Interest rates in most markets remain fairly low, limiting the interest burden for debtors and upholding credit quality. But low interest rates have also sent investors around the world searching for yield, and many have turned to apartments to satisfy their craving. Some are seeking rental cash flows, some are seeking price appreciation, and some are seeking assets that are not denominated in their local currency.
In many of the cities I visited during my recent swing through Asia and Australia, stories of investors from China arriving by the busload to buy high-rise units were common. While China has enacted further restrictions on capital flight, a favored few still seem to be able to bid aggressively on foreign real estate.
Authorities seeking to control the situation are confronted with a series of challenges. Since the marginal purchaser in the most popular property markets does not require leverage, raising interest rates on home loans provides less of a deterrent. Sweden attempted to address its property excess by increasing interest rates in 2011, but had to retreat in the wake of unsatisfactory results.
Attention in many regions has therefore turned to a cocktail of macroprudential policies. Financial supervisors have taken aim at property developers, warning banks to limit leverage and underwrite especially carefully. In the U.S., the Federal Reserve has used its ways and wiles to chill conditions surrounding multifamily lending.
The wisdom of this strategy is not immediately apparent, as restricting supply would tend to increase prices, not reduce them. Those hungry for property would merely increase their bidding for existing units.
Fiscal authorities have been adding layers to their property tax systems, targeting foreign purchases and adding special levies for vacant units, multi-unit ownership, and property “flipping.” All of these points were included in a plan introduced to curb real estate excesses in the Toronto area. A global summary of the costs of real estate speculation can be found here.
These tools all work in theory, but it remains to be seen whether they will work in practice. There is little data to calibrate how high property taxes need to be in order to bring about a modest (but not severe) correction in the market.
The most critical test for macroprudential management of property markets is underway in China. Domestic investors are largely confined to investing in domestic assets, fueling huge rises in apartment prices and construction. Recent curbs have reduced rates of price increase to “only” 15%. There is more work to be done in China, and success is by no means assured.
Apartments and commodities have a lot in common. Excavation can lead the way to new supplies, which are mostly homogeneous. Both are the object of global demand. Both can be the subject of consumption and speculation. And both can be the subject of irrational exuberance.
One of my clients in Asia said it eloquently: We need to find a way to make apartments primary residences, as opposed to an asset class. There is no GPS available to guide this transition, so policy makers will have to rely on their senses and hope for a little luck from the heavens.
Everyone Into the Pool
Last week, the European Commission (EC) came out with a new proposal to address the financial fragmentation within the European monetary union. It envisions the creation of sovereign backed securities, which would essentially be a bundling of individual sovereign obligations into a single European bond. The idea has much to recommend it, but needs some additional work.
The plan seeks to boost demand for debt issued by weaker governments by including it within a basket of sovereign bonds that includes bonds issued by stronger countries. Demand for the new securities could come primarily from Europe’s banks and the ECB, pending rulemaking that makes them eligible to satisfy statutory requirements.
More crucially, the plan seeks to break the link between the sovereign and the domestic banking system, the so-called “doom loop” that has surrounded stressed European countries. Whenever the sovereign debt comes under stress, the banking system that is required to hold government bonds sees its balance sheet weaken. A stressed banking system then puts further pressure on an already weak sovereign. The ensuing crisis prompts an outflow of capital and deposits from weaker countries to core eurozone economies.
These synthetic securities would delink the domestic banking system from the national government by allowing private institutions to hold a basket of eurozone sovereign debt, instead of just their own sovereign’s. Further, the repackaging would enhance the supply of safe assets on the continent. At a more symbolic level, a bond that represents all the governments in the union also serves as a shot in the arm for the European project.
It is important to note that the proposal rules out any form of debt mutualization or intergovernmental transfers. For example, if the Greek government is not able to fulfil its obligations, other European governments would not be making the bond holders good. The EC sees this as necessary to avoid the problem of moral hazard: any proposal that includes intergovernmental transfers would be a non-starter in Berlin.
Finally, the proposal can limit the fall-out on peripheral debt yields if and when the European Central Bank (ECB) decides to unwind its government asset purchase program. The organization that would be set up to carry out the issuance of these bonds could replace the ECB in buying those bonds without disrupting the demand dynamics of the eurozone government bond market.
