Panama Real Estate Investment Travel Information


Panama City Boom and Bust Cycle

(11 votes)

Written by Matt Landau

Friday, August 10 2007

My old college economics professor, the same guy who wrote the letter "F" so many times on papers and tests, helped me analyze the past, present, and future of the Panama real estate boom. How do economics explain what is happening today in Panama City and why, by law, will this market "BUST"?

You hear the word "bust" tossed around a lot, but economically speaking, what does it mean and will it in fact occur in Panama?

The case, say five years ago in Panama City, was that you had a very inelastic supply. What is an inelastic supply? An inelastic supply essentially means that in this period, NO inputs could be altered. Even if the price of Panama City real estate was increasing, there was not enough time to increase the quantity being that real estate takes time to produce, several years in most cases. This period several years back, economists refer to as the market or momentary supply which can be seen on the graph as Sm.

The next shift we saw here in the city was known as the Short Run. These were the few years following that initial boom during which variable inputs (such as labor or raw materials) could be altered. Workers were brought into the city from the interior of the country and various materials such as cement, wood, and marble were shipped in as well. This increase in inputs meant a slightly more elastic supply curve, showing in the graph as SS.

The last period, and that which I believe we are currently experiencing is known as the Long Run (seen on the graph as SL. This is the period in which all inputs become variable: meaning once-fixed inputs like capital equipment now become changed. This was the point when we started seeing the shortage of cranes I'm guessing. Since Panama developers had time to adjust and adapt to changes in the market, my professor explained that supply elasticity is greater in the long run than in the short run.

As we have seen in Panama City, the more time that elapses after a price change, the greater the response will be from sellers.

Starting Point: Suppose the market for condos on Balboa Avenue is in long run equilibrium at pt A on the graph. The equilibrium price for these condos in 2002 was, say, $700/m2 and one per day was sold. At this price there was no incentive for anyone new to enter the real estate business and no incentive for anyone currently in that business at the time to leave. All developers in the city were earning a "normal" rate of profit.

Shock to the System: This shock came about three years ago: it was relatively unanticipated and the effects were a permanent increase in demand. We can speculate that this may have been the result of natural disasters in the states, or baby boomers, but in reality, no one really knows what caused this shock to the system! Some theorize that some group (maybe a Multinational) had a part. At this point, the increase in consumer demand increases only the price (not quantity) in the market time period. We get to point B with a price of, say $3,000/m2 for that same Balboa condo.

Short Run Response: How did developers react to this increase in price? This higher price allowed developers to earn a higher than "normal" profit and in an effort to take advantage of this higher price, developers adjusted their inputs in production. In the short run, only variable inputs can be added--labor and raw materials. It pays developers to hire extra crew, to fix old equipment and to search for new product. These short run supply responses increase the quantity supplied of Balboa condos. In essence, the supply curve (which was perfectly inelastic in the market period) becomes somewhat elastic as time elapses and these short run adjustments can be made. Notice that the market price of the Balboa Apartment falls to $2,000 and about 3 are now sold per day (pt. C).

Long Run Response: In the long run adjustments to capital stock can be made. In other words, more cranes can be brought into service. How long does this take? Every industry will be different. It may take two years (or longer) for new equipment to be ordered and built. Once new equipment is brought on-market the quantity supplied becomes even greater. [Note: We ignore here environmental sustainability and the potential impact of ‘development'.] While the volume of condos being sold is higher (5 per day), the market price has dropped to $1,000/m2 (pt. D). If you borrowed money to buy a Balboa condo expecting the price of that condo to be at $3,000/m2., you are now in serious trouble! (Note: these numbers are semi-arbitrary. We're not saying that $3,000/m2 is the limit, but a limit does in fact have to exist).

So what happened? The market price boomed, and then it busted. The explanation for the boom is simple: more people wanting to buy the limited available supply in the market time period. This creates a temporary spike in price. A lot of "suckers" are drawn into this market, lured by the expectation of making a quick buck. Any time you hear about "easy money" to be made, beware of the potential bust! As lots of sellers scramble to profit from the higher price, they bring more resources into the industry. This leads to increases in output over time (the supply curve becomes more and more elastic as time passes). Hence product price falls to a point at which eventually all above-normal profits are eliminated.

Assuming no other changes, pt. D is the final resting spot where the market again reaches a long-run equilibrium point. Surviving firms at pt. D are earning only "normal" profits. Those "suckers" can survive in the market ONLY if price is higher than $1,000/m2. Others will be forced out of the industry-bankrupt, closed up, their resources sold off.

There have been many boom and bust episodes in world history. Examples in the USA include: the market for commercial office space in the 1980s, the market for Beenie babies, the markets for most commodities: coffee, sugar, chocolate, spices, oil and many others. This story is a reminder of how relentless competitive markets can be in providing consumers with the lowest possible prices for goods. While this long run supply response is wonderful for consumers, it spells doom for some businesses. It also explains why businesses tend to hate competition, some attempting to form (illegal) cartels to limit supply (as in the oil cartel OPEC).

This is all thanks to Dr. Wight whose words are still sometimes over my head. But I think his report can help understand where we are in Panama City real estate, and perhaps where we are going. While it doesn't necessarily take into account all factors exclusive to Panama, it does prove that the Panama real estate market is not invincible. It will, barring the miracle that ‘demand increases forever, eventually hit a ceiling and prices will fall. And while that is not to say that buildings will be empty (because they very well may not: people with less money may move in and occupy units because Panama City is such a cool place to live), it is technically what people mean by BUST.

Comments (2)

Jesse J: ...

Interesting analysis, I surely think we are getting past the peak and it will be very interesting to watch as so many units complete over the next 1-2 years.

Then it will be further interesting to see where the market settles. Will it be $1500? $2000? back to $1000 or lower? Time will tell.

The good news is we have the baby boomer factor that pretty much secures some return on any condo investment that isn't ridiculously overpriced and that you are willing to hold onto for a few years anyway. At the end of the day the prices are still lower than much of the rest of the world.

August 15, 2007

Serge: price of cement