The following article is my first part on a five-part series focused on How to Buy Property in Spain Safely. You may also be interested in reading Buying Resale Property in Spain, Buying Off-Plan Property in Spain, How to Buy Commercial Property in Spain or How to Buy Rural Property in Spain.
In this article I’m going to focus, briefly, on the advantages and disadvantages of buying a so-called 'distressed property' from either a bank or a REA as well as shedding some light on the types of distressed assets available to small-time investors.
By Raymundo Larraín Nesbitt
Lawyer – Abogado
8th of August 2011
Spanish Banks, following the collapse of the Spanish Property bubble in 2007, have become the de facto largest Real Estate holders in Spain with thousands of properties on their books, whether resale’s or off-plans. Every major lending institution has incorporated specific real estate divisions to off-load the glut of properties available, acting as conduits. The number of unsold property in Spain is estimated to be in the region of one million units. The market will probably take a considerable amount of time, years, to absorb such a huge stock. And the pain will be prolonged furthermore if the credit shortage, the market’s lifeblood, is sapped away in the wake of increasing interest rates in the Eurozone.
As I have pointed out previously in other articles, this phenomenon has unleashed a fierce competition, with Real Estate Agencies (REA, for short) and Developers on the one hand, and lenders on the other, all vying to sell properties. In Spain you can choose nowadays whether to buy property from a bank or from a REA. You will be spoilt for choice.
Despite what many would believe, there is a case to be made in favor of REAs. The Market has already cleansed the majority of the fly-by-night rogue cowboys who had set-up shop in the heat of the moment and who gave a bad name to the Spanish property industry. The Estate Agencies which have been left standing after the dust has settled down are those which always had a more professional approach to clients and, in their majority, were already consolidated long-established companies spanning in some cases decades. I find it hardly surprising to witness how these well-respected realtors are still standing in the bubble’s aftermath given their hard-earned professionalism.
Types of Distressed Property
Broadly speaking, there are two main types of distressed assets available to pick from, hinging on whether a repossession procedure has concluded (or for that matter even started) or whether it is ongoing. Each has its own associated advantages and disadvantages.
1. Non-Performing Mortgage Loans, Key-Ready Properties or Pre-Auction Real Estate Assets (cesión de crédito)
Broadly speaking, NPLs is the typical case when a borrower falls into arrears by more than three months and faces the prospect of a repossession procedure. The lender, after three months in arrears, is in a position to issue legal proceedings against him. These properties, usually, involve a three-way negotiation between borrower, lender and investor. They are also known as short sales or fire sales.
Another sub-type of NPLs occurs when developers, unable to meet their financial commitments, relinquish ownership legally (following a legal procedure known as ‘dación en pago de deuda‘) and in exchange a lender discharges them from the mortgage debt, and its liability, in full (for more details on this procedure, please read my article on The Dacion en Pago Explained). In this manner, struggling developers are letting go of whole developments tallying hundreds of units. These are the type of so-called distressed property in which some investment funds (vulture funds) are specialized in acquiring, especially from ailing Spanish Savings banks. They have the leverage to negotiate huge discounts as they are buying properties in bulk numbers, in the hundreds, from Savings banks. In this particular case there’s only a two-way negotiation, investor fund and bank. The developer is now out of the picture.
Additionally, and exceptionally, it is also the case of bank properties which have already undergone a full-blown repossession procedure (‘Adjudicación Bancaria’ or post-auction properties) and whose previous owners have already been formally evicted by a bank. I write it is exceptional because a repossession procedure is currently taking, post credit-crunch, an average of 2-5 years in Spain. So post-auction properties available now, in 2011, are probably the ones which were repossessed early on at the start of the market’s collapse. We still have not seen the brunt of these much sought-after repossessions which everyone is keenly waiting for, quite simply because they are still NOT available in today’s market. The above should be noted by those eagerly booking flights to Spain expecting to find 50% discounted deals and who end up being sorely disappointed as these deals are, apparently, nowhere to be found.
