Long term value report

This report is an initial analysis and reconciliation of the characteristics of three alternative long-term value methodologies; Adjusted Market Value, Investment Value and Mortgage Lending Value, compared to market value.

View the report

Property industry leaders announce breakthrough in mission to reduce the risks of commercial property lending boom and bust

A decade after the last UK real estate peak, ‘Adjusted Market Value’ analysis can now be used to reduce risk of commercial property lenders fuelling then being overwhelmed by the property cycle.

July 3 2017– Ten years ago, at the end of Q2 2007, an overleveraged UK commercial property market finally reached the end of a long bull run.

Over the next two years, values dropped by 42% and UK commercial property lenders were looking at huge potential losses, with Lloyds/HBOS and RBS being bailed out by the UK taxpayer in October 2008. The UK economy today still bears the financial fallout and scars.

But new industry research, published today by The Property Industry Alliance (“PIA”), concludes that, if lenders and regulators had had access to suitable long-term value metrics in the period leading up to the 2007 crash, they could have anticipated the extent to which commercial property was becoming overvalued and seen that a major crash was looming.

Not only that, lenders and regulators could have reached that conclusion three years before the market eventually peaked.  As lending volumes typically increase greatly at the top of the cycle, this would have given them sufficient time to moderate exposure and ensure they were better positioned to manage the major downturn that followed.

The Property Industry Alliance (“PIA”), which brings together leading representative bodies from the UK commercial property industry, acting through its Debt Group, today releases the results of its two year research project focused on identifying effective long-term value metrics that can be used by lenders and regulators to help identify periods of significant overvaluation and anticipate major crashes.

The research paper was born out of one of the key recommendations of an independent industry report, “A Vision for Real Estate Finance in the UK”, published in 2014.  The Vision report made recommendations for reducing the risks to financial stability posed by the commercial real estate cycle.

One of the key recommendations of the Vision report was that long-term value metrics should be developed to help lenders and regulators understand how current property prices compare to a more sustainable, long-term concept of value.  The Long-term Value research analysed the performance of three different “Long-term” value measures and their ability to predict crashes, using historic market data.

The most reliable of the three proved to be “Adjusted Market Value”, which compares current market values to a long-term trend derived from the inflation-adjusted long term capital value index.


Correlation between AMV overvalue signals and actual subsequent five-year value falls

This method weighs up whether values are rising above levels where, historically, crashes have taken place before.  By using this information to moderate new lending, lenders and regulators could take action to reduce the risk of lending losses when market values fall.

While the property cycle cannot be prevented, this work seeks to reduce its impact on the financial sector – something that may also serve to reduce the amplitude of the cycle by limiting the extent to which debt drives it.

As part of the findings, the report also recommends that further research is undertaken to develop the Long-term Value metrics further, including at sector, subsector, portfolio or individual property levels.

The important next step is to explore how the metrics could be best applied by individual lending institutions and, indeed, regulators, to better manage the cycle: reducing losses from exuberant lending at the peak, and improving lending appetite after a crash when the economy most needs credit.

The PIA Long-term Value working group that conducted the research included representatives from the Bank of England, the valuation industry, rating agencies, academics, researchers and the major UK clearing banks.

Rupert Clarke, the former CEO of Hermes, who chaired the research group, said: “The biggest challenge facing property lenders and regulators is how to avoid catastrophic write offs at the end of every major market cycle. This Long-term Value research is a game changing breakthrough for the proactive management of end of cycle systemic risk. The vital next step is to make sure lenders, regulators and all the lending stakeholders grasp the nettle and resolutely hard wire Long-term Value techniques into their risk management framework.”

Phil Clark and John Gellatly, co-chairs of the PIA Debt Group, added: “This research is an important milestone after almost a decade of work undertaken by the PIA and the wider industry to understand the scale and complexity of commercial real estate lending activity in both the boom and bust phases of market cycles.

“Specifically, it builds on the foundation established by the Vision report and is a major step towards reducing the risk posed to the UK financial system by the next commercial real estate crash. The report identifies further work required to improve, as well as increase awareness and understanding of, the effectiveness of Long-term Value metrics and how they might be used.

“This is essential in order to ensure recognition and adoption of these types of methodologies in the lending and regulatory process.”

Peter Cosmetatos, chief executive of commercial real estate lending trade body CREFC Europe, said: “We welcome the publication of this research, which will be of interest to many of our members.  Any metric that can be shown to give reliable advance warning that a major fall in property prices is likely could play an essential role in helping lenders manage cycle risk and avoid some of the errors of the past.

“We look forward to exploring how the industry might best build on this work to support responsible and sustainable commercial real estate finance markets.  From a regulatory point of view, we believe that it is particularly important to avoid unnecessarily distorting competition across different types of lenders subject to different regulatory and capital frameworks.”

Further information:

Giles Barrie, FTI Consulting: 0203 727 1042, giles.barrie@fticonsulting.com


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