Borja Mateo (www.borjamateo.com) is a real estate expert and author who believes many people misunderstand the property market, which leads them to make the wrong investment decisions. He recently published an article in the Diario de Mallorca answering some basic questions about the current state of the market. Here we summarise his most interesting points.
The current state of the market can be gathered from the following facts: Prices of real estate have fallen around 48% since their peak. There are between 6.1 and 8.5 million properties which are either empty, under construction or in the rental market. The annual demand for new housing is of 130-170 thousand units, so the existing housing stock will be enough for many years. Current prices still do not reflect this over-supply reality.
“The area in which I am interested is different” This is a common mistake. The drop in real estate prices affects all areas to a greater or lesser extent. Reduced access to credit and the high supply of properties are relevant factors currently affecting all areas. It is true that some areas are less affected than others, but it will be dangerous to believe that a particular area is completely immune to drops in prices.
“Banks are going to start lending soon and prices will skyrocket”. Reality is quite different: banks are not going to go back to previous lending levels anytime soon. The Basel III reform, which has greatly affected the credit market, means in practice that much less credit will be available for families in the near future.
“Lowering the price any further would be like giving the property away”. False. No property owner thought prices would drop like they have, but it happened. Prices that seem bargains today, in a few years may be considered expensive. It is a fallacy that prices will not go any lower. Only when the number of property transactions has recovered strongly we will be able to say that prices have bottomed out: for this to happen, we think prices have to come down even more.
“Nobody is going to sell a property at a lower price than the one they paid for it”. These days, buyers and tenants have the upper hand. The over-supply of rental properties is pushing prices down. Lower rents mean lower property valuations, as their potential rental yield is factored in. This underlying conditions are not going to change for a while.
“The property is being sold at cost price”. The fact that the price of land has dropped by 80-100% from its peak, means building is now much cheaper than during the housing bubble. Therefore, it is perfectly feasible that the current market price of a property is now well below what it cost to build.
“Nobody is going to want to sell at a price lower than their mortgage”. Many people would happily sell just to cover the amount of their mortgage -just ask those who have been evicted. Today’s prices are 20% lower than last year’s, and more expensive than they will be in twelve months’ time.
“In my area, no one needs to sell, so prices will not fall”. An unemployment rate that may reach 28% in 2013 affects everyone. Prospective buyers demand discounts. As general supply increases and demand decreases the decreasing-prices dynamic intensifies.
“The bank is financing it, so it has to be a good investment”. Mortgages are great business for banks: buyers are offering a large asset (the property) as guarantee, plus their own personal guarantee (all their present and future assets), plus often those of a guarantor.
“After a cycle of drops in house prices, there must come one of rising prices.” In the current situation, with an existing house stock that exceeds 63 times the annual demand for housing, this cycle could perfectly last for 20 years since 2006.
“Why rent when you can buy. Renting is throwing money away”. In the same way that rent is an expense, so is the payment of interest -and much more so when it comes to acquiring an asset whose market value is falling. If we compare Mr A who buys a property with transaction expenses of 7%, a decrease in prices of 10% over the next 12 months, and a mortgage at 1.5%; with Mr B, who rents an equivalent property paying a rent priced at 3% of the property’s value, we can see how only during the first year, Mr A has lost 14.3% of the purchase price while Mr B loses only 3%.
So, as a general comment, the best thing now would be to wait as much as one can before buying or renting (or to sell as soon as possible) as prices will fall further in the foreseeable future.