UK commercial property is overvalued by 12.2% and nearing the point at which a sharp fall is highly likely, according to research from the Property Industry Alliance.
Using MSCI capital growth figures, the research showed that property values, relative to the long-term average, have risen from 9% in the first half of 2017 to 12.2%.
Historically, when adjusted market values (AMV) reached the 15% threshold, there was a 100% probability of a fall of at least 20% in commercial property values in the following five years.
UK property is in danger of reaching that level within the next six months if values continue rising at the rate they have in the past year.
Charles Cardozo, operations director at Radley Associates, said: “There has been a 3% rise in the AMV measure over the past six months, which if repeated over the coming six months should send clear warning signals to the lenders that market values are moving into danger territory.
“Lenders and regulators are advised to remain vigilant of CRE lending levels, particularly to industrial and central London offices, where valuation levels look most challenging relative to historic trends.”
Although the danger of an overheating market is rising, Peter Cosmetatos, chief executive of CREFC Europe, said banks were aware of the dangers and were approaching the industry with caution.
He said: “The latest figures appear to validate the conservative approach that banks in particular appear to be taking in the current market environment, especially as regards higher leverage points.
“Anecdotally, banks remain cautious about lending to central London property in particular, with loan to values generally being less than 60%, indicating a sensible approach to the cycle risk.”
How is this calculated?
PIA calculates an adjusted market value for property by comparing the current market value with the long-term, inflation-adjusted average, which is based on the UK All Property Capital Value Index. The further the adjusted value drifts from the average, the higher the likelihood of a coming correction.
The organisation identified the model in research it published last summer.
How overvalued was property in previous cycles?
According to the model, property was overvalued by 20% in 2004, which would have told lenders that the market is overheating and a crash within five years was highly probable.
Similarly, lenders would have been alerted to an overheating market by the first quarter of 1988 – six quarters before the market peaked in 1989.
When PIA published its research last year, Rupert Clarke, chairman of the Long-Term Value Working Group, told EG: “The focus is on finding something that prevents lenders from getting carried away at the end of the cycle, to prevent them from making such large losses that the financial stability of the economy is affected.
“It happened last time round. It happened in 1974 and in the late 80s. It happens time and time again and it has an impact on the economy.”
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