Real Estate Market Observatory

4.1Real Estate Market Observatory

Understanding the dynamics of real estate markets in itself and its potential impact on the mortgage sector is however not enough. The extent to which real estate and mortgage markets are interrelated, which depends on the degrees of development of the mortgage market must be taken into account. The linkages between the real estate sector, the mortgage market, the stability of the financial sector and the real economy has exacerbated during last years.

Furthermore, the nature of the prevailing sale and purchase transactions should be understood by the authorities (for example, examining whether there is a significant share of investment purchases).

Only after obtaining, analyzing and monitoring market data the regulators would be able to calibrate prudential requirements, such as capital charges, loan-loss provisions, and portfolio composition structure, in order to proactively discourage concentrated or aggressive lending²².

If mortgage lending is small real estate markets tend to have an autonomous dynamic from the mortgage lending market developments. Their development, especially in terms of prices, will reflect the investment of local wealth with little leverage, or external capital inflows. This is particularly relevant in ECA, where privatization of the bulk of the housing stock, low penetration of banking services and significant share of informal economic sectors contribute to relatively small mortgage markets.

Mortgage lending can drive real estate markets through the level of interest rates, LTV levels that reflect expectation of continuous price appreciation or a multiplier effect of capital gains on existing properties. Its impact on the market equilibrium will depend on the relationship between supply and demand, but by market segment.

Similarly, financial authorities must distinguish between excessive and unsustainable price increases or lending dynamics from rapid developments due to structural reasons; or, which is even more difficult, they should be able to assess at what point a healthy (structural) growth becomes excessive²³. Information systems must be developed to help such diagnoses and policy decisions with adequate indicators and metrics.

Assessing the state of real estate markets implies much more than measuring the evolution of prices. Other important metrics from the supply side include the volume of transactions, new building activity, the stock of units for sale and the turnover in new housing developments, rental yields, among others. Segmentation is equally important for these indicators.

Real estate appraisal becomes particularly critical in case where securitization or mortgage covered bonds are used for mortgage funding. Mortgage lenders, investors and regulators in particular in setting LTVs standards and provisioning rules rely of the veracity of the collateral price information and thus on the quality of assessing such prices.

The accuracy and efficiency of valuations depend on the market information system, and increase in parallel with it. Still, it is necessary to organize the real estate valuation profession on sound principles even at an early stage, which includes the definition of licensing and expertise criteria as well as code of conducts that can ensure that this function is fulfilled on an arm length basis.

An information system on mortgage lending should ideally provide indications on new activity and loan portfolios, broken down between residential real estate and developer finance. Databases should include loan level information on all material terms and conditions, e.g. LTV, DTI, property location, year of origination, etc. to allow for precise analytical work.

The analysis of loans benefitting from mortgage default insurance or other form of credit guarantee is of high relevance for the pricing of risk; it must be developed and made available to the market. Mortgage data should be segmented in parallel to the structure of real estate market information.