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The impact of commercial real estate secured lending on financial stability - Professor Neil Crosby, Dr Steven Devaney, Dr Cathy Hughes – Department of Real Estate and Planning

Corporate finance buildings

Since the Global Financial Crisis, commercial real estate (CRE) is one aspect of the financial system which, virtually ignored previously, has come under scrutiny. The Independent Commission on Banking’s review of the UK financial system identified the failure of the financial system to weather a major CRE market downturn in 2007 as a major cause of the crisis. Although this review failed to address CRE lending in its proposed reforms, the Bank of England (BoE) was alive to the issues, as was the industry.

During 2013 and 2014, a “Cross-Industry RE Finance Group” produced “A Vision for Real Estate Finance in the UK”. One of the major aspects of this vision was the need to reform the valuation process of CRE assets for secured lending purposes. Crosby and Hughes (2011) had already published work on bank lending valuations and illustrated how a different cash-flow modelling approach to valuation would have identified the impending downturn in CRE prices in 2005, two years earlier than the eventual fall. At present the bank lending valuation does not attempt to do anything more than identify current exchange price and does not attempt to provide any further advice concerning the ability of the asset to act as security for the whole period of the loan.

Crosby and Hughes (2011) informed the final vision report in 2014. From 2014 to the present, Professor Crosby has played a leading role in shaping the approach of both industry and Government to reform of the bank lending valuation process. Firstly, following on from the Vision Report, he acted as a lead author of the subsequent 2017 industry report developing different forms of valuation modelling and back-testing those models to see if they identified the downturn. The back-testing extended to previous CRE market downturns and crucial findings included the nature of different downturns, which explained why certain models picked up some downturns, but not all.

Secondly, he acted as consultant to the BoE and helped develop its modelling of CRE markets and the model’s use in stress testing the UK financial system. This work is cited in its Financial Stability Reports and has been discussed with the International Monetary Fund, which is developing its own responses to global CRE financial stability issues.

Thirdly, Professor Crosby was lead author of the Royal Institution of Chartered Surveyors (RICS) professional guidance on bank lending valuations for the UK and Europe. He has since taken on lead authorship of the global real estate valuation industry response, steered by the three major global and European valuation standard setters (the international valuation Standards Council, The European Group of Valuers’ Associations and the Royal Institution of Chartered Surveyors), to the new definition of valuation included in the Basel III accord (2017) and its potential adoption by the EU within its Credit Requirements Regulations. This work is ongoing into 2021 and is intended to lead to European-wide professional guidance on the adoption of a long-term valuation approach to concur with the Basel III new definition.

Finally, in 2020, Professor Crosby and Dr Devaney, in collaboration with Cambridge University, undertook further BoE-supported and industry-funded research developing the long-term valuation and market analysis modelling of the UK market. The BoE has already stated that it intends to use the more sophisticated modelling recommended in that report.