Forecasting For Safe Property Lending During Property Bubbles

Before I started researching this piece in earnest, I was hoping to sound a little bit less like a broken record when it comes to the usefulness (rather, uselessness) of economic forecasts to help you make saving, lending, investing and property decisions.

This is an area I have visited and re-visited for more than two decades, starting many years before I co-founded 4thWay in fact.

And indeed, I was right to consider I was on to something this time that actually does have some forecasting ability.

But, unfortunately, it’s still not that simple.

What I have been looking into

What I was looking at was whether there was a way to forecast imminent trouble when we lend to businesses in commercial real estate. “We” means most of you reading this page, since most P2P lending is lending of exactly that kind.

Commercial real-estate lending is lending to:

• Property developers;
• Those who buy and sell property; and
• Landlords who own and lease out office space, retail space, industrial sites, hotel buildings and other business premises. (To be clear, not lending to the business tenants occupying those buildings, but lending to the owners of those buildings.)

Firstly, here’s what we’re up against

In my past research endeavouring to find any useful forecasting anywhere, I have looked into forecasting residential property prices, interest rates, gold prices and a lot more.

While doing so, I’ve sadly found that no past trends predict the future. For example, if property prices went up or down over the past month, quarter or year, it tells you absolutely nothing about what will happen in the next 12 months. (That particular research used data sets going back to the early 1950s.)

I also found that there were no popularly cited economic forecasters in a fairly large database I built, stretching back 20 years, who could predict the near future of anything with any consistency better than random chance. Not a single forecaster. Zero. Think of your favourite big-name forecaster who was made famous for some major prediction: I mean him/her/them too.

An indicator with not quite enough promise

However, for commercial real-estate lending, I recently stumbled across some very interesting possibilities. I have now researched those, which is why I’m writing this up for you today.

The one indicator out of all those I looked at that seems to have some reasonable predictive value going back to the 1970s was rapidly rising commercial property prices, adjusted for inflation.

I don’t mean just adjusted by inflation for consumers. So not just the “CPIH”, consumer-price inflation index you usually read about. But rather inflation across the entire economy, e.g. inflation for businesses and in wholesale prices.

What I found was that a rise of 20% or so in commercial property prices that are adjusted for economy-wide inflation has at least some predictive power if it occurs within two years.

You can probably expect when such an event occurs that commercial property prices adjusted for inflation will fall sharply again in the very near future.

Why reading those entrails doesn’t have the value I first hoped

Unfortunately, it then falls apart for people lending their money. Here’s why:

• By the time there has been a 20% adjusted rise in two years, it’s already largely too late. You will have been lending and re-lending as those prices rose. So you’re locked in with some of your lending at those higher property prices already. You couldn’t have known to stop lending earlier, because, for example, a 10% rise in one year doesn’t predict that the same rise will be repeated in the following year. The one small way you might be able to take advantage of it is to sell some or all of the loans you recently made, but many P2P lending providers won’t even let you do that. (And the remaining points on this list further diminish that tactic.)
• You won’t immediately know when prices have risen 20% adjusted by inflation. I mean, you will most likely face a delay in that data arriving on your desk, or you will take time to dig it up from somewhere. So the forecast doesn’t even arrive at the right point in time.
• Even if you can get the data reasonably on time, routinely acquiring the data you need on commercial real estate prices is probably costly. (For example, subscribing to Green Street’s data services or to the MSCI UK Monthly Property Index, which might have the price data you need. I’m sure that’s not going to be cheap.)
• Even then, you’ll probably still have a lot of time-consuming work to do to refine the data in the way you need it. For starters, separating total returns (including rents) from property price changes and adjusting your results based on economy-wide inflation. For which you’ll need to pool together more data. Not quick or easy.
• A rapid inflation-adjusted rise in commercial property prices predicts a fall that is also adjusted for inflation. However, when you lend against a property, you lend against a fixed value not against an inflation-adjusted value. So the actual pound fall in value to the property you’re lending against might not be so significant to you as a lender, still leaving you well shielded. In other words, the prediction was a dud for you.
• Furthermore, while this indicator based on average commercial property prices predicts a fall in those average prices, it still doesn’t necessarily predict a particularly tough time for lenders in terms of borrowers struggling to meet their monthly costs or repay their debts. I haven’t found that to be an especially reliable pattern.
• Also, other factors not related to property prices can cause you lending woes. This means that if there’s no 20% rise in two years, that doesn’t mean your entire portfolio is safe from macroeconomic shocks. Such as what happened to property developers who started projects around 2021 to 2023 or for those recently who were letting out office space.
• Finally, these predictive events have only occurred three times in the UK since 1970. Since they’re so rare, it means that most of the time your portfolio won’t be impacted, which further reduces the value of this indicator to many long-term lenders and investors.

So even where there’s predictive value, all or most of us likely won’t get enough monetary value out of it in a timely way, with low enough effort.

Hammering home the usual message

What I’d most like you to take from this is the reinforced message that you should reject short-term patterns that you think you see when making money decisions.

Humans are built to spot patterns and we’re absolutely brilliant at it. It’s a great strength in lots of ways.

But, in saving and investing, it means we extrapolate recent past patterns into the future, even when the recent past has no bearing on the future.

I’m sure over the next few decades I’ll continue to search for forecasting methods that actually work on a practical level. But don’t hold your breath.

Instead of forecasts, spread your money across lots of loans, to lots of different types of borrowers. When your loans are secured on property, then make it different types of property. And do it across many different lending accounts. Plus, make it just one branch of your saving, lending and investing strategy, as you diversify elsewhere too. Bottom line: diversification works; forecasting doesn’t.

Further reading

You’re Missing Out On This Profitable Type Of Lending To Landlords.