The 1985-1994 Global Real Estate Cycle. Page 28

# _5.2 Adjustments in the Real Estate Industry_

## The Valuation Problem

Real estate values, especially for non-residential properties, are extremely sensitive to assumptions made about vacancy rates and rent levels. If the global real estate crash has publicized one thing, it is the poor quality of information on real estate markets. From the viewpoint of investors, there is a large credibility gap between property and other assets. The _Mallinson Report_ on valuation published in the UK in 1994 underlines the weakness of real estate forecasting among other issues related to property valuation. Credible market statistics and analysis is sorely lacking for fimd managers compared to the standards of information prevailing for fixed-income securities. Property valuations in corporate balance-sheets are often questionable and are finally being questioned. Real estate markets are cyclical in part because they are inefficient, and the current information gap accentuates this inefficiency.

## Closer Links Between **The** Real Estate Industry and Capital Markets

An unsettled question is whether this first global cycle has led to a permanent change in the structure of the real estate industry toward greater concentration into larger firms better able to access capital markets. There could be a lasting restructuring of the real estate industry along the line of what is evolving in the United States, Le. much closer and direct links between the real estate industry and the capital markets. In the past, commercial property finance was the preserve of banks, S&Ls, and insurance companies. All these institutions are now withdrawing from property lending. Large-scale developers are moving from property finance provided by private investors to financing through capital markets vehicles. The two main vehicles are REITs and securitization. The new REITs, which have lost their former tax break offer an equity investment in real companies that often specialize in one type of property in one region. They offer institutional investors a liquid way to hold property. The correct value of better liquidity is not entirely clear but through these REITs investors have been prepared to hold property at yields lower than what individual property buyers demand. The supply of securitized commercial property mortgages is expanding steadily. In the wake of the RTC securities, an increasing volume of property loans is coming from banks, insurance companies, and a few property developers. There has even been some high yield securitization of "junk" property sold to specialist property funds and hedge funds looking for large total returns under the expectation that the worst of the bust is over.

# _5.3 Households: Price Deflation, Negative Housing Equity and Default_

The impact of the global real estate cycle on the household sector differs greatly according to the strength of personal balance-sheets in every country. High housing price volatility of global cycle has often interacted with high and rising levels of indebtedness for large segments of population during the 1 980s. These interactions have produced in turn rising levels of loan delinquency, defaults and personal bankruptcies. A significant portion of the gross assets of households may be very illiquid and of little use during financial distress, such as pension rights, consumer durables, and some forms of property. The underwriting rules for housing loans followed in the 1980s are under often under question, or should be.

## Increasing Fragility of Personal Balance-Sheets During the 1980s

There were considerable initial differences in the overall level of personal indebtedness in the personal sector across OECD countries at the beginning of the 1 980s. There were for instance important differences in the level of indebtedness between Britain and Canada on one hand and France on the other. As a nule, levels of indebtedness were originally lower, personal balance-sheets stronger and personal