The real estate market: In the eye of the storm

This year, the equity and bond markets are undergoing a sharp correction. The real estate market is surely next on the list.

Given its importance, such an eventuality should be taken seriously. First of all, the value of this asset class is considerable. Globally, the real estate market was estimated to be worth $325 trillion in 2020, compared to "only" $109 trillion for the equity markets*. The residential market is the most important part, but we must also think about office real estate. For the past 10 years, the real estate value of these two segments has only gone up and sometimes in very high proportions. The main reason for this rise is well documented: for ten years, central banks have artificially maintained interest rates close to zero, whether in the United States, Europe or England.

Real estate has a particular characteristic compared to other asset classes: in order to buy, it is possible to borrow very large sums of money, which sometimes represent 100% of the value of the property. The lower the interest rates, the easier it is to borrow a large sum, so real estate has benefited greatly from these very low rates. But for several months, the situation has changed radically. Inflation is back, at its highest level in 40 years. Central banks, initially surprised and wait-and-see, are now raising rates quickly and aggressively. The US 30-year rate, the benchmark rate for setting mortgage rates, has risen from 3% to nearly 7% in one year. A household with a repayment capacity of $2,000 per month can now borrow only $27,000, compared to $400,000 a year ago, a drop of more than 30% in its "purchasing power". First-time buyers, who can account for nearly half of all transactions, are the most affected. Already the number of transactions is falling, -20% over one year in August in the United States. Homeowners who borrowed at variable rates are also victims of this paradigm shift. With rates rising, their purchasing power is falling. In Canada and Sweden, two countries where variable-rate mortgages account for more than half of all real estate loans, prices are down 8% since February.

The office real estate market is also correcting.

Already weakened by the consequences of COVID (telecommuting), it is now suffering from a liquidity problem. In the last ten years, real estate funds have grown very rapidly and are now major players in office real estate. In the UK, faced with buyouts for some time, they are being forced to sell, a situation that is accelerating the decline in asset prices. In the United States, three American academics** estimate that office real estate could fall by 28%. In Europe, Bank of America analysts expect a 12% decline.A decline in the real estate market has consequences in many industries. For example, in China, the collapse of the market has caused a halt in new housing construction, triggering a 15% annual decline in cement production, a magnitude never before seen in history. To maintain their margins, affected industries are likely to cut back on staff, which will increase unemployment. In the banking sector, for example, Wells Fargo is reducing the size of some teams because refinancing requests have virtually disappeared. To summarize, the housing market had a "golden" decade. But the rapid and sudden rise in rates is weakening its foundations. This new decade promises to be much riskier.

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* https://www.savills.com/impacts/market-trends/the-total-value-of-global-real-estate.html** https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4124698