The Only Type of Property You Should Buy in Spain

Monday, December 13, 2010

Dear Reader,

As a reader of these dispatches, you will know that some international real estate markets are in crisis...and that's creating opportunities for buying distressed property. However, when buying distressed deals, you need to follow some simple rules.

• Never take on construction risk. Only buy completed units.
• Never take on project risk. If there are 300 units in a project, but only 30 have sold, steer clear. Think about it...who's going to pay to repair the elevators when they break down?
• Buy quality.
• Avoid areas of oversupply no matter how cheap the sticker price. Areas of severe oversupply will likely continue their downward trajectory for the foreseeable future.
• Look for intrinsic value. Beachfront, or historic buildings, will always have appeal.
• Remember, prices and valuations can be completely "made up". Look to compare prices with verifiable recent transactions.

Colin Murphy focuses on distressed deals. He brought our readers some strong opportunities in the last twelve months. Colin went on a scouting trip in Spain recently, with a member of my Real Estate Trend Alert (RETA) group. He compiled a short report on the trip.

I like Colin's analysis of what he saw. He covered all the bases. Read his piece below...

Ronan McMahon

My Take on the Spanish Property Market

I was in the south of Spain earlier this week with an American who wanted to purchase a holiday home. I´m in the area often enough, but I haven´t spent time viewing a variety of properties along the coast and in the hills behind it since the middle of last year.
I figured it would be a good time to see what had changed and if there were any great deals out there.

After some intensive online researching and about 1200 miles on the road, we ended up viewing 17 properties, located in Las Mijas, Almuñecar, La Herradura, Lentigi and Granada. If you're not familiar with Costa del Sol, that's a pretty decent mixture of small versus large towns and coastal versus mountain properties.

One of the village properties we viewed in the mountains of Granada had extraordinary views and was really well priced at 105,000 euro ($198,067). Most village properties aren´t like that though, and the owners of them generally wanted 30-50% more than any rational buyer would be willing to pay.

Medium quality - it´s not going to work as an investment strategy
With the exception of one (which I'll come to later) the coastal properties we saw were of medium quality and prices were generally 10-30% lower than peak rates. Think 190,000 euro ($251,313) for a two-bed and 240,000 euro ($317,448) for a 3-bed, with either sea views, or walking distance to the beach, or both. The trouble with these units is that there are tens of thousands (and perhaps hundreds of thousands) of them all over the Spanish coast.
They'll make perfectly nice holiday homes, but supply will exceed demand for another decade or more. That makes it difficult, if not impossible, to foresee even modest capital gains for the owners of these properties. As for rental yields, you'd be lucky to get 2-3%.

100% mortgages in Spain - what´s the catch?
As a property agent with a reasonably high profile, we receive a lot of requests from developers to promote their products. An increasing number of these have been Spanish developers offering 100% mortgages (including closing costs) for buyers and high commissions (6-10%) for the agents. They're usually big developments (500 units+) with facilities such as swimming pools, golf courses, sports centers, shopping malls etc.

I've always had suspicions about these developments and I included one in our schedule to satisfy my curiosity. I won't give away too much information about the resort we viewed, but there are lots of them in the Costa del Sol and it´s highly unlikely we will ever promote one.

The development we viewed had more than 1000 units all told, and although construction has completed, most have never been occupied. The developer told me they were 80% sold, but he actually meant that they've taken 20% deposits for 80% of the properties pre-construction... most of these buyers probably have no intention of completing, certainly not at 2007 prices.

As sales fell off a cliff in late 2008 and people delayed closing, the developer's cash flow dried up and funds have clearly not been available to maintain the resort over the past 18 months. Mould was visible on every property we viewed with cracks on the interior and exterior walls, walkways and ceilings. No heating or lighting fixtures had ever been installed.

The golf course was overgrown, the sports centre was never started, the shelves on the supermarket were bare, and the entire roof of the indoor swimming pool will need to be replaced due to the inadequate air conditioners that were installed.