The deluge of repossessions in Spain took place post 2008, when the Euribor rate, index to which 95pc of Spanish variable rate mortgage loans are referred to, peaked off reaching an all-time high in October 2008. Needless to say, these coveted properties, genuine bank repossessions, will truly be the “real deal”. These property’s prices will be well-below the market’s value (BMV). However, such properties are currently scarce as we’ve only yet seen a trickle of them. As repossessions in Spain peaked off post 2008, and a full repossession procedure is taking 2-5 years on average, the glut of bank repossessions will probably not be made available in the market until after 2013.
These are the type of properties which savvy investors picked up in Spain’s last recession, mid to late nineties, and who experienced an astounding capital appreciation in the ensuing real estate cycle. If you are lucky enough to pick one of these, you have guaranteed bragging rights.
- Pre-auction dwellings will be cheaper than your average market property, but not necessarily dirt cheap. The exception would be what I label above as genuine bank repossessions (post-auction) which are foreclosed properties that have undergone the full 2-5 year repossession cycle and which are now empty bank-owned property. These properties are genuinely below market value (BMV) but are currently scarce for the above reasons.
- They are key-ready properties. Meaning once contracts are exchanged you can take possession of them immediately being able to let them right off the bat (providing they have been issued with a First Occupation Licence, LFO for short, if they are off-plan). Additionally in some regions of Spain, i.e. Balearic Islands, a specific municipal licence is mandatory to rent a property. Not all properties can be legally rented in such regions, only those that qualify, so you can be heavily fined by a town hall if you are caught letting lacking the mandatory licence to rent. For more details on the legal significance of LFOs, please read my article on The Licence of First Occupation Explained.
- Banks will be able to provide you with unmatched lending terms, providing you qualify for a credit. You will be hard pressed to find better finance conditions elsewhere. Bear in mind lenders has a vested interest in selling these properties which entail maintenance expenses (property-related taxes, Community of Owners’ fees etc.) as their core business is lending, not acting as landlords.
- You can even inspect the property prior to making a decision on whether to acquire it or not. This is a huge advantage that removes uncertainty as you actually know what you’re money is buying. The owner’s permission will be required however, as they are still dwelling in it, but they are bound to cave in as it is in their own best interest to avoid a repossession procedure as this would potentially jeopardize their whole estate, whether in Spain or located elsewhere.
- You will waive having to wait for years on end until a long protracted repossession procedure is concluded.
- Pre-auction properties tend to be in a spotless state as the borrower, the owner, has a vested interest in shifting the loan burden to someone else ASAP. So it’s not in their best interests to trash the property. Post-auction, a bank will be the owner and they will likewise have a vested interest in offering an attractive property for viewings.
- Due to their nature, the procedure may be somewhat rushed when it involves a three-way negotiation, as time is pressing for the distressed borrower because a repossession is looming. Time is of the essence in this scenario as a Branch Manager can only do so much to stave off temporarily a full blown out repossession procedure. Even more so nowadays when many competencies have been taken from local branches and are now decided upon strictly from lender’s centralized headquarters. This disadvantage does not apply in two-way negotiations, bank and investor, as there’s simply no rush because repossession already took place and it is done and over with. The property is now owned by the bank, not by the borrower.
- You will need to have ready-at-hand a sizeable deposit to commit (normally a non-refundable security deposit) equating normally to 10-15% of the sales’ price to strike it off the market. Meaning you normally cannot rely entirely on a lender to finance the whole transaction, even more so if you are non-resident in Spain.
- Frequently REAs can offer better prized properties than those offered by banks. In fact, banks’ properties can seldom be labeled as a “bargain”, and frequently, in my humble opinion, may not be the best choice, at least now in 2011. This may well change as from 2013, when sought-after repossessions are released en masse. I will go into more detail on this further below.
