Friday, 18 September 2009

The good the bad and the ugly of the property market lull

18th September 2009

The Malta Independent - Friday Wisdom

I have been careful not to define the current downturn in the local property market as a crisis, merely as a lull. The distinction between a lull and a crisis is that the former is cyclical whereas the latter tends to be more structural.

So far it is fair to define the problem as a lull as it follows a rather long period of strong growth and as yet we are not seeing distressed selling on a major scale leading property prices to drop below their replacement cost. There is nothing however to stop a lull from developing into a full blown crisis if the downturn gets more pronounced and extended.

It would be wrong to attribute the downturn in the local property market to the international financial crisis. Certainly the financial crisis did not help and has deterred foreign buyers from making investments in the local property market at a time when bargains are available in countries where there is a real property crisis like in the UK, Spain and Ireland. But the sources of the local property downturn are more homegrown.

It can be merely defined as an excess of supply from property developments that were initiated years back when the boom was at its peak. This is forcing property units to come on to an over-supplied market that has gone soft. The excess supply is super-imposed on withdrawal of demand from investors who are now holding back waiting for property prices to fall before they make their next move. Purchase of property for investment purposes has largely disappeared and demand for property for own use is low and cannot support prices in an over-supplied market.

Normally a situation of excess supply and falling demand gets equated by a fall in price. So far the fall in prices we have seen has been relatively modest leading observers to believe that developers are holding out and carrying inventory waiting for better times.

It would be unreasonably optimistic however to assume that better times are anywhere round the next corner. Once potential buyers and investors have been put in a frame of mind that waiting can lead to a better deal, demand is unlikely to show up at a tempo which could underpin property prices. The carrying costs of inventory will eventually force developers, often pushed by their bankers who hate non-performing loans more than turkeys hate Christmas, to dump property at distressed prices. This process will be accentuated as many unsold inventory approach the fiscal five year time limit to avoid 12 per cent of the sale price as final withholding tax. The risk of having to pay a turnover related withholding tax on property sales undertaken at little or no profit, will be another factor which could turn a property lull into a full blown property crisis.

Should we let the market to clear itself either through a lull or through a crisis or should the government intervene in order to restore some sort of stability and orderly adjustment without risking a fully dysfunctional property market?

This was the question that Minister Tonio Fenech broached of his own accord when addressing a pre-budget business breakfast meeting this week. Minister Fenech posed more questions than provide answers and attendees were left with the distinct impression that government had no clear idea of what it should do, if anything at all.

The minister tried to put a positive twist on it arguing, quite rightly, that this property lull makes life easier for first time home buyers and makes property more affordable. He said government should hardly be expected to intervene to support property prices when during the boom accusations were made that government is letting property prices rocket up beyond the reach on many first time home buyers, causing social problems. Now that the wheel has turned, government should not be expected to disrupt the market from price falls that restore eroded values to social justice.

What’s good for social justice is however bad for property developers, especially those that bought at the peak of the market and now have to carry unsold inventory incurring finance carrying costs and risking slippage into the 12 per cent withholding tax regime. But business is business, and developers who picked rich rewards during the boom cannot complain when the markets turn against them. So I agree that government should refrain from intervening to interfere in market adjustments which allocate the good and the bad between property developers and property buyers.

What government should not refrain from is intervention to ensure that the bad does not turn into ugly. There would be few winners and many losers if the lull were to turn into a crisis. Passive property owners would suffer seeing the value of their residences fall even though they have no intention to sell. Banks would see an explosion in nonperforming loans and given the exposure of the local banking system to property as security, the stability of the system would be more directly challenged than it has been by the international financial crisis. With a de-stabilised banking system the whole economy would suffer.

So while government should allow the market to undergo the necessary tactical adjustments, it should be on its guard to do what it has to do to ensure that the market remains orderly. And what should it do? In the very least it should extend or lift the artificial five years limit for slippage into the 12% withholding tax regime, which was a tax amendment conceived on the wrong premise that property prices will go up forever without any downward adjustment. Secondly it should freeze for some time all new permits for new development to give time for the market to clear the excess supply which has been allowed to accumulate.

The good and the bad of the property market are fair game. The ugly is to be avoided.

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