The unique character of the property cycle has the potential to create special risks for those investing in a property market, for those lending against commercial property, and for banks, which do both. Additionally, in the case of banks, these risks are seemingly toughened by their own weaknesses and collective behaviour: ?institutional amnesia? has been a feature of banks involvement in property markets.
A banks lending may be to a property company in the form of an overdraft service or short-term loans secured against the assets or collateral. Or it may be against a real estate development project in the form of non-recourse or limited recourse loans, often to special function ?off-the-balance-sheet? financing vehicles. This involves the bank and/or other financiers, along with the developer in a subsidiary company.
In the case of commercial real estate loans the borrowers ability to repay the loans is highly correlated with the LTV ratio and the value of the collateral. This is because the property is acquired for resale in a secondary market or because increased vacancy rates and reduced rentals are quickly reflected in the price of the commercial real estate property and hence the value of the collateral.
Therefore, fluctuations of available space and rental values make property lending an inherently risky business and convert banks? property exposure, in the case of subsidiary companies, into risks essentially equivalent to those of others undertaking investment in real estate. Factors leading those risks included:
- Over-optimistic valuations and future forecasts
- Decreasing loan to valuation ratios
- Late competitions and cost overruns
- Letting risks and high vacancy rates
- Environmental and planning restrictions
- Indemnities, covenants, and recourse
- Illiquid secondary real estate markets
- High financial gearing and sensitivity to interest rate (Lewis, 2000).
Tags: The property cycle and risk for lenders ?
Source: http://www.estonianrealestate.net/market/the-property-cycle-and-risk-for-lenders.htm
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