2. Bank Repossessions or Post-Auction Properties
These foreclosed properties, on which borrowers have defaulted, are subject of an ongoing repossession procedure with everything this entails from a legal standpoint. The lender is in the process of repossessing the property and has still not taken possession of it (whether physically or legally). If you want to delve further on the matter, you may want to read my in-depth article Bank Repossessions in Spain.
- The prime advantage is the extremely low price fetched in a Public Auction allowing banks to sell on these properties well-below their true market value (BMV). Public Auctions in Spain, following new regulation, mean a lender can withhold an auctioned property for as little as 60pc of its appraisal value if no one bids on a second round (this used to be 50pc early on this year). This means, for example, that a property that has been valued at say 100k, specifically for auction purposes (but whose real market value can be as high as 150k), the bank will get to keep it for only 60k (that is 60pc of 100k) when the auction is over (providing no one bids, the bank gets to keeps the property that was acting as collateral for the mortgage-backed loan). These appraisals, which are specifically for the purposes of a Public Auction, are already well-below the true market value. So, following with my example, this would translates into a 40% “discount” being applied to a base value (100k) which was already well-below the intrinsic market value (150k). In this case the bank has adjudicated itself, post auction, a property that is worth 150k for only 60k; I’ll do the Maths for you, that is a 60% profit on its real saleable value. Another matter, of course, is just at what price a bank will sell on the property for…The bank at this point in time, post auction, has now been declared as the formal legal owner to the property, but still has no material possession of the property, as the owner, and his family, need to be evicted now.So all in all, on buying an ongoing bank repossession, you are looking at discounts which amount, at the very least, to well and above 50%, as explained in my above example. On signing a mortgage-backed loan in Spain, a Mortgage deed will always include two valuations, one specific for the purposes of a Public Auction (which is well-below a standard market valuation) and a second one representing the loan-to-value (which is the valuation everyone is familiar with). The 40% “discount” a bank obtains on adjudicating itself a property in a Public Auction is applied on the lower valuation, the one specific for the Public Auction.
- Repossession procedures take long in Spain (years). This has been aggravated by law courts being clogged with procedural matters post credit-crunch. Meaning that at no time will you be able to take material possession of the property until the procedure is fully over with, years.
- At no time will you be able to inspect the property prior to making up your mind, as the owner must still be vacated, by force, if necessary. You are buying the property as is. The reason being is because the bank does not have possession of the property. The borrower, the owner, is living in the property and is in the process of being evicted so they will naturally have no interest in showing a buyer the property. So basically you are blindly buying a property relying exclusively on the veracity and accuracy of the Land Registry, which as we know, is not always that accurate i.e. undeclared extensions undergone by rustic property.
- It may fall on the buyer to legally vacate the owner, and his family, with the assistance of a lawyer and court agent, which may prove very stressing bringing all sort of undesirable surprises. Besides, this will entail additional legal disbursements (formal eviction procedure) and time. For more details on how eviction procedures work in Spain, please read my article “How to Evict a Tenant who is not Paying the Rent”, from 2007.
- Banks may leave it up to the buyer to carry out all the necessary legal checks on the property i.e. Planning irregularities, existence of an issued Licence of First Occupation, undeclared extensions, outstanding fees owed to the Community of Owners, ongoing boundary disputes with neighbours etc. Do not think for one moment that only because you are buying a bank-owned repossession, the lender is guaranteeing it is fully legal unless they commit themselves, in writing, in a contract, to ensure its legality on a buyer’s behalf, and even then, you should still double-check its legality regardless. It normally falls onto the buyer, or more likely his appointed lawyer, to carry out the legal checks.
- Borrowers can trash the property on being evicted legally to the point the damage seriously detracts from the assets’ worth. Neither the lender, nor the law court, nor your lawyer can be held responsible for this. It’s a chance you take on buying such distressed property and is entirely unforeseeable as you cannot inspect the property previously; it’s a calculated risk you are taking. You simply cannot take pre-emptive measures to avoid it. Naturally the ex-owner can be held accountable for their actions, but in practice it will be futile as they will normally be assetless, which is why they are being repossessed in the first place. So even on winning a case against them, you will not see a penny.
