Europe needs a crash test

Work needs to be done, but ‘adjusted market value’ can alert property lenders to looming drops in value, in good time, argues Rupert Clarke (pictured) of the Property Industry Alliance

This month’s launch of the quarterly publication of ‘adjusted market value’ – a metric that monitors when property values stray from the long-term average – represents a major breakthrough.

Commercial real estate lenders now have a traffic-light system to assess whether the UK market is becoming overheated and is likely to experience a major crash – up to three years before the crash actually happens.

Although in past cycles much of the raw data to allow lenders to do this have been available, interpretation has been very subjective, resulting in no clear conclusions and limited, or no, pre-emptive action.

In contrast, AMV analytics has translated this data into a quantitative tool, validated by its ability to anticipate the last four major crashes. Of course, it might be different next time, but the overwhelming probability is that it won’t be. While AMV is not perfect – there are certainly no guarantees that it will capture every major crash from here to eternity – it is very likely to capture crashes triggered by excessive investment momentum; a behaviour embedded in all the major crashes in the past 100 years.

Life in practice is more complicated. The application of AMV to the MSCI/IPD UK ‘all-property’ index provides a relatively straightforward macro-indicator, but obvious questions arise.

What about the sub-sectors – central London offices look extremely overvalued versus the long-term trend, for instance? Or, surely everyone can afford to relax because we are in a low inflation/low investment yield era, so shouldn’t the trend analysis be fine-tuned to account for this? And, even if we have all this information, how should it be applied to real-life lending scenarios? What are the likely regulatory applications and how might they affect the make-up and behaviours of the lending market?

These, and other detailed analytical questions, will all be part of the second phase of the ‘long-term value’ research planned for the next 12 months. As in the first stage of the research, representatives of the Bank of England will form a key part of the steering group, ensuring that the analysis is relevant and practical and that, as engaged participants, they can shape the outcomes to meet their needs as a regulator and for those in lending organisations.

Not only will this further research interrogate AMV, it will also revisit the reliability and usability of slightly different forms of investment value metric. Further analysis and adjustment of the methodologies should offer additional market, sub-sector and lending insights over and above those already reported, giving lenders and regulators increased flexibility and confidence in the use of individual measures and tools, although a crystal ball is likely to remain out of reach.

In the meantime, commercial real estate lending organisations and regulatory bodies that embrace AMV as a vital and serious lending macro-risk metric, will almost certainly avoid repeating many of the major mistakes that were made in previous cycles.

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