Real Estate Development, Construction, Economy - Thesis Example

Academia Research Real E Dev Real E Development, Construction, Economy Introduction Real e assumed great importancewith faster development of private property ownership. Purchasing and developing real estate requires large investment. Real estate development is a multifaceted business that includes renovation of existing building and construction of new building by arranging finance, marketing the lot, providing lead management of the whole project and running the risk of market ups and down. When the economy of a country grows the real estate segment also grows because of high correlation between the two. Construction industry moves side by side. Constructions of not only buildings is required but also the construction of the accompanying infrastructure such as roads, bridges, flyovers, other civil engineering works, architectural products and so on has to be done. The correlation of real estate, construction and economy is so big that a downfall in the industry can jeopardize the whole economy for years. Japan has faced it in the eighties and economies of USA, Britain and many other are facing today. The real estate and construction sectors combined had of late been a booming business all over the world and make up one of the largest business segments in the U.S. economy. Real estate development takes place in three major areas: Residential, Commercial and industrial. In residential segment consumers are encouraged to buy houses on account of low interest rates prevailing in the market, Sub-prime lending, lower return from other segments or stock market investment. Home owners are interested in remodeling old houses that is also part of construction industry real estate Real Estate Dev..2 development. In the commercial and industrial sides also real estate development was very hot except after the sub-prime real estate debacle. According to 'The Economist' the total asset in residential property in developed economies was worth $48 trillion and in commercial property worth $14 trillion in 2002. This was 54% of the total assets in two classes of assets, Property and financial.1.(Wikipedia) From the sources of Bank of International Settlement and wall Street journal it has been found that over three years from 2001-2004 housing values have moved up 63% in Spain, 48% in France, and nearly doubled in South Africa. In single year in 2004 prices have rises 48% in Bulgaria, 19% in Hong Kong and scaled up in China, UK, Australia and India. 2. (Global Real Estate Boom) Real estate prices had unprecedented rise for so long and so fast in many countries of the world-America, Britain, Australia, France Spain, and China. Rising property prices helped to prop up the world economy after the stock market bubble burst in 2000" According to estimates by The Economist, over the last five years the total value of residential property in developed economies has gone up by more than $30 trillion. Over the past five years, to over $70 trillion. This is an increase of about 100% of the combined GDP of those countries. This dwarfs any previous house-price boom. It is larger than the global stock market bubble in the late 1990s or America's stock market Real Estate Dev..3 bubble in the late 1920s (55% of GDP). It is perhaps going to be the biggest bubble in history. There is a definite comparison between the real estate bubble of Japan in 1989 and that of 2005 in USA/UK Real Estate bubbles are created from time to time in some countries at certain intervals though it is not fixed and not forecast able. It occurred in 1920, 1980 and again they are threatening to raise heads in 2007-08 in USA, UK China and some more countries. This time the house prices have been rising up for long. More than 25% of homes bought in USA and UK are for investment purpose not for owner occupation showing that the investment in housing is for speculative motive. Majority of first time buyers did not make any down payment for the loan sanctioned. The home prices in most of countries have gone up 100% of their GDP to lure speculators in this segment. This is more than the global stock market price rise in 1990s that was 80% of their GDP.3 ( Economist, Money News) Construction Industry can be categorized into three basic categories namely:- 1. Construction in heavy and civil engineering works, the construction of large projects such as bridge, road, etc comes under this category. 2. General construction: the construction works that involve building of real estate ones such as residential or commercial real estate assets, come under this category Real Estate Dev..4 Construction projects involving specialty trades such as construction works that involve building up of specialized items of electric related works such as architectural products, decorative items, etc. Many economies of developing countries such as China, India, Brazil, Russia are deeply involved in construction and real estate development because of the rapid development therein and the continuation of the development process. With the process of development, the migration of people takes place from the rural to urban areas. In UK and USA real estate development has also taken place but the real cause behind is not economic development that is at a lower rate but because of falling interest rate and sub prime lending.4.