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The Titanic effect on Economy and Real Estate

The Titanic effect on Economy and Real Estate

What can we expect in relation to price developments?

Anyone who has seen the movie Titanic certainly remembers that after the side collision with the iceberg , part of the crew, including the captain, thought that the situation would be under control, until the real impact was realized, and the ship architect Thomas Andrews announced that the great “sea monster” would be sunk in less than 2 hours.

Contrary to common sense, the coming economic crisis is not caused by the coronavirus. The virus only accelerated the bursting of the bubble that was created in recent years, which is a result of an expansionary monetary policy, I mean, cheap money that was entering the economy and that ended up creating bubbles in some assets, including real estate.

Not long ago I was reading an article about what to expect from the stock market evolution, in which the analyst argued that after the March crash, in the coming months and until the end of the year, the market would probably be disconnected from reality, and could even close positive this year, and probably early next year it was going to be a kind of Armageddon, with a big crash and the entry into a big depression. You can read an excellent article on this topic here .

This reminded me of the reaction of the real estate market when it comes to a cycle reversal. Many market players do not want to admit that the cycle has been reversed. On the other hand, buyers retract (after all, they have to pay the capital and take the risk) and become more opportunistic (they want a higher risk premium, translated into a greater discount). Sellers are slower to adapt, because they feel (mistakenly) that they are going to lose money compared to the values ​​that were practiced until very recently.

How does this play out in practice?

As sellers resist adjusting to demand, the take-up time (time needed to sell a property) increases, until the discount rate starts to increase and the price meets the demand. This same phenomenon has already happened in the periods 2007-2011 and 2011-2013 of the financial crisis and the intervention of the troika in Portugal with resulted in heavy credit restrictions.

 

Average Take-up Time and Discount Rate since 2007 in Lisbon

The expected scenario for the coming months is a progressive increase in the take-up time from the current 5 months to values ​​close to 10 months until the owners start having to face reality and lower the price to get demand from buyers.

Some people expect a so-called V or U shaped recovery (rapid fall followed by rapid recovery). I think it will be too optimistic and the real consequences of the global shutdown are yet to come in full extension. According to the European Commission, the European economy should experience a historic contraction of -7.4% this year . There are industries that are being completely devastated and it will take years to recover, as is the case with hotels, and all activities related to tourism. Portugal is a country that is too dependent on tourism – it represents 12% of Portuguese GDP (the largest weight in Europe). In recent years there has been a huge investment in the hotel sector, particularly in Lisbon and Porto, much of this investment coming from Private Equity. Many of these funds are heavily leveraged using bank credit. Typically, those who buy and build a hotel hand over their management to an operator who pays rent. What is expected to happen when many of the operators start to miss debt payments?

Contrary to the 2007-2008 financial crisis in which the sub-prime mortgage credit was the fuse , when banks lent to individuals at high risk of default, more recently banks began to focus their loans on large Private Equity groups , through the so-called Leveraged Loans, which main activity is buying diversified assets (companies, real estate, etc …). In the USA alone, this market represented 1.2 trillion dollars, and growing. This is a time bomb.

Realism and preparation for the worst case scenarios in order to take advantage of opportunities

Let us remember that in the last financial crisis, the first signs appeared in July 2007, reaching the highest point with the bankruptcy of Lehman Brothers on September 15, 2008, that is, more than a year later.

Without wanting to do futurology, we will probably be living at 2:00 am on the Titanic before sinking. With a logical caveat that this sinking will be just another crisis that we will overcome like the previous ones. In other words, unlike the Titanic , we shouldn’t panic, but we should see this as a serious warning to prepare properly, because it is during the crisis that the best opportunities arise for those who are prepared. This is what Smart Money is doing, seeking to reinforce its cash position.

… should we sit waiting to see what happens?

No, not really! It is very likely that the number of real estate transactions will drop significantly in the near future, but as with the Titanic’s, the orchestra may be playing for a while. Some will whistle to the side, and others will prepare for any scenario and to take advantage of the opportunities that will inevitably arise.

It all depends on your profile. Here are some tips:

  • Home switching: If you are thinking of moving home, this may be the best time, if you hurry. Adjust to the market, put your house up for sale at a price suitable for the new reality, and even if it sells below what you would have gotten 3 months ago, you will also buy cheaper so the net effect will be neutral;
  • Second home sale: whoever seeks to sell to reinforce their cash position and take advantage of any opportunities ahead, this is the right time because credit has not yet been impacted, and the effect of the crisis is not yet incorporated in the price (as explained above). Again, adjust the price to the current reality, because it is better to sell quickly than to drag the property on the market with successive price reductions and end up selling lower than you could have if you had initially adjusted the price;
  • Foreign buyer: if you are a foreign buyer looking for buying a house in Portugal, to enjoy the unique lifestyle of our country, or to buy a second home for holidays or investment, it will not make much sense to postpone decisions. You will probably be buying a property in the premium segment, and most of the sellers/developers will be more receptive to negotiating a bigger discount. As we are probably talking about an investment with a term of more than 5 to 10 years, it will not make much sense to condition a personal decision due to a market fluctuation, which will later recover, as always happens;
  • Buy to rent: If you are thinking of investing, you will probably need patience until the opportunity arises. The best purchase should be informed, you need to incorporate a risk premium (5% to 10%) in your investment analysis model for a correction to the value of the rents. In any case, rental yields are expected to suffer less than capital valuation;
  • Buy to renovate/flip: This will possibly be the most risky business in the residential segment at this time, as it will be more sensitive to a capital fluctuation (property price variation), so it is extremely important to make a purchase that incorporates a higher risk premium (10 to 20%). Recently, this was already the type of asset where we’ve seen the highest level of speculation, so be prudent;
  • Commercial Real Estate: offices, retail and hospitality will be one of the most impacted by the crisis. Probably within months, some historic opportunities will arise for doing great business. Be aware.

A final word of optimism

The real estate market is made up of cycles, like the economy. We should thing of real estate investment as a long-term investment (at least 5 to 10 years), and in the long term the outlook remains very positive. Portugal will continue to be one of the most attractive destinations for real estate investment. As we mentioned in our previous article , the paradigm will change in post-COVID19, and teleworking will be the “new normal”. This will also increase the emigration from the Nordic countries to Portugal, looking for more pleasant conditions to live. After all, in a scenario where remote work is a reality, it is preferable to live in London and pay £ 2,500 / month for a 2 bed apartment or move to Lisbon and pay half, have a lower cost of living and enjoy the excellent quality of life that the city of Lisbon offers, and a more pleasant climate?

If you need help to define the best strategy for your case, contact us.

 

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