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Property price rise alarm aims to prevent next crisis

The Property Industry Alliance has developed a warning system that it wants lenders to adopt to help prevent another financial crisis.

Property price rise alarm aims to prevent next crisis

A new commercial property price warning system aims to raise a red flag when valuations start to look too high - in a bid to stop lenders from causing another financial crisis.

The debt working group at the Property Industry Alliance (PIA) has developed a metric that sounds an alarm when commercial real estate prices move too high that it hopes will be adopted by lenders and regulators.

The ‘adjusted market value’ (AMV) metric looks at previous property cycles to work out how far values can go before a market crash looks inevitable.

Based on the MSCI IPD All Property index for the third quarter, the metric shows commercial real estate prices are currently 10% above the long-term average after inflation is stripped out.

This gives a 50% risk of prices falling by 30% within the next five years. This risk increases to 100% if values move 20% above the long-term average.

The PIA said historically once values are more than 20% higher than the long-term average, prices have crashed by at least 30% in real terms.

While talk of frothy markets and prospects of another crash may worry some commercial property investors, the PIA said lending levels are ‘far more conservative’ than in the period leading up to the last crisis.

Research by De Montfort University shows average loan-to-value ratios are around 60% today, compared to 75% in 2006-2007.

Check for signals

Rupert Clarke, chair of the PIA’s debt group and managing partner at property developer Lipton Rogers, said banks and fund managers need to ‘hardwire this methodology into their risk metrics’.

This would allow them to become ‘more cautious when it starts to hit amber and take decisive action when it moves into red’.

‘At the moment, the vast majority of lenders have no clear action plans to prevent themselves from being sucked into the commercial real estate lending ‘blackhole’; lending too much against overvalued properties at the end of the cycle,’ he said.

Peter Cosmetatos, chief executive of CREFC Europe, which represents property lenders, said the AMV metric was not a panacea, but it could help to promote better lending.

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