An imperfect, but essential warning system

The Property Industry Alliance’s ‘adjusted market value’ metric is high-level stuff, but has the potential to prevent catastrophe.

The industry working group behind a proposed method to spot real estate lending bubbles gave their idea its first public airing to a room full of property people this week, sparking an interesting discussion of its merits.

The group, formed by UK body the Property Industry Alliance, wants to equip lenders, and the UK regulator, with the tools to recognise a dangerously overvalued market. ‘Adjusted market value’, which it says is the best metric available, adjusts indexed all-property market values for inflation and plots them against a long-term average trend line.

Scrutinising decades of historical data, the group discovered that, using AMV, the last three crashes were predictable. When adjusted values have risen 20 percent over the trend line, disaster has historically ensued.

Plans to monitor this early warning system on a quarterly basis were announced at the latest presentation of the IPD UK Quarterly Index; the property valuation data set by which AMV will be tested on an ongoing basis.

IPD events tend to attract crowds mainly made up of equity investors, and members of the audience were quick to quiz the working group’s representatives at the event – industry veteran and chairman of the group, Rupert Clarke, and Charles Cardozo of risk analyst Radley & Associates – on how AMV might affect their lives.

What, asked one investor, would the metric say about the likely future of the UK student accommodation sector, perhaps hinting that this big-picture thinking might not relate to individual sectors. Another audience member asked whether the metric accounts for the skewering of central London office values by cash-rich foreign investors. The real-world accuracy of the level of overvaluation recorded by AMV was questioned by another attendee, on the basis that potential interest rate hikes could impact values.

Fielding these questions, Clarke and Cardozo were clear that AMV needs to be taken for what it is – a high-level indicator of overvaluation across the UK market. From the starting point of identifying the metric, work now needs to be done to test its effectiveness for individual sectors. But AMV, the pair argued, is based on a wealth of data, and is only helpful where that data exists.

AMV, to borrow Cardozo’s phrase, is a “blunt instrument”, but that does not mean it is without merit – far from it. It may be limited to the macro-view (for the time being at least), but that means that AMV has the potential to serve as the lending industry’s warning light. Crises happen at the macro-level after all.

The metric will not predict the cause of the next downturn, nor will it tell lenders how sound their individual lending decisions might be. What it has the potential to do is highlight exactly when the market is getting overheated, relative to history. For lenders committed to genuinely cautious strategic thinking at this late stage of the cycle, clear evidence from the past is essential data.

As for where we are now; AMV is 10 percent above the trend line. This isn’t critical, but it is an amber warning. In past cycles, 15 percent above trend indicates a high probability of a major market fall, but it still gives lenders enough time to respond.

What lenders, and the regulator, do with AMV is yet to be determined. But the property debt market has consistently failed to recognise end-of-cycle risks. AMV is not the perfect warning system, but it is a good start.

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