QNB Group’s weekly report confirmed that real estate markets in advanced economies are facing pressure due to tightening monetary policy and the problem of inability to afford costs. All of these factors provide a tough outlook for the real estate sector over the next several quarters.
Real estate plays an important role in developed economies, as it is closely linked to the business cycle, and contributes significantly to the growth of the wealth of families, companies and governments. The complexities of the labor-intensive supply chain associated with the creation, financing and distribution of real estate affect a variety of sectors, including the labor market, transportation and financial services.
It should be noted that real estate or real estate property is the largest asset class in the world and serves as a major source of wealth for households. Real estate has historically proven its ability to withstand as an asset, as it allows the preservation of wealth in the long term. Indeed, over the past two generations, real estate prices have provided positive inflation-adjusted returns in all G-7 economies.
But with the exception of Italy, which was affected by the euro crisis, and the United Kingdom, which was affected by Brexit, the major economies have seen a significant rise in real estate prices since the global financial crisis. This trend accelerated further after the COVID-19 pandemic, mainly driven by lower and declining interest rates that reduced mortgage costs and stimulated housing demand and real estate property yields.
It is important to realize that this recent strong performance does not guarantee a similar trend in the future. Historically, the real estate sector has often been at the center of major economic crises, as we saw during the global financial crisis, the American Savings and Loan crisis of the 1980s and 1990s, the UK secondary banking crisis between 1973 and 1975, and the Great Depression of the 1930s.
Therefore, the health of the general conditions in the real estate sector must be evaluated. We believe that real estate prices in developed economies will face significant pressure in the coming quarters due to two main factors.
First, the rounds of aggressive monetary tightening launched by major central banks last year represent a strong headwind for real estate markets. Rising interest rates and diminishing liquidity can put downward pressure on real estate prices, as borrowing costs increase and access to credit decreases. As central banks increase interest rates, mortgage interest rates usually rise accordingly, making real estate financing more expensive for potential buyers. Thus, this can lead to a weakening of the demand for real estate, which results in a decline in its prices. Moreover, tight liquidity conditions can restrict the availability of credit, making it more difficult for buyers to obtain financing. This additional restriction reduces demand, which ultimately contributes to lower real estate values. It is worth noting that the impact of real estate prices on injecting liquidity into the economy remained historically late, which provided great support in the aftermath of the pandemic. However, this pattern currently indicates that a price correction may be imminent.
Secondly, the rapid growth of real estate prices in recent years has exceeded the average increase in salaries and incomes, which has led to a widespread problem of the inability to afford real estate. In large cities with sustained non-resident demand, inflation-adjusted prices rose by an average of 60%, while real incomes and rents grew by only about 12%. Since mid-2021, average mortgage interest rates have doubled in all the cities analyzed, and when you add that to the rise in real estate prices, we find that the amount of affordable living space for skilled workers has fallen by about a third compared to pre-pandemic levels. In addition, inflation and asset losses due to financial market turmoil in 2022 have reduced the purchasing power of households, further depressing housing demand among the upper-income class. These figures indicate that real estate markets in major developed economies need to cool down for a few years in order for housing affordability to recover.
