October 2018:  Chairman of the PIA Long-term Value Methodologies working group, Rupert Clarke, issues report ‘THE CRE LENDING BLACK HOLE’

Research undertaken has revealed for the first time that UK banks collectively made no profit from real estate lending during the market cycle from 1992 to the 2008 crash. Authored by Rupert Clarke, a 35-year veteran of the real estate and financial services sector who was previously chief executive of Hermes, the report says commercial property lending generated profits of c.£7.0bn during the last cycle. This was dwarfed by £19.3 bn of write-offs, mainly from loans made towards the end of the cycle.

Bad commercial real estate (CRE) loans were a large part of the reason HBOS and RBS needed bailouts a decade ago. According to the research, these problems were not unique to 2008: banks also failed to profit from lending to real estate during the previous two cycles – a period spanning over 50 years.

According to the report, at the lowest point in June 2009, more than £50 billion of capital was at risk of total loss. The research says that loan-to-value (LTV) ratios (a measure of how much value risk is being taken) were not adjusted to reflect increasing risks as property market values rose significantly towards the end of the cycle. It is vital that as the cycle progresses, LTVs should be proactively managed to reduce risk.

Clarke is calling on banks and their shareholders to take a more proactive approach to ensuring institutions have strategies for lending towards the end of cycles and processes in place to fully understand the risks they are taking on.

Lord Adair Turner, chairman of the Institute for New Economic Thinking and chair of the Financial Standards Authority between 2008-13, said:

“Commercial real estate lending has been central to almost all financial crisis of the last half-century. This report explains why, revealing the huge financial impact of irrationally exuberant late cycle lending which destroys value in the industry and in the wider economy. Any banker, real estate investor or regulator who wants to learn the lessons of the past should read the report, and design strategies to avoid similar mistakes in future.”

Rupert Clarke, chair of the Property Industry Alliance Long-term Value Group, said:

“Organisations, and those that run them and invest in them, need to be confident that CRE lending activities are sustainable and that appropriate governance is in place. It’s vital lending activities are not only well managed and successful in the short term but robust and sustainable throughout all stages of the lending cycle.

“Investors, banks and regulators need strategies in place to address specific challenges around lending during the latter part of property cycles. Without such measures, future cycles will continue to see shareholder capital eroded and economic stability undermined.”

Saker Nusseibeh, chief executive of Hermes Investment Management, said:

“Sustainable investing demands that Boards, investors and shareholders have strategies that deliver value over the long term. The findings of this ground breaking report on CRE lending make it clear that all the stakeholders in CRE lending, both in the UK and internationally, need to commit to putting in place strategies and governance that fully recognise the lessons from the past.”

The research concludes that the “profitability Black Hole” from CRE lending was almost certainly experienced in previous UK property cycles. Given the similarities between the UK CRE lending market and others internationally, it also concludes that other CRE lending markets internationally have experienced similar through-the-cycle profitability challenges.


The report identified four key behavioural reasons behind lending organisational failures:

  1. Peer Pressures: Fear of Reducing Market Activity “too early”: The financial markets are extremely competitive with direct and indirect peer pressure to grow profits. Reducing exposures (and profitability) when the market is performing well goes against the grain for all stakeholders.
  2. Organisational Inertia: The best analogy is the fable of the “frog in the water pot” failing to notice the temperature gradually rising towards boiling point. Traditional lending criteria and the gradual and progressive heating up of the market lulls the stakeholders into a false sense of security.
  3. Short term horizons and failing to look at the big picture: Although the mathematics of the cycle should be obvious to anyone looking at the big picture, because the focus of the governance chain (lending team, risk committee, board, analysts, shareholders) is generally short term, CRE lending strategies and activities have seemingly been completely blind to the magnitude of end of cycle risks and their impact on full cycle profitability.
  4. Lack of Clear End of Cycle CRE lending Strategies: For some reason organisations have failed to recognise that they need specific and well thought through strategies that anticipate and pre-empt default organisational behaviours which almost certainly will exert pressures to keep on lending in spite of all the warning signs. However, with almost no exceptions, lending organisations have not had (and still do not seem to have) any specific end of cycle strategies, with many being of the view that, because each cycle is different, it is simply too difficult to predict the end of the cycle. Unless there are extremely clear and unambiguous warning alarm bells, lending organisations will generally keep on lending even if the market is looking overheated. Waiting for everyone to agree that all metrics emphatically signal that the market is overheated is definitely leaving it too late.

Peter Cosmetatos, chief executive of lenders’ trade body CREFC Europe, commented:

“We shouldn’t be too surprised to learn that commercial real estate lending, crucial as it is for supporting investment in the built environment and real economy, is a difficult business to make money from.  In such a highly cyclical market as commercial real estate, those joining the party late in the cycle are most obviously at risk, skewing the profitability picture for the market as a whole.  Having said that, any lender would be wise to have a strategy for managing the peak of the cycle, and both regulators and investors should want to understand and support such strategies.”

Phil Clark, co-chair of the Property Industry Alliance (PIA) Debt Group, said:

“This report is an important addition to the industry’s ongoing research and initiatives on the UK CRE lending market, based around some of the recommendations from the 2014 ‘Vision for Real Estate Finance in the UK’ paper. The Property industry Alliance continues to work on the key initiatives of long-term value research and in establishing a CRE lending database, both of which will deliver greater transparency across the UK CRE lending markets. The analysis within the “CRE lending Black Hole” paper makes it very clear that end of cycle strategies are required to ensure that the CRE lending business model is sustainable.”

CRE Lending Report

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