Residential and Commercial: The property crises continues but in different ways

Whereas the crisis of residential real estate is still raging (including the United States), it is now up time for the commercial real estate to fall into disarray. No surprise ahead for the readers of the GEAB, but the trends differ according to regions. In some cases, it is about time to follow the market developments to decide when to re-enter; in others, leave the market as quickly as possible. The major trends seem to be already established for the period running till summer 2010.

Everywhere, without exception, the price of real estate (residential and commercial) is now falling. And, in LEAP/E2020’s opinion, this trend will not stop anywhere before summer 2010. At that point, it is highly likely that very different trends will develop.

As regards residential real estate, the US market will continue to fall, as well as in the United Kingdom, Ireland and Spain, and in the micro-markets marked by the real estate bubbles of the past decade (Dubai (1), Baltic states, Marrakesh, Costa Rica, …) (2), to which will be added the Chinese market (still in an artificial bubble phase thanks to the stimulus package initiated by Beijing). As long as there is no come-back in growth paired with a recovery in employment, these markets will be very depressed. And the more time goes by, the more the banks will have to face what is unavoidable: to severely write down the value of their estate. In these markets, this assures that the risk of continuing falling prices remains very high.

Elsewhere, in those markets where the property speculation craze of the last few years did not take place, we will witness a stabilization of prices in mid 2010 after a new downturn which could see prices fall a further 10% to 20% below current prices.

Landlords henceforth know that they have to adapt to the new residential real estate market, a buyers’ market (and no longer a sellers’ market as it was in previous years) (3). In this regard, if one needs to sell, it is better to do it now than a year hence, since prices will then have fallen further.

Except for emergency cases, when an immediate purchase of a house is necessary, it is therefore wise to stay away from any investment in real estate with a view to a quick resale till summer 2010 in most of the European, Asian and Latin American countries. On the other hand, it will soon be time to follow market developments starting end of 2009, in order to get ready for possible purchases after summer 2010 (4). In any case, there is no need to be worried “missing” price lows because these will be stuck at a low level for quite a long time, since no quick and strong economic recovery is to be envisaged at this stage.

As for the “post-bubble” markets, try and sell now since the downturn will go on for at least two years, with prices falling a further 20% to 50% compared to current prices (the micro-markets whose property crisis only began in 2008 will be the hardest-hit). In the United States, with the unemployment growth and falling income in the background, residential property repossessions will continue to increase in number, affecting new social categories (5) (notably middle and upper classes (6)). As regards price, the residential property market has therefore only one way to go: downwards (7).

We strongly repeat our recommendation about condominiums: keep on avoiding them since the economic ravages of the crisis (job losses, income slumps) turn them into a trap because of the collective service charges. Fewer and fewer joint owners can cope with increasing service charges!

A peculiarity of the current economic situation, probably long-lasting, requires serious thought before any transfer of assets from parents to children. The increasing precariousness of the work situation of those aged twenty to forty demands that one thinks twice, in the children’s own interest, before proceeding, for instance, to transfer a house. Parents, usually retired, are generally exposed to a much smaller risk of foreclosure than younger generations, in the current context of economic crisis characterised by redundancies and bankruptcies in increasing numbers. The crisis is not done yet with letting us discover surprising consequences.

As for commercial real estate, the situation is much simpler. Generally speaking, prices are dropping rapidly in all countries. The supply of offices, commercial centres, shops, hotels, … is disproportionate compared to current demand, in view of the latter’s bearish trend for years to come, in particular. In the United States, there is an ongoing real crash in the commercial real estate market which is of a size never seen until now (see graph below). This contributes directly to the falling income of local authorities (8) and obviously to increase the real liability of American banks (which one day will need to be balanced (9)). Even Manhattan is hard-hit by this great slump in price and turnover (10).

In Europe also, commercial property has become a big cost for banks and property agents. In this field, commercial property prices worldwide are beginning to follow the same trend as residential properties two years ago: the one in which price falls begin to speed up. As regards this market, a word of advice (except in case of emergency): wait for at least a year, maybe two (11).

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Notes:

(1) The population of Dubai is falling rapidly and some analysts expect a 17% decrease in the population in 2009. Besides the empty office buildings, one can expect a ghost town as regards housing. Source : Kippreport / EFG-Hermes, 29/03/2009

(2) In these small countries where there is a high concentration of recently constructed property, the “post-bubble” market is easy to decipher because one can see empty residential buildings and offices everywhere, half-finished construction sites, … and displayed prices barely changed despite absent buyers. It is the “asset on the balance sheet of a bank” effect: the finance institution prefers to keep the accounting fiction of a full-price asset rather than to rake in the income of a sale agreed at 30% or 50% of that price, which would shrink the asset in the same proportion. In bigger countries, these same “rotten” assets are generally widely scattered and the visualisation of the extent of the problem is hence more difficult. In both cases however, in our team’s view, not later than after summer 2010, the banks will have to face the reality of the “post-crisis world” and start to get rid of their real estate portfolios at the then market price.

(3) And it has become a tenants’ market as it is already the case in Manhattan, a neighbourhood however famous for the scarcity of its flats. In France, like everywhere else, the banks record a continuous increase in the number of failures linked to home loans. Sources : Bloomberg, 25/08/2009 ; Agefi, 01/09/2009

(4) On this subject, for our readers interested in the French real estate, allow us to cite the growing controversy surrounding the French statistics on this issue. Two years ago, we pointed out French opacity in this field compared to other western countries. The crisis visibly allows this case to become public and this is a good thing. Source : Les Echos, 11/09/2009

(5) Even the American government has to acknowledge that millions of new property repossessions are to be expected. It shows how tragic the situation has become. Source : CNBC, 09/09/2009

(6) Even the richest enclaves are now badly hit as illustrated by this panorama in pictures published by Forbes on 25/06/2009.

(7) The article by Diana Olick published by CNBC on 25/08/2009 presents a very informative analysis concerning what is hidden behind the US “good” real estate summer figures. It has also to be kept in mind that every summer the real estate indices are rising… and then go separate ways depending on the time of year.

(8) Source : SFGate, 24/08/2009

(9) The head of the FDIC (the federal body which currently saves at least three banks a week in the United States) stated during a conference in Tokyo that commercial real estate cause more banks to fail in 2009 and 2010 than residential real estate. Source : MarketWatch, 02/09/2009

(10) Source : New York Times, 09/09/2009

(11) Maybe even five years in the UK, as suggested by the Telegraph on 08/31/2009.