The industry group tasked with devising a method to help lenders identify overvaluation in the UK property market has announced plans for the publication of a quarterly metric.
The Property Industry Alliance’s Debt Working Group plans to publicise adjusted market value on an ongoing basis. AMV is a percentage determination of UK commercial property’s overvaluation, comparing the MSCI IPD All Property index with a long-term trend line.
By understanding how overvalued property is relative to trend, the group intends to create a tool that will allow banks and regulators to act to cut exposures, reducing risk to the UK financial system.
The metric was identified as the most effective by the group in July. The method shows that, in previous cycles, every time values have exceeded 20 percent above the trend line, prices have crashed by at least 30 percent in real terms.
“Rather than seek to alter the way market values are determined, we’ve attempted to offer a solid basis to supplement the information available to lenders and the regulator”
– Charles Cardozo
Based on the IPD index for Q3, the metric shows commercial real estate values are 10 percent above the long-term average, once inflation is stripped out. It gives a 50 percent risk of prices falling by 30 percent within the next five years.
“Our ambition is that all lenders – banks, funds and debt funds – hard-wire this methodology into their risk metrics, become more cautious when it starts to hit amber and take decisive action when it moves into red,” said Rupert Clarke, chairman of the PIA debt group and managing partner at Lipton Rogers.
“At the moment, the vast majority of lenders have no clear action plans to prevent themselves from being sucked in the CRE lending ‘black hole’, lending too much against overvalued properties at the end of the CRE cycle.”
Charles Cardozo, director at Radley & Associates and a member of the group, added: “This is the start, not end of the journey, as further technical work will need to be conducted on the methodologies to analyse and fine-tune the models.
“Rather than seek to alter the way market values are determined, we’ve attempted to offer a solid basis to supplement the information available to lenders and the regulator, with a metric specifically intended to inform risk management and regulatory capital requirements.”