Opinion Archive

What to Make of the Real Estate Market

May 14, 2008

Your correspondent spent the better part of the past week at a convention of the Urban Land Institute (ULI) in Dallas, Texas. Out of the many hours of talks referring to the economy, in general, and the real estate industry in the US, in particular, two conclusions stand out. The first is that the most likely economic scenario (with a 50% probability) is that the recession will be mild, ending by the fourth quarter of 2008, but with a sluggish and drawn-out recovery. The second is that we are only halfway through the housing price decline cycle, which they predict could see another 10% fall in house prices, nationwide. Of course, there are important regional differences, with California, Florida and Arizona being “ground zero” of the crisis and Texas, Utah and Washington having come through unscathed up until now.

Panelists also highlighted differences among market segments, with condominiums being the hardest hit and commercial property holding its own. Also, as lending standards have become ever-more stringent, the rental market is expanding significantly with people who would normally have purchased their home, but who are unable to get loans in today’s market. Although many projects have been cancelled, the slack between sluggish demand and oversupply will, according to ULI’s experts, take longer to disappear because of the amount of foreclosed properties entering the market.

Mi casa is affected by su casa

The US real estate market is important for Mexico on several levels. First, it impacts the country’s second and vacation home sales directly. Despite the availability of US financing for Mexican homes, most buyers have ended up paying for their Mexican acquisitions by leveraging their US assets. This because of better interest rates and less hassle. Second, it hits the Mexican economy in general via the so-called “wealth effect”; the increase, or decrease, in spending that accompanies an increase, or decrease, in wealth (or perceived wealth). As the price of their homes decreases, Americans feel poorer, so they spend less. Given that consumer spending constitutes about 70% of US GDP, and that upwards of 80% of Mexico’s exports go to the US, this is very important.

As one of the few Mexicans at the ULI convention, your correspondent was approached by several potential investors regarding opportunities in the Mexican real estate market, specifically in the retail, industrial, and logistics sectors. This implies that a lot of investors are looking for opportunities outside the US market. On the negative side, Ernst & Young, an accounting firm that provides investment consulting, highlighted the fact that, despite the $250 billion dollars in infrastructure investment announced by the Calderón administration, this crucial sector’s underperformance will hamper Mexican growth.

But Mexico’s real estate sector is relatively healthy. Fortunately, there were no “NINJA” loans (money given to people with “No Income, No Job, or Assets”); lending standards have never become too relaxed. A director of Century 21 Mexico (the country’s largest real estate broker) was recently quoted in this newspaper as saying that the overall market remains healthy – except for northwest tourist destinations, such as the Tijuana/Ensenada corridor and Puerto Peñasco (“Rocky Point”). As mentioned in previous articles, these have been adversely affected due to their symbiotic relationship with the southern Californian and Arizonan markets.

These areas probably represent the best opportunities. The US grows by approximately 3 million people per year. Unless there is a significant fall in American living standards, this growth promises a healthy long term future for real estate. Further, given that inflation is making all building materials more expensive, it is a safe bet that prices in the most depressed markets (the American southwest and Mexican northwest) will look like a bargain within 2-5 years, as replacement costs rise.

But American demand is changing. ULI panelists noted that consumers are shifting to smaller houses. The average size of an American home grew from 983 square feet (91m2) in 1950 to 2,400 square feet (220m2) in 2005. Today, stagnating incomes and dramatic energy inflation mean that the market is looking for smaller units, a trend that will probably continue well into the future.

In Mexico, there is a (very necessary) shift from isolated buildings and projects to more master-planned communities. Nevertheless, the country still has a long way to go in terms of urban planning. This fundamental piece of the development puzzle has been neglected for too long and its success is hampered by the fact that Mexico’s 2,500+ mayors serve for a single 3 year term, without the possibility of reelection.

Mexico would do well to solve its urban planning deficit and take advantage of the long term opportunities in the real estate industry. Investors would do well to take advantage of what could be the best buying opportunity of this decade.

For the latest thought-provoking article by Agustin Barrios Gomez please go to our Opinion Column page

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