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The Response of Various Real Estate Assets to Devaluation in Argentina

Paper publicado en “The Journal of American Academy of Business, Cambridge”, VOLUME 7 * NUMBER 1 * September 2005 - ISSN 1540 – 1200. This study reviews the effects that Argentina’s currency devaluation had on the prices of residential, industrial and office real estate in that country. Authors: Ph. D Ricardo Ulivi - Arq. MDI German Gomez Picasso - Arq. José Rozados



Abstract

This study reviews the effects that Argentina’s currency devaluation had on the prices of residential, industrial and office real estate in that country.
The findings indicate that residential prices in the best locations kept their prices better, in dollar terms, that the other sub-markets; and that the reaction of prices in the industrial and office market is initially greatly affected initially by the devaluation, but that the subsequent performance is mainly determine by what happens to economic growth as a result of the devaluation. In Argentina’s case, the devaluation led to strong economic growth—two years of over 8% growth—which in turn helped recover the market prices of the industrial and office market.

Introduction

Real estate prices, as any other assets, are affected by the socioeconomic environment they are set in. Generally speaking, market prices are set by the interaction of supply and demand factors. But, what happens to real estate prices when a sudden devaluation occurs? Some lessons can be learned from the Argentine experience of recent years.

By the end of 2001 and beginning of 2002, the Republic of Argentina was shaken by a very profound financial crisis that drastically impacted the overall financial system and resulted in a currency devaluation of nearly 70%. How did this crisis and devaluation affect the prices of real estate? Was the reaction of all real estate submarkets similar or can we establish differential and particular behavior characteristics to each type of real estate submarkets? For example, was there any difference between the residential properties, industrial, and office markets?

In an earlier paper, the authors concluded that the argentine devaluation affected residential real estate prices as a function of its location. The better the location, the lesser the fall of prices as a result of the devaluation.

This paper will analyze the residential, offices and industry values before devaluation and their price behavior after the crisis. We will try to explain how the market prices of each real estate submarket (“residential”, “office” and “industrial”) behaved as a result of the devaluation.

Background

During the decade of the 1990’s the Republic of Argentina had a money exchange parity regime established by law. The so called “Convertibility Law” issued during 1991 established a fixed conversion of one peso into one dollar. This law was abolished in early 2002 and in its place a free exchange market was in established.
Even with out the convertibility law, it was a well established fact that, in the real estate area, most real estate assets were historically quoted in USA dollars.

The City of Buenos Aires, Federal Capital of the Republic of Argentina, with 2,770,000 inhabitants, historically held the higher average real estate values of the country.
Buenos Aires presents residential sectors of varied quality and sociocultural levels with a strong concentration of administrative activities in the so called “center” (downtown) of the City, displacing the industrial activities to the periphery or outskirts in the suburbs outside the City geopolitical limits.

To establish a starting point and understand its development after the crisis, it is necessary to present a brief summary of the building typology for the years before devaluation. However, we will first present the database used for this work.

Data and Methodology:

For this report, an analysis was made of the most representative byproducts of each market under study (residential, industrial and office). For housing, the “apartment” typology, represented by 1 and 2 bedroom units located in the City of Buenos Aires Northern corridor; for “offices” the comparison between those classified as A+, located in the City center area and in the City of Buenos Aires’ Northern corridor; and for “industries” standard type buildings suitable for logistic and industrial processes located in the City of Buenos Aires peripheral areas and the suburban ring in the Province of Buenos Aires, were selected.

Due to the lack of statistics on the issue, the values for each square meter were produced by the joint contribution of ReporteInmobiliario.com, Merlo Negocios Inmobiliarios, L. J. Ramos Brokers Inmobiliarios, and Toribio Achaval. The later two are well established realtors.

SEVERAL REALITIES

During the second half of the nineties, the residential market was very active due to the facility to obtain home loans. The average value of a square meter for a used apartment in an average zone like Caballito was in the order of US$900 to US$1,000, while the same unit in the City’s Northern corridor, identified as mid-high socioeconomic class level, quoted in the order of US$1,000 to US$1,200.

The office market was also subject to a major activity upsurge during the nineties due to the growth of the economy’s service sector and as a result of the privatization of state owned companies. Therefore, most office space built in that decade was in the AAA and A+ class, fitted with a service infrastructure lacking in the City stock office buildings, and with sale prices ranging from US$2,500 and US$3,000 per m2, and rent figures averaging 30 US$/sq.m. Class B and C offices showed quotations well below with average prices of US$1200 for Class B and US$900 to 1000 for Class C, according, obviously, to the scale and the number of square meters of each operation.

Because of a recession that started at the end of 1998, the outlook was already bleak for the industrial building segment by 2001, with a major surplus of industrial buildings, a direct consequence of the deindustrialization process that started in the seventies and which affected mainly small and medium size industries. The quotation prices for building suitable for logistics and/or non-specialized industrial processes in the periphery of the City of Buenos Aires and in the City suburbs was in the order of US$200 and US$300 a square meter, according to the access facilities and building condition.

During most of the year 2001 and specially during the last semester, the real estate market was slowing down, with for sale offers gradually increasing in the three types of sub-markets driven by the owners’ intention of obtaining liquidity to protect themselves against a possible currency devaluation . . . that actually took place at the beginning of 2002.

