Economy, Business And Markets

Searching for Equilibrium

Searching for Equilibrium Searching for Equilibrium

E conomists who believe in, and promote the theory of, boosting the housing industry as one of the effective tools to ease the long recession have criticized the new government’s stimulus package because it does not  focus on this key sector. At the same time there are builders who warn of a future lack of supply as prices “have not kept pace” with the inflation rate. While those active in the housing industry are doing all they can to revive their once lucrative business, they should be reminded of the advantage of deferring sales that will be exhausted one day and also that this is a key to better comprehend why the housing market refuses to awake from the present slumber.

The housing market has normally experienced cyclical behavior but never a downtrend due to sticky prices and this write-up will try and explore why housing prices now are sticky downward. Iran’s housing market is unique in the sense that after two years of almost total immobility, there is almost no foreclosure characteristic of a bursting bubble seen in many countries in the recent past. There can be justifying reasons to avoid the foreclosures, but it seems the main reason is that sellers are willing to defer their sales. Hence, the question is how do sellers defer and whether or not it makes economic sense.

First it should be mentioned that some builders/sellers can afford to postpone their sales as they don’t always need to free their investment or repay debts. This is primarily due to the low ratio of loan to value and high level of property ownership by banks and public institutions. A good portion of properties are used as collateral or as bank capital. As banks are dealing with rising levels of NPLs, further reduction in the value of property only tends to make a bad situation worse.

Going back to the skimpy ratio of loan to value, mass builders can sell a few units to repay their debts if any. Hence, the big players have the option and ability to defer sales and maintain their leverage at any cost.  The pattern is visible from the recent trends in the housing market report published by the central bank. While the total amount of deals has decreased by a whopping 8.2%, prices have increased 0.9% compared to the same period last year, so the report says.

 Ignoring Reality

Apart from owners who have put up their property for collateral and the banks, why do individuals and small private owners defer sales? There is a general and long-standing belief that a house is a safe investment and that their prices do not fall and never have, at least in our contemporary history.

On the other hand, because of short duration of return of capital it makes economic sense not to sell the house at the bust. Thus, sellers deliberately ignore market realities and live in the illusion of prices that prevailed in the too distant past. Unfortunately, government intervention manifested mainly in the subsidized loans makes such an illusion appear real.    

On the demand side the story is equally bad if not worse. Demand from investors has fallen substantially as they have been unable to dispose their previous purchases. The demand from those who consider housing a shelter and not an investment has sent rent prices through the roof due to declining purchasing power and low level of loans to value that contribute little to nothing to demand of this type. Pressure on rents makes the return of capital shorter and hence justifies the systemic delays in sales.  

Sticky house prices have led rental prices to become more synchronized across the districts in Tehran. As a result, people can no longer choose their dwelling places based on their purchasing power and then there is the overexpansion of slums and those living on the fringes. Although house prices have not increased in tandem with inflation, investment in housing market still makes sense because new constructions have declined from its peak four years ago but have not disappeared all together. Thank you shopping malls!

  Taken for Granted

It seems there is a general belief that we cannot survive a housing bust as not only properties are a big portion of banks assets but the housing industry is also a top employer in the vast associated industries. It is taken for granted that higher property prices leading to increased constructions and the steady creation of jobs can generate growth forever!

The current market is apparently a response to the previous overexpansion of the sector, which according to Jamshid Pajooyan has a rate of return of about 400% that now is not sustainable with declining demand and along with it the purchasing power of large sections of the society.

The dilemma of the government is huge. On the one hand, the boom of housing industry is crucial for banks and other public institutions that hold lots of properties and are lobbying for government intervention. On the other, the government has the social responsibility to help first time buyers and provide them the means to avoid the galloping rents.

This is not a new situation and has been around for a long time. Hence, the narrative of inflating prices has been always popular. Because rising prices make lenders and investors more confident, just as borrowers become more optimistic and risk appears to have been contained. Hence, as soon as potential buyers begin to believe that the prevailing market price is no longer declining (in real terms), they will return to the marketplace. This return is a key to boost the housing market when politicians are happy in their claims to having helped the poor and it appears as a win-win situation since defaults and losses on mortgage loans remain low, while banks’ capital and constructors’ returns keep growing.

 Baggage of the Past

The government has opted for this path partly due to the baggage of the Mehr Housing Project, the controversial public housing project which was launched for two million people at the lower end of the economic ladder. However, the government, deluded by a win-win scenario, is still subsidizing purchase and construction facilities. This can be justifiable only if resources are directed to address the market shortage. The only good deed of the government is the move to tax vacant premises that should cut short the delay in sales including builders leaning on avarice.

It is apparent the officials are determined to revive the industry and avoid further losses that have also created hype in the media as the recent CBI report encourages buyers to act and claims the present price offers are stable.

If there was no further government intervention, sellers will eventually see a ceiling on the prices they will be able to command for their properties and start to sell.  Instead of seeing an improvement in prices, sellers would be forced to suffice with lower prices. Thus, it would be accepted that the high and flying real estate prices and jobs of yesteryears are gone forever.

From this standpoint, those who are serious about selling would sell at realistic prices while the government subsidies on loans are still in effect. The narrative without government intervention would benefit all as housing will become more affordable and resources will be directed to productive industries and create jobs for the army of unemployed.

However, government intervention will lead to a new round of sticky prices, this time in anticipation of an improvement that will be long in coming. This process never allows the housing bubble to implode and thus significant decline in prices is hard to imagine unless of course with higher loans to value ratio that in turn increases the risk of default.