MAXIN GLOBAL FUND - USD is a Long / Short Directional hedge Fund incorporated in Luxembourg.  It started trading on February,22 2022 and replaces MAXIN ADVISORS' MODEL PORTFOLIO which has been trading since January 1st 2014. 

A Generational Housing Bubble

A repricing of some real estate assets has already started in some markets as the world faces up to rising interest rates, economic recession risks and historically high inflation, all of which pose their own challenges for various real estate sectors.

Since the last global property bubble in 2006-07 and the financial crisis that resulted from it, central banks have held interest rates close to zero. While few have paid attention, this has led to a reflation of many of the same property bubbles that caused the disaster to begin with. Most housing markets around the world are either registering record valuations or are close to previous records.

Does this mean that the world is facing down another 2008-style housing and financial crisis? Quite possibly.

Macro Overview

As the real estate market reaches new heights, it’s crucial to understand both the market’s cyclical nature and the factors influencing these prices.

From Boom to Bust – Real Estate Market Cycles

Real estate market cycles are known for their unpredictable and dramatic swings and typically follow four phases: recovery, expansion, hypersupply and recession. Each phase can last anywhere from five to ten years and is influenced by various economic factors such as interest rates, demographic trends, and economic health.

The current state of the market in Western markets is sending warning signals that we may be on the brink of the most gut-wrenching phase: recession. This phase is characterised by a sudden and sharp decline in demand, rising vacancies, and plummeting prices. Real estate market recessions have far-reaching impacts, causing a ripple effect that can be felt throughout the economy. The effects can be devastating, leading to bankruptcies, foreclosures, and significant financial losses. But are real estate prices ultimately influenced by?

The Forces Behind Real Estate Prices

1. Supply and demand: One of the most significant factors that impact real estate prices is the balance between supply and demand. If there is a shortage of housing units in a particular area, then the demand for properties may be high, leading to higher prices. Conversely, a glut of supply, usually fed by higher prices may send prices plummeting as demand decreases.
2. Interest rates: Interest rates have a significant impact on the real estate market. When interest rates are low, it becomes more affordable for buyers to borrow money to purchase properties, leading to an increase in demand and higher prices. Over the past 13 years, zero or even negative interest rates and bond yields have led to a boom in the property sector as households borrowed heavily at extremely low rates.
3. Economic health: A strong economy typically leads to a strong real estate market, as it leads to an increase in employment and income levels, which in turn can drive demand for properties.
4. Demographic trends: Demographic factors such as population growth, household size, and income levels can also impact real estate prices. For example, if there is an increase in the number of households in a particular area, the demand for housing units may rise, leading to higher prices.

Now let’s take a closer look at the data and statistics that underpin the current state of the real estate market.

Supply and Demand

USA

When it comes to analyzing the supply and demand of the real estate market, housing sales are an essential signal of the market’s overall health. A decrease in housing sales can indicate that the market is on shaky ground, with weakening demand and a possible oversupply of housing units. This shift in the balance between supply and demand can cause prices to tumble and the market to shift in favor of buyers.

Some recent key highlights in the US alone:

• Existing-home sales retreated -2.4% in March to a seasonally adjusted annual rate of 4.44 million. Sales declined -22.0% from one year ago.
• The median existing-home sales price dipped for the first time since 2007, declining -0.9% from the previous year to $375,700.
• The inventory of unsold existing homes rose 1.0% from the prior month to 980,000 at the end of March, or the equivalent of 2.6 months’ supply at the current monthly sales pace.

Sales of new homes, which make up approximately 10 percent of the US housing market, have also already taken a dramatic hit from their 2021 peak, and it remains to be seen whether they continue to decline further in the near future.

US Commercial Real Estate is already in a sharp downturn

As an early sign of things to come more globally, the US Commercial Real Estate Market has already entered a sharp bear market with vacancies rising to levels last seen during the 2008 real estate crisis, leading to a significant increase in developers defaulting and the banking system having to provision potentially heavy losses on their commercial real estate portfolio.

US commercial real estate prices fell in the first quarter for the first time in more than a decade, according to Moody’s Analytics, under the combined forces of corporations cutting costs and laying off employees in many sectors and the adoption of work-from-home in a lasting way. The rise in employees working from home has driven some downtown retailers and restaurants out of business and forced owners of office buildings to reduce rents to retain tenants or to sell all together.

The price declines seen so far have been more marked for higher-priced properties, according to commercial property company CoStar Group. Its value-weighted price index has fallen for eight straight months and in March stood 5.2% lower than a year ago.

As anecdotal evidence of the downturn, Post Brothers recently bought a Washington office building that went for $92.5 million in the fall of 2019 for $67 million, while Clarion Partners is offering a San Francisco office tower for roughly half of what it paid around a decade ago.

