Come what may, the prices of property will never be the same all over the world. In some part, it may be rising while some may experience a decline in it. On the other hand, in a few parts of the world, the prices of the property may be somewhat stabilized.
No matter whatever it is, it will surely impact the Commercial Real Estate Debt as an asset class. However, this explains the reasons as to why debt is typically less sensitive to such price movements. It is therefore required by the investors to protect their investments through secured assets.
If you consider the data you will see that for most of the investors in the asset class, in most of the times they are either alarmed or elated looking at the headlines in the media daily. This is because the media has this tendency to highlight information that may easily elicit the emotional response of an individual, especially fear or greed. Why? This is because it eventually results in more clicks and sales.
This affects not only the investors but may even result in the professional analysts to have opposing views. However, if you put aside the headlines, you will come to know about the true economic story, the economic growth sustained and the sound fundamentals as well.
The key data revealed a lot of significant facts and several positive signs such as:
- Economic growth reaching a high
- Improvement in the business conditions
- Increase in the non-mining business investment
- A strong sentiment within the property sector and
- An overall rise in the confidence of the investors.
If you take a look at it more specifically you will see that the prices of the residential property may show a pullback currently but that does not indicate it is crashing or yet to crash.
The housing sector scenario
Typically it can be said that the housing sector is currently gliding to a soft landing, so to speak. Nationally, the prices of property are seen at a still higher level at 32% as compared to the prices of the property five years ago. Currently, 9 out of 10 properties sold have resulted in a significant profit margin.
However, it is not that the housing sector has not experienced a decline ever since. In fact, it has seen in the recent past years especially after the recession but that fall is mainly attributable to the upper portion of property values with the others remaining quite steady throughout.
The reason o this is that there is no one single and specific property market. In fact, this is a highly complex network that involves different states, cities and price points that vary distinctly. It is for this reason that you will see that the lending policy of different states may be different from the central government overseeing that the set limits is not crossed.
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History matters most
House price movements are based on history and so does its fundamentals and there are several notable facts and instances seen.
- Historically, these movements have been ever modest and the change in the cycle is typically characterized by the market itself.
- Moreover, this typically self-moderates after some time especially after strong growth in price. This is proved by the fact that since 2003 there has not been any significant fall in the house price index and has never been more than 6% even if it happened in a particular year.
- It also shows healthy economic and employment growth which is the norm and following it, experts expect that the cycle will show the same level of moderation.
- It is also noticed that the rental vacancy rates is also pretty resilient staying below 5% in the last three decades and at the moment it is significantly low.
Thanks to the rise in demand for housing and continued population growth, two of the most significant drivers to result in such resilience, it is expected that the housing sector will continue to grow, sustain and survive, no matter whatever is the market and economic situation. This means, investing in real estate will never fall and you can make a lot of money if you are diligent in your debt investment in this sector.
Managing the risk
Therefore managing the risk of real estate debt investment is the primary requirement by the investors. Investing in property debt as it is can be very productive in specific scenarios.
If it is a construction loan there are specific ways to protect the investment especially when the valuation of the project falls during the construction process. These are:
- You must consider the pre-sales value of the project and base the loan on this to make it more secure. You should not base it on the projected value of the finished project after development because this is usually up to 40% higher. This comprises of the unsold stock and equity as well as the profit of the developer.
- On the other hand, when the value of the property falls by say about 40%, then the loan amount can be paid back through the sale proceeds. Assuming that the value falls by 20% only then the equity can be covered but for that matter, the developer may have to relinquish the profit from the project.
Well, these are all worst-case scenarios and primarily there are very few instances when a developer or an investor has suffered any losses on their investments. It is required to have a very strong risk management framework in place and at all points throughout the investment process right from the selection of the deal to the active management of the funds and asset.
In case of probable defaults that may arise, the stocks can be used in the market to absorb within the reasonable timeframe not exceeding nine months and a six month selling period in any normalized market.