Global property markets are under pressure. A year of rising interest rates, led by the US Federal Reserve, with other major central banks following suit, has left this leveraged sector under a cloud with numerous headlines warning about potential losses (see some articles below). We take a closer look at the complex cross currents to grapple with what litigators should look out for.
Source: Image by StockSnap from Pixabay
Background: A good run
The post-GFC landscape was pleasant for the sector. Low interest rates around the world, and an asset class that had been battered during the crisis (particularly in the US), provided a heady combination of low price valuations and low interest costs.
As markets have recovered since the lows of April 2009, housing has shone, and pro-longed easy monetary polices in the 2010s and then during the pandemic have bolstered asset prices further.
There have been price scares over that period, as central banks have attempted to unwind easy money policies, but each time monetary authorities have relented and the euphoria has continued.
A new paradigm
Between the shocks of the pandemic and the onset of the Ukraine war, the world is witnessing a supply side inflation shock: something not seen since the 1970s.
Inflation can be driven by demand (consumers buying too many goods) and supply (a constraint in goods being produced). Russia and Ukraine are major commodity producers, and the conflict and resultant sanctions regimes have shocked markets.
Further, the pandemic also resulted in shocks to manufacturing and global logistics, and finally this year, as most economies opened up, the world witnessed an explosion on pent-up demand.
Central banks, led by the US Federal Reserve have been keen to respond to this. Speeches by Jerome Powell (and his peers around the world) have made it clear that they want to quell 'structural inflation'. This is the effect of a pervasive belief across consumers (individuals and corporations), that inflation is here to stay, and the change of consumption habits based on that new paradigm.
This leads to increased purchases of assets of limited supply, a front loading of expenditure and generally not keeping cash (as it is believed to be devaluing fast). These behaviours would further exacerbate inflation and feed a belief that cash is worthless. Given the fact that central banks' primary role is to protect the value of a currency (and so their mandate is to contain inflation, which erodes the value of cash), the Fed and its peers are keen to be seen as serious.
Powell also cited the example of the Burns' Fed in 1976, which stopped raising rates in the face of a slowing economy, only for inflation to return more vehemently shortly afterwards. Paul Volcker is the Fed chairman who is today legendary for stomping out inflation and credited with ushering in the period of low inflation we have seen since the 1980s.
The politics of inflation
Societies around the world are also facing political schisms. Whether it is Brazil or the U.K., wealth inequality and slowing standards of living are impacting politics. In it's warning to the Liz Truss government, the International Monetary Fund was concerned about the impact on 'inequality' - quite a rare admission by a supranational usually more focused on trade and governance.
Inflation benefits those with assets over those without. Finite assets (like land, gold, and highly sought after goods) keep their value, whilst incomes and pensions often do not. At the end of a period of inflation wealth inequality often worsens, which is viewed as particularly politically risky in the current global context.
What it means
This potent cocktail of circumstances has left those asset classes that benefited from leverage (and so low interest rates), looking quite vulnerable. When gilt yields rose dramatically following the 'mini-budget' of the Truss government, we saw property funds in trouble, with some halting redemptions.
Nor are these pressures confined to the UK. One of the articles below highlights the significant pressure on Chinese property companies, with a material number of their bonds now trading at distressed levels. The US has been out in front in the rate hiking cycle, and so the slow down in the US property sector has already been underway for some months now.
For observers of rate hiking cycles, this is all familiar stuff. If we look at the parallels to the 1990s, when the US Fed hiked rates through that decade, we witnessed various property related distress. Of course at the time, we had disinflation through globalisation, and so the effects were not as widespread. Today, we have a trend that is quite the opposite - inflation at over 10% in the Eurozone and the UK recently, and similar numbers in many emerging markets.
With inflation bucking and central banks keen to bring it to heel, we could see the property sector as one of the victims of that tug-of-war. Litigation is a function of losses and opacity (of contract). We think that the macro environment for leveraged assets could get worse before it gets better.
We have a private forum, called Litigation Hotspots, where we elaborate on where exactly we see potential litigation and more detail on how it unfolds. Connect to us on LinkedIn to be invited to that forum.
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Gloomy glossary of articles:
FT: West End property values start to fall as higher UK rates bite
Bloomberg: China's Last Offshore Property Bond Havens Are Crumbling
FT: US property sector braced for job cuts as rate rises crush home sales
Seattle Times: Global housing market pain has echoes of crash 30 years ago