The impact on the banking system is also deflationary. Excluding farms and residential properties, banks accounted for more than 60% of the $3.6 trillion in commercial real estate loans outstanding in the fourth quarter of 2022, with smaller institutions particularly exposed, according to the Federal Reserve’s semi-annual Financial Stability Report. The magnitude of a correction in property values could be sizeable and therefore could lead to credit losses” at banks, the FED’s report said.

The risk of a “doom loop” developing is therefore high, with a pull-back in lending by banks leading to a steeper drop in commercial real estate prices, in turn prompting even further cuts in credit. The loan-to-value ratio of mortgages backed by office buildings and downtown retail properties was in the range of 50% to 60% on average at the end of last year for credit extended by bigger banks, based on data collected by the Fed.

But the main risk comes from the fact that Regional and community banks currently account for a disproportionately large share of office real estate lending. With smaller banks being less capitalised and more concentrated than larger banks, the impact of the downturn could lead to significant failures ahead.

Further consolidation of the banking industry may prove to be the solution that allows the banking industry at-large to work out problem loans.

Europe

When looking at the Euro Area, the euro area housing index, which measures changes in the price of residential properties across the Eurozone has shown a decrease after a prolonged period of growth, which suggests that the real estate market may have hit a cyclical high. Considering that the ECB and European countries generally will have to further lift interest rates in response to rising inflation and a strengthening economy, the housing market could face additional pressure as higher borrowing costs may dampen demand and cause prices to decline further.

To summarise, in the recent months and quarters the macro-level housing demand has already strongly weakened, and in many regions, there is an oversupply of housing units. This imbalance between supply and demand has caused prices to decline, creating a challenging environment for investors and developers alike. In some areas, oversupply has been exacerbated by overbuilding, while in others, it has been due to a decline in population growth or a shift in economic conditions.

In some European markets such as Sweden, a significant real estate crisis has already unfolded leading the country to a recession in the past two quarters and a sharp decline in retail sales.

Interest Rates

USA

Calls that inflation and rates were “peaking” or “transitory” proved wrong again and again; the rise in inflation has spread beyond volatile commodities into core parts of the economy. Surges in residential rents and home prices have also contributed to higher inflation.

In response to high inflation, most central banks have raised interest rates. These tighter financial conditions have caused a decline in the prices of a wide range of financial assets. They are also clearly having an impact on private market real estate asset values in many markets, although transactional evidence is thin and uneven. Listed real estate leads the way in price declines, while private real estate index valuations lag behind and a bid-ask spread has emerged in many markets, causing a slowdown in transactions.

Interest rate hikes can have a gradual, yet significant impact on the housing market, as it may take time for the full effects to be realized. However, recent data shows that interest rates increased at the steepest pace in over 40 years and it remains to be seen whether they will have to be lifted additionally.

As central banks seek to choke off inflation by tightening monetary policy, there is at least the reasonable expectation that some of that inflation will be passed into rents and thus property cash flows. But when governments employ long-term borrowing to bail out energy consumers in the short term, as is necessary in Europe, interest rates are pushed up further and the impact on property values may be more detrimental.

Europe

The economic situation in Europe is reaching a critical point, with core CPI continuing to surge, and interest rates lagging behind. As inflationary pressures continue to mount, the European Central Bank (ECB) is under increasing pressure to act decisively and raise interest rates to avoid the risk of an overheated economy.

Failure to take timely and appropriate action could have catastrophic consequences, leading to a further erosion of the purchasing power of consumers and businesses and threatening the stability of the Eurozone economy. Thus, the ECB faces a daunting challenge as it navigates the difficult task of balancing the need to control inflation with the need to support economic recovery. With so much at stake, the ECB must take bold and decisive action to increase interest rates and prevent the economy from spiralling out of control.

Economic Health

USA

The current state of the US economy is concerning, with several economic indicators pointing towards a potential recession. The nation’s staggering government debt has reached record levels, and the debt to GDP ratio has surged to unprecedented heights. Moreover, spending has fallen to a historical low, which could further exacerbate the dire situation.

Compounding these issues, interest rates remain high, posing a significant obstacle to economic growth. Additionally, core inflation has remained stubbornly high in the US or is still increasing in Europe, which can lead to a reduction in purchasing power and a decrease in consumer spending.

In addition to the factors mentioned, high interest rates and a surge in customer deposits have also played a significant role in the unfolding banking crisis in both the US and Europe. The high interest rates have made it increasingly difficult for banks to borrow money, which has led to a liquidity crunch, making it harder for them to lend money to customers. This has resulted in a decline in loan growth, which has further exacerbated the situation.

Moreover, as the crisis has unfolded, customers have become increasingly worried about the stability of banks and have started depositing their money in these institutions. While this may seem like a good thing, it has actually worsened the situation by further reducing the lending capacity of banks, exacerbating the liquidity crunch.

These factors, when considered together, suggest that the US economy is facing a significant downturn. Indeed, the potential for a severe recession cannot be ignored, given the magnitude and complexity of the challenges currently confronting the nation.

