While UK property values relative to the long-term trendline edge towards “danger territory”, members of the industry working group keeping a watching brief on them say lenders need not panic quite yet.
The group, formed by UK body the Property Industry Alliance, is monitoring ‘adjusted market value’, by which it takes the latest Investment Property Databank quarterly capital growth figures, strips out the effect of inflation and compares them with the historic trend.
The aim is to warn real estate lenders when values rise far enough above the trend line, to levels which have historically preceded market crashes.
Based on end-2017 IPD figures, AMV is 12.2 percent above trend, up from 10.6 percent last September. When values are 15 percent above trend, there is a high probability of a fall in real capital values within a five-year period, a probability that increases if the overvaluation reaches 20 percent.
A repeat of this increase over the next six months “should send clear warning signals to lenders that market values are moving into danger territory”, Charles Cardozo of risk analyst Radley Associates, a member of the working group, said as the figures were announced.
However, speaking to Real Estate Capital, Cardozo adds that the figures need to be read within the context of the cycle. “The metric is an attempt to understand our position in the cycle. There have been four major property cycles in the past hundred years, so the trend reflects long timescales. The quarterly change is not major, although the continuing progress into overvaluation territory is concerning.”
As the metric assesses the likelihood of a crash in the coming five years, Cardozo says those writing loans now should take note. “Lenders over a five-year period should be considering gradually reducing loan-to-value levels, given that the market is more likely to correct than not.”
The increase in AMV in the last two quarters can be attributed to above-average capital growth – particularly in the industrial and office sectors – combined with relatively low retail price index growth. If property value growth continues through a period of low inflation, real property values increase.
Rupert Clarke, managing partner at developer Lipton Rogers and chairman of the working group, admits that the 160 basis points jump to 12.2 percent was a surprise, but explains that recent lower levels of reported quarterly, rather than annual, inflation, as measured by the RPI, account to a large degree for the shift.
“A lot would have to happen for AMV to reach 15 percent in the next six months – inflation would have to remain low compared to property price increases,” Clarke says.
While Clarke adds that there is “every case” for lenders to continue writing loans, he argues the latest long-term value metric serves as a further reminder that loan terms should be defensive as lenders enter a period in the cycle when a correction is a more realistic prospect.
“Lenders make the largest losses on loans written at the top of the market, so it pays to be cautious when it seems to be getting overheated,” he says. “We are at a point where there are increasing signs of overheating. That doesn’t mean a correction will happen, but the likelihood of it happening is increasing. It’s a good time to be cautious.”