Real Estate: A New “Bubble” That Poses A Danger To The World Economy?

Is China the “source of evil” once again, as it was with the coronavirus? Yiannis Pangalas’ Will

The global real estate crisis, which is expanding quickly, reminds people of the catastrophic financial crisis of 2007–2009. Mortgages in the US that banks approved but often lacked even the most basic collateral led to a crisis that spread to other countries.

Because of the approximately €175 billion in real estate spending in 2023, the real estate sector is experiencing significant difficulties. Commercial and residential real estate loans totalling $ are under pressure globally. Amounting to four times the credit of the following big industry.

According to a survey by the law firm Weil, Gotshal & Manges, risk levels for real estate credit are at their highest levels in a decade across Europe, which is also the area with the biggest issues.

According to MSCI statistics, commercial property values in Britain fell by 20% in the second half of 2022, but according to Green Street, the decline in the US was just 9%.

But how did the real estate industry come to pose a danger to the world economy once more? And lastly, if there were any lessons learned from the previous financial catastrophe, were they applied?

Low-Interest Rates’ Function

It should come as no surprise that the terms for issuing loans were more favourable during the decade of cheap money, with interest rates at negative, zero, or low levels.

Due to the abundance of chances created by the previous crises’ unhealed wounds, the building businesses went into a construction orgasm. The real estate firms, who saw these possibilities and bought properties, were also nearby.

The next “big thing” in commercial real estate development seemed to be. But it was impossible to predict what would come next: the outbreak of a pandemic.

Corona Virus

Other practises and traditions, such as confinement in houses, teleworking, and distance schooling, have been spread around the world by the coronavirus. A new employment paradigm, including remote work and subsequently the hybrid model with rotating office work or the choice to work some days from home and others from the office, has evolved in the workplace.

The office area, which is part of commercial real estate, was abruptly devoid of people. Businesses discovered that existing premises were no longer required and, more importantly, had stopped being lucrative.

The new order has brought along new realities, including flexible working arrangements, digital nomads, and an increase in the number of requests from employees looking for improved working circumstances.

Commercial property owners and construction firms are under pressure from the new reality and are either compelled to abandon projects that they had started before to the epidemic in the midst or apply for additional loans to finish the ones that were already underway.

However, teleworking stimulate the residential real estate market by raising demand and, therefore, mortgage rates. The cost of buying a new house is rising noticeably, and it is currently more costly than it was before to the epidemic.

Increasing Interest Rates And China

The first “bomb” originates in Asia, notably from the world’s biggest real estate market, China.

The country’s biggest construction company, Evergrande, filed an application for protection from creditors in an effort to avoid going into financial default because of Beijing’s rigorous zero-case policy, which provides little room for manoeuvre.

The Harvard University expert argues that it will take some time for the situation with China’s commercial real estate market’s building activities to return to normal.

He and economist Yuanchen Yang estimate that in 2020 China’s real estate sector contributed around 29% to the nation’s GDP, a figure comparable to that of Ireland before to the financial crisis of the first ten years of this century.

The second-largest economy in the world is experiencing a severe real estate market problem. There are more and more warnings that it will spread to the West. Warnings were ultimately realised but were foreshadowed by Russia’s invasion of Ukraine and the accompanying energy crisis that caused inflation to soar.

In order to combat inflation, central banks throughout the globe are making changes, such as ending easy access to credit and raising interest rates. The real estate market is currently at risk due to the tightening of monetary policy, which has increased the cost of financing.

The Housing Market Is “Frozen”

The real estate market’s structure and sales activities “froze” with the withdrawal of easy credit. Banks provide warnings to people implicated, telling them to sell out quickly or face seizures.

Jobs and economic growth are in danger as a result of the construction industry’s declining activity, which is spreading across the economy.

Builders FirstSource, a supplier of home building supplies, has eliminated 2,600 jobs in the US. The Swedish company Electrolux has revealed intentions to lay off 4,000 employees, the majority of whom would be located in North America.

As real estate broker Jones Lang LaSalle’s head of consulting, Ian Guthrie, notes, a special conjuncture is now developing due to several variables.

The real estate sector is under increasing strain as interest rates rise. “Values are under pressure, and cash flows are under strain, therefore we have a lot of prospective loans that may fail.”

Rapid crisis spread is occurring. In the United States, Brookfield’s brokerage division issued a warning in November of last year that it could find it difficult to restructure the debt for two towers in downtown Los Angeles and did not completely rule out the potential of foreclosure.

South Korea’s economy has been shaken by the business responsible for building LegoLand’s failure to pay its debts, requiring the central bank to step in to stabilise the markets.

Occurrence In Europe

Following the crisis, property owners participated in the acquisition of new assets due to the availability of cheap financing and the lower borrowing costs compared to real estate. However, Bloomberg research found that the outcome was that the real estate market became the weak link in the trash category, with an 8% chance that a bubble could burst in the next two years.

European authorities have previously issued warnings that certain projects in Europe may not be viable due to a volatile combination of factors including declining office space demand after the pandemic, increased material prices brought on by supply chain delays, and increasing financing rates.

Due to a lack of purchasers, many landlords in Europe are obliged to lower their rent. Samhallsbyggnadsbolaget I Norden AB has decided to sell properties valued at close to EUR 1 billion in order to settle its debt. Sweden is a classic example, where values have been in free decline.

The State Of Affairs Across The Atlantic

In the US, there are also indications of a crisis. Despite the fact that homes continue to be overpriced, Michael Nott, head of research at Green Street Banks, asserts that prices will drop between 5% and 10% in 2023. Banks themselves also send out risk signals that indicate potential losses. The initiative cost around $1 billion, according to Bank of America, which revealed its results for the fourth quarter of 2022. There is a chance of default on office space loans of $. On the other side, Wells Fargo anticipates further pressure on the real estate market if demand continues to deteriorate.