UK CRE lending has been loss-making for three cycles, industry watchers claim

Property lenders must create late-cycle strategies to avoid the “profitability black hole” of previous cycles, a debt working group has urged.

The UK commercial real estate lending industry failed to make any profit from its activities during the market cycle from the peak of the market in 1992 to the crash of 2008, due to a combination of lender peer pressure, organisational inertia and short-term strategies, a damning report has claimed.

The report, compiled by the debt group established by the UK’s Property Industry Alliance to draw lessons from the debt bubble created in the last cycle, urges debt providers to put in place late-cycle strategies to avoid a repeat of the profitability “black hole” which it said swallowed any gains made throughout the cycle during its closing stages.

The report, which was put together for the Property Industry Alliance debt group by former Hermes chief executive Rupert Clarke, also found the problems were not unique to 2008, with banks also failing to profit from UK real estate lending during the previous two cycles, spanning a 50-year period.

Speaking to Real Estate Capital, Clarke explained accelerating lending in the latter stage of the cycle leads to large losses for debt providers. “At the moment, the market is in good shape overall, however lenders need to be confident that they can control end-of-the-cycle risks.”

The debt group analysed Bank of England data on the quantum of commercial real estate lending between 1992 and 2008 – the property lending peak-to-peak – and contrasted it with Bank of England data tracking loan write-offs since 2008. Using historic Cass Business School data (formerly compiled by De Montfort University) margin and fee revenue across the industry was estimated, to provide a picture of the profits – and eventual losses – made throughout the cycle.

The conclusion was UK commercial property lending generated profit of around £7 billion (€7.9 billion) in the last cycle, but suffered £19.3 billion of end-of-cycle write-offs, resulting in an overall cycle loss of £12.3 billion.

“Whilst the through-the-cycle loss-making experience certainly did not apply for all CRE lending organisations, it seems likely to have applied for the majority,” Clarke said.

The sheer volume of loans written in the last two years of the cycle created the conditions for the overall loss across the industry. In the early stage of the cycle, loans outstanding stood at £32 billion, rising to £255 billion by the time of the crash, with £164 billion of the total written in 2006 and 2007. Loan-to-value ratios were not adjusted to reflect the increasing risk as property values spiked at the top of the market.

“One of the main reasons that lending losses wipe out historic profits is that banks typically have the least exposure when lending is most profitable and least risky – when margins and fees are high and CRE values and loan-to-values are low,” the report stated. “During the early stage of the cycle, in spite of high margins and fees, even very active lending organisations fail to make enough absolute profit to shelter the large end-of-cycle losses, which almost inevitably occur at the lending organisation’s point of maximum exposure.”

In addition to the analysis of loan write-offs, the report noted additional lender exposure to equity finance, which reached £6.5 billion immediately before the peak of the market, the majority of which would have been exposed to complete write-offs.


The report outlined four main reasons for banks failing to grasp the scale of the potential problem building in the run-up to 2008. Peer pressure among lenders was a factor, it said, with bankers fearful of reducing activity before rivals at a time when the market appeared to be performing well.

Organisational inertia also played a role, with bankers failing to review lending criteria, despite a gradual and progressive heating up of the market. Short-term lending strategies, which did not take into consideration the magnitude of end-of-cycle risk, due to the generally short-term horizons of lending teams, risk committees and boards, as well as analysts and shareholders, also contributed.

The report also highlights a lack of clear end-cycle commercial real estate lending strategies, with most organisations failing to recognise the need for specific lending criteria which could act to pre-empt excessive late-cycle lending.

“Unless there are extremely clear and unambiguous warning alarm bells, lending organisations will generally keep on lending even if the market is looking overheated. Waiting for everyone to agree that all metrics emphatically signal that the market is overheated is definitely leaving it too late,” the report said.

Among the metrics the debt group is investigating to provide a warning sign of an overheating market, is a measure of how far capital values are above a long-term value trendline. Clarke told Real Estate Capital the metric is just one tool lenders could use to monitor the health of the market in which they operate.

“Lenders can also measure liquidity in the marketplace, or the percentage of real estate debt as a proportion of its balance sheet,” said Clarke. “There are a range  of indicators that can be used – it is essential lenders take a macro view and are prepared for the end of the cycle.

End-of-cycle strategies, the report says, should make clear what action will be taken by who when the warning signs point to an overheating lending market. Other suggestions made by the debt group included a clearer focus by the regulator on real estate lending activity as well as preemptively managing bank shareholder expectations.

“Most importantly, the industry as a whole needs to engage and debate whether this report presents a fair picture,” said Clarke.“Until strategic weaknesses are fully recognised, agreeing on the best solution is rather academic.”

The report is of equal importance to non-bank lenders as well as large real estate finance units of commercial banks, Clarke argued, given the volume of private debt capital flowing into alternative lending organisations is likely to grow as the cycle plays out.

The report emphasised current lender and regulator behaviours seem prudent, with average loan-to-values below 60 percent and aggregate outstanding loans at around 65 percent of the 2008 high. “At the moment, the market is in pretty good shape overall. We haven’t seen the rapid escalation of lending for lots of different reasons, and there is caution around LTV and the amount of lending,” said Clarke.

Commenting on the findings, Lord Adair Turner, chairman of the Financial Standards Authority between 2008 and 2013, now chairman of the Institute for New Economic Thinking, said the report is essential reading for bankers, investors and regulators who want to learn the lessons of the past.

“Commercial real estate lending has been central to almost all financial crises of the last half-century,” said Turner. “This report explains why, revealing the huge financial impact of irrationally exuberant late-cycle lending, which destroys value in the industry and in the wider economy.”