Year of Reckoning: Reviewing 2008 and Confronting What 2009 Holds for Jamaica’s Housing Market — January 2009

Publication Date: 3 January 2009 | Coverage Period: 3 December 2008–2 January 2009 | Category: Monthly Review

The Month in Brief

• Bernard Madoff was arrested on 11 December 2008 and charged with operating what is alleged to be the largest Ponzi scheme in financial history, with estimated losses of US$50 billion; the scandal has deepened investor distrust and further chilled appetite for alternative and offshore investments including Caribbean real estate.
• Jamaica closed the calendar year 2008 with GDP contraction estimated at approximately 1.5–2.0%, the first annual economic decline in a decade, as tourism, remittances, and export revenues all fell simultaneously.
• The US unemployment rate reached 7.2% in December, the highest in sixteen years, with the labour market shedding more than half a million jobs in the final month of the year alone.
• Jamaica’s tourism sector reported a December high-season performance substantially below prior-year levels, with visitor arrivals to major resort areas estimated 10–12% lower than December 2007.
• The Bank of Jamaica maintained a cautious monetary stance through December, with the exchange rate ending the year at approximately J$89–91 per US dollar following several interventions.
• The incoming Obama administration signalled its intention to introduce a major economic recovery package on taking office in January, raising hopes — though not yet certainty — of a more rapid stabilisation of the US economy.

The Year in Review: 2008

Twelve months ago, as this publication reviewed the outlook for 2008, the dominant concern was inflation: commodity prices were elevated, construction materials were expensive, and the question for Jamaica’s housing market was whether rising costs would price the middle segment out of reach. That concern, while legitimate, now seems almost quaint in the context of what 2008 actually delivered.

The year witnessed the most severe global financial shock since the 1930s. The collapse of Bear Stearns in March was the opening act; the conservatorship of Fannie Mae and Freddie Mac in September the midpoint; and Lehman Brothers’ bankruptcy filing on 15 September the event that transformed a serious financial crisis into a global catastrophe. AIG’s near-collapse and emergency bailout followed within 24 hours. By October, equity markets worldwide were in freefall, credit had seized, and the financial system that underlies the entire edifice of modern property markets — the ability of buyers to borrow, sellers to receive payment, and developers to finance construction — was functioning only because of massive state intervention.

Jamaica entered 2008 in a position of relative vulnerability: high public debt, modest foreign exchange reserves, a dependence on tourism and remittances for foreign exchange earnings, and a commercial mortgage market already operating at rates that excluded the majority of the population. The external shock amplified each of these vulnerabilities. Remittances fell; tourism fell; the exchange rate came under pressure; and the commercial banks, already cautious, moved to actively restrict new mortgage lending.

Residential property transaction volumes for the full year 2008 are estimated to have fallen approximately 20–25% below 2007 levels in the Kingston metropolitan area, with steeper declines in the upper and upper-middle segments. The price level has been more resilient than volumes, with the absence of the forced selling that characterises markets with high leverage providing a degree of stability. Sellers have generally preferred to withdraw from the market rather than accept deeply discounted offers, with the result that the market has thinned rather than crashed.

Government Policy and Regulatory Environment

The Golding administration enters 2009 facing the most challenging fiscal environment since the financial sector crisis of the 1990s. Revenue shortfalls through the second and third quarters of the 2008–09 fiscal year have accumulated, and the January budget review will require either expenditure reductions or increased borrowing — neither of which is without cost. The government’s preference has been to maintain capital expenditure, including housing-related infrastructure, while seeking savings in current expenditure; whether this balance can be sustained through a full year of recession is uncertain.

The BOJ maintained its elevated policy rate stance through December, with rates in the 10–12% range serving both an inflation-anchoring and a currency-defence function. The central bank’s decision to absorb the costs of a tighter-than-otherwise-necessary monetary policy reflects the fragility of Jamaica’s external position: a disorderly depreciation of the Jamaican dollar would raise import costs, accelerate inflation, and undermine confidence in a manner that would be far more damaging than the current combination of tight money and slow growth.

The Madoff scandal, revealed in December, carries an indirect but real relevance to Jamaica. Several Caribbean-oriented financial intermediaries had exposure, directly or through fund-of-fund structures, to Madoff-managed entities. The erosion of confidence in alternative investment structures that the scandal has caused extends well beyond direct investors: wealthy individuals who might have considered Caribbean real estate as part of a diversified offshore portfolio are now questioning the entire category of non-transparent investment vehicles. The reputational fallout from Madoff will take time to dissipate.

Construction and Development Activity

The construction sector ended 2008 in contractionary mode. New project starts through the fourth quarter fell to their lowest level in years, with the majority of developers choosing to complete committed work and defer all new activity. The pipeline of projects in active construction — predominantly those that broke ground in 2006 or early 2007, before the external environment deteriorated — will deliver units to market through the first half of 2009, potentially widening the gap between supply and an already-diminished pool of qualified buyers.

