Long-term value metrics key in avoiding repeat of 2007 lending boom

The UK property industry has idenfitied the long-term value measures that should be developed to help regulators and lenders avert another 2007-style lending crisis.

The Property Industry Alliance (PIA), which includes representative bodies from the UK commercial property industry, has released results of a two-year research project focusing on the best long-term value metrics for identifying periods of significant overvaluation and anticipating major crashes.

Its paper, ‘Long-term value methodologies and real estate lending’, argues that the peaks in the past two market cycles were predictable well before they arrived.

“Real estate lenders could have avoided suffering substantial losses, if they had analysed the data and had hardwired mechanisms in place to respond to the outputs,” the paper says.

It concludes that estimates of long-term valuations can provide useful signals for when the commercial real estate market may be overvalued and face a high risk of a major fall in values.

It encourages lending institutions to consider how, in the light of the study, long-term value metrics can be given a central role in risk management systems.

Responding to the report, Alex Brasier, executive director for financial stability, strategy and risk at the Bank of England, said borrowers and lenders should be the first line of defence against forgetting that downside risks are greater when property markets have risen above long-term values.

“This work – by the property industry for the property industry – is a vital step to guarding against the same mistake being made in the future,” he said.

The PIA researchers said further work is planned to complete the analysis of the different approaches and to see how they might best be used to inform decision-making by lenders and regulators.

Rupert Clarke, the former chief executive of Hermes, who chaired the research group, said: “This long-term value research is a game-changing breakthrough for the proactive management of end-of-cycle systemic risk.”

He said the biggest challenge facing lenders and regulators was how to avoid catastrophic write-offs at the end of every major market cycle.

“The vital next step is to make sure lenders, regulators and all the lending stakeholders grasp the nettle and resolutely hardwire long-term value techniques into their risk management framework,” Clarke said.

The report builds on a 2014 industry report, “A Vision for Real Estate Finance in the UK”, which made recommendations for reducing the risks to financial stability posed by the commercial real estate cycle.

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