SMALL- and medium-sized enterprises (SMEs) who use their own commercial property as loan collateral could be hit in the event of a market adjustment, the Bank of England (BoE) has warned.
Three quarters of SMEs in Britain use their own commercial property as collateral to secure bank loans, according to figures from the central bank.
Alex Brazier, executive director for financial stability strategy and risk, warned that if SMEs secure these loans at stretched commercial property values, they can be exposed to any adjustment.
“That channel can be pernicious if companies investing in commercial property at the top of the cycle are forced to reduce debt as prices fall and they break their loan covenants,” he said.
“They can be forced into sales of property, driving prices down even further and making life even more difficult for those companies in the wider economy that have secured their debts on their property.”
In his speech to the Brevan Howard Centre for Financial Analysis on Thursday, Brazier reiterated the BoE’s warning last year that commercial property prices in the UK are stretched and are vulnerable to repricing – either through an increase in long-term interest rates or an adjustment of growth expectations.
“At the UK-wide level, commercial property prices rest on persistently low interest rates but at the same time, they’re factoring in typical rental growth prospects and degree of uncertainty around them,” Brazier said.
“It seems unlikely that rates can be so persistently low without either weaker growth prospects or more uncertainty.”
He warned that even if the “magic combination” of persistently low rates and historically typical rental prospects comes true, valuation methodologies point to prices 10 per cent below today’s level.