Among the legacies of the Covid-19 crisis, we have – first and foremost – the surfacing of a renewed inflation regime. Signs of this trend emerged in 2021, with price rises not seen for decades across the world. This dynamic has been compounded by the Russia-Ukraine war, which has significantly hiked energy prices and exacerbated pre-existing supply-chain bottlenecks.
This has encouraged investors to broaden their investment landscape in an attempt to preserve their investments’ real value. In this respect, an obvious option has been to look at global real estate markets. Despite the Covid-19-driven economic shock, house prices have continued to rise in most developed markets (DM), as well as in some emerging markets (EM). The current situation differs across regions. Even so, the fact that prices are rising simultaneously in different countries raises the issue of a possible ‘common factor’ underpinning the increase. One possibility for a common factor is the major central banks’ (CB) monetary policy stimulus delivered during the Covid-19 crisis, coupled with strong demand both for societal – the pandemic has boosted demand for onefamily houses – and investment reasons, the latter being the desire to invest in real assets.
At the G10 level, the increase in house prices and household debt is exacerbating fears that real estate may become a source of macro financial vulnerability, similar to what happened during the 2008 Great Financial Crisis (GFC), especially now that major CB are withdrawing their stimulus. In the United States, the recent rise in mortgage rates could depress household demand for housing and some borrowers will no longer be able to get a mortgage or will be deterred by the additional cost. However, the current situation looks less tense than during the pre-Lehman period and real estate should not be a source of systemic risk for several reasons:
- Despite the increase, growth in household lending remains far off its mid-2000s pace in most countries.
- Household debt seems to be less at risk than during the pre-Lehman period. In the United States, the average borrower profile is now far more solid than in the mid-2000s, when the excesses of subprime loans were regarded as the main cause of the subsequent crisis.
- Banking surveillance has been stepped up considerably over the past 15 years. In several large countries (including the United States, Germany and France), the vast majority of household debt is now at fixed rates, with limited exposure for indebted households to interest rate rises.
China’s real estate market is on a different cycle. In light of the recent troubles experienced by major domestic builders, the authorities aim to decouple the Chinese economy from the housing sector and cool down the speculative forces which drove prices to bubble levels. China has entered a new era of housing regulations, no longer using the sector as a countercyclical tool to boost the economy and we expect a contraction of sales at around 10-15% in 2022.
Investors have plenty of tools available when it comes to investing in real estate markets. They range from investing in physical real estate assets to more sophisticated financial tools backed by mortgages, to collateralised debt and loans obligations. An analysis of the risk-return profile of these tools shows positive returns since their inception date for every tool, with US non-agency securities generally yielding higher returns than those guaranteed by the government, translating into a higher risk premium. In terms of risk, publicly traded real estate investment trusts (REITs) appear as the most volatile tool due to their equity component. In any case, all tools appear to be options to complement a global diversified portfolio in an era of high inflation and rising rates.