- You will need to have ready-at-hand a sizeable deposit to commit (normally a non-refundable security deposit) equating normally to 10-15% of the sales’ price to strike the property off the market. Meaning you normally cannot rely entirely on a lender to finance the whole transaction, even more so if you are non-resident in Spain.
- Frequently, post 2003/2005, mortgage-backed loans attached huge charges that outstripped the intrinsic property value, as a consequence of lax lending criteria and appallingly flawed valuation standards, which in practice negate any profit-taking. Meaning the asset is actually worth less than the attached loan defeating the whole purpose of investing in it as numbers will simply not stack-up. Hence the large number of public auctions in which no one is bidding in Spain; not even professional bidders (Subasteros) who are steering clear of them. Statistically, 9 out of 10 auctions in Spain remain without a bidder and it is basically because of the above reason (negative equity). To this you must add of course, the shortage of liquidity in Spain, as a mandatory deposit of 20% (it used to be 30%) is required to be lodged before the law court prior to the auction to qualify as a potential bidder.
Banks vs. Real Estate Agencies: It’s the Credit, Stupid!
As explained in the article’s introduction, banks are now competing against REAs and Developers to sell distressed assets. I will be grouping Developers and REAs within the same group for simplicities’ sake. There are significant advantages and disadvantages associated to choosing from one or the other. However it must be noted that banks lately, after having realized just how complicated it is for them to actually sell property to foreigners, are increasingly hiring or retaining the services of foreign realtors in-house or else outsourcing the sale process altogether to REAs so as to off-load their crammed property portfolios.
Acquiring Distressed Property from Banks
- The most significant –and unique– advantage is, without doubt, privileged lending terms, credit if you will. As I noted back in 2009, lenders were falling head over heels to offer the most attractive financial terms to investors willing to acquire bank-owned properties. The reason is obvious. Spanish Banks are desperate to shift their ever-growing property portfolio, even more so in the midst of rising interest rates and record-high unemployment levels, to investors so as to both transfer risk and ongoing maintenance expenses. These remarkable lending terms, reminiscent of the boom days, are unavailable for external properties not directly bank-controlled. Moreover, as the ECB will foreseeably be hiking the official interest rate for the Eurozone to stave off increasing inflation risks, Spanish lenders will be increasingly under pressure to shut off credit making it all the more inaccessible as they themselves will struggle to secure credit from foreign markets except, of course, the unrelenting ECB facility. This will widen the gap, furthermore, between offered finance on bank-owned properties and those which are freely-owned ones, making it increasingly appealing to buy the former solely from a credit-perspective. Estate Agencies and Developers, free-market companies, are bound to struggle facing tough competition from lenders’ State-subsidized (or even European-subsidized) superior lending terms.
- Properties offered by banks are, generally speaking, overpriced and you will be hard pressed to find a bargain.
- Properties offered by banks are, generally, not well-located.
- Properties offered by lenders are not usually properties that cater to foreigners’ tastes and in fact, generally speaking, appeal more to Spanish buyers.
- Banks generally lack the professionalism, the know-how, which Real Estate Agencies have built upon over the years. Do not expect from a bank the same service level agreement (and in English!) that you have come to expect from a private realtor. For a bank employee, showing a prospective client a bank-owned property, is a tedious burocratic chore that detracts valuable time from their core tasks with no specific reward attached to it; for an Estate Agent, it’s their bread and butter with a possibility of making a commission. EAs will be genuinely interested in providing a good service (their commission depends on it!) whereas bank employees regard it as an unrewarded additional burden consequence of today’s market downturn.
Acquiring Distressed Property from Real Estate Agencies
- REAs tend to have in their books better-priced property, genuine bargains, whether resale or distressed.
- Offer a much wider selection of property. The reason being is because they are flexible, networking alongside other REAs to pool in databases, sharing offered properties, as well as those offered by banks. Banks, on the other hand, have their offer restricted solely to properties they own.
