Analyse: Real estate readjustment

Addressing the private sector on 20 April, the Prime Minister-cum-Finance Minister averred that “our development should not rely on just real estate development” but also on “productive activities that will generate higher added value and create national wealth,” Three weeks later, the government signed a protocol amending the Mauritius-India Double Taxation Avoidance Agreement in a way that could jeopardise the global business expansion. The new policy wrecks havoc on a productive sector that is profit-making and that provides employment and foreign currency income. In return, the Mauritian government receives some thirteen billion rupees that it will inject mostly in construction of new buildings! It would rather make sense to spend this money in product and market diversification of the global business sector, just as European Union funds for the sugar industry were utilised to diversify into new productive activities. The Prime Minister’s statement has created confusion as to whether the real estate is a productive sector. It is. According to Statistics Mauritius, real estate activities would produce added value of nearly twenty-one billion rupees in 2016, representing 5.4 per cent of gross domestic product, more than the textile industry (4.8 per cent), the information and communication sector (4.1 per cent) or the insurance group (3.1 per cent). Real estate together with construction constitute a large portion of the national output, 9.8 per cent: there is no denying that they are an important component of the Mauritian economy. However, despite all the support that successive governments have given to construction and real estate activities, their contribution to GDP growth in 2016 is a paltry 0.2 percentage point compared to 0.6 point for the financial and insurance activities. While the latter are boosting the economy, the former are not making it grow as expected. Once established, buildings will not sustain economic growth if they do not house successful business operators, even less if they are used as government office and add to public debt. The foregoing begs the question of whether construction drives the economy. In other words, can we spur economic activity by stimulating real estate? In fact, it is the other way round. To get the housing market moving upwards again, there must be willing buyers who have the necessary financial means. To be able to buy, people must first have jobs. But there is no job creation without economic growth. And without well-paid jobs, people do not have the purchasing power to consider buying or investing in real estate. In 1803, the French economist Jean Baptiste Say posited that “a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value”. When a producer sells his product, he immediately becomes a buyer who has income to spend. To buy, one must first sell. Production is the cause of consumption, i.e. greater output leads to higher consumer spending. So an increase in productive activity will bring about more demand for homes and other real estate assets. With unemployment rate remaining stubbornly high at 8 per cent, not to mention the rate of underemployment, the Mauritian economy is not creating sufficient jobs. Loss-making small and medium enterprises will eventually shut down and vacate the spaces they once occupied. Firms that survive are financially unsound and therefore unable to expand. Global business service providers are now haunted by the same fate… The current dire economic situation is making it hard for builders to sell or rent commercial and residential spaces profitably. You can see vacant commercial spaces that were occupied for years by the same tenant, and empty houses that are competing with apartments. Banks are loaded with commercial property loans, many of which are classified as non performing. With loan delinquency rates up, the years of aggressive loan underwriting are gone. Cheap and abundant money have flowed into the real estate sector and caused diversion of scarce resources from productive projects to unproductive ones. The Mauritian economy is now in a tailspin caused by the malinvestments that found their way into the real estate development process. The significant fall in the policy rate of the Bank of Mauritius (from 9.25 per cent in July 2007 to 4.40 per cent today) has had little impact on the construction activity which contracted by a total of 31 per cent over the past five years. It is ironic that banks are sitting on cash but are not lending. The annual number of building permits issued for non-residential buildings decreased from 652 in 2013 to 465 in 2014 and to 375 in 2015. The only effect of below-market interest rates is that, combined with buyer tax incentives, they have kept real estate prices elevated in many areas. Let the real estate market deflate. People compare the cost of building or buying a house to the cost of renting one. If it is still better to rent than to buy, then the price is too high. Prices must drop to a point where the deal makes sense (the buyer feels there is some value in the asset that he buys) and where mortgage payments do not use up a family’s pay packet. After all, a household budget consists of many other essential items. This is a free market approach that bankers have to employ. Deflation is required to cool down an overheated market. It will thus restore the confidence of prospective buyers. It is a healing process that clears away the bad investments made during the construction boom. The more these readjustments are delayed, the longer complete recovery is postponed.