Construction material costs fell significantly in the second half of 2008, with global steel and cement prices declining sharply on demand destruction. This provides a prospective benefit for projects planning to start in 2009, where input cost assumptions can be reset at materially lower levels. However, the financing constraint — the difficulty of securing project finance from commercial lenders at any price — is more binding than the cost constraint for most developers contemplating new activity.

The NHT concluded 2008 having maintained its construction programme throughout the year, a significant achievement in the context of the environment. The Trust’s active schemes in St. Catherine, St. James, Clarendon, and St. Andrew are scheduled to deliver units through the first half of 2009, providing the most significant addition to affordable housing supply in the current cycle.

Investment and Capital Flows

Foreign direct investment in Jamaican property — predominantly from North American and European buyers seeking vacation, retirement, and investment properties — essentially ceased through the fourth quarter of 2008. Developers marketing to this audience report that inquiry levels are at multi-year lows and that the small number of inquiries being received are from buyers in strong enough financial positions to negotiate aggressively. The era of the aspirational second-home buyer financing a Caribbean property on the back of appreciated US home equity has, for the foreseeable future, ended.

The domestic institutional investor community — pension funds, insurance companies, building societies — enters 2009 with constrained balance sheets and a heightened aversion to credit risk. New mortgage origination has fallen sharply at commercial institutions, and the lending criteria that remain in place are applied with considerably less flexibility than was the case in 2006 and 2007. For the property market, this translates into a buyer pool that is more creditworthy on average but dramatically smaller in number.

Diaspora Dimension

Remittance flows to Jamaica for the full year 2008 are estimated to have declined approximately 10–13% from 2007 levels, based on provisional Bank of Jamaica data. This represents the largest annual remittance decline on record, and the deteriorating US labour market suggests that further declines in 2009 are likely before conditions stabilise. For the approximately 20% of Jamaican households that rely on overseas transfers as a primary or significant income source, the 2008 decline represents a material deterioration in living standards that has direct consequences for their ability to service mortgages and maintain housing expenditure.

Diaspora members considering property purchase in Jamaica are, in the current environment, doing so from a position of diminished financial capacity. US home values have fallen 20–30% from their peaks in the major diaspora centres; retirement portfolio values have contracted by similar magnitudes; and employment conditions in the construction and service sectors where many diaspora members work have deteriorated sharply. The pipeline of diaspora-funded property purchases that would normally be expected over the next 12–18 months has contracted significantly.

Affordability and the NHT

The NHT’s 2008 annual report will show that the Trust disbursed mortgages at a pace that maintained access to affordable housing for its contributor base throughout one of the most difficult external environments in recent memory. This countercyclical performance — made possible by the Trust’s unique funding model and statutory mandate — has provided a critical buffer against the worst outcomes for Jamaica’s lower and middle income housing market.

The structural affordability challenge — the gap between what commercial lenders will offer and what median-income households can service — has widened through 2008 and is unlikely to narrow in 2009. Commercial rates remaining in the 15–18% range, combined with incomes under pressure from the slowing economy, means that the segment of the population capable of accessing commercial mortgage finance has shrunk. The NHT’s 2009 lending programme will therefore be the primary vehicle through which working Jamaicans can access homeownership — a responsibility that the Trust appears prepared to meet.

Looking Ahead: 2009

The prospects for Jamaica’s property market in 2009 are, in one word, challenging. The global recession that the IMF and most independent economists now regard as inevitable will reduce tourism revenues, suppress remittances, slow FDI, and constrain government fiscal capacity simultaneously. The housing market will feel each of these channels.

The Obama administration’s anticipated stimulus programme — widely expected to be in the range of US$700 billion to US$1 trillion — offers a potential floor under the US economy and, by extension, a partial floor under Jamaica’s external position. If enacted swiftly and effectively, it could stabilise US employment and, over time, restore remittance flows and diaspora investment capacity. But stimulus effects take time to work through an economy, and the first half of 2009 will reflect the deterioration of 2008 regardless of what policy actions are taken in January.

Jamaica’s property market enters 2009 with the structural features that should prevent a disorderly collapse: limited speculative excess at the cycle peak, conservative underwriting standards relative to the US market, a functional NHT providing countercyclical support, and a seller base that has, on the whole, preferred illiquidity to distressed sales. The correction will be real — in volumes, in the time properties spend on market, and at the upper end in prices — but it need not be catastrophic. 2009 will test that assessment comprehensively.

Jamaica Homes Monthly Housing and Development Review is published on the first business day of each month. This edition covers the period 3 December 2008 to 2 January 2009.

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