Today we take a look at the health of residential and commercial property markets around the world. Slowing economic activity and a credit crunch contributed to a decline in housing activity, prices and construction in most major economies. Eastern Europe and the Baltics, as well as the U.S. and UK, have endured some of the sharpest declines. In many countries, not only in the U.S., the bottom of the property markets still seems far off, with sales, prices and starts forecast to continue declining, albeit at a slower pace, through much of 2009.
In fact, many European economies (and Canada) tend to have housing cycles that lag behind the U.S. by about 2-3 years, suggesting that their declines could also persist beyond a U.S. housing stabilization. Sounder lending standards and lower incentives to invest in residential property in some countries may allow them to avoid the depths of the U.S. property correction but others may suffer more severely. The liquidity resulting from quantitative easing has contributed to a slower deterioration of the housing markets. Yet with high inventories in many markets, it may take some time to absorb the excess. This will continue to erode the value of asset-backed securities and banks’ balance sheets and defer the revival of construction activity, a major driver of growth.
The decline in retail trade and contraction of the financial sector has worsened the commercial property outlook. Commercial vacancy rates are on the rise in almost all major centers in Europe and North America and net effective rates have declined by 25-30% in major cities in Asia, suggesting that new investment is unlikely as these cities try to absorb overcapacity in retail and hotel trade. Meanwhile, still tight corporate debt markets pose obstacles for corporate finance. Despite the weak fundamentals, REITs and other property investments have benefited from the renewed risk appetite and have been climbing off late. These property investments might well be vulnerable to any reversal of risk appetite.
The fourth year of the U.S. housing recession – and the worst since the Great Depression – is well on course. Total housing starts have plunged from the 2.3 million seasonally adjusted annual rate (SAAR) peak of January 2006 all the way to the 458 thousand SAAR of April 2009 (the last data point available) – a dip of 80%. In the single family housing segment, annualized starts fell by 80% between January 2006 and January 2009. Single family starts seem to have stabilized since the January 2009 low of 357 thousand SAAR.
On the demand side, new single-family home sales are down 74% from their July 2005 peak. Both demand and supply of homes have fallen very sharply and inventories persist at an all time high. While the supply side might have bottomed out, it is likely to move sideways for a long period of time, absent a substantial rebound on the demand side. The weakness on the demand side is bound to persist throughout this economy-wide recession, which will continue to drive prices down in the quarters ahead.
At this stage, even with the contraction in construction, the excess supply in the housing market can’t be reabsorbed without a significant pickup in demand. Inventories of new homes remain at elevated levels, at roughly 10.7 months’ worth supply at the current rate of sale versus a long-term average of 6 months. Starts built for sale have fallen below single family home sales, but this will not result in a fast inventory work-off as long as completions built for sale, which lag starts, continue to outpace purchases (by about 200 thousand SAAR in Q1 2009 as per RGE Monitor’s computations). To put these numbers in perspective, compare this with a measure of vacant homes for-sale-only. Vacant homes for-sale-only were at 2.12 million in Q1 2009. In the decade between 1985 and 1995, the number oscillated around 1 million units on average and 1.3 million units between 2001 and 2005. This implies that there exists an excess supply that ranges between 0.8 and 1.1 million units, of which roughly 85% are single-family structures.
With historically low mortgage rates and falling home prices, affordability is at an all time high, yet demand for housing continues to show weakness. The only activity on the demand side can be explained by purchases of foreclosed homes. A significant recovery in demand is likely to be impaired by weakness in the labor market and uncertainty around future income. Moreover, deflation in the housing sector, though slower than in the past months, is likely to continue to push buyers to postpone purchase activity.
Therefore, while it is probably time to call for stabilization on the supply side, where the slide of starts is close to an end, the fact that the demand side continues to be weak implies that there is still a long way to go before we can talk about stabilization of home prices. According to the S&P Case-Shiller index, as of February 2009, home prices are back at the levels of Q3 2003. From the peak in mid-2006, the Composite indices are down about 31%. RGE Monitor expects home prices not to find a bottom before mid-2010 with a 38% peak to trough fall. But given the poor conditions on the real side of the economy, RGE Monitor sees a meaningful chance for over-correction that would bring prices down 44% from the peak reached in the first half of 2006 (S&P Case-Shiller is the reference index for these predictions).
