Global commercial property prices were barely affected by the pandemic

Global commercial property prices were barely affected by the pandemic despite the fall in output and changes in the structure of the economy, such as the heightened demand for goods over services and increased home working.

But higher interest rates in the wake of the pandemic are changing this picture and bringing a belated impact back to commercial property markets.

High debt costs suggest a pricing correction is needed, with US industrial real estate to move 13% lower and European office properties 12.5% lower according to our estimates, based on the best buildings in gateway markets.

Central banks continue to aggressively tighten policy rates with price pressures rife across goods and services, suggesting that a rapid return to price stability is unlikely despite commodities making their way back to multi-year averages.

Significant regional disparities do exist, though, with natural gas prices that are more than 10 times higher in Europe than in the US. Nonetheless, the global economy is now likely to be slowing under the strain from higher rates and inflation.

This has meant the cost of debt for a real estate acquisition has significantly increased since the start of the year, as interest rate swaps have increased alongside the margin a lender applies to a real estate loan (as the probability of default rises in a worsening economic environment).

Real estate is a slow-moving beast, with few property agents willing to move their prime yields since the Ukraine-Russia war without clear evidence of a shift in market pricing.

Pricing expectations between buyer and seller have widened over recent months, causing transactional activity to slow.

According to MSCI Real Capital Analytics, the annual investment volume was down 19% y/y and 24% y/y in Europe and Asia Pacific respectively in the second quarter, while remaining stable in the US.

A period of price discovery set to take place during the second half of the year will ultimately provide more transactional evidence to support a repricing at the prime end of the market.

Our global analysis continues to suggest the prime segments of select European and Asia Pacific offices, alongside US industrial are most exposed to a pricing correction, with Stockholm and Seoul offices, as well as Inland Empire, Los Angeles, and New York logistics warehousing leading the way.

Assuming a loan that’s 50% to 60% of value and at a low-risk interest coverage ratio, investors require a 26% price correction for the Stockholm office market, taking prime yields to 4.2%, up 110 bps from the current prime yield.

A 25% correction is needed for the Los Angeles logistics market, with prime yields moving out by 100 bps to 4%. Also in Europe, the Milan and London office markets require prime yields to correct by 65 bps and 50 bps.

In the Asia-Pacific region, we estimate that the office markets of Seoul and Hong Kong should see a pricing correction of 25% and 15% respectively, a big shift from no correction implied just three months ago.

Source: Oxford Economics

The story of China’s property bust and lessons for the Philippines

What goes up must come down. China’s mighty economy is facing serious challenges. The culprit is its ailing property sector. The property crisis has caused hundreds of real estate companies to default on their loans. Banks have had to write-offs debts in the vicinity of half a trillion US dollars. Thousands of construction-related suppliers face insolvency and millions of investors are stuck with unfinished properties which they cannot sell.

The story of China’s property bubble started in the early 1990s. On the back of the country’s manufacturing revolution, millions of families migrated from the countryside to urban areas, lured by jobs and better incomes. In 1995, only 29.04% of China’s population lived in urban areas. That number has ballooned to 63.89% today. Skyrocketing demand for new homes in urban areas prompted property developers to build at a dizzying pace.

In China, land cannot be owned but is instead leased from the state. Property developers took on massive loans to pay these leases and build their residential blocks. Banks were liberal in granting loans as high demand and healthy profit margins meant low risk.

The state supported the property boom, too. As far as the government was concerned, a thriving real estate market translated to a domino effect of economic benefits. Demand for construction supplies like steel, glass, and cement exploded. Millions of jobs were created. Wealth was generated, fueled by property appreciation. Spending power increased. Everyone was happy. The property sector became so large that it grew to constitute 30% of China’s gross domestic product.

The heady property boom caused property prices to soar to such an extent that it now takes 56 years for an average Chinese worker to pay for an average apartment in Beijing. It will take him 50 years in Shanghai and 46 years in Shenzhen. For context, it only takes 17.3 years to pay for an equivalent apartment in London.

Cultural nuances played a part in the property explosion. In China, it is widely believed that property is the most stable investment one can make. Also, one can only be a respected professional if one owns his own home. These ideas compelled the Chinese to purchase property, even at scandalous prices.

Chinese developers, fueled by easy loans, built to a point that their inventories were out of sync with real demand. At its worst, homes for 90 million people remained unoccupied. They are known today as “ghost cities.”

The prevalence of ghost cities caused the Chinese government to take heed and temper the building boom. The government declared that fresh loans can only be obtained if property developers passed three red-line financial ratios. First, their liability to asset ratio had to be less than 70%. Second, their net gearing ratio had to be less than 100%. Third, their cash to short term liability ratio had to be less than one.

