard methods went out the window as we witnessed 1% rental yields and an average home costing 10x annual salary. Nonetheless the perception amongst potential buyers during the boom was that it was a good time to buy at the going price. Which just goes to show that prices tend to overshoot the “hard” analysis on the way up. That is also likely to be the case on the way down. Were the prices on Friday low? With anaemic economic growth, a large overhang of unsold property, austerity measures set to intensify, threats to Upward Only Rent Review leases, property and water taxes, interest rate rises, continuing high unemployment, potentially a declining population, threats to rent assistance, potential repossessions versus property that had not been this affordable for two decades, I would say that prices have some way to decline yet. My unscientific assessment of the prices on Friday is that they represent 60% drops from peak which was the Central Bank’s adverse projection. My view is that they will go lower. Does the market generally think prices on Friday were low? I would tend to say yes and if the prices were achieved on Friday were reflective of the market then the Permanent TSB/ERSRI house price series which says that we were 39% off peak at the end of Q4, 2010 must surely have lost credibility.

(3) absence of credit – it is difficult to accurately establish the condition of credit availability in Ireland for property at present but anecdotally it is said to be abysmal – the difficulty is not that we can’t measure the contraction in total credit, the difficulty is that we don’t know what the demand is with both commercial and residential buyers not wanting to purchase falling knives. We do know Irish banks have challenging deleveraging targets which will deter new lending. But on the other hand, the Government claims that in return for the €24bn bailout, Irish banks will extend €10bn of new credit to households and businesses each year for the next three years. Anecdotally few banks want to extend credit for commercial property in Ireland but there are exceptions – Barclays Bank recently confirmed that it had extended €35m for property purchases inIreland. And although we know that there is a general problem with vacant housing and commercial space, it would seem from estate agent listings that much of that property is not making it onto the market at present. If property was offered for sale we would then perhaps get a better idea of credit availability. Although we are unlikely to get an official assessment, anecdotally most of the sales on Friday were cash sales.

So was the auction on Friday a fire sale? I would tend to say no because the bank was not truly forced to sell and might have waited longer in the hope that prices recovered and because in my opinion, the prices were not bargain basement. Anecdotally it seems there was an absence of credit. So with only one of the three criteria, I would say it wasn’t a fire sale.

It wasn’t a “normal sale” either because of the absence of credit and because the properties were reportedly sold by one bank in cases where receivers had been appointed and banks are not in the business of sitting on property long term. Also the prices achieved, which appeared to be 60% off peak, will have come as a shock to followers of the PTSB/ESRI house price series. So I would term the sale a “distressed sale”

A “normal sale” would have seen potential buyers having access to credit with sellers free to withdraw from the sale if prices achieved were not acceptable and where prices were not at the lowest publicly recorded inIreland.

Of course if you control a large amount of property assets, you will want to avoid fire sales. You might consider how credit can be advanced to potential buyers. You will want to assure potential buyers that prices will not go lower and that there may be shortages. You will not want to reveal to potential buyers that you are being forced to make sales. Those of you following the NAMA saga will be familiar with the agency’s manouevring under each of the three headings. And that should be accepted as the nature of NAMA, it is not a neutral participant in the market and it wants to see prices stabilize and rise. It should be remembered that although last Friday’s auction probably doesn’t meet the criteria to be considered a fire sale, it would seem that there will be large-scale forced sales in the not-too-distant future and perhaps then we will truly see fire sale prices. NAMA too probably understands that better prices will be achieved through a work-out of the asset rather than a fire sale. This should tend to incentivise NAMA to deal with the developer.

And lastly, from an English language usage point of view, the correct term is the two-word “fire sale”, not a hyphenated “fire-sale” or a single word “firesale”.

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