The developer clearly owes the bank a fortune and the bank is desperate to divide this debt between hundreds of buyers rather than one developer (who is probably insolvent).
Hence the 100% mortgages.

The pitch is that the bank provides 80% on their "valuation", the developer "pays" your 20% deposit plus your closing costs and then you get your "free" property with exclusive access to their rental pool.

Give me a break!

So you get a 2-bed property for 250,000 euro ($330,675), without having to spend a penny. You just need to service a 200,000 euro ($264,540) mortgage over 20 years at a variable interest rate with a net rental income that probably won't amount to more than€4,000 euro ($5,290) per year. Setting aside the substantial problems with the existing and non-existing facilities, no other bank would give you a valuation of more than 175,000 euro ($231,472) and they wouldn't lend you more than 70% of it.

Clients ask me about Spain all the time and I've no doubt that my company, Torcana, would have quite a few takers for Spanish property like this with 100% mortgages, great facilities and easy access to the beaches and airports. We'd mostly sell them to people who would buy sight unseen. We might sell 50 of these over two months if we put our minds to it, and we´d make a tidy commission on them all.

The only problem is that our reputation would be destroyed within a year, because these are terrible investments.

That doesn't sound like a sustainable business plan to me and so it looks like we'll be sticking to places like Florida until other markets become sufficiently attractive (not to mention safe) for investors.

I´m curious about two things
Firstly, why are Spanish banks allowed to blatantly inflate the valuations of properties on their books and then offer mortgages on them? It is incredibly unethical.

Secondly, what sort of property agent would actually encourage their clients to invest in resorts like this? If they had visited the site before promoting it, they'd have noticed everything I pointed out above. If they haven't visited it at all and were in the dark about what was going on, then it's unlikely a serious buyer would trust them with their money.
The result of all this is that lots of naive buyers are going to get (forgive me) screwed, but they won't purchase anything close to the amounts of properties needed to reduce the current oversupply and return some semblance of market normality to the area.

It´s not all bad news - there are some gems out there
As mentioned above, we did actually view one property that was worth putting an offer on. In my opinion, we found pretty much the only type of property I would ever encourage an investor in coastal Spain to purchase.

It's in a small development, with 120 units. The surrounding area isn't overdeveloped. There were only 11 units available and asking prices have been reduced by 40% from peak. There are no mortgage gimmicks on offer. There was plenty of activity in the resort and lights on in many of the units, an encouraging sign in late November. Most owners are keeping them exclusively for personal use - they don´t want to rent them out.

The quality of the properties is extremely high - the floors, walls, fixtures, lighting, electronics, heating and security were all at a standard comparable to a five-star hotel. It was located 400 meters from the sea, close to lots of shops, bars, and restaurants, and with easy access to the motorway, the airport and the train station.

My friend will probably put a lowball offer on a two-bed two-bath unit with spacious interiors and a large garden and terrace. The asking price is 40% below the peak rates, and they'll probably accept 50% below peak prices for a cash deal and an end-of-year sale.

Even with this great price and the lack of rental competition in the resort, the net rental yields are still going to be very low - about 3.5%. That´s probably as good as you can get right now.

In my view however, this is the only type of property in Spain where you have a varied exit market strategy and a real chance of selling at a profit in five to seven years time. The problem of course, is that there aren't very many of these deals around, and you'll need at least a 30% deposit.

Spain - still a wonderful country
That's Spain for you, folks. It's an incredibly beautiful country with world class infrastructure, culture and cuisine, but the property market is in tatters and the banks controlling it are in denial.

In short, we need to keep waiting until the market turns in our favor and/or something exceptional lands on my desk.

Unless you want to purchase a vacation home and you're happy to settle for a low rental yield, just stay in a fancy hotel or rent a nice property whenever you come to visit.
As you might imagine, there's plenty of both for you to choose from.

Colin Murphy

Editor's Note: If you'd like to find out more from Colin...or about distressed opportunities...you should consider joining RETA. You'll hear about the latest distressed deals, and other real estate opportunities.Click here to find out more.

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distressed

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