Mallorca Property Market Update (10/10/08)

Spanish Property Article - Mallorca

Mallorca Property Market Update (10/10/08)

An Article by
David Novi

Summary

The latest Mallorca property market update from Novi Property Mallorca. Analysing the key economic and financial variables underpinning the market, and looking at how these are likley to change in the months ahead, we look at the prospects for owners and buyers of Mallorca property, where investment opportunities might lie, and the importance of market research and professional valuation advice.

Article

At Novi Property Mallorca while we have always tried to bring our clients regular updates on the Mallorca property market and general economic situation, it seems almost impossible, in the current world economic climate, to do so when everything is moving so quickly! What we say today may be very different to what we might conclude tomorrow!

That said there is still real value in looking at where we currently stand and what are the likely consequences for the Mallorca residential property sector both now and in the future.

While people still want to sell and others still want to buy (and this won't change even if the world economy falls into deep recession or even "depression") we have a "market" and thus issues of pricing and economic returns remain real. We can't all throw our arms in the air, go home and wait for things to get better (it would be a long sabbatical from "life on earth" if we did that!)

So what is the current situation and the economic backdrop likely to effect the market? Let's look at some of the basic variables that are, and will be, effecting demand and supply now and in the near term:

Demand

Consumer spending is starting to fall as a result of real factors - consumers have less money in their pockets, due to higher interest rates and mortgages etc and the very stringent tightening of available credit - and psychological factors - all the current uncertainty is making consumers much more conservative when it comes to making large expenditure decisions. All this is likely to feed into the general economy effecting profits, wages, employment etc and thus contribute significantly to the economic slowdown at regional, national and international levels.

Unemployment is on the rise and likely to rise significantly. Spain already has one of the highest rates in the EU, over 10%, and the result will be significant economic hardship for a very large number of people.

Interest rates are at historic highs in the Euro zone with the Euribor, main reference rate for Spanish mortgages, rising on an almost daily rate, putting more and more home owners in financial difficulties. While bad debt levels associated with residential mortgages stood at around 0.5% at the beginning of the year the figure is rising past the 3% level and could reach 5% by the end of 2008 early 2009. This is significantly undermining demand and consumer confidence. What will be interesting will be to see the reaction of the main international Central Banks in the weeks ahead and whether, as predicted, we will see the start of concerted cuts in base rates (as we write this the ECB, Federal Reserve, and Bank of England have cut rates by 0.5%). Although much will depend on the impact of these cuts on the key interbank lending rates, such as the Euribor (currently remaining on a stubbornly upward trajectory despite the base rate cuts), we suspect this will be one source of comfort in the months ahead, as liquidity and confidence returns to the market.

Credit squeeze (need we say more!) - the availability of mortgage finance has plummeted while the costs (interest rates and bank margins) soured. Until recently it could have been argued that there was still quite reasonable demand but the major problem was converting this demand into actual transactions due to restrictions on new credit. It seems likely that this underlying demand is now on the wane, due to the wider economic problems, although we would not say it has dried up (anecdotally both Novi Property Mallorca and others operating in the market note ongoing buyer interest even if the approach is ever more cautious and price sensitive).

Exchange rates - at least for non euro denominated purchasers the issue of exchange rates is very real. Over the last 6 months we had seen very significant strengthening of the Euro (or weakening of the other currencies depending on your opinion!) against Sterling and the US Dollar. The result was to effectively make any purchase around 15% more expensive. This trend is now reversing and although only time will tell whether this will continue, as many commentators predict, it looks likely that for UK and US buyers (particularly those with "cash") conditions will improve.

Supply

Vendors don't need to sell! This is in fact a real issue in the Mallorca market. A significant % of vendors will sell at the "right"price but otherwise seem happy to sit out the downturn. What will be interesting is to see how many will be prepared, and able, to do this if the length and depth of any recession increases as much as now seems possible.

The flip side is the number of vendors who do need to sell. Much will depend on what stance the banks take with regard to bad debts and associated repossessions / refinancing packages. Both politically and economically it seems likely that banks will attempt to renegotiate mortgage terms with consumers that run into difficulties, but undoubtedly the number of properties coming to the market for these reasons will increase in the months ahead.

While Mallorca is suffering much less than the Spanish Mainland from the "supply overhang" resultant from the unprecedented, and unsustainable, construction boom of the last 5 years, certain sectors of the market (low and mid range apartments and houses for example) are effected. In the last few weeks we have started to see real price competition and cutting amongst hard up developers, particularly in this market segment, with cuts of up to 30%.

It appears most developers have been quick to turn off the "supply tap" so at least it seems unlikely that the new build supply side will worsen

In summary there are certainly more negative variables than positive, and most importantly a great deal of uncertainty. What seems likely is that the general demand side will weaken further and this will put downward pressure on prices. How far prices will fall is perhaps the key question in every property owner's or purchaser's mind. While one could debate in depth the relationship between different asset classes (property, shares, bonds etc) particularly in relation to pricing, with world stock markets undergoing such significant corrections in pricing (European markets have fallen by over 30% during 2008) and supported by the negative supply and demand variables referred to above, it is very likely that property prices will fall significantly. Falls generally of 30%* during the course of this phase of the economic cycle are likely and as, until recently, owners in Mallorca seemed prepared to try to hold out the downturn, much of this correction in prices is still to come.

So what does this mean for potential buyers of Mallorca property, what should they do and who will be the active players?

"Cash is king". While the credit markets remain under such pressure and with disposable income levels falling cash buyers will be the main players not only because they will have the funds but because they will have the power to negotiate significant price discounts. We believe for these buyers there will be real value opportunities in the months ahead.

Valuation advice will be critical - While general comments can be applied to the market, absolutely critical in the current market will be quality professional valuation advice if buyers are to ensure they buy at prices that reflect true underlying values.

New properties - It is likely that there will be greater downward pressure on prices in the new homes market, as developers face increasing cash flow problems and slash prices in the months ahead. In the second hand market we foresee two markets emerging - a real market where prices closely reflect underlying values, and over priced properties where vendors either won't or do not need to significantly reduce asking prices. Research / professional advice will be very important in identifying into which market area any particular property falls.

We see land values falling offering interesting investment opportunities for developers and individual house builders. With construction contract costs falling, as builders compete for ever decreasing projects, this could be an interesting time to look at this sector of the market.

Exchange rates -We see improvements for Sterling and US Dollar denominated purchasers of around 10%. Along with falling prices this should make certain well priced properties interesting long term investment opportunities.

Due diligence, due diligence, due diligence! While this is critical in any market with "desperation levels" rising amongst estate agents and vendors, "hard sell" techniques are on the increase with pressure on buyers to sign reservation and option contracts before full legal due diligence has been undertaken. Choose a good agent or representative, use an independent lawyer and only sign when the latter completes all searches and other contract enquires.

*Note - Here we refer to "asking prices" not "values". In a rising market there is a tendency for asking prices to be significantly ahead of values, in the case of the Spanish market, generally some 10%. This differential tends to widen at the start of the downturn as asking prices remain on hold while values fall. As the bottom of the market is reached, characterised by increasing distress levels, asking prices can in many cases equate to underlying values as vendors apply a sense of realism and urgency to attract buyers. We are of the opinion that underlying values will fall by between 15 - 25% in Mallorca. Each case / property however requires individual attention / analysis, as some properties remain totally overpriced while others have seen price adjustments in line with true values in the market.