On May 19, the Federal Reserve announced that “starting July, certain high-quality commercial mortgage-backed securities issued before January 1, 2009 (legacy CMBS) will become eligible collateral under the Term Asset-Backed Securities Loan Facility (TALF).” Moreover, the maturity of TALF loans backed by legacy CMBS was extended to 5 years. While TALF is a non-recourse lending facility originally created to reignite the consumer and small business loan securitization market, the effective drying up of the CMBS re-financing market puts $160 billion of CMBS maturing this year out of the $700 billion at risk in 2009 alone. See: Commercial Real Estate Bust Gaining Steam: Access To TALF Just In Time? CMBX prices spiked in anticipation of the new facility but the special investigator general for the TARP, Neil Barofsky, is less enthusiastic. As he noted upon the publication of his quarterly report on April: “One of our strongest recommendations of the last report was: Do not expand the TALF to buying legacy assets. If its structure is not changed considerably, it’s very, very dangerous. We know the ‘AAA’ rating was a sham. We could be buying securities that are backed with assets that we know were likely riddled with fraud”. See Assessing Treasury’s Strategy After Six Months of TARP: Critical Warren And Barofsky Reports.
Despite a continued downward trend, spring seems to have slowed the descent of the Canadian housing market, at least temporarily due to seasonal factors. The regions with the sharpest price rises in recent years, especially in the resource-rich west, now face significant price corrections. However, with higher down-payments and less outstanding debt, fewer Canadians will fall into negative equity and the chance of defaults is lower than it is south of the border. Moreover, the depreciation of the Canadian dollar may attract some foreign investors. However, Canada is in for a major correction this year with continued weaker construction activity as domestic demand weakens in a
reduction of the country’s terms of trade.
The housing sector is one the most important factors affecting the economic slump in the UK, which is similar in many ways to the difficulties facing the U.S. economy. The latest data on the UK housing sector continues to be mixed but some analysts are tentative to call the bottom in Q2 2009. The latest Halifax price index fell 1.7% m/m in April with price levels back to 2004 readings. Nationwide data brought a 0.4% decline in April but the y/y contraction fell from 15.7% in March to 15% in April. Mortgage lending showed some signs of recovery in April according to the data from CML with a 9% m/m drop. Despite hopes of a recovery, lending is still 60% lower than a year. The monthly data could be quite volatile in the coming months, drawing a slow bottom-like pattern. A real recovery of the housing sector will depend on improvement in the personal income and employment situation in the economy, which are not yet foreseen.
The European housing cycle lags the U.S. cycle by about 2 years but the extent of house price increases, as well as the extent of over-construction, exceeds the U.S. experience in many countries. Starting from the mid-1990s, house prices in the UK, Spain, Ireland, Scandinavia and France exceeded the price increase in the U.S. whereas construction as a percent of GDP expanded to unsustainable levels, especially in Spain and Ireland. This severe construction overhang in the latter countries will take several years to unwind thus retarding a return to balanced growth as suggested by the strong housing-consumption correlation in these countries. Recent research by Citigroup foresees price drops of 10% to 15% by 2010 and 20% to 30% over the next 4 to 5 years. See The State of Housing Markets Around the World: Not Bottoming Yet?.
Will the housing downturn in Europe prove as disruptive as in the U.S.? Daniel Gros from the Center of European Policy Studies (CEPS) last year pointed out that the EU banking sector is less exposed to a housing downturn than its U.S. counterpart due to a set of particular features. First, in the U.S. most mortgages are ‘non-recourse’: If the value of the house is lower than the mortgage on it, the borrower can just walk away and simply send the keys to the bank (“jingle mail”). By contrast, in Europe borrowers remain liable for any difference between the value of the property and the amount of the loan. Second, the mortgage-backed covered bonds in EU are subject to legal quality standards and stay on banks’ balance sheet as opposed to bankruptcy-remote RMBS which should provide an incentive for adequate lending standards. The disruption of the covered bond market during the credit crisis however has shown that this distinction is not a sufficient safeguard against stress in the mortgage market. See Transatlantic Differences in Real Estate: Covered Bonds and Recourse Loans.
Distress is particularly clear at the national level. For instance, house building accounts for 14% of the Irish economy and Allied Irish Bank calculated that for every 10,000 fewer homes built, almost 1% is shaved off the Irish growth rate. So far, house prices have fallen over 10% year-over-year. See: Celtic Tiger No More: Ireland Enters Depression Territory.
Spanish housing prices fell on a yearly basis for the first time in Q4 2008 and analysts at BNP Paribas estimate that a comparison with the long-term price to rent ratio shows that as of Q4 2008, home prices are still overvalued by about 40% and prices are expected to fall by 20% in 2009 alone. See: Spain’s Housing Bust Gathers Pace: Builder and Developer Loans Most At Risk.
In France, the housing bubble did not translate into a construction bubble. This has raised hopes that any adjustment will occur primarily through prices rather than through a painful retrenchment of economic activity. See: France After The Housing Bubble: No Construction Overhang.
