Bank valuations vs. market value
Raymundo Larraín Nesbitt, April, 10. 2018
Lawyer Raymundo Larraín explains the difference between both concepts as they are often confused by non-residents. He also ventures the start of a new expansionist super cycle in some areas of Spain.
Article copyrighted © 2018. Plagiarism will be criminally prosecuted
By Raymundo Larraín Nesbitt
Director of Larraín Nesbitt Lawyers
8th of April 2018
The Spanish property market has been a roller coaster over the last decade. From the dizzying heights of 2007 to the gut-wrenching lows of 2011. Over the last 15 years bank valuations have compounded this erratic behaviour exacerbating it. When property values were high, lenders overvalued properties by a long shot; when property values fell, lenders undercut property values even well-below their current market value.
I have been prompted to write this article on the back of low bank valuations which have nearly botched a series of conveyances I have been recently involved with as demand for Spanish property remains unabated. If you are an industry insider, you may want to skip this article altogether because it would be like teaching granny to suck eggs. This article is aimed to be read by neophytes who are largely unaware of how things work in Spain. I thought it would be a good idea to shed light on two points as I keep having to explain them to clients.
Firstly, to dispel a common blunder between non-residents that Spanish bank valuations are a true reflection of a property’s market value at any given time, which is simply untrue.
Secondly, why bank valuations seem to be always so out of touch with reality never seeming to match the real market value.
- Bank valuations are NOT a reflection of a property’s market value
One of the first things I was taught in Economics 101 at university, is that the price of a good is always determined by the intersection of demand and supply at any given moment. In other words, prices of goods and services fluctuate over time in line with demand and supply.
A property that was worth one and a half million euros at the peak of the market, can now go for €900,000. But it may have fallen as low as €700,000. So, what is its real price? Is it 1.5m, 900k or 700k? The ‘real’ price is what someone else is willing to pay a vendor at any given moment. If you can find someone willing to pay 1.5m, that is its current market value.
Bank valuations however do not reflect real market values. They are devised for a mortgage loan application and often are calculated for the purposes of an auction value (in the event of a bank repossession).
A common occurrence is for a foreigner to agree to buy a property for say €500,000, apply for a mortgage loan and then be upset to find out his lender values the property at ‘only’ €400,000. The buyer feels cheated at the €100,000 shortfall and becomes angry with the vendor, estate agent and even with the lawyer!
Bottom line, Spanish bank valuations are NOT a reliable assessment of a property’s current market value.
- Why are bank valuations so out-of-sync with the market value?
Lenders, believe it or not, have their own vested interests which at times (read frequently) are misaligned with a borrower’s interests. Lender’s valuations serve a purpose: the bank’s purpose, not yours.
- Why were properties overvalued during the property bubble haze? In the early two thousands the then Chairman of the US Fed, Mr Alan Greenspan, flooded the financial market with cheap credit on slashing interest rates. He inundated the financial market with cheap credit. This prompted a credit bubble of gargantuan proportions which led to a house of falling cards with which we are all too familiar. Back in the day, it was in the best interests of lenders to overvalue properties well-above the accepted market price so that borrowers borrowed as much money as possible (read up to their eyeballs) to over-indebt themselves. This (reckless) credit policy led banks to profit from huge gains in the short-term (at the expense of the mid to long-term growth). Basically, anyone with a pulse qualified for a mortgage loan. In my opinion self-certified mortgages exemplified like no other this ‘irrational exuberance’ (credit furore) at the start of the new millennia.
- Why are properties so undervalued now in 2018? Lenders suffered great losses post 2008 leading to hundreds going under. Many were forced to request state-backed loans to prop up zombie balance sheets. The Spanish government bailed out several banks but imposed harsh repayment terms in exchange. The slow and painful readjustment of the banking sector - which still endures a decade on - led to merges and acquisitions, tighter credit regulations and also to laying off dozens of thousands of bank employees and forced early retirements. As a result of this state-imposed downsizing, lenders are now ultra-conservative on their lending criteria and value properties prudently (read undervalue them significantly). The interest of lenders now, a decade on, is the opposite; to only lend money restrictively to creditworthy customers which actually have the ability to fully repay mortgage-backed loans. This goes on to explain why lenders nowadays purposely (under) value properties well-below the current market value, because they wish to spread the loan risk and force would-be borrowers to pay a larger percentage of the property’s value out of their own pocket. In the event of a default, a bank wouldn’t lose as much.
Buyers should not be shocked if their chosen lender values the property they are buying 25 - 35% below the agreed asking price. Bank valuations are simply a reflection of a lender’s credit policy, nothing more; which currently is ultra-conservative in the aftermath of the banking collapse of 2008 (The Great Recession).
What really matters on buying is that the property you are purchasing can be resold later on for a higher price. That is what should concern you foremost. Asking rental prices and capital appreciation underpin any sound financial investment. Spain's real estate market seems to be staging a comeback in full swing on both accounts according to the latest macroeconomic figures.
Asking rental prices are soaring by two digits year-on-year as reported by experts. The exact figure remains contentious, as some prestigious media, like El Pais daily, quote a 21% annual increase whilst others, such as El Mundo daily, estimate the national average rental increase to be at 10.2%. In any case, minutiae aside, the consensus is clear and unanimous that we are witnessing a whopping two-digit rental growth in asking rental prices year-on-year. Nothing short of a new rental bubble. I analyse this new lease frenzy in my article Holiday Home Taxation in Spain. Nothing short of a new rental bubble.
Capital appreciation is quickly catching up with the above figures. After having reached all-time lows in 2011, properties in Spain are gradually picking up the pace seven years on (abetted by historic ultra-low interest rates which translate into cheap mortgages). Although Spain’s real estate market remains largely fragmented in a two-speed recovery, with some areas steaming ahead whilst others sluggishly trail behind, there is a reported one-digit year-on-year gain across the board. And even stunning two-digit capital appreciation year-on-year in selected areas with prime beachfront locations as well as in large Spanish cities such as Madrid (17%), Palma de Mallorca (14.7%) and Barcelona (11%); source TINSA. Some bold economists and rating agencies (Fitch) are even predicting the start of a new property bubble…
The average rental yield in Spain can be expected at 5% pa (dependent on location). If to that you also add the potential of capital appreciation, Spanish real estate is poised for combined two-digit gains over the next years easily trumping alternative investments and paltry fixed returns in a context of historic ultra-low interest rates.
If one thing remains constant in Spain’s ever-changing property market is that it is cyclical (roller coaster metaphor). Hard data suggests we are geared towards a new expansionist super cycle.
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Buying property in Spain? Our law firm has over 15 years' experience dealing in conveyance transactions nationwide. Deal only with native English-speaking lawyers and economists, we will be very pleased to discuss your matter with you.
The thrust of my whole article can be neatly summed up in the wise words of a great American writer.
“A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain.” – Mark Twain.
American writer, humourist, entrepreneur, publisher, and lecturer. Among his novels are The Adventures of Tom Sawyer (1876) and its sequel, the Adventures of Huckleberry Finn (1885).
Larraín Nesbitt Lawyers, small on fees, big on service.
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Article originally published at Spanish Property Insight: Bank valuations vs. market value
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House Hunting in Spain – Interview with The New York Times. June 2015
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Buying Property in Spain from a Developer (Off-Plan Property) – 8th March 2017
How to inspect an off-plan property overseas – Q&A with The Sunday Times. July 2017
Buying Property in Spain – 10 Reasons to Hire a Lawyer – 8th November 2016
Non-Resident Taxes in Spain – 8th December 2015
Non-Resident Income Tax – 8th December 2017
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