Lenders Looking at New Commercial Property Metric

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If it seems like the UK commercial property market is constantly on a roller coaster ride, your perceptions are correct. The property market operates on a seemingly unending cycle of booms and busts that are actually rather predictable. As a commercial property adviser, I've had to work with clients through these booms and busts. However, they may become a thing of the past if the Bank of England (BoE) has any say.

The BoE has been working with leaders in the property industry to develop a new metric for evaluating commercial property based on the cyclical nature of the market. They are now encouraging lenders to adopt this metric when evaluating loans. If the metric proves successful, it could lead to a more consistent commercial property market with fewer booms and busts.

According to the Financial Times, the new metric is based on what industry leaders are calling 'adjusted market value'. Right now, lenders focus heavily on loan-to-value (LTV) ratios based on current property prices. They have had no other way of analysing risk prior to this new metric being developed. Unfortunately, the current way of doing things is partially responsible for the volatility of the commercial property market.

Adjusted Market Value Is Long-Term

As the Financial Times reports, the UK commercial property market has been fairly predictable for quite some time. Every 15 to 20 years, the market increases dramatically and then crashes equally dramatically. Much of the problem is directly related to the weakness of the system used by lenders to evaluate whether to make loans or not.

As commercial properties begin to escalate, there is more pressure on lenders to open up their coffers to buyers and investors. This heats up the market, encourages more people to buy, and raises prices based on the simple supply and demand principle. As long as banks continue to lend using LTVs and current property values, the market continues to rise until properties eventually become overvalued. Then everything crashes because values are too high.

The BoE says that current commercial property values ‘appear stretched’, citing office space in London as a prime example. They are warning of another crash if something isn't done to bring values more in line with reality. They hope the new adjusted market value metric will help.

Adjusted market value compares current property values with long-range trends and past cycles. It also adjusts for inflation as well. The metric suggests that the current market is overvalued by up to 10%. It also suggests that the market could fall up to 20% over the next five years.

Commercial property investment advice already seeks to look at long-term potential to some degree. But until now, there has been no solid metric that used hard data to predict under and over valuation of properties. The BoE's new metric may be the solution. If it performs as it's intended to, it could make the lives of commercial property advisers and lenders a lot easier.

Sources:

Financial Times – https://www.ft.com/content/05883224-5e57-11e7-91a7-502f7ee26895

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