- Offer generally well-located property.
- Offer properties that appeal more to foreigner’s tastes.
- Offer increased professionalism.
- Can speak and write fluently in your own language.
- Are unable to compete with banks’ superior lending terms on acquiring their properties. This is obviously not a concern if you are a cash buyer.
- Are financially weaker than a bank and may go under with your deposit. That is why I advise caution, dealing only with long-established agencies which you can trust. Security deposits should be paid always into law firm’s accounts, not into REAs accounts. Make sure the lawyers you hire or deal with are registered to practice and members of a Bar Association. Unregulated companies pretending to be law firms are sadly rife in Spain. Only registered lawyers have Professional Indemnity Insurance for negligence or malpractice. The same is true of genuine law firms, they also have insurance covers. If unsure, always contact the local Colegio de Abogados (Bar Association) and ask if a lawyer, or law firm, are indeed genuine and registered to practice.
- At times, less serious outfits, do not offer genuine bargains. Some of the advertised so-called 'bank repossessions' are not genuine repossessions at all and are fairly overpriced in my opinion. They are in fact overpriced pre-auction properties, normally unsaleable off-plan, which mislead customers into thinking they are buying post-auction properties (repossessions) when it is simply not the case. To entice gullible would-be-investors, they will show overinflated bubble prices, at which these assets never sold in the first place, and offer a 50% discount on that unrealistic overinflated price tag, which still may be well-above the current market value, by the way. And they, misleadingly, label and market these as 50% discounted “bank repossessions”. Needless to say, this is no bank repossession, it’s a con. Over the last years there’s been a hyped flurry over Spanish repossessions and the much-vaunted 50% discounts which are explained in detail in my article on “Bank Repossessions in Spain”, from 2007.
Buying Distressed Property in Spain – Conclusion
As can be gleaned from all the above, there is a clear correlation between risk and reward.
Key-ready properties, NPLs, offer less reward, in terms of making money quickly, but in exchange offer legal and material security, besides being readily available. You surely won’t be able to brag to your friends on what a shrewd businessman/businesswoman you are. These distressed properties are advisable to small-time investors who are on the lookout for a relatively well-priced overseas holiday home rather than making a quick profit from an investment.
Ongoing bank repossessions offer the highest rewards (discounts above 50%) to the dauntless. But likewise, have the highest associated risks. I would advise these properties are acquired only by expert savvy investors who can bear the financial brunt of unexpected losses and will normally be buying units in bulk numbers at specially pre-agreed discounted prices from financial institutions.
As pointed above, in general terms, the best bargains to be found offering the best risk-reward ratio, are genuine key-ready bank repossessions or maybe even daciones en pago (handing back the keys to a lender) which both small-time and professional investors may buy. However, these properties are currently scarce and, as highlighted above, you must be wary of them not being in negative equity due to lenders’ placing huge charges on them in the boom times because they had unrealistic overinflated valuations to begin with.
While it’s true there are exceptional opportunities available now in the property market, you ought to ponder in your decision-making serious ongoing risks, such as currency fluctuation (i.e. sterling) which may bring losses in the long run when sterling recovers against the euro if you buy now, creeping interest rates in the Eurozone which will affect your ability to repay a loan, generalized deflation of real estate assets, credit shortage aggravated by rising interest rates, and last but not least, is Spain’s noteworthy ongoing sovereign debt problem which consequences still remains to be seen. But ironically, it is precisely because of all the aforementioned market uncertainties that unique bargains are to be found in today’s market, a buyers’ market, not apt for the faint of heart.
Finally, as per usual, I cannot stress how important it is to hire a lawyer to examine the transaction previously and advise accordingly.
“It was the best of times, it was the worst of times.” – Charles Dickens. A Tale of Two Cities.
English writer and social critic. He created some of the world’s best-known fictional characters and is regarded as the greatest novelist of the Victorian era.
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