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Real estate: still attractive but part of the financial crisis - ASHARQ AL-AWSAT English Archive
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London, Asharq Al-Awsat- For the past few weeks this article has focused on the London Olympics to highlight some of the great opportunities that are available in Great Britain. Perhaps this week we should return to the sovereign problems of the world. I will look at real estate’s role in this. Real estate is also an asset class that is very popular with Middle East investors.

The real estate market in the Middle East began a necessary correction phase in 2010 with more demand coming from the residential sector. This demand is primarily generated by the low and medium income segment of the population and therefore developers are now focusing towards building affordable and economic housing. The Middle East real estate market is expected to be favorable with stable growth in the long run due to mounting domestic demand for affordable residential properties, friendly government laws and growing government investments. Some countries in the Middle East may offer investors growth in the coming year or more.

The real estate market in Saudi Arabia has strong growth primarily due to an increasing domestic demand for real estate properties. In addition, the arrival of religious pilgrims and leisure tourists to the country has driven the market in the recent past and has resulted in lower vacancy rates in retail shopping malls and hotel rooms. But are there lessons that might be learned other regions?

The European debt crisis is likely to constrain real estate prices across the euro zone, in the US the market is still flat, in China and Hong Kong property prices are falling significantly. Great Britain still provides opportunities for investors with cash, nerve and a long term perspective. High quality ‘safe haven’ assets will continue to be in high demand, especially those which provide a positive yield.

Since late 2009, fears of a sovereign debt crisis grew among investors with rising debt levels around the world. Causes of the crisis varied by country. In several countries, debts from a real estate bubble were transferred to sovereign debt.

The rising price of real estate in Spain over the past decade has been a key cause of that country’s financial crisis. €80 billion of loans by Spanish banks to the country’s construction and real estate sectors are now considered near worthless, and at serious risk of default. The banks held some €50 billion in reserves which could be set against those losses. Rapidly falling house prices could still fall another 35% which would further erode bank revenues and push up bad debt provisioning. Most regional savings banks (cajas ) lent heavily to real estate companies which at the end of the bubble went bankrupt. The cajas were left with the collateral and properties of those companies; in effect overpriced real state and residential-zoned land which was worthless rendering the cajas in essence bankrupted. A major bank audit indicated the extent of the problem.

Government debt in Spain comes mainly from Spanish banks buying Spanish government bonds: a bankrupt banking sector would mean virtually no takers for Spanish Government debt, except at extreme interest rates. The way out was to address the banking problem. Other euro-zone countries have recapitalized Spain’s banks through the ECB’s Long term refinancing operation (LTRO).

This real estate problem in not limited to Europe. There are bubbles in many other countries including China. The Chinese property bubble is in residential and commercial real estate. The bubble started to deflate in late 2011 when housing prices began to fall, following policies responding to complaints that the middle-class was unable to afford homes in large cities. The deflation of the property bubble is seen as one of the primary causes for China’s declining economic growth in 2012.

Shortly before the American housing bubble burst, experts across the globe argued that the world had reached a new plateau of economic growth, where the old rules of economics no longer applied saying, “this time it’s different.” The same has been said about the current boom in China, specifically with regards to its large degree of top-down state control over the economy, which somehow enables it to ignore the laws of economics.

In 2008, in order to get back to post-crisis growth levels, the Chinese government announced $586 billion worth of “investment” with the very same purpose.

When governments claim to be “investing” in something, one should always substitute “spending” or “printing money.” Even when profit-and-loss calculations guide these “investments,” the capital still comes from taxation or inflation rather than voluntary savings. There is good reason to be concerned about China. A study conducted last summer by the Beijing University of Technology reported that a typical Beijing flat costs a staggering 22 times the average income in the city, while the same figure for the city of Shenzhen was 18. On a national level, the Chinese Academy of Social Sciences concluded last year that a typical Chinese property costs 8.8 times the average income. Compare this to just 5.5 in the United Kingdom in 2007 and 4 in 2009. In the United States, home prices peaked at a little over 5 times average income during its housing bubble, according to the S&P Case-Shiller Index.

As in Dubai most new Chinese real-estate developments are snapped up before they are built. The buyers are speculators who do not rent out the properties, hoping instead that they will yield even higher profits once flipped in pristine condition in the future.

Yes, there are lessons to be learned from the current market failures. The Middle East is still evolving its models for the affordable housing market. Dubai, China, Spain and many others demonstrate the dangers of inappropriate control s over lending; inadequate business plans and robust market studies by developers; and untested government interventions.

Finally back to Great Britain. There is still massive potential in the buy-to-let market because of the rising tide of people unable to afford their own home. It is possible to find pockets of demand in every town or city but understanding the dynamics that surround them is crucial. In most places, there will be a certain type of property that is consistently in demand, in which case void periods will be lower, positively affecting incomes. Speak with local professionals and understand what is in short supply, rather than simply specifying what you like. Also bear in mind your objectives. Are you looking for capital growth, or monthly income? Be clear about your exit strategy. In London, a two-bedroom flat is a liquid asset, as they are always in demand for all types of buyers, therefore the marketing and sales cycle is relatively short. In other cities, however, family housing is a better buy as there is an oversupply of flats. Factor in how long you want to retain the property for and what constitutes a ‘liquid asset’ in the area.

I worked for some years as a senior executive in ‘Triple A’ rated London listed real estate development company. Its success was due to its investment in the best advisers and in paying properly for that advice. That company was years ahead of its time. I believe that Real Estate remains a sensible asset class but it has become a lot more difficult to be successful in since the financial crisis. Many developers still do not understand this nor do they recognize the importance of paying for what some think of incorrectly as expensive advisers. They will continue to make many costly mistakes. They do not need to!

Asharq Al-Awsat

Asharq Al-Awsat

Asharq Al-Awsat is the world’s premier pan-Arab daily newspaper, printed simultaneously each day on four continents in 14 cities. Launched in London in 1978, Asharq Al-Awsat has established itself as the decisive publication on pan-Arab and international affairs, offering its readers in-depth analysis and exclusive editorials, as well as the most comprehensive coverage of the entire Arab world.

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