The Bank of England confirmed last night that it will work in partnership with the UK real estate finance industry to build a commercial property loan database, the Real Estate Finance Group’s (REFG) centrepiece proposal to improve the resilience of the sector throughout the cycles.
Alex Brazier, a member of the BoE’s financial policy committee, said in his address to the Property Investor’s Banquet at the City’s Guildhall the CRE industry must act now to avoid repeating the mistakes of the past.
Over-gearing in UK real estate, he said, “has been a major driver of instability in the past, making you vulnerable to the slightest change in sentiment”.
Mr Brazier told the audience, including senior executives of the UK commercial property industry, that outlined the Bank’s support for two key proposals put forward by the CRE finance industry, through REFG, a cross-industry group of senior real estate professionals chaired by Nick Scarles.
The first was the capture of “systematic data”, which, he said, would minimise the risk of “gearing [moving] into a shadow on our radar screen”.
He told the audience: “I welcome the efforts of your industry, in partnership with us, to build a database of CRE loans: a dataset that will be run and managed for the public good, while respecting commercial confidentiality.
“It can give you, and us, the information we need to manage the risk of loosening underwriting standards.”
Secondly, Mr Brazier, who is the BoE’s executive director for financial stability, strategy and risk, also confirmed the Bank’s backing for the adoption of ‘through-the-cycle’ property valuations to arrive at LTVs – another central plank of REFG’s Vision for Real Estate Finance in the UK proposals, launched two years ago.
In explaining the context of the Bank’s support, Mr Brazier said: “We’ve seen in the past how a change in sentiment can drive commercial property prices up even without the prospect of improvement in the cashflows which the property will generate.
“An ultimately pernicious spiral of sentiment and debt begins. Valuations and debt increase sharply relative to the cashflows that support them. In short, finance magnifies the cycle.
“To your great credit, your industry has been in the vanguard of thinking to deal with this.
“The proposal of the cross-industry Vision for Real Estate Finance, led by Nick Scarles of Grosvenor, was that everyone – lenders, borrowers and regulators – should consider appropriate levels of debt not relative to market prices but relative to cash flows capitalised at long-term, cycle-neutral, rates.
“Put simply, if prices rise because of sentiment rather than cashflow prospects, that should result in greater reliance on equity, rather than debt, finance. So when the inevitable reverse in sentiment happens, it won’t be magnified by an over-indebted industry.
“The industry proposal is music to our ears. If you apply it, it will stop debt running away unsustainably in the good times. And it will cushion the bad times.
It’s countercyclical, mirroring the way capital requirements for banks will now operate.
“And it’s completely in tune with the broader aim of reducing the way finance magnifies cycles.
“So we want to help you make progress with it. As capitalisation rates come down from their post-crisis highs, the need to do so is increasing.”
Mr Brazier said in the coming months, the Bank will start reporting market-wide indicators of valuations and gearing based on cashflows capitalised at cycle-neutral rates.
Responding to the Bank’s support for two of the central REFG proposals, Nick Scarles, group finance director at Grosvenor Group and chairman of REFG, said: “We are delighted that two of the key recommendations of our Vision are going to be progressed.
“The creation of a UK-wide commercial real estate loan database, coupled with the use of a long-term value metric to assess lending risk will be a big step forward in improving financial stability.
“We very much hope that, in time, some or all of our other recommendations will also be implemented. We’re particularly keen to see the introduction of a CRE qualification for all those involved in CRE lending.
“I am firmly of the view that the best regulation is developed following a considered and constructive dialogue between regulators, those regulated and those affected. This is a great example of just that.”
Peter Cosmetatos, chief executive officer at CREFC Europe, the trade association for the European real estate finance industry, said: “The recommendations from the Vision report have provoked a great deal of mostly constructive industry discussion over the last couple of years, none more than those for a loan database and a long-term value metric for analysing lending risk.
“This strong endorsement for those key recommendations from the Bank of England should encourage enthusiasts and sceptics alike to engage with the Property Industry Alliance Debt Group’s efforts to ensure the outcomes are workable and as helpful as possible for the market.
“As the voice of the property lending industry, CREFC Europe looks forward to playing a central role in the work ahead.”
The next steps for the CRE finance industry falls to Property Industry Alliance (PIA) debt group, co-chaired by Kames Capital’s Phil Clark and Aviva Investors’ John Gellatly.
In the first instance, implementation of the proposals will be sought without the need for primary legislation.
PIA’s debt group has work-streams focussed on three of the REFG’s proposals: the CRE database; the long-term value metrics; and the CRE finance qualification.
The Bank of England will be invited to attend these working groups. Details of the work and recommendations of these subgroups will be publicised in due course.