The Australian housing market downturn is likely to be milder than in the U.S., UK and EU in 2009. Australia’s house price correction had a head start going back to 2003. Furthermore, housing demand from migrants to the commodities-rich west and the chronic housing shortage in eastern Australia will keep prices from stabilizing back at pre-boom levels unless Australia fails to avoid a deep recession. Indeed, building approvals and housing loans to owner-occupiers began to recover since October 2008 after the government doubled grants for first-time purchases of homes until December 2009. Mortgage interest rates fell to their lowest level in four decades after the Reserve Bank of Australia cut the overnight cash rate 425bp within a year to 3% in April 2009, the lowest since 1960. Tax cuts, government handouts and lower petrol prices will also raise the affordability of housing. Affordability may not mean higher house prices, though. Despite increased sales (new home sales in Q1 2009 rose 20% since end-2008), house prices fell 6.7% y/y in Q1 2009. Rising unemployment and lower household wealth will keep buying sentiment mild this year but, short of a deep recession, improved affordability and ongoing housing shortages will help Australia avoid a housing crash as bad as in the U.S. and Europe.
New Zealand’s housing market is in worse shape than Australia’s but is also likely to avoid as deep a correction as in the U.S. and Europe. The Reserve Bank of New Zealand has cut 575bp since July 2008 to 2.5% in April 2009 but longer-term, fixed mortgage rates have recently begun to rise again due to expectations of a quick recovery and higher interest rates. Fiscal policy has been laissez-faire towards the recession, opting merely for tax cuts as the government would rather not stand in the way of the economy’s structural adjustment. With housing assets 5.7 times the household disposable income, New Zealand property markets are even more leveraged than their U.S. counterparts. House prices fell 8% in 2008 and are down 9.2% y/y as of April 2009. Some analysts believe the housing market will bottom on an annual basis in 2009. The housing market has already bottomed on a month-over-month basis, with the median price rising from $325,000 in January 2009 to $340,000 in April. Immigration has revived housing demand and sales have been strongest in the low-end segment thanks to increased affordability. However, new building starts and new home sales remain below the boom levels of 2004 and will likely remain so due to credit constraints, rising unemployment and sluggish economic growth in the year ahead.
Central and Eastern Europe
Like other parts of the world, property prices in most of Central and Eastern Europe (CEE) have taken a beating and further price falls are expected in 2009 and 2010. In addition to tight credit conditions and economic contractions across the region, collapsing demand from Western European buyers is also having a negative impact on prices. For example, demand from Spanish and Irish buyers, whose countries are in severe recessions, has accounted for around 80% of total foreign demand in Hungary’s property market, according to Global Property Guide. Notably, property prices are not tumbling in all CEE countries. The Czech Republic saw residential property prices rise almost 10% y/y in Q1 2009, according to the Knight Frank House Price Index. In contrast, Latvia saw the some of the sharpest housing price falls (-36% y/y) in the world in the same peri
Despite government investment, Russian construction activity, which previously boosted growth, has fallen in 2009, given the contraction of credit and reduced affordability of housing following the drop in real wages and increase in real interest rates. Banks curbed lending to developers who had begun delaying projects in mid-2008 as higher project costs limited profits. The number of purchases of flats with mortgages fell by more than 63% in Q1 2009 compared to 2008. With a contraction of at least 6% on the cards and a significant consumption decline, residential and commercial properties are likely to face further falls in H2 2009.
Middle-East and Africa
Slowing growth, tighter liquidity and some slowing of supply shortages has reversed the Middle East property boom of recent years, raising the risk of a bust in countries most reliant on external credit. Almost all markets are witnessing price correction, lower sales and slowdowns – if not cancellations – in real estate and construction projects as speculative buying is falling, in the face of financing difficulties.
The GCC real estate and construction sector, which accounts for most (74% of) projects in the region faces most terminations. Around 91% of all real estate projects postponed or terminated in the GCC is in the UAE, perhaps not surprising given that Dubai house prices have fallen as much as 42% in Q4 2008 and Q1 2009 and may drop further as new homes are completed and population falls in the Persian Gulf business hub. Retail and hotel properties also face over-capacities which will need to be worked off. Although regions like Qatar, Saudi Arabia and Abu Dhabi may be best placed in the regional downturn they also face vulnerabilities – the latter is being infected by a weak market in Dubai which is contributing to domestic migration. Qatar’s real estate market correction has taken prices back to 2002 and 2003 levels.
Non-GCC countries face reduced funding from the EU and GCC. Jordanian real estate transactions dropped by 32% in Q1 2009 but foreigners – especially from the GCC – continue to invest at a slower pace. Egyptian demand has plunged significantly as growth weakened.
South Africa experienced the biggest drop in property prices in two decades in April as the economy moved towards recession. Due to low consumer confidence, soaring unemployment and challenging credit conditions which limit access to financing, the housing sector will face further stress especially as interest rates continue to be high in real terms.
