The crisis in the debt markets has hit residential and commercial property around the world. The past decade has seen housing booms in the US, the UK, Spain, Ireland, central Europe and beyond. But the property boom was supported by cheap credit that has now dried up.
So with property prices down, is the time now right to start buying again? Are we heading for a global house price recession or will there be a soft landing? Liam Bailey, head of residential research at Knight Frank, tackled your questions on the global property market. Mr Bailey has substantial experience across the whole residential sector, from development and private housing to investment and affordable tenures.
Simply looking at graphs of house prices since World War II, it becomes clear that every time prices boom they are followed by a decrease of around 30% (adjusted for inflation). Why do large numbers of commentators disregard these graphs and seem to genuinely believe it is different this time?
Liam Bailey: I agree, there is a tendency to view the housing market (and actually all markets) on a very short term basis - the media could take some blame for this in that short term booms and busts do make for good reads.
There is an element of difference in the market each time however - during the early 1990s downturn we did not have an expanding buy to let sector - we actually had a declining one. There are always slightly different fundamentals which make it difficult to assume that the experience from the previous booms will pan out in the same way.
I live in SW10 (London) and must receive three or four fliers per week from the likes of Knight Frank and others telling me that much is still right in the world and don’t worry prices will not fall too drastically. Isn’t this in itself a pretty good contrarian indicator? I seem to remember quite a few similar market updates from equity market analysts back in early 2001.
Liam Bailey: There is no doubt that sales volumes are falling and therefore attracting your interest as a prospective vendor and particularly a purchaser is more important now than it was this time last year. However there is a difference between volumes and prices. The last time we saw volumes fall significantly was 2004-05, by upwards of 30% compared to a long term trend and prices didn’t fall, at least at a national level.
This time round we expect the same thing, mortgage volumes are already down 30% or more on a year on year basis and the market is going to be tough, however whilst prices have slipped in many locations they haven’t dipped significantly yet. The flyers suggest that 2008 will be a buyers market - but you already knew that.
What is your opinion on the potential of the residential market in the Middle East, i.e. Dubai, Abu Dhabi and Qatar?
Liam Bailey: The fundamentals look good. In demographic terms populations are rising rapidly; in economic terms wealth is being created at a strong pace. There is an conscious effort being made to widen and improve the depth and security of the local economy.
So there is more demand for housing and more money to spend on new, better specified accommodation. So far so good. The problem comes when we look at matching this future demand against future supply. There is no doubt that development volumes have increased rapidly over recent years and there is a risk of saturation in the medium term if all proposals are followed through. The potential offered by the markets here really depends on your time horizon - the short term and long terms both look good, the medium term could be more difficult.
How will the global credit crunch affect the property markets in Eastern Europe? Which Eastern European countries do you think will do best and which are expected to fare worst? Globally, which property markets are the best bets medium term?
John O’Brien, Ireland
Liam Bailey: While lending criteria across most European countries have tightened, the impact of the credit crunch will be felt more in a general economic slowdown than in a direct impact on the residential market, although there are anecdotally increased restrictions on lending to individual borrowers in Eastern Europe. That said, economic growth prospects for Eastern Europe remain very strong in comparison with Western Europe, despite recent downward revisions to growth forecasts. The EBRD growth forecast for Eastern Europe in 2008 is between 5 and 5.5%. Demand for residential property in growing urban locations such as Warsaw, Sofia and Bucharest, where prospects for employment growth are good, remains strong.
Furthermore, mortgage markets in Eastern Europe are less mature in terms of the range of products on offer and in terms of the overall size of the markets than those in Western Europe. Consumer exposure to rising interest rates is lower. There is no sub-prime mortgage market to speak of, and rates of mortgage indebtedness are considerably lower than in countries such as the UK. Certain Baltic markets have seen property prices rise on the back of increased availability to consumer credit, and so we would expect property price growth to remain subdued over the course of 2008 in Baltic cities, as levels of consumer debt are higher than Eastern Europe in general. Rates of growth in these markets have been unsustainably high over recent years, and the slowdown in growth is likely to prove a welcome respite for domestic demand.
All the signs are that house prices are set to fall fairly significantly across the UK as a whole. What do you think will happen in the London market (and the central London market specifically)? Will domestic demand for residential property (buying and renting), combined with a continuing influx of foreign money into the capital, see prices continue to hold firm/rise? In the event of a slump in financial services, would you expect to see a significant reduction?
Chris Hawkins, London
Liam Bailey: The main issue in your question is whether London will be somehow protected from the wider market downturn. There does seem to be some evidence so far that London has remained ahead of the UK market and has not seen the downturn experienced elsewhere.
