Macroeconomic trends depress global real estate markets

Key takeaways

• Household finances are falling due to higher interest rates, which threaten to further depress property prices 

• In response, developers are cutting back on projects to counter low demand and rising borrowing costs, which in turn hurts investment levels

• The global real estate crisis raises concerns over another market crash infecting the banking and financial services sectors.

Global residential real estate markets peaked post COVID-19 on the back of forecast long-term cheap debt, and people's desire to spend lockdown and beyond in a bigger home. What homeowners, governments and central banks failed to anticipate was a rapid rise in inflation so soon after the pandemic - along with consequent central bank rate rises. Now, these macroeconomic factors are dictating the terms. The sheer size of the real estate market in global economies makes the sector emblematic of broader economic concerns. As per our FPI index, Infrastructure and real estate is among the top 10 underperforming sectors globally, posting a year-on-year drop of 1.3 percent to a score of 90.49 in September 2023. 

As a forerunner to the worldwide property slump, residential real estate markets in the advanced economies overheated during the pandemic while interest rates were low. Since then, many of these economies have entered a vicious debt trap, led by decreases in property value and credit availability. In contrast, households in emerging economies have relatively lower levels of debt and suffered fewer booms and busts in their housing markets, as evidenced in our FPI results, which show how the real estate industry in these markets has taken less of a hit.

• Sweden (real estate sector contribution to national GDP: ~22-23%): In Sweden, households are nearly twice as indebted as the European average, with property accounting for 80 percent of household debt. Over the past year, aggressive interest rate increases, and high inflation have pressed household debt to the limit, directly impacting the real estate sector.
• Canada (real estate sector contribution to national GDP: ~13%): Interest rate hikes over the last 16 months have put a dampener on the Canadian housing market. Buyers are reluctant to pull the trigger on purchases (due to market and interest rate uncertainty) and sellers hesitant to list (citing oversupply concerns) - thus creating a `logjam'. Amidst all these developments, the government has embarked on a high-growth immigration strategy to close the labor gap. Housing these new arrivals has further stressed the Canadian housing market. According to BMO research, for every one percent of population growth, housing prices are estimated to rise by three percent.
• Germany (real estate sector contribution to national GDP: ~20%): German real estate has become a buyer's market. In order to meet the European Commission's climate goals, more than 60 percent of Germany's housing stock will need to be renovated over the next 10 years. As energy efficiency becomes one of the top priorities for buyers, the transition is expected to increase costs and widen the price gap between houses that meet these climate goals and those that do not. Owners of the large number of properties not up to scratch have to cope with falling values.
• Australia (real estate sector contribution to national GDP: 13%): Australia's housing crisis is primarily caused by a lack of supply. Short-term housing demand is also rising as immigration returns to pre-COVID levels. Australia has one of the lowest supply rates among developed nations, with about 400 dwellings per 1,000 people. However, as prices continue to rise, there are early signs that the market is in recovery mode, despite a recent string of construction company collapses that have damaged market confidence. Cooling inflation, the likely peak of interest rates, good rental yields and a southern hemisphere summer selling season are expected to boost transactions in the coming months.
• Thailand (real estate sector contribution to national GDP: 8-10%): The domestic residential property development market is being supported by local conglomerates and investment in new real estate projects (especially around central Bangkok region). This is likely to create more supply in an already oversupplied market and for those with exposure, balance sheet stress in the near-term. Thailand condominium sales have recently been supported by investors from China and Russia, primarily relating to the tourism sector, and these buyers are expected to continue support residential sales in the fourth quarter. Albeit, there were concerns over bond payment defaults relating to real estate developers in early 2023, and with an uncertain global economy, it is not clear if this trend will continue.
• Malaysia (real estate sector contribution to national GDP: 2-3%): Malaysian local property firms are facing oversupply in the market and are trying to clear the overhang. Some property developers are delaying launch of new projects. Moreover, property developers need to counter rising building material costs, which if not passed on to the end customers, further erode margins.
• Indonesia (real estate sector contribution to national GDP: ~15%): The real estate, construction, and property industries make up about 15 percent of the country's GDP. In spite of the current high interest rate environment, new home demand and prices in Indonesia are forecast to remain largely stable over the next year, as domestic banks maintain their steady mortgage rates. Moreover, real estate developers are ensuring that the selling price per square meter remains affordable by either maintaining it or reducing the size of homes.
• Hong Kong (real estate sector contribution to national GDP: 8-10%): Hong Kong's house prices are in a downward spiral due to a large inventory of unsold units—the highest level since 2007. This is at a time when Hong Kong’s population has dropped for a third straight year, with a net outflow of 60,000 residents in 2022. Historically one of the hottest markets globally, the Hong Kong real estate sector is impacted by rising interest rates and a slowdown in the economy affecting confidence, which saw seasonally adjusted quarter-to-quarter comparison real GDP fall by 1.3 percent in in Q2 2023.

The pandemic pushed house prices up in numerous geographies as economies, particularly in advanced nations, brought down interest rates whilst property supply remained relatively fixed. Post pandemic, prices began to fall in many countries as these two factors reversed, while in other nations gains slowed.

The Organization for Economic Co-operation and Development (OECD) opined that countries with a larger portion of household debt pegged to floating rates are more likely to have higher mortgage payments and a bigger chance of defaulting. According to data from IMF, a group of 38 mostly advanced economies, property markets in Canada, Australia, Norway, and Sweden are at greatest risk, due to a range of factors, including the analysis from OECD (see chart below).

Countries at high risk in the IMF analysis are similar to those that show increased risk of default in our FPI analysis. This further supports our assertion of underlying financial distress surrounding the infrastructure and real estate sector. For the high-risk counties, we expect housing stress to flow into discretionary spend sectors, with FPI scores in those industries to experience knock-on effects in coming quarters. Moreover, because the real estate sector is a significant part of the GDP in many countries, economic growth might also be impacted. 

Whilst domestic real estate rises and falls occur frequently, it is uncommon for markets to move in a coordinated fashion on a global scale. Many multinational real estate companies, for example, achieve lower risk premiums due to their geographic diversity; but recent events have challenged this widely accepted principle. The domino effect on consumer markets has already been mentioned, but with no clear end in sight, the next quarter FPI report will examine further ripple effects on enabling sectors such as banking, fund management and REITs. The FPI scores for 3Q23, available by mid-October, will help us determine whether there are any signs of recovery, and identify which sectors are experiencing the biggest impact from the knock-on effect.