Sovereign Debt Crisis

and the consequences for real estate
a presentation by Jose Luis Pellicer of the Research Team at AEW Europe

I have never had a serious operation, but I recalled my limited experiences during Jose’s address to our lunch on 16th September 2010. You are woken after the operation, with the surgeon staring at you. You, at first, wonder whether he is St Peter or the other chap, but then he reassures you that the operation went well. After a moment’s relief, your thoughts then turn to how awful you feel and how impossible it will be to recover. Well, Jose assured us that the operation of rescuing the financial system had gone well -– "Armageddon avoided" as he put it. But the cost has been vastly over-extended government finances in most of the major economies. Recovery involves the unwinding of that. His prognosis was that the job would take at least another 12 to 18 months, with the pain making physiotherapy look a doddle. Should governments not address the issue and default, then that would be even more painful in our sophisticated market economies. In response to a question, whilst there are clear risks for Greece, and, to a lesser extent, for Portugal and Ireland, many others who offer poor stats may not be as weak as they seem. For example, in Spain its 20% unemployment figure includes many immigrants who may return home, and household indebtedness is much less than in the UK. He therefore presently sees little risk of a domino effect to major economies – provided that we take the medicine (or do the exercises!).

Jose could not see the cavalry arriving in the form of non-Western economies. South America is too small to be material, and China shows every sign of over-heating – which would be very negative for Germany and Eastern Europe.

The only realistic tool available to most governments is to reduce expenditures; waiting for economic growth to rebalance the books is not a viable option. Our concern must therefore be on the effects of this solution on real estate.

In some ways, we have been in a sort of ‘phoney war’ since the immediate crisis was stemmed. Not unnaturally, the immediate effect was to make investors risk-averse. This favoured, perhaps paradoxically, government bonds and also apparently-secure forms of real estate, thus buoying prices, but Jose doubts whether that will be sustained. The occupation market is bound to be hit and this must, surely, cause yields to soften – perhaps considerably. He particularly drew attention to the retail and ‘logistical’ market. Demand is bound to fall, perhaps dramatically. In many parts of Europe there are already worrying levels of retail over-supply. One questioner asked whether the weight of money could see property yields harden however due to inflationary fears; Jose thought not.

All-in-all, Jose was not a bearer of good tidings. If the issues are faced, there will be pain, but recovery will come. He was asked whether the process might not become politicised; whilst accepting that this was a risk, and, inevitably, cuts will require political decisions, he was optimistic that politicians would not worsen the situation. That was about the only positive note your Scribe was able to write down, plus, of course, the pleasure of hearing a speaker who was master of his subject. We wish Jose well in front of a ‘home’ audience when he speaks at the inaugural lunch of the new Chapter in Madrid on the 29th September.

Michael Mallinson
Scribe