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Residential Real Estate – Value After the Subprime Crisis. Britt Gwinner, CFA Principal Financial Specialist International Finance Corporation Viña del Mar, 7 May, 2010. Contents. The Basic Picture – housing demand around the world How was mortgage finance linked to the recent crisis?

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residential real estate value after the subprime crisis

Residential Real Estate – Value After the Subprime Crisis

Britt Gwinner, CFA

Principal Financial Specialist

International Finance Corporation

Viña del Mar, 7 May, 2010

contents
Contents
  • The Basic Picture – housing demand around the world
  • How was mortgage finance linked to the recent crisis?
  • Going forward
the international finance corporation
The International Finance Corporation
  • Goal: Improve lives and raise living standards through sustainable private sector development
  • Member of the World Bank Group, owned by 179 shareholder countries, assets USD 51.4 billion, capital USD 16.1 billion
    • Global—for more than 50 years has focused on developing countries
    • Local—full time presence in more than 80 countries and activities in many others
  • Housing Finance Investment Services:
    • Loans for mortgage lending; Collateralized mortgage lines of credit; Warehouse lines of credit; Credit enhancement for MBS; Structured finance; Equity investments; Construction finance
  • Housing Finance Advisory Services:
    • Policy and regulatory infrastructure, mortgage toolkit and training, capacity building

3

growth and urbanization
Growth and urbanization
  • World Bank Data Visualizer
  • http://devdata.worldbank.org/DataVisualizer/
real estate a tale of many markets
Real estate: a tale of many markets
  • Real estate: more than 1/3 of the value of all the underlying physical capital in the world
  • Developed countries: mature residential real estate markets
    • Populations are stable or shrinking – demand for financing from turnover, renovation, aging population, regional growth dynamics
    • >90% of housing units in developed countries are of adequate quality
  • Emerging markets: large pent-up demand for housing
    • As countries develop, they urbanize
    • Emerging markets urbanization has been poorly planned - housing and infrastructure inadequate, housing demand is strong
    • Self-built houses on squatted land lack connections to sewage or water, built of inadequate materials
    • 44.7% of households in Africa, 25.6% in South Asia lack access to improved sanitation
    • 20 to 30 million housing units in Latin America lack a basic amenity such as running water, or are built of substandard materials
    • Inadequate housing compounds the cycle of poverty – health, social investment, wealth-building

6

slide7
Mortgages mostly unavailable in emerging markets But as real incomes rise, so does capacity to make a mortgage payment

7

housing finance and growth
Housing Finance and Growth
  • In emerging markets, housing finance is related to new construction and as a result fixed investment, and generally with domestic inputs, both labor and materials
  • In developed markets, housing finance is more linked to trading of existing housing and economic cycles
    • In the U.S., there are 7 million new loans each year, 6 million of which are for existing housing
    • In developed markets, real estate and related services count for between 2% and 4% of PIB
    • In the U.S., 8 of 10 recessions since 1949 were proceded by reductions in residential investment

8

mortgages and fixed investment
Mortgages and Fixed Investment

In theinitialphase of development, mortgagefinance can add 0.5% of fixedinvestment as a percent of GDP foreachincrement in thesize of themarket

Source: Duebel (2008)

9

real estate as an asset class
Real estate as an asset class
  • Traditional roles: inflation protection, diversification
    • Securities backed by inflation-indexed mortgages are natural inflation hedges (Chile, Mexico, Colombia)
    • Real estate investments can decrease the cost of inflation insurance for long-horizon investors (Amenc , Martellini, & Ziemann, Journal of Portfolio Management, 2009)
    • IRR of about 11 percent for 60/40 stock/bond portfolio with a varying investment in real estate over time. (Performance of Real Estate Portfolios, Fisher and Goetzmann, Journal of Portfolio Management, 2005)
    • International real estate can reduce portfolio risk (Chua,Journal of Real Estate Portfolio Management, 1999)
  • A recent comment from Prof. Robert Shiller:
    • “After prices fall, the media begins to publish stories of investor foolishness. Investors, feeling stupid or betrayed, have a “betrayal aversion” that causes them to react intensely and sell in anticipation of future price drops.”