In the central London market, and in particular the super-prime market, there has been a degree of good news in recent months and these markets appear to have motored on unscathed. However there is no doubt that London is exposed, the financial services sector in particular underpins the market to a greater degree here than elsewhere and a downturn in City employment will put downward pressure on the London market.
The unrelated issue regarding tax reforms for non-dom residents could also have an additional negative impact on the London market. London ought to be the best performing UK region in terms of the housing market - however all of the above issues taken together mean that there is little scope for outperformance over the next year or so.
Do you think the Croatian real estate market is likely to be attractive in the coming months given the country’s preparation for 2012 EU accession, the possibility of recession in 2008, and a high Repo rate by the Croatian Central Bank due to inflationary worries?
Ali Dicleli, Reading
Liam Bailey: Security of title is less of an issue than it used to be, but it’s still important. Following the relaxation of development controls in recent years, resort development has been facilitated and in the next 12-18 months we anticipate that the market will see a number of large scale integrated resort developments.
Despite this, land assembly and planning can be problematic. However, it is encouraging to note that developments in certain areas (especially coastal areas) remains tightly controlled. Economic growth prospects are good, and the tourism industry is increasingly strong and being encouraged by the government, though it has not yet returned to the strength it exhibited in the late 1980s.
Potential EU accession will undoubtedly raise the country’s profile for potential investors. Economic and employment growth prospects are good. Prices along the Dalmatian coastal areas have been rising quickly over the last two years, as have prices in the capital Zagreb.
Credit has dried up. However, won’t the easing of interest rates, which has started with the U.S. eventually reinflate the world economy and potentially cause serious inflation problems in the next couple of years, thus making real estate a strategic choice as one asset class to hold to mitigate inflation risk? Or could substantial inflation pressures cause interest rates to spike and put many property holders in dire straits because of the cost of the rising cost of capital?
Carey Vandenberg, White Rock, B.C.
Liam Bailey: Interest rate cuts are usually undertaken in order to provide a boost to the economy. The cut will only be inflationary if resources in the economy are employed to full capacity. At the moment the US economy doesn’t appear to be in such a condition and therefore there appears to be less risk of inflation. Even if inflation did begin to rise, the most noticeable effect could be to see a decline in the value of the US dollar, which would ultimately support the domestic economy and increase exports.
There are continued fears regarding the US financial markets, which pose a far greater risk to both the global and US economy and property values than the risk of slightly higher inflation. A temporary cut in interest rates does not seem to be such a significant risk. A sudden spike in inflation is unlikely unless there there was a speculative attack against the US dollar, which seems unlikely.
The effect of an increase in inflation on the property market - this is a tricky question. Much depends on the proportion of mortgages that are with a fixed or floating interest rate. For fixed rate mortgages inflation would be blessing, and a curse for floating rate mortgages. I wouldn’t suggest hedging against inflation if you’d have to use borrowed money. Hedging with equity could be more justifiable, especially if you’re investing with a long term horizon.
I’ve no other debt, but my mortgage is 4.5 times my salary. Is it time to seriously consider a re-think?
Liam Bailey: It all rather depends on your view of the market, the security of your employment and your ability to generate future income growth. You might think you could sell and move to a smaller property or a cheaper area - which might make sense. However, for most people the decision to play the market with regard to their own main residence collapses when they consider the cost of selling, moving, legal fees, stamp duty on repurchase and all the other costs we have to put up with.
Do you expect it to be a matter of months or of years before prices in Spain will bottom out and what level of price declines do you expect (relative to peak prices)? Moreover, should one distinguish between domestic and tourist property or will they suffer equally? In which areas or sectors would you expect the best buying opportunities to arise? Finally, would you consider investing in real estate mutual funds a sound alternative to buying a home or a flat?
Joris Buyse, Luxembourg
Liam Bailey: Spain should not be viewed as a homogenous market. While the general market has slowed, price falls have been restricted to certain areas of Spain, notably overdeveloped coastal areas. Rates of growth in these areas had been unsustainably high. A loss of confidence amongst buyers has been exacerbated by extensive media coverage of allegations of, and convictions for corruption of local authorities, illegal building and the repossession and demolition of properties in some areas - though this represents a tiny proportion of the market. This largely affects the second / retirement homes market.
For the most part the primary homes market, although it has slowed, has not collapsed. The next 12-18 months are likely to be a critical period - it is likely that over the remainder of 2008, the market will remain depressed and some coastal locations with particular oversupply problems may see further falls, although some markets - notably Madrid and Mallorca - have weathered the storm better than others. We have already seen interest from experienced investors looking to purchase at the bottom of the market. Prices for quality products with a reputable agent and developer have tended to hold their value better.