(Construction Industry) Construction industry is vital for the growing economies and contributes a big share of world GDP which is as high as one tenth. Huge employment generation on the global scale is generated in this industry, which is 7% of the total employed workforce around the world. Two-fifth of the gross energy consumed world over is consumed by this industry. The total resource used by this industry is almost half of the world utilization. The rapid growth in IT segment world over particularly in India, China, Brazil have boosted this industry significantly with magnificent building and real estate development. The trend in construction industry in USA is noticeable. The residential sector registered 15% growth and commercial residential real sector registered 7.5% growth till 2005. Real Estate Dev..5 From 2006 and in 2008 fiscal glut was noticed in this segment. India's construction sector is booming mainly due to the initiative taken by the government for expansion of developmental facilities. The construction is growing at a phenomenal rate of 7-8% pa.6. (Construction Industry). The growth rate of residential construction industry has high correlation ship with the economic growth of an economy. This can be seen in both in China and India where people who migrated from village to the town and cities for work in industries and projects required homes to live in. There was forecast of accelerated rate of growth in China in this industry because of higher rate of growth expected. This forecast has not come true because of the global slowdown in growth in almost all industries. The demand for dwelling houses in USA has already fallen significantly in 2007 and 2008 as well. In India also the construction industry has suffered on account of the rising rate of interest spurred by the Reserve Bank of India to control the spiraling prices in the economy. The commercial side of the construction industry has not gone down and registered 12% growth in 2006 in USA. In 2005 and 2006 this industry grew five times of the previous year. In USA construction industry and real estate and other allied services constitute one of the largest contributors to the economy. According to the US Bureau of Labor estimates 7.6million Americans worked in construction and 1.5 million Americans worked in real estate industry. According to the estimate of US Bureau of Census about $1.2 trillion was invested in construction industry that was likely to account for 8.5% of all economic output in the US. The outstanding debt involved in the mortgage was worth $14.6 trillion Real Estate Dev..6 by the end of 2007. But a large portion of this debt became bad and banks were writing these loans off. This led to fall of construction and real estate industry from 2008.Tens of thousands of workers became unemployed.) The sales of homes in USA were about 6.4 millions that dropped to 5 million in 2007. Sales of new single-family homes too dropped from 1.6 millions in 2006 to just 775,000 in 2007. Home builders suffered the maximum. 7. (Construction Industry) The impact of downfall in the real estate and construction industry is bound to be big. The revenue of the USA's biggest builders Pulte dropped heavily to $9.1 billion. The whole real estate market that was ruled by sub-prime mortgages had to suffer because of default in repayment and the lack of liquidity in the market. The sales of Toll Brothers, another real estate company skyrocketed from $2.7 billion in 2003 to $6.1 billion in 2006 fell to $4.6 billion by 2007. Buyers from of high income group who bought these home pricing about $688,000 out of mortgage finance too were unable to afford to run for long. From 2000 to 2005 the residential construction and sales of homes were strong but by 2006 residential market had slumped leading to home price declining in many cities of USA except a few such as Houston, Portland, Austin. Several years of record high in new construction was broken by February 2008 when new-single building permits issued by National Association of Home Builders were off by 40%. .(Construction Industry) Commercial projects like hotels, hospitals, shopping centers, and local government projects that made the construction industry booming were off the self caused by lack of demand and lack of institutional finance. Commercial construction spending dropped. Real Estate Dev..7 Investment in non-residential construction such as hotels, motels, and electric utility generating plants that was worth $396 billion by 2006 and $349 by 2007dropped by 2008. Commercial public sector (for government), non-residential construction, which was $255 billion in 2006, and $287 billion in 2007, however did not suffer... There was continuing good demand from the ever-hot health care sector for new or remodeled properties as America's 77 million Baby Boomers. The median sales price for new homes in 2006, which was $246,500, according to the he National Association of Realtors NAR remained at almost the same level in 2007. During economic slowdown during 2000-03 housing market was not bad because of easy credit availability and low interest rate. Buyers were able to get 30-year mortgage at 5% interest rate and lower down payment of $2400 pm for a home worth $424,999 and 20% down payment. The terms went on changing to get a house worth $525,000 on the same payment basis. Demand was exorbitantly high, finance was easy to get and therefore borrowers did not care about the installment payment. Housing prices in certain countries such as USA, UK, Ireland, and Spain were so steeply high that people started anticipating the danger of emerging speculative bubble. US was the real cause for the fear since the country was already in danger on account of sub-prime mortgage that led to property price plunging. UK was likely to be the next economy to go on the path treaded by USA. In UK the house price moved up 300 % Real Estate Dev..8 never seen before. What is the reason behind people's craze to buy real assets, land, building, flats at any price and by accepting any terms for finance Japan already faced the housing boom and bust in the 80s and still the house prices are falling. In Germany and Canada the house prices have been declining without interruption. India witnessed housing boom recently but there does not appear to be any crisis. 