Asia has witnessed sharp real estate correction led by the Asian Tigers, plus China, India and Vietnam. All these markets saw declining home and office prices and rentals, lower sales and rising vacancies. Prices are approaching fundamental values and slowing construction activity might somewhat close the estimated excess supply. But further price and rental correction are imminent. This because household and corporate demand will remain subdued in 2009 despite policy measures such as interest rate cuts and fiscal incentives as well as attractive discounts offered by realtors. Slowing or contracting consumer spending and rising job losses in most economies are hitting residential and retail markets. Slowing corporate earnings and capex, declining exports and liquidity crunch are weighing down on commercial real estate. Though banks are reducing exposure to the real estate sector, lower earnings among realtors and income pressures among consumers are raising the risk of delinquencies. Nonetheless, as the global liquidity crunch abates overtime, high growth potential and attractive returns, given rising incomes and urbanization in developing Asia, will revive domestic and foreign investor interests in Asia’s real estate.
Unlike many global markets, the residential property market in China is showing some signs of stabilization. Significant price discounting, lower mortgage rates, incentives and overly ample credit extension are contributing to an increase in transactions and helping to reduce the existing inventory. Chinese property prices began falling in mid-2008 as anti-speculation measures and slower economic growth reduced investment. However, transactions could slow if authorities rein in lending growth in mid-2009. Commercial property has yet to show signs of recovery. The global capex retrenchment is also putting pressure on commercial property as it delays some expansion plans especially by foreign companies. Although domestic companies are somewhat less affected, a slower pace of consumption growth may weigh on both office and retail property markets.
The Hong Kong real estate market seems to be bubbling up again at least in terms of sales to investors as increased credit availability, and a weakening US and Hong Kong dollar, encourage investment. However, new tenants remain scarce and vacancies are on the rise, suggesting further downward pressure on prices, especially as Hong Kong’s economy, including the financial sector, continues to contract and consumption weakens.
Home prices in India have corrected 15% to as much as 40% in some prime areas since September 2008. The recent pick-up in demand due to discounts by realtors and mortgage rate cuts by banks will be largely outweighed by the excess supply of homes in the market. So another 15-20% price correction is underway in residential and office markets over the next 6-to-8 quarters. This is especially because bank lending standards have tightened, households face wealth erosion and slowing job market, affordability remains low and corporate sector faces liquidity pressures. Mall construction and rentals have taken a hit and so have activity and employment in the construction sector. Drying funding from foreign investors and domestic equity market is forcing the indebted real estate firms to divest shares to raise capital, hold back expansion plans, and refinance bank loans which has been helped by recent central bank measures.
Singapore’s real estate sector started moderating in Q2 2008 and home and office prices witnessed record decline of over 10% in Q1 2009 with rents also falling sharply. Another 15% to as much as 25% correction is expected in the residential sector and may be even higher in the luxury section. Woes in the financial and service sectors, negative wealth effects among households and shrinking population due to outflow of laid-off immigrants – all will weigh down on residential and retail real estate. This will be exacerbated by falling speculative investment due to tight domestic and foreign liquidity.
Vietnam’s property prices are down over 30% in some markets with luxury section taking the biggest hit and office rentals showing steep decline. Though realtors have been cutting prices and banks are resuming lending, demand has been slow to pick up. Investors also remain reluctant to enter the market since they largely depend on fore
ign liquidity. The sector is unlikely to improve in 2009 and this will be exacerbated by lower investment via remittances and FDI.
The housing sector in Brazil was one of the world’s most dynamic until the global economic crisis hit in September 2008. The January-September-2008 sales of new houses and condos were actually up 25% from the same period in 2007. The nation’s largest home builder, Cyrela Brazil Realty, laid off 300 workers in the end of 2008 and lowered its sales estimate for the year by 25%. Looking ahead, the housing sector in Brazil looks poised to get back into brisk growth trajectory once the uncertainties surrounding the global financial crisis settle down and the economic activity starts to recover. In fact during the recent years, financial institutions and in particular commercial banks have begun to develop and occupy the residential property lending market with substantial consolidation in 2008. Even though home builders and developers continue to offer financing for new home purchases, this practice is substantially restricted to the construction phase. After the construction is concluded and the homes are ready for occupancy, there is a near universal preference that banks and other financial institutions provide term financing to the buyers. Early this year, the Brazilian government announced it will spend 34 billion reais ($15.1 billion) to build a million homes as part of President Lula’s plan to spark growth in a slumping economy. Families earning less than 1,395 reais a month will have to make only symbolic payments in exchange for home ownership, while those making less than 2,790 reais will be eligible for subsidies.