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25 May, 2024
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The 2023 investment chessboard

'If the current situation persists, it is more likely that prices will fall (at least slightly) than rents will rise.'

Andreas Andreou

Andreas Andreou

by Andreas Andreou

Today's data is completely different from what it was a year ago in terms of investment.

Rent increases are unlikely because incomes rarely rise during periods of high inflation; instead, inflation nibbles away at them.

Not only that, but the investment data in Cyprus over the last few years has benefited real estate investment more than any other investment vehicle. We've made the case before that real estate has essentially been playing championship football with no real competition.

Interest rates were zero to negative for the majority of that time, discouraging savings and encouraging borrowing, inflation was not a threat, and (for better or worse) various schemes were in place that either encouraged demand or supply of property.

Locally, alternative investment vehicles such as stocks and bonds have been severely weakened. Consider that a 10-year Cypriot government bond had an income yield of 0.124% exactly one year ago, while dividends from public companies were almost non-existent, with most stock prices moving parallel downward due to the high level of volatility.

As a result, when property income yields for conventional leases ranged from 3% to over 5%, with the added bonus of a positive capital gains horizon and the (for many) bonus of the mental satisfaction that comes from simply owning property, it was obvious that property investment would take its toll.

As an aside, by "contractual leases," I mean leases that are written down and have a term of at least one year, which are the most common type of rental. This category excludes short-term contracts, which include licenses to use premises through electronic platforms. In these cases, income yields can be significantly higher than those of traditional leases.

So, what happened in the last year to drastically alter the landscape?

As a result of Russia's invasion of Ukraine and the ongoing war conflict, we have seen a fivefold increase in inflation in one year compared to the previous 30 years. From 1991 to 2022, the Eurozone's average inflation rate was 2.12%, despite pandemic economic policies that drove inflation up to 5.1% just before the invasion. Since the invasion, annual inflation in the Eurozone has averaged around 10.1%.

The ECB has raised interest rates in response to escalating inflation. As a result, general deposit rates have quadrupled on average in the last 10 months, while household borrowing costs have doubled. The income yield on a 10-year Cyprus government bond is now 4.124% (up from 0.124% a year ago), while the average 10-year eurozone bond yield is now 3.16% (up from 0.28% a year ago).

This means that the property market will face serious competition in 2023, at least on the surface. The practical equating of the income yields of government bonds and real estate is not justified, not only because an investment in real estate carries more investment risk than an equivalent investment in government bonds, but also because an investment in real estate is more difficult to liquidate.

In order to be comparable, real estate should have an immediate income return potential of more than 6%. This would require either an increase in the income they generate or a decrease in their value.

If the current situation persists, it is more likely that prices will fall (at least slightly) than rents will rise. Rent increases are unlikely because incomes rarely rise during periods of high inflation; instead, inflation nibbles away at them.

An increase in borrowing costs weighs on demand and makes meeting construction costs more difficult, which are also weighed down by inflation. A decrease in demand and a decrease in supply must imply a decrease in transactions. However, this does not imply a decrease in values. To predict what will happen to values, the degree of sensitivity of demand to various variables such as property prices, income, alternative prices, and so on, as well as how supply reacts at the general and local levels, must be examined.

On the other hand, if inflation begins to slow gradually before 2023, the negative impact on real estate will be minor to non-existent.

Finally, it is worth noting the importance of economic stability from a governmental standpoint, as well as how this can be best achieved during the current presidential election season.

Until then, I wish everyone a Happy New Year!

[This article was translated from its Greek original]


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