Home Banking & FinanceAnalysis Hedging on real estate

Hedging on real estate

by Nabil Makari

Real estate, long perceived in Lebanon as a long-term investment which would allow reaping profits in an economy of services, was in addition seen as an attractive investment due to a high number of expats and tourists willing to buy local housing for vacation purposes. However, since the beginning of the financial crisis in Lebanon, the sector has increasingly emerged as a hedging tool for depositors willing to limit a haircut on their bank deposits. 

Over the past years, real estate investment hunger had weakened gradually and significantly from a peak in 2012, and this weakness, which was correlated with the high interest environment for deposits, has been reversed since the beginning of the financial crisis in Lebanon in 2019. With capital controls and local currency depreciation, the impending fear of a haircut of deposits has resulted in movements from deposits to real estate, causing a price hike in the sector. Nevertheless, it is necessary to ponder whether this is a long-term trend or merely a result of the political situation of Lebanon, filled with doubt and uncertainty.

Overall price hike

According to Bank Audi’s Real Estate research report dated July 2020, the value of real estate sales went up by 52.5 percent year-on-year in May 2020, to reach $3.7 billion, following double digit contraction in the past two years. Indeed, real estate prices had dropped in 2018 and were selling at a discount in comparison to 2015. Asking prices of residential real estate in Beirut grew by 20 to 30 percent in June 2020 relative to the previous year. This mostly shows a trend on the part of buyers willing to hedge their deposits and to invest in relatively “safe” assets. 

On the other hand, this does not appear to be a generalized trend adopted by the Lebanese population as a whole but rather by specific classes. Soon after the October revolution, buyers started looking for safe havens for their deposits, and this demand was met with a supply by property developers. Indeed, according to Mireille Korab, head of Real Estate Business Development at FFA Real Estate, from October 2019 to January 2020, the spike in purchases had been driven mostly by wealthy individuals hoping to buy bargain products to avoid a haircut, while property developers were willing to sell quickly to close their debts. Since then, this spike has been driven by many more high net worth depositors, according to Korab, trying to avoid the same probable fate to their deposits. 

By June 2020, most developers had repaid their loans, and prices therefore had gone back to the same level as 2015, according to Korab.

 Who is buying and selling?

Early on, sellers consisted of property developers who were eager to pay back their bank loans, the real estate properties being sold until June 2020 involved apartments that were usually only a few years old or still under construction, mostly around Beirut. However, this was followed in the second part of the year by sales around the country where people bought real estate, whether apartments or land, hoping to hedge potential losses from a haircut. 

This has resulted in land prices going up, noting well that the price of such real estate using local Lebanese dollars (lollars), with an ever rising discount of lollars to cash dollars. As a result of developers having repaid their loans, the market is more and more difficult for banker’s checks, as sellers are currently focusing on selling their obtained banker’s checks at a discount on the black market to obtain fresh dollars, according to Korab. “For the wealthier of the sellers, they are not selling unless it’s fresh cash to limit their exposure to the real assets they would use,” says Korab.

At this stage, with no financial restructuring and no International Monetary Fund (IMF) package in sight, due to negotiations with the IMF having reached a standoff, the price of real estate might very well keep going up, with the lollar to dollar discount also going up. This would therefore result in higher prices for rent and buying housing as such prices would go up, with rent prices usually following the price of the underlying asset, and most property sellers insisting on being paid either fully or in part in cash dollars.

This movement on the real estate level is limited mostly to residential properties and land, as commercial real estate has taken a hit. With the impact of Covid-19, real estate for restaurants, shopping malls, and other high-yield commercial real estate has not proven an attractive investment or hedge, especially with regards to short-term leases. With no short-term use for many of these real estate assets, there is little demand for them in the current situation, though long-term leases could prove attractive as they would be considered a long-term investment should the Covid-19 situation be eventually resolved or at least attenuated.

In light of the reimbursement of loans by developers, who are the remaining potential sellers in this situation?

