Banks lending on property must fully understand the late cycle risks they may be taking on now and ensure they have strategies in place to avoid hits to profitability, says new research.
A paper produced for the UK Property Industry Alliance says banks made ‘catastrophic’ losses from UK commercial real estate lending (CRE) at the end of the last property cycle and could do so again.
Written by Rupert Clarke, previously chief executive of Hermes and former banker, the report says CRE lending to UK property generated profits of £7 bn (€8 bn) during the last cycle, but that this was dwarfed by £19.3 bn of write-offs, mainly from loans made towards the end of the cycle.
The research says that loan to value ratios were not adjusted to reflect increasing risks as property market values rose significantly towards the end of the cycle. ‘It is vital that as the cycle progresses, LTVs should be proactively managed to reduce risk’, the report says.
Yields for many real estate markets in Europe are back down to, or even below, their levels in 2007, just before the global financial crisis.
Although the research studied the UK banking sector only, it says the conclusions could apply much more widely, given the similarities between the UK CRE lending market and others internationally. ‘Other CRE lending markets internationally have experienced similar through-the-cycle profitability challenges’, it says.
However, 10 years on from the collapse of Lehman Brothers, Clarke does also point out that the CRE lending industry is not exhibiting many of the behaviours that were widely prevalent in previous cycles. ‘In the current market, the fallout from the GFC and CRE lending losses remains a strong positive influence on industry and regulator behaviours.’
