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Systems rationality: Post-lockdown commuting, herding and real estate debt lessons

Herd-like lending behaviour is counter-productive and exacerbates real estate risks. Gregor Bamert argues a wider range of capital sources and investment approaches may help combat this in future.

Systems rationality: Post-lockdown commuting, herding and real estate debt lessons

On my first trip back to our London office recently, I started to consider the psychology of commuting in a post-lockdown world. The most direct, and rational, route for me and many other people is to take the train to London Bridge and walk from there. This wasn’t an issue when we could all squeeze into the train and then march across London Bridge like a tightly packed flock of sheep.

Nowadays though, the train quickly reaches capacity and we all walk in a slow, hesitant way trying to adhere to social distancing, inadvertently creating bottlenecks and delays. As a result, I end up arriving at the office late and agitated.

We should do things that are different to what others are doing

What can we do to have a better commute? The answer is that we should do things that are different to what others are doing. That may mean taking a variety of routes, modes of transport and travelling at different times. Hopefully, that will see a steadier, more manageable flow of commuters that will improve everyone’s journey. It is exactly this, more measured, flow which we need in real estate debt.

Notwithstanding natural and physical constraints, the built environment continues to evolve. Buildings have and will continue to adapt to changes in the way they are occupied and how they interact with the wider community.

Despite this, the one thing that doesn’t seem to change about the commercial real estate market is the proclivity to cyclicality. There are several drivers of this, including the development process, the economic cycle and investor behaviours (see Mastering the real estate cycle).

Looking at returns over the medium term, we see a marked contrast between the relative stability of income returns and the volatility of total returns. The role of debt as an amplifier of this cyclicality can be clearly seen when we overlay the availability of debt on returns.

Debt amplification: The role of leverage in real estate cyclicality

Figure 1: Loan origination and property returns
Source: Property returns – PMA, data at of May 2021; CRE loan origination – CASS Business School, data as of April 2021

Debt tends to extend the peak of cycles by boosting returns when real estate is priced above fair value; it also exacerbates downturns by limiting liquidity during a recovery.

Allied to this, greater availability of higher leverage is a key indicator of late cycle risks. But borrowers should beware of this temptation (see page 8 of our Real Assets House View 2021) as the downside risk is disproportionate to potential returns.

So, what does all of this have to do with my commute?

Well, the packed train is a result of individually rational actions ending up as collectively sub-optimal, which is exactly what we have seen in real estate debt. At times of increasing valuations and ample market liquidity, lenders are eager to provide finance. What we saw during the run up to the global financial crisis was that many lenders had very similar underwriting approaches as well as risk and capital models. As a result, all lenders were chasing the same deals on increasingly aggressive terms. When things went wrong, they went wrong for all lenders and nobody was capable of lending.

Economic theory would suggest the solution is to move from individual rationality to collective rationality. In other words, to achieve the optimal outcome among several parties, they should co-ordinate and agree a collective decision.

While this may work in the field of decision theory, it is not practical or legal in most commercial settings. In fact, what we are looking for is quite the opposite. What we are looking for might be termed “system rationality” – i.e. the diversity that comes from individual parties acting rationally and still doing something different from others.

Is such an approach really possible?

There is now a more diverse set of participants in the market

Changes to the structure of the real estate debt market since 2008 show some encouraging signs. There is now a more diverse set of participants in the market. These include not just traditional banks and capital markets-oriented investors such as commercial mortgage-backed securities buyers, but also debt funds, insurance companies, pension funds and so on.

Due to different objectives, investment horizons, risk appetites and regulations, these lenders can be attracted to different transaction types and different stages of the cycle. As highlighted in Bayes Business School’s recent UK Commercial Real Estate Lending Report1, while many types of lenders saw significant reductions in lending volumes during 2020, others actually increased their activity during the pandemic.

There is a clear opportunity for different types of lenders

While we remain in an environment of considerable uncertainty, there is a clear opportunity for different types of lenders to find transactions where others choose not to look. Whether by taking on some development or repositioning risk, accepting exposure to unloved sectors or building relationships with new borrowers or sponsors, investors can participate in an increasingly differentiated marketplace.

Nobody can say with confidence exactly what the next twelve months will hold; however, there will be opportunities to do things differently. To that end, you probably won’t see me on the 7:23am to London Bridge very often.


  1. ‘UK commercial real estate lending report: YE2020,’ Bayes Business School, 2020, PP.7

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