DEVALUATION AND FINANCIAL “CORRALITO” (freezing of bank deposits in the country’s financial institutions)

A recession that lasted four years started in 1998. This prolonged recession led the country to the major crisis that, at the beginning of 2002 produced the devaluation of the peso, and the abandonment of the one peso-one dollar parity that dominated the economy for previous ten years. In addition, most bank accounts were frozen by the government. Such restriction to the free availability of the deposits in the financial system developed an evident “psychosis” in the population that felted and considered the freezing as confiscatory.

The peso lost nearly 70% of its value with respect to the dollar by the end of 2002. At the same time, the financial institutions started to return slowly their client’s money, since accounts had been frozen.

Such traumatic way out of the convertibility system produced a shock on the economy’s relative prices and, of course, on real estate values.

As mentioned earlier, the residential and office market situations were similar as regards to demand and prices up to mid 2002. The industrial buildings market offered a different scenario due to the heavy impact received during recession.

Findings

After the first three months of 2002, during which the real estate business market was practically paralyzed, the behavior of the different real estate sub-markets was different. The “industrial” market suffered the most important change of values after devaluation of the Argentine currency, with prices dropping 67% during the first year. Next was the “office” market depreciating 53% during the same period. The residential “apartment” market value dropped only 29% during the first year after devaluation.



DROP IN VALUE 2001 vs. 2002 (%) 53 67 29 offices industry apartments Nevertheless, the various assets experimented varied behavior during this period of almost three years, and today (1994) values are 19% below pre-devaluation prices, offices are 31% below and “industry” prices, with the worst performance, are 39% below pre-devaluation prices.



PRESENT VALUE W/RESPECT TO 2001 31 39 19 offices industry apartments Prices of homes, not only showed the best price recuperation, but they recuperated at a faster rate than any other typology. After 12 months, home values were established at 67% of pre-devaluation prices, while “offices” had not reached yet 47% of pre-devaluation values. Even today, “industries” have values much lower than pre-devaluation, representing only 35% of the previous values.

INDUSTRIES Sales Values in US$/sq.m. - (quarterly)

Source: Merlo Negocios Inmobiliarios



APARTMENTS - Sales Values US$/sq.m. (quarterly)

Source: ReporteInmobiliario.com, Toribio Achaval



OFFICES - Sales Value US$/sq.m. (quarterly)

Source: ReporteInmobiliario.com, L.J. Brokers Inmobiliarios



On the other hand, the “residential” sales market showed a constant number of operations, while the other two typologies under analysis had smaller number of operations. For “offices” practically no selling operations were made during the first post-devaluation year, while for “industries” only a small number of operations were concluded at “opportunity” values and, in most cases, at court-ordered auctions. This uneven evolution of the operations reveals the quality of the demand, which was controlled by a strong “personal investment” against “institutional investment”. It shall be pointed out that for the “industry” sector only 24% of the market represents buying and selling operations, and the remainder represents rental operations; for “offices” something similar is happening, only 20% are buying and selling operations.



We can observe a strong depreciation of the rent values after the crisis. This strong drop in return for investors, in addition to the macroeconomic instability acted as an additional factor to practically preclude genuine buying and selling operations in the “industry” and “office” real estate sector.



DROP IN RENTS 2001 vs. 2002 (%) 58 74 73 offices industry apartments The graph shows that rents diminished less for “offices” (58%) while for “industry” and “apartments” the reduction was 73% and 74% respectively. It can also be observed that the drop in rent for housing was even higher than for industries and offices.
Nevertheless, this drop in return was not enough to stop the buyer’s interest, in general small-scale savers, that privileged the tangible value of an asset in good location against the lack of other options and the general uncertainty framework.

Summary and Conclusions

• For the particular case of the residential market, the experience in the City of Buenos Aires has shown that after the initial devaluation shock, the level of operations did not show any sharp declines, leveling with a 15/20% drop below pre-devaluation values. On the other hand, this segment of the market had a behavior more similar to tradable goods (susceptible to export) and not to non-tradable goods (for internal consumption) linked to the variables of local relative prices.

• The value of offices and industrial buildings had a behavior in accordance with tradable goods, linked to the internal market, with values following the devaluation of the peso in front of the dollar.

• During the first year after devaluation, the office and industrial buildings buy/sell activity was practically zero. Few, if any, transactions took place.

• The residential market evidenced a depreciation lower than the other analyzed typologies, showing a faster price recuperation rate, and reaching some stability at two and one half years after devaluation.

• The office and industrial properties showed a reduced mobility during the first and one half years after devaluation, delaying for the same period the recuperation of the price level after the initial impact.

• Offices have evidenced some value recuperation only when the economic started to grow.

• Industrial buildings, due to their specific character connected with production, evidenced the slower rate of recuperation of the price level.

• The Argentine experience has revealed that during a crisis investors feel more secure in investing in the residential market than in other real estate submarkets. Return is put aside for security.

Authors

Ricardo Ulivi, Ph.D. is a professor of finance in the School of Business and Public Administration at the California State University, Dominguez Hills, Carson, California.

José Rozados is an architect and appraiser in Argentina. In addition, he is the co-publisher of the weekly Reporte Inmobiliario, which reports on trends in the Argentina real estate market.

Germán Gomez Picasso is an architect and appraiser in Argentina. In addition, he is the co-publisher of the weekly Reporte Inmobiliario, which reports on trends in the Argentina real estate market.

* DEVALUACIÓN = DEVALUATION

© ReporteInmobiliario.com, Noviembre 2005.

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