Written by 10:41 am WTF is going on with the Economy?!

For real estate, it’s not 2008

real_estate_2008

This is a re-post of our 12th issue of our “WTF is going on with the Economy?” newsletter which talks about real estate. You can read the original here. Get future issues delivered directly to your inbox. Sign up here.

Real estate is the one investment type that everyone knows. 

From an early age, we’re told that home ownership paves the road to riches.  

We stop in front of real estate agencies, checking out the listings in the window. When we’re bored at work, we go on different real estate websites and browse the local market.

And as soon as we have the bare minimum of cash, we start house shopping. Once we find one we like, we head to our favorite neighborhood bank. There, the branch manager will gladly lend hundreds of thousands of euros to purchase the home of our dreams. 

It’s almost like it’s in our collective DNA. 

So you’re probably fully aware of what’s happened in the global property markets over the past decade.

Let’s recap.

It all started in 2008. At the time, the real estate and mortgage markets were ready to burst. After years of the insatiable demand for property, consumers had borrowed too much and were in over their heads.

Like those that came before them, people were convinced their ticket to wealth was in bricks and concrete. They couldn’t buy property quickly enough. Caught up in their cravings, they made a series of terrible financial decisions.

Banks being banks, made the situation worse. Like drug dealers enabling addicts, they kept lending money, often with unsustainable conditions attached. To make even more money, the banks packaged up all of their loans into investment products and sold them to investors. 

None of the terms nor “secured” mortgages made any sense. By the time the bubble burst and the dust settled, the world was facing one of its worst financial crises in modern history.   

Millions of people lost their homes. Banks failed, and governments had no choice but to rescue them. The packaged mortgage investments were mostly worthless, leaving investors with nothing.

The impact of the collapse rippled around the globe. Residential real estate prices collapsed from Barcelona to Bangkok.

In the aftermath, investors with cash saw a huge opportunity. Homes in hot cities were available for pennies on the dollars. Those who had the appetite gleefully slurped up bargains, building real estate empires

Their strategy was simple: tough it out for a couple of years while the economy gets back on its feet. Then, the profits will start rolling in. 

It turns out, their patience paid off. 

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Following the crisis, the global economy shifted. People gravitated to major cities, chasing jobs and urban lifestyles. Demand for housing skyrocketed, sending rents and prices soaring. 

For many of us on the outside, though, the picture was starkly different.

Some felt betrayed by the system, unable to enter the wealth-building game like those before us. As rents kept rising, many began to feel resentment and were waiting for prices to crash. If only there was a correction, then bargains would be had again. 

It was only a matter of the next recession happening. 

To many, that moment is now, as the Coronavirus has brought the global economy to its knees.

With the world in disarray, many believe that the real estate markets will crash harder than they did 12 years ago. 

But today’s crisis is fundamentally not like the one from 2008.

If you’re using comparisons from then to make real estate decisions now, you’re probably in for a bad time. 

Here’s why.

Governments stepped up to avoid catastrophe.  Unlike in 2008, governments are helping homeowners and banks by extending mortgages and guaranteeing loans. The last thing anyone needs right now is a bunch of banks failing, and policymakers know it.

These measures are buying time for the economy to get back on its feet. As such, we’re not going to see a lot of people losing their homes, which would drive down real estate prices. 

The mortgage market is a lot healthier than it was 12 years ago. After all of the bailouts, governments forced banks to clean up their act. They stopped giving “toxic mortgages” to people who could never reasonably pay them back, making repossessions less likely. 

Banks today can only lend so much money based on the value of the property. We call this the “loan to value” or “LTV” ratio in finance. The lower this number, the more cash a buyer needs to put upfront. Think of it like this: if a bank says a mortgage needs an LTV ratio of 0.8, then the buyer needs 20% of the price in cash to get the loan.  

Lower LTV ratios keep the number of bad mortgages down, reducing repossessions. With fewer repossessions, there are less homes for sale at a discount on the market.

Together, these actions have prevented an unsustainable mortgage bubble. Since the mortgage market isn’t about to collapse, house prices aren’t as likely to collapse as they were in 2008.

Mortgage rates can go down.  Mortgage rates are historically low everywhere. However, they can fall farther. Since 2008, central banks have been much more willing to cut interest rates than ever before. We’ve talked about this before, but in short, central banks set interest rates, which impact everything in the economy. Mortgages are no exception. 

When mortgage rates go down, real estate prices go up. Why? When it’s cheaper to borrow money, more people start looking for loans. When real estate sellers see more people wanting to buy property, they raise their prices.  

We’ve seen this effect in action over the last decade. In countries across Europe, mortgages plummeted. At the same time, home prices kept climbing. Now, as we enter a recession, real estate prices will more than likely fall. That’s typical behavior in an economic downturn. If central banks are willing to keep rates low to fight the recession, then real estate prices won’t fall so far. 

The upcoming recession is going to be rough, to say the least.

one really knows how it’s going to shake out. The Coronavirus is still the biggest X-factor. Until we have a clear path out of the pandemic, the economy cannot go back to full speed. No one can say what will happen. But what we can do, is put our expectations into perspective. 

For the real estate market, there undoubtedly will be some deals as the market will slow down. Not everyone borrowed within their means, and banks are by far from perfect (that’s an understatement). Sadly, some people lose their homes. Others will want to sell to move in search of work or to seek out more personal space. Also, this issue focused on residential real estate. Office buildings are an entirely different can of worms.

However, assuming that housing prices will behave exactly like the last recession and basing your decisions on that will probably lead to some disappointment.  

Given how 2020 is going so far, no one needs any more let downs.

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