Puerto Rico's Housing Prices Heading for a Fall

Puerto Rico Daily Sun
Monday, December 15, 2008
Vicente Feliciano

Real estate in Puerto Rico has been in the doldrums for a couple of years. The situation will get worse during the following months.

The key is the increasing number of construction loans with problems. Some developers are on the verge of bankruptcy. Non-accrual loans in the banking sector went from $1.5 billion in June 2007 to $3.1 billion in June 2008. Then they increased by a whopping $1 billion in just one quarter, reaching $4.1 billion in September 2008. The majority of this increase was construction loans, with several institutions reporting 40% of their construction loans in non-accrual status.

There are no statistics as to how well home sales are going. However, car sales could give an indication. During the period January-August 2008 car sales were 6% below the same period last year. During September they were off by 20% and in October down by 26%. It is unlikely that the housing market is performing completely different.

During 2008 the $25,000 tax credit for home purchases was available. In spite of this, developers were having difficulties to close sales. Starting in January they will not have the advantage of the tax credit.

In addition, the recently passed notary law had an exemption for projects that qualified for the tax credits. Notary fees could be 0.5% for the purchase transaction and an additional 0.5% for registering the mortgage. On January both rise to 1% unless Governor-elect Fortuño makes good on his promise to strike down the law.

Developers could lower prices in order to sell the inventory. However, DACO regulations state that if prices are lower the developer would have to extend the price cut to previous purchasers. Therefore, price cuts would be particularly painful for developers. There are ways to get around the regulation. For instance, developers could offer a car to go with the housing unit. However, it would add to the complexity and difficulty of the transaction.

Another problem for the housing market is the risk reassessment from the financial markets. Three years ago there were plenty of offers of 100% financing, interest-only loans with a seven year balloon payment, no income tax returns required to prove financial capability, and so forth. These are called non-conforming loans and they are presently hard to find.

Puerto Rico, with a low savings rate and a large underground economy, was particularly hard hit by this development. In June 2005 origination of non-conforming loans stood at $2,201 million. By June 2008 was $714 million, and the following quarter was at $610 million. It is expected that the number would be even lower for the period October-December 2008.

Interest rates on conforming loans, the ones that require a down-payment and income tax returns, have come down. This is propelling refinancing transactions, but new housing investment is more constrained.

The confidence of Puerto Ricans on the real estate market has been shaken. For over a generation they have seen nothing but rising prices. Recently, sales of existing houses have been hampered by the recession, stricter credit standards, and the $25,000 credit on new housing.

What will happen if banks foreclose on some of the new construction projects? Units will be sold at knock-down prices. This will push down the whole market.

Intervention by the Commonwealth government, using taxpayer money, delayed the day of reckoning. Faced with priorities such as the crisis in health reform and revenue shortfalls, the Commonwealth government is ill equipped to continue forestalling the forces of the free market. The only hope now is that President-elect Obama sends the cavalry of the Federal government to intervene.

Otherwise, it will be a rude awakening for Puerto Rico that the rules of supply and demand apply to the housing market.

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