Residential Real Estate

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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

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Contents

1. The Basic Picture housing demand around the
   world
2. How was mortgage finance linked to the recent
   crisis?
3. Going forward

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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
• Globalfor more than 50 years has focused on
  developing countries
• Localfull 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

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The basic Picture

• Section 1

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Growth and urbanization

• World Bank Data Visualizer
• http//devdata.worldbank.org/DataVisualizer/

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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
• gt90 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

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Mortgages mostly unavailable in emerging markets
But as real incomes rise, so does capacity to
make a mortgage payment
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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
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Mortgages and Fixed Investment
In the initial phase of development, mortgage
finance can add 0.5 of fixed investment as a
percent of GDP for each increment in the size of
the market Source Duebel (2008)
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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.

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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,
  its 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 issuers balance
  sheet and security portfolio, assets may be
  replaced, complete recourse to bond issuer
• Yields comparable to AAA corporates

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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

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What happened with the crisis?

• Section 2

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U.S. subprime boom and bust finance driven,
excessive leverage, weak credit underwriting
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What have mortgage defaults looked like?
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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

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Going forward

• Section 3

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What havent 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

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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

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Thank you
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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

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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 lt 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

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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_at_ifc.org