Europe

The European economy is teetering on the brink of a lasting contraction, with economic growth stagnating at almost zero for the past year and Germany having already registered two consecutive quarters of GDP contraction. Despite numerous attempts to jump-start the economy, policymakers have been unable to spark a sustained period of growth or reverse the tide of economic uncertainty.

The situation is compounded by the looming threat of a recession, with several factors contributing to the increasingly pessimistic outlook. From skyrocketing inflation to soaring public debt and weak consumer spending, the Eurozone is facing an array of challenges that could derail the entire economic system.

Demographic Trends

Looking into the future, demographic variables will become as important as interest rates, income growth, and construction costs in determining the return on real estate assets as we head for a demographic-induced housing bubble.

At present, demographic pressure on housing markets is at its peak. This implies continued strain on supply in the next several years, followed by long-run erosion in demand that can only be reversed by high levels of immigration. Members of the large Millennial generation are now between their mid-twenties and early forties – the prime age range for new household formation.

The current bubble in demand generated by Millennials will slowly deflate, as Baby Boomers downsize their living space and age out of the housing market. Falling fertility rates mean post-Millennial generations will be smaller. The net impact is slow or stagnant population growth or even population loss. In fact, several parts of the United States are already experiencing population decline, including historically popular states like New York and California.

Under these conditions, any demographically driven increase in new home demand becomes temporary. While the rate of new household formation will eventually fall, the volume of houses put back on the market by seniors will steadily increase.

Here’s why we think that we may be hurtling towards the phase of recession which will heavily deflate real estate prices

As we know, the rapid increase in prices has been driven by a combination of factors such as low-interest rates, strong demand, and limited supply, which have resulted in a highly competitive market. However, this surge in prices has created a situation where housing has become increasingly unaffordable for many people, leading to a decline in demand. Additionally, the COVID-19 pandemic has had a significant impact on the economy, with rising unemployment rates, reduced consumer spending, and a slowdown in economic growth in both the US and Europe. As a result, demand for housing has weakened, and supply has increased, leading to a surge in vacancies and a decline in rental rates. This situation has put downward pressure on real estate prices and indicates that we may be entering the recession phase of the real estate market cycle.

Asia-Pacific: A Region of Stability Amidst Economic Uncertainty

Contrary to the Western markets, there is a growing consensus that the Asia Pacific is emerging as a relatively safe harbour in these turbulent times. Price pressures are relatively subdued in most of Asia, which suggests that central banks may not follow Western economies with aggressive rate hikes.

The developed economies of the Asia-Pacific region are experiencing inflation rates running below those of the West, although these economies are not immune to tightening financial conditions and slowing global economic growth. However , the Asia Pacific region contains tremendous diversity in the extent to which global economic trends are being felt locally. It’s two largest economies, Japan and China, are seeing stable or loosening monetary policies as the rest of the world tightens. Meanwhile, monetary conditions in the smaller economies in the region closely resemble the dynamics in Western nations.

Furthermore, spending in the Asia-Pacific Region, and especially China is recovering strongly: Although growth in discretionary spending is moderating, regional consumption demand is expected to remain resilient in 2023 as the tight employment market continues to underpin wage growth and boost personal finances.

Around 72% of retailers expect further sales growth this year and are planning to open new stores over the next 12 months. Among the major retail trades, fashion and cosmetics will enjoy the strongest rebound in sales, while those in the luxury segment will normalise.

Mainland China’s re-opening is fuelling hopes of growth in tourist spending, with Hong Kong SAR and Southeast Asia set to be among the main beneficiaries. Mobility in major mainland Chinese cities is recovering now that infections have peaked, underpinning a sizable rebound in retail sales. Policy stimulus to boost the retail market, such as incentives for purchasing home electronics and new energy vehicles, is likely to be introduced over the course of the year.

Thanks to the economic recovery in mainland China and the return of tourists, Hong Kong SAR’s retail market is poised to recover in 2023, although the sluggish housing market may weigh on local spending.

In summary, the Asia-Pacific market will be more stable during this economic headwind, given the following main reasons:

• Weaker Inflation

Inflationary pressure will continue to decline on the back of weaker global demand, lower energy
and food prices and improving supply chain efficiency. Australia, New Zealand and India are the
only major Asia Pacific economies forecasted to see inflation reach 5% or more in 2023, with that
in other markets expected to pull back to under 3.5%.

• Peak Interest rates

The Fed Funds Rate is projected to peak at around 5.25%-5.5% in mid-2023, ending the steepest rate hike
cycle in history. Further interest hikes in major Asia Pacific markets are not expected to exceed a
total of 100 bps in 2023, with Japan and mainland China the exceptions in keeping rates low.

• Mainland China Recovery

Asia Pacific GDP is forecasted to grow by 3.6% in 2023, maintaining the pace set in 2022.
Performance across the region will be polarised, with growth in mainland China set to pick up to
4.9%, but expansion in the region’s mature economies including Australia, Japan and Singapore
forecasted to fall to sub-2.0%.

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