The chances of history repeating itself and of real estate debt playing a key role in creating another financial crisis seem low, given the conservative nature of the lending market. This was the consensus among panellists at the fifth annual Oxford Real Estate Conference, hosted last week by the Oxford Real Estate Society. Participants discussed what went wrong 11 years ago and whether lessons have been learned. The general view was that the reckless use of debt, which inflates property values, is not the norm in today’s market.
Pre-2007, banks were pushing hard to get business done and were using dubious formulas to underwrite risk, such as valuing future rental growth as part of an assumed income. At the time, the power was in the borrowers’ hands, as they were able to close highly leveraged deals to boost returns. Investors were used to borrowing 90 percent of their equity and lenders were happy to oblige, motivated by big cash bonuses and big lending targets.
Today, lenders do not have the same incentive structures. Debt providers also have a better appreciation of who should be taking on risk, why they are doing it and whether lenders are being appropriately rewarded for that risk.
Meanwhile, buyers are more educated about how to use debt and face greater scrutiny about investment decisions. Borrowers and lenders work much more in partnership, and there is a mutual understanding of how each will protect their capital.
Martin Wheeler, co-head of ICG-Longbow, provided statistics illustrating the lower levels of debt in the market compared with those at the time of the global financial crisis. In 2008, the overall volume of UK property investment was valued at £700 billion, against which there was £365 billion of debt. Today investment volumes are similar, but only £200 billion of this is debt. Wheeler said this was a good thing, even though he himself is in the business of providing that debt.
Although a real estate debt bubble does not appear to be building to anywhere near the extent seen by 2007, debt market professionals at the conference were alive to factors that they suggested could contribute to a downturn in the market.
Back in 2004-05, when real estate was starting to look expensive, capital continued to flow into the sector. Property investors got carried away in a market that did not appear abnormal to them. This booming investor demand drove up prices, which contributed to the asset bubble that eventually burst. Some panellists noted that the market is in a similar place now from an equity point of view: that huge reserves of global capital are focused on prime property, which should prompt concerns about rising prices.
Attendees also voiced fears about the wider influence of debt. Ludovic Phalippou, a professor of financial economics at Oxford University, argued that the next financial crisis would be a result of the “hottest” investment proposition at the moment: private corporate debt. “I’m nervous about the private debt market,” he said. Phalippou noted that the way leveraged debt vehicles generate returns resembles how investors took risk premiums at the start of the subprime housing bubble in the US.
Reckless property lending appears to be less of a threat this time. Nevertheless, those attending the conference were not complacent about the other potential causes of a downturn. Soaring values, driven by large amounts of equity, and problems resulting from aggressive lending in the wider private corporate debt market are among the threats that are still worth monitoring at this stage.
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