Dark clouds ahead for Commercial and Residential Real Estate (CRE + RRE) in The Netherlands. Whole construction industry needs in fact a restructuring.

Last Saturday, when I went to the super market with my wife and children, I was again annoyed by the fact that all formerly vacant space in my residence Almere (The Netherlands), seems to be built full with new commercial real estate (CRE) and combinations of CRE and residential real estate. Playgrounds and parking lots are filled up with an array of unattractive office/apartment buildings, that seemingly nobody asked for.

And also in other cities and villages this building frenzy for CRE and RRE doesn’t stop yet. Municipalities sell every vacant meter of building ground in order to get direct income and future tax revenues out of it. Project developers and building companies still take the gamble to build this ground full with houses, apartment buildings, business premises and offices, hoping to get a bigger slice of the CRE/RRE pie.

Companies, lured with reduced energy costs, tax breaks, favourable establishment conditions and improved facilities, leave their old office space behind, in order to rent space in new office buildings. The old office space often remains vacant for a long time or even indefinitely. All this reshuffling of companies from their old office space towards new office buildings, makes that there is a substantial average vacancy of 15+% in CRE in The Netherlands, with local peaks at 25% or more. The result: more industrial zones in every city and village, filled with ugly buildings and warehouses; more unused office space everywhere and less room to breathe and to recreate for the people in The Netherlands.

And also in the Residential Real Estate-market, there is a problematic situation: the deadlock that has the RRE-market in its grip, makes that news houses and condo’s outside the most popular cities, like Amsterdam, are also (much) longer vacant than planned in advance. Private housing is currently much too expensive and all attempts of the government to get tenants out of rented houses into private-owned houses, by making renting more expensive, are causing a deadlock in the rental housing market too.  

Tenants that have a cheap social rental house/condo, keep this, even though they could afford a more expensive one in theory (outside the ‘social sector’ rental market). Moving to a larger rental house/condo, would mean they lose their current favourable terms and they would have to pay much more rent, due to their higher income. Many tenants cannot or won't afford this.

Starters at the housing market have only access to cheap rental houses if they have a very low income, otherwise they are forced to look for houses at the so-called ‘free sector’ rental market. They also can't afford this. A private-owned house is currently for many tenants one bridge too far, due to the unsustainable prices on the housing market.  Result: a perfect lockup at the private-owned and rental housing market. And houses and apartments that are built for… nobody.

Summarized, the real problems in The Netherlands are:

·   The CRE-market has a 15-20% structural overcapacity currently. New office buildings and industrial zones cannibalize on older office buildings and industrial zones, by attracting the companies that had their residence there.

·   The private-owned and rental housing market is in a perfect deadlock, that won’t be removed until the government, municipalities, banks and realtors takes measures to lower the housing prices (renting and private-owned).

·   The whole complex of municipalities, project developers, investors and the construction industry is set up for a larger supply of CRE and RRE, than will be in demand in the coming years.

And there is another development that might send shockwaves through the CRE and RRE-market. This can be read in the following article in the Dutch financial newspaper “Het Financieele Dagblad” (http://www.fd.nl/). Here are the pertinent snips.

ASR abolishes € bln in real estate.

The large Dutch insurance company and former Fortis subsidiary ASR wants to sell €1.1 bln of its real estate, consisting of shops and shopping malls; a quarter of its total CRE portfolio. With the sales operation, ASR is front running the stricter capital demands that will be established in 2013 as a consequence of Solvency 2. These stricter rules force insurance companies to keep up 49% of capital on their real estate investments.

The association of institutional investors, the IVBN, notices that other members are also wrestling with the high capital demands that are associated with the new Solvency 2 rules. ‘These rules might force insurers to reduce their investments in real estate’, according to executive director Frank van Blokland of IVBN. Next to ASR, the insurance companies ING, Delta Lloyd, Achmea and Generali should keep more capital for their real estate investments.

‘The market has fears for the new capital demands’, according to Director Real Estate Ad Buismand of Ernst & Young. ‘There are fears that insurers will substantially reduce their real estate portfolios. The risk is that prices will be put under even more pressure’. After the pension funds (€68 bln), insurance companies are the biggest investors in real estate (€15 bln). ‘Bears see Solvency 2 as the kiss of death of the real estate market’.

That ASR doesn’t await the establishment of the new rules – this could still take a number of years, due to a transitional period – is caused, according to the company, by the fact that ASR (as one of the last insurers) still manages much real estate themselves.

In better times than these, it would already be an economic challenge when the whole insurance industry with their €15 bln real estate portfolios, want to abolish substantial parts of these portfolios. In a normal situation, this would already cause enormous pressure on real estate prices.

But now, when the whole CRE+RRE market is already in deep trouble with overcapacity, structural vacancy and stagnating prices, Solvency II might hit the real estate market like a perfect storm. Because the question is in this very troubled market: who will buy it??? Let’s look at some candidates:

·   Pension funds? No, they have already their own problems with:

o    low coverage ratios;

o    the uncertainty on the new pension agreements;

o    investments yielding too little;

·   The banks? The four large banks are all more or less busy to abolish their CRE-portfolios, due to disappointing yields and new capital demands, as a consequence of Basel III.

·   Private investors and project developers? Some might be willing to invest in ‘bricks and mortar’, but only on absolute A-locations. Most CRE is (of course) not in those locations.

·   Remains local and central government?! This would be an expensive way to keep taxpayers’ money locked up for years to come.

In the end, it might be that demolition of substantial parts of the portfolio’s is the only way to revive the CRE and RRE market. That is a large destruction of capital, but might prevent more good money thrown at bad money.

And for the building and construction industry as a whole, including project development?

I’m afraid that about 30-40% of the companies and workers in this industry is doomed to disappear. Because the current CRE/RRE-market is based on unsustainable overcapacity: building houses, offices and shops that nobody wants to have or nobody can afford. And this business model will go wrong in one way or another.

Of course, this 30-40% is not based on a thorough investigation of the building and construction industry. But if you reckon that there is (in average) 20% of vacancy in the CRE-market, of which 15% is structural. And if you reckon that building companies are still finishing new CRE-projects every day. And if you further look at the stagnating housing market in The Netherlands and the unwillingness of all parties involved to do something about this stagnation and you add this all up: then seems a disappearance 30-40% of the current construction workers not a very wild guess. Because this whole industry is already playing in extra time for at least 5 years. And the market does not grow more favourable on this industry.

If the central government is smart, it would advance to this development by searching for other working opportunities for large parts of the workers in this industry. But I’m afraid that politics will assume the ostrich position until it is too late.