What the Financial Crisis Means for Real Estate Values

Any financial crisis affecting a country affects the value of the commercial real estate in that market. The most basic maxim of real estate investment is that "what is good for business is good for real estate." This capsules the principle that conditions for business (good or bad, expanding or contracting) drive the demand side of the real estate value equation. This demand, in turn drives the supply side that reacts with some delay, as real estate developers need time for design and construction.

Russia's commercial real estate market of the past eight years has been driven upward by the expanding economy internal to the country, while accompanied by generally favorable conditions in the world economy external to the country. A major dependence on high oil and commodity prices has left Russia exposed to any global downturn. The downturn has now happened, and the external conditions are extremely negative for business (shortage of capital and credit) and impossible for real estate expansion.

But many countries have been through this before, and commercial real estate has demonstrated its position as a bedrock of any economy and a durable asset for the long-term. Stakeholders that invest in commercial real estate (either users or rent-seekers) recognize the long-term nature of land and buildings, and plan for that in their ownership and financing strategy.

Both users and rent seeking investors recognize that the value of the real estate they own does not disappear with the daily change in the stock market -- or with the weekly change in loan interest rates and terms. The value from real estate ownership is generated by the long-term financial benefits the property can bring by providing rent (or its equivalent use value) and future resale. These anticipated benefits are long-term in nature, and not suddenly realized or lost.

It is critical to remember that value results from the actions of two parties -- the buyers and the sellers. The attitudes and beliefs of only one side do not change market values. Rather the value of real estate changes only as both parties adjust their perception of what the benefits actually are. Did real estate in Russia lose 70% of its value in the month Russian companies lost that much value in the stock market? Likely not -- as it is possible that same 70% would be returned to those companies in the next month.

Did real estate in Russia lose any value as a result of the recent stock market crash? Likely yes, as long-term investors begin to consider the instability of the economic situation that could cause that kind of volatility, they began to raise their risk assessment and adjust their investment return requirements for depositing long-term cash. The potential sellers have done the same as they consider their upcoming financing needs and the necessity to protect existing projects, and now consider selling projects that would not have previously been marketed.

So a financial crisis can mean a decline in real estate values if it is sustained and involves factors that affect both buyers and sellers. The current factors affecting the Russian market have also frozen the addition of supply. This sets the stage for more rapid value increases when business conditions return to positive -- a scenario well demonstrated after the 1998 financial crisis, when the surprising economic recovery drove increases in demand much faster than supply could appear.

So the message is not to panic; well-considered and quality real estate will retain value as related to the business conditions around it. Less competitive properties are subject to losing relatively more value when tested by a crisis, and may not return as fast when conditions improve. As in the stock market, those who have responsibly structured their financing and can maintain their long-term conviction on the investment will experience better results.