According to Bank Audi’s report, supply has decelerated lately, whereas demand has soared. Indeed, sellers are not very keen to sell real estate unless they require fast cash, for example in case they need to send money abroad, after exchanging the bank check received for the transaction and for cash dollars at a discounted rate. In addition, development projects have frozen, due to reduced availability of construction loans, and the fact that most of the materials can only be obtained in exchange for cash dollars. According to the latest statistics released by the Order of Engineers of Beirut and Tripoli, the total surface area of new construction permits decreased by 32.6 percent in 2019, and by a further 61 percent on a yearly basis as at July 2020. 

In addition, according to Byblos Bank’s Real Estate Demand Index for the Third Quarter of 2020, 0.6 percent of Lebanese residents had plans to either buy or build a residential property in the coming two quarters, down from 1.1 percent in the second quarter of 2020 and compared to 4.7 percent in the third quarter of 2019.  

Banking on fresh dollars

Could the real estate market also prove an attractive investment for holders of dollars in overseas accounts? In the current political situation, with no clear economic policy in sight, there is little security offered to long-term investments.

On the other hand, the depreciation of the Lebanese pound has made local prices cheaper for holders of foreign currencies, especially holders of US dollars. With Lebanon having many of its citizens living abroad, it is conceivable that these expats would be enticed in investing in Lebanon to obtain real estate at attractive prices and engage in development projects. According to Korab, “Developers at present wouldn’t sell for other than cash, because cash would help diminish the cost of construction.” 

Indeed, with the depreciation of the Lebanese pound, costs of construction have gone up due to the depreciation of the local currency and the fact that much of the raw materials being purchased are sourced from abroad. Developers, not being able to transfer money abroad, have to rely on cash transactions, and with the spike in real estate prices in lollars, in addition to the current political situation in Lebanon, there is little appetite for development of real estate projects. According to Byblos Bank’s Real Estate Demand Index for the Second Quarter of 2020, the demand for residential real estate had dropped sharply during the second quarter of 2020, which suggests that “the stock of residential units remains significantly higher than the actual demand, and that the purchasing trend is originating mainly from a relatively limited number of buyers.” In addition, according to this report, potential local real estate buyers are reluctant to acquire and build a residential unit, as “they have been forced to address more urgent and basic needs.”

Nevertheless, buying land in real cash dollars could prove attractive for holders of cash dollars as these transactions do not have an investment component such as that of development projects, and do not require any import of raw material. 

The road ahead

The road ahead will depend mostly on Lebanon’s political and economic situation. Should negotiations with the IMF lead to a rescue package (conditional upon the introduction of reforms), more effective governance and the financial situation on the path to recovery, Lebanon could prove an attractive place for real estate investments. 

Services are the dominant sector of the Lebanese economy, and the depreciation of the currency could help attract more foreign investments as well as attract more tourists. At this stage, foreign investments would result in a lower rate of Lebanese pound to US dollar, and development projects could be kick-started, which would help rein in the need for cash in real estate transactions. In this case, a more stable exchange result would make dealing in the real estate market easier. On the other hand, should the current situation become a long-term one and lag on, the discount of the fresh dollar to the lollar would keep growing and real estate prices in lollars would keep going up to keep up with the need for cash due to higher discounts. “The price is readjusted in terms of fresh cash,” says Korab. Indeed, in November of 2019, nominal real estate prices were close to those of 2011. Last May, real estate prices had spiked to a level similar to that of prices between 2013 and 2016, which were higher than those of 2018. Overall, the shape of real estate in Lebanon depends on reforms and economic solutions: should reforms be put in place, the real estate market would become more stable and result in investments in development projects. If not, the discount of lollars to US dollars would keep widening and prices would go up and readjust to fresh cash.

In conclusion, the rise in real estate prices in lollars is a direct consequence of economic uncertainty, and an inefficient meeting of supply and demand. Should an economic roadmap be adopted, and successfully implemented, prices would be readjusted and the movement of deposits to real estate would drop, while investments in real estate could start anew.

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