10

investment vehicles for residential real estate 1
Investment vehicles for residential real estate (1)
  • Fixed Income
    • Residential Mortgage Backed Securities (RMBS) – True sale to special purpose vehicle (SPV) that issues bonds
      • Long duration, some uncertainty in principal amortization (prepayments), varying structures, stand-alone credit rating, almost no replacement of assets, no recourse to loan originator
      • In Peru, AAA local scale RMBS provides 32bp over 3y AAA corporate (when corporates are available, it’s a thin market), 202bp over 3y sovereign
    • Covered bonds – general obligation bonds with contractual and/or legal backing from a portfolio of mortgages
      • Long duration, prepayments may be mitigated, credit profile a function of issuer’s balance sheet and security portfolio, assets may be replaced, complete recourse to bond issuer
      • Yields comparable to AAA corporates

11

investment vehicles for residential real estate 2
Investment vehicles for residential real estate (2)
  • Equity
    • Rental apartment buildings, property developers, land banks, private equity
    • Residential rental - works best where laws permit a reasonable balance of tenant and landlord rights and responsibilities
    • Rental reforms recently passed in Brazil, considered in Mexico, others have stronger market traditions (Uruguay)
  • Hybrid
    • Real Estate Investment Trusts or Funds – United States, Asia, increasingly in emerging markets – while tax advantages not relevant to most pension fund investors, return may be

12

a largely external crisis
A largely external crisis
  • There are no subprime mortgages in emerging markets
    • Lending generally to high income borrowers, with low LTVs and full documentation
  • Emerging sovereigns and corporates benefitted from low borrowing spreads during the boom
    • But, macro management has broadly been strong, emerging markets come out of the crisis with relatively low decline in GDP, many cases of growth
  • At the worst of the crisis, funding retreated to New York, London, Madrid, etc.
  • Limited development of some capital markets mitigated bad effects –e.g., Egypt, Guatemala
  • Relatively strong economic performance protected others – China, India, Brazil, Peru

16

what haven t private pension funds invested more in real estate
What haven’t private pension funds invested more in real estate?
  • Constraints
    • Macroeconomic volatility – inflation, inconsistent policies, financial crises - Mexico ‘95, Russia ‘98, Argentina ’01
      • High real rates + volatility make government debt more attractive
    • Lack of long term fixed-income instruments, lack of secondary market liquidity, yield curves
    • Investment channeled through personal rather than institutional means
      • Uruguay rental apartment buildings built & owned by individuals, family firms
    • Informal markets flourish because of faulty legal and regulatory structures

18

how to boost private pension fund real estate investments
How to boost private pension fund real estate investments?
  • Lower real rates make private fixed income issues more attractive
    • Recent history in Chile, Mexico, Brazil, Colombia, Indonesia, India, China, etc.
  • Promote a range of long term fixed-income instruments, and a range of credit ratings – move away from incentives to pure triple-A markets
    • Permit securitization, covered bonds, funds, REITs – issuer chooses best execution
    • Chile as a model – 1980s reforms created AFPs, letras hipotecarias
    • Wider range of pension, insurance benchmarks
  • Promote secondary bond market liquidity
    • Benchmark government yield curves – extend maturity, issue to promote liquidity
    • Strengthen exchanges transparency, efficiency
  • Improve legal and regulatory structures of real estate markets
    • More efficient land use planning, title registration, contract enforcement

19

annex lac rmbs during the crisis
Annex - LAC RMBS during the crisis

Reliance on local investors, mostly low mortgage delinquencies, persistent demand from private pensions and insurers

  • Chile – Structured issuances up 6 times in 2009 v. 2008, of this, 9% was RMBS
  • Panama – La Hipotecaria 9 RMBS issues through 2008, securitized consumer loans 9/08, rolls commercial paper through 3/09, issues MTNs 4/09 – all to local investors
  • Peru – corporate issuances, structured finance for auto, consumer, leasing, and Titulizadora Peruana issues RMBS 02/10, USD 34.5 million, oversubscribed
  • Mexico – Severely affected by the crisis, downgrades in RMBS issues by failed lenders, but strong performance by RMBS from major banks, Infonavit, Fovissste

21

annex lac rmbs during the crisis cont
Annex - LAC RMBS during the crisis (cont.)

Colombia

  • USDeq 2.4 billion issued since 2002, trading at average price of 104.6 at end March, 2010
  • UVR (inflation-adjusted), increasingly nominal fixed-rate peso
  • Prepayment rates have run 10.5% UVR, 14% peso, defaults < 2%
  • Structured finance volume 2009 almost twice 2008
  • TC placed USDeq 791 million in RMBS 2009, more than half of recent issues purchased by domestic pension funds

22

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Contact Info:

W. Britt Gwinner

Principal Financial Specialist

International Finance Corporation

Miguel Dasso 104, Piso 5

San Isidro, Lima 27, Perú

+51 1 611-2573

wgwinner@ifc.org