The real estate industry is heading for an unprecedented crisis. The sector has already had to go through many difficult phases, but the crash potential is now many times greater.
Real estate loans affordable to almost everyone over the past 10 years have driven home prices to unprecedented heights. High single-digit or even double-digit returns could be achieved annually during this period, especially in metropolitan areas.
But the rise in inflation and the associated tightening of monetary policy by the ECB, Fed & Co are putting an abrupt end to this trend. Around the world, real estate prices are collapsing, and where the biggest bubbles had emerged, things are now going downhill the steepest.
In Europe, real property prices in the fourth quarter fell nowhere as sharply as in Sweden (-13.7%) and Germany (-12.1%) compared with the previous year. Internationally, only New Zealand (-16.5%) and Hong Kong (-15.1%) saw prices slump more sharply, data from the Bank for International Settlements show. For the first time in 12 years, real estate prices fell worldwide.
This negative trend is likely to continue as long as central banks keep interest rates high to fight inflation.
The German Ifo Institute confirms the downward trend with its latest forecast for new residential construction. After 295,300 apartments were completed last year, the number will fall to 200,000 by 2025. This is directly attributable to demand falling due to high costs.
And where demand collapses, so do prices. At the same time, the supply of properties for sale is increasing because fewer and fewer people can afford the expensive follow-up financing.
The construction industry and also banks will be equally affected by this development. The latter because loan default rates are rising and the collateral deposited on balance sheets will have to be adjusted due to falling property valuations. This is a clear harbinger of a recession ahead, as the economy will run out of money for investment. Raising money is becoming more and more expensive and credit institutions are lending less to meet the real estate risk on their balance sheets.
How the German government will manage to meet its target of 400,000 homes a year under these circumstances remains a mystery. Chancellor Olaf Scholz said last month:
“Even though times are very stormy right now as far as this target is concerned, we are not backing away from it, not even in view of the rise in interest rates.”
In the USA, the impending collapse is already becoming apparent. Investors bought 48.6 percent fewer properties in the first quarter of 2023 compared with the same quarter of the previous year. During the same period, 30-year mortgage rates rose from 3.2 percent to more than 7.0 percent. According to Goldman Sachs (NYSE:GS), that’s not going to change anytime soon, as its forecast for 2024 is for a mortgage rate of 5.9 percent. A level that is unattractive to investors as prices continue to fall.
To prevent the real estate market from unleashing another financial crisis as it did in 2007, the U.S. Federal Housing Administration floated a proposal that banks be allowed to take amounts owed on unpaid loans from a federal fund. In addition, borrowers would be allowed to reduce monthly mortgage payments for up to five years.
Meanwhile, in San Francisco, the situation continues to worsen. Just a week after Park Hotels & Resorts (NYSE:PK) stopped making payments on the $725 million loan for the Hilton San Francisco Union Square (NYSE:SQ) and Parc 55, the city’s largest shopping mall announced it could no longer service the $558 million loan.
The situation is similar in New York, the city of high-rise office buildings. The city’s comptroller, Brad Lander, has inevitably had to look at what the impact of the collapse of the commercial real estate market will be. The doomsday scenario he drafted predicts a 40 percent downturn in that sector. The associated loss of city income would increase year by year, reaching $1.2 billion by 2027.
But where there are no more office workers, the local economy also lacks customers, resulting in the closure of restaurants, bars, nail salons, etc.
The examples shown are by no means isolated cases, but are representative of a systematically widespread problem worldwide. No one hears about the numerous small real estate bankruptcies that are already taking place, because these are insignificant for good headlines.
What is worrisome is that the market shakeout triggered by high interest rates has just begun.
The insane thing is that the trigger for these dislocations is high interest rates. Interest rates that had to be tightened because of high inflation – inflation that only became a problem because of the far too long period of low interest rates.
Bernd Pulch 