8 (Economic Meltdowns: Let Them Burn Or Stamp Them Out) For last decade or so consumers in Britain are so much accustomed to spending spree financed by debt that made them the most indebted nation in the world more than the Americans are. They have record debt of 1.4 trillion that is more than their GDP. The economic boom bolstered by a decade -long housing boom in UK in particular created consumer confidence and perception of wealth that is not experienced by anyone else. At the onset of prosperity in real estate market in UK very little opportunity for investment was present in this segment. People and financial institutions both took advantage of the opportunity of borrowing and lending in this segment even by ignoring the basic rules and laws. 70% of bank funds were diverted to real estate mortgage. The income of families and household was diverted from buying goods and services to buying properties- houses and buildings. A large chunk of money was used in payment of debt service to banks and financial companies. Britain faced acute credit crisis in the recent periods caused by slack lending practice by banks, financial turmoil caused by dearth of liquidity, extending risky loans to unpredictable parties and passing on to other institutions, excessive dependency on credit rating companies, over dependence on in financial markets or inadequate liquidity risk Real Estate Dev..9 management. This has put many sectors of the economy at risk such including UK commercial property sector. There was exponential growth of savings and debt in UK market. They were used mainly for financing the purchase of real estate, stocks and bonds. 9. (Economic growth Statistics by Bank of England) One very important reason for overvaluation of residential properties was the house prices in relation to rent hitting all-time highs in the U.S., Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. Inflation being lower, the real price was comparatively higher showing larger overvaluation of the properties. The ratio of home price to rents received is the indicator of overvaluation of residential real estate. If prices of the property drops rents will not cover the interest rate paid on mortgages and the investors would like to sell it off. This will increase supply of homes for sell and lead to depression in the market. 10. (The UK house market is set to go this way gradually. (Money News) Renting property accounts for 9% of GDP of UK involving 100 billion annually. 62% of GDP in UK accounts for consumer spending with rising inflation rate. The greater part of this expenditure is diverted to mortgage payment. There is likelihood of shortage of new houses in the present scenario of credit crisis that is to support the falling house prices in future as happened in Japan where after a boom for a decade in the housing sector from 1981 to 1991 there was a fall in house prices for the next decade. Conclusion Real Estate Dev..10 Problems can arise when housing prices rise at a rate much higher than the increase in average household income, which has been the situation in all of the hottest housing markets of the recent past. Many home purchasers have been trying to stretch to buy their homes. Some have gone into far too much debt. Those who are trapped in the credit crisis and not able to repay their debts are facing the tune for foreclosure. Those who invested in real estate development have to suffer losses. New developments in real estate segment have been limited. With downturn in the economies the construction activities in other segments have also been suffering. Governments like that in United States might plan investment in infrastructure to boost employment or set bell- out plans at the cost of taxpayers' money but the industry as whole is moving downturn. The fact remains that the real estate development including the construction industry is the fundamental base of any economy and the downturn in this segment is definite to affect the entire economy. When this segment becomes sick and forms as the base for the overall global downturn the situation may lead to the worst for the global economy as seen at present. The real estate cycle is well known to typically last 10-15 years and with this the economy is to suffer to that account till it revives to contribute to the growth of the economy. Footnotes: 1. Real estate holds 54% of the total asset, The Economists 'Developed Economies' Wikipedia, 2 Housing values have moved up many times Global Real Estate Boom, Friday, June 17, 2005 | 08:00 AM in Real Estate 3. Real estate prices had unprecedented rise for so long and so fast in many countries Economist: Housing Bubble 'Biggest in History' MoneyNews Monday, June 27, 2005 www. archive.newsmax.com/archives/ www.economist.com/printedition/edition visited on June 2008 4. Construction Industry can be categorized into three basic categories namely Construction Industry. www.economywatch.com/world-industries/construction visited on 5th Dec. 08 5. Construction industry is vital for the growing economies and contributes a big share of world GDP which is as high as one tenth Construction Industry) 6.& 7.(Construction Industry) The growth rate of residential construction industry has high correlation ship with the economic growth of an economy (construction Industry) www.economywatch.com/world-industries/construction 8. Japan already faced the housing boom and bust in the 80s Economic Meltdowns: Let Them Burn Or Stamp Them Outand Why Housing Market Bubbles Pop www.investopedia.com/articles/economics/08 visited on May 08 9. For last decade or so consumers in Britain are so much accustomed to spending spree financed by debt.. Economic growth Statistics by Bank of England) www.statistics.gov.uk/ visited in June 2008 . 10.(The UK house market is set to go this way gradually. (Money News news.bbc.co.uk/1/hi/business/7374730.st visited on June 08 Bibliography: 1.Big Picture | Global Real Estate Boom www.bigpicture.typad.com.comments/rea_estate_/index.html visited on 5th Dec.08 2. Construction Industry) www.economywatch.com/world-industries/construction)Economist: 3. Construction Industry. www.economywatch.com/world-industries/construction visited on 5th Dec. 08 4.Economic growth Statistics by Bank of England) www.statistics.gov.uk/ visited in June 20088 5.Fleming, Sam, Daily Mail1 November 2007, 8:21am www.thisismoney.co.uk . 6. Eliott, Larry : economics editor The Guardian, Thursday October 25 2007 Max King, guest columnist, this is Money www, guardian.co.uk visited in June 2008 3 October 2007, 3:36pm 9. www.economicsnetwork.ac.uk/archive/maths_worksheets/household_spending.doc 10 www.bankof england.co.uk visited on June 08 11 Economic Meltdowns: Let Them Burn Or Stamp Them Outand Why Housing Market Bubbles Pop www.investopedia.com/articles/economics/08 11.www.inen.wikipedia.org/wiki/Real_estate accessed on 5th Dec. Read More