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It’s vital we cool the property cycle



Thorny issue: It's debatable whether buildings like the Shard have made money for developers. Pic: Jeremy Selwyn.

Anthony Hilton

One of the eternal questions in the boardrooms of our major property companies is whether they ever make any money from central London office development — or merely appear to because they are consistently rescued by inflation. Our most admired buildings are so often financial follies. 

The current icon, the Gherkin, cost the better part of £600 million to build but was subsequently sold for £300 million. It is debatable — to be polite — whether Heron Tower or the Shard, neither of which is fully let, have made money for their developers. The Pinnacle remains a hole in the ground on Bishopsgate because its backers are no longer so convinced it is a good idea.

Nor is it just a problem for the Square Mile. Twenty years ago, the newly competed Canada Tower at Canary Wharf could boast that it was then Europe’s tallest building; shortly after it could also boast it was one of Europe’s biggest busts… so much so that it almost dragged its developers the Canadian Reichmann Brothers down with it.

The Bank of England’s Andy Haldane pointed out in a recent speech that commercial property cycles come round every bit as often as the wider business cycle but are about three times as vicious — and he has the graphs to prove it. There was a commercial property boom followed by bust in the Thirties, Fifties, Seventies and Nineties, and of course in the run-up to 2008. The average peak-to-trough price decline across these five cycles was 26%, but the one we are in at the moment is at the top of the range. Today, even after some recovery, top-quality property remains 37% below its peak; the secondary stuff is about half the price it was.

The trouble is less that commercial property is horribly cyclical but that, because it is almost always built with borrowed money, its problems are big enough to destabilise the whole economy. Nor is it a uniquely British problem. We had the Seventies fringe bank crisis in this country, but the Eighties savings and loans crisis in the US, the early Nineties meltdown in Scandinavia, the 1997-98 Asian financial crisis and the near 20-year stagnation in Japan were also all caused by property booms turning into busts and dragging the banks down with them. That is again where we are today, and why since 2008 the banks have had so little money to lend to normal businesses.

Indeed, it is often argued that when it comes to causing damage to innocent economic bystanders, only commercial property comes close to rivalling the chaos caused by banks. Actually though, it seems a bit unfair to separate them. Each feeds off the other, and when one sneezes they both get pneumonia. Who started it becomes irrelevant.

The real question is how to stop it, and this is where it gets interesting. One reason the business is so cyclical is that when property prices are rising, banks are more willing to lend because they think they have a bigger safety margin, and that willingness pushes prices up even more. Once prices start rising, it takes about a year for this to fire up extra lending, but the link is clear and undeniable. Ever higher valuations support ever higher levels of borrowing, which support even higher values, and so it goes on until the whole thing overreaches itself and collapses.

So part of the answer may be in getting the banks to change the way they lend — or rather the valuations on which they base their lending. To this end, an industry body, The Real Estate Finance Group chaired by Grosvenor finance director Nick Scarles, suggested in a consultation paper published in the autumn that loans should be based not on the latest current value of a project, but on the average value of property across the cycle.

It plans to issue a final report in February or March, and does appear to be on to something. As Haldane, who is taken with the idea, noted in his aforementioned speech: “Any ramping-up of property values above their sustainable value would not then automatically give the appearance of safety and thereby encourage looser credit conditions.”

It would do more than that though. Scarles and his team suggest the capital that banks have to set aside against property lending should be on a sliding scale, getting more onerous as values rise. This way there would be less, or indeed no, incentive for banks to chase prices higher as lending on low valuations would require less capital so should be equally profitable. It would also leave more space for hedge funds and others to come into the market, which again would be a positive because the more diverse the sources of lending, the more stable you would expect the market to be.

Clearly there would have to be much more data collected across the industry on who was lending what to whom, and on what terms, so that the Bank of England supervisory teams and outside academics and commentators could have a clearer idea of the health of the industry at any one time. The working paper makes positive suggestions for that too, provided the data is presented in ways that protect the identities of individual borrowers and lenders.

But it is not yet a done deal, so we need to strike a note of caution. Haldane was speaking at the 20th anniversary of the Commercial Property Forum , an industry body set up to help the Bank of England in 1993 in the wake of that decade’s property crash. The minutes of its first meeting highlighted property statistics and valuations as the two areas where greatest improvement was needed. Twenty years on and that is still where the problem lies, so this time really does need to be different.

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