Corresponding levels of loans were granted to companies depending on how many ratios they hurdled. Those that failed all three were denied access to bank financing altogether.

Among the thousands of property developers that raised red flags was the Evergrand Group. Evergrand is China’s second largest property developer and, to the horror of the state, it failed to hurdle all three red-line ratios. Evergrand’s debts amounted to an eye watering $305 billion, equivalent to 2% of Chinese GDP. Its cash reserves amounted to only $15 billion. It owed money to 171 domestic banks, 121 foreign banks, and to the Chinese people who bought their bonds.

Evergrand’s downfall can be attributed to over-expansion. It used whatever money it raised to start new projects instead of finishing existing ones. As of October last year, Evergrand had 1,200 projects under development, with only 200 finished and 700 pre-sold but unfinished. With so many unfinished projects that it could not fully monetize and even more new projects needing financing, it was only a matter of time before the company ran out of cash.

Evergrand is only one example of thousands of Chinese property firms that are in dire financial straits. Two-thirds of all Chinese developers have failed at least one red line ratio.

What has been the effect on the Chinese economy?

The property sector accounts for 20% of banks’ loan portfolios. Banks can’t get paid until existing inventories are sold. The problem is, most inventories remain unfinished and funds have run out to finish them. Buyers rightfully stay away from unfinished projects. Banks are caught in the middle and must absorb an avalanche of bad debts.

With thousands of property firms falling into insolvency, suppliers of construction materials can’t get paid. Evergrand alone owes its suppliers more than $100 billion. Suppliers and subcontractors are defaulting on their debts too.

Knowing that their developers don’t have the funds to finish their units, investors who purchased at pre-development using bank financing have stopped paying their mortgage. Banks are again caught in the middle and must write-off some $220 billion on unpaid housing mortgages.

Those who bought bonds from distressed property developers are unable to redeem them. Thousands have lost their life savings.

The Chinese government recently announced that it plans to relax the three red-line ratios to give more property developers access to cash. With a financial lifeline, it is hoped that they can finish their projects and monetize them. While this will bring relief, it does not negate the severe damage already inflicted to the banking system, suppliers, and private investors.

There are valuable lessons to be learned for Filipino property developers. First, build in sync with demand. Second, in the use of funds, priority should be given to finishing existing projects rather than starting new ones. Third, debt should not be abused no matter how easy it is to come by. Prudent financial stewardship must be supreme.

On the part of buyers, they must look into the financial stability of the developer before purchasing properties from them. The three red-line ratios are good parameters to assess their financial stability.

It is not true that real estate is the soundest investment since they never depreciate. As we have seen in the Chinese experience, property values can drop when the bubble bursts.

Source: BusinessWorld

The Philippines' inflation rate rises further to 6.4% in July 2022

The Philippine’s annual headline inflation continued its uptrend as it moved up further to 6.4 percent in July 2022, from 6.1 percent in June 2022. This is the highest recorded inflation since October 2018. With this month’s inflation, the Philippines’ average inflation from January to July 2022 stood at 4.7 percent. In July 2021, inflation rate was lower at 3.7 percent.

The main source of the upward trend of the July 2022 inflation was the higher annual growth rate in the index for food and non-alcoholic beverages at 6.9 percent, from 6.0 percent in the previous month. Transport index followed with 18.1 percent annual growth, from 17.1 percent in June 2022. Also contributing to the uptrend in the overall inflation during the period were the higher annual increments in the indices of the following commodity groups:

a. Alcoholic beverages and tobacco, 8.5 percent; b. Clothing and footwear, 2.5 percent; c. Furnishings, household equipment and maintenance, 3.1 percent; d. Recreation, sport and culture, 2.2 percent; e. Restaurants and accommodation services, 3.4 percent; and f. Personal care, and miscellaneous goods and services, 2.8 percent.

On the other hand, the annual mark-up in the indices of housing, water, electricity, gas and other fuels; and health decreased to 5.7 percent and 2.4 percent, respectively. The indices of information and communication, education services, and financial services, all maintained their inflation rates from their previous month’s rates.

At the national level, food inflation increased further to 7.1 percent in July 2022, from 6.4 percent in June 2022. Food inflation was lower in July 2021 at 4.2 percent.

By food group, the increase in the inflation for fish and other seafood at 9.2 percent; meat and other parts of slaughtered land animals at 9.9 percent; and sugar, confectionery and desserts at 17.6 percent contributed largely to the acceleration in the food inflation during the month.

Vegetables, tubers, plantains, cooking bananas and pulses registered lower inflation of 5.6 percent. The rest of the food groups exhibited faster annual growth rates of their indices.

Source: PSA