Price Correction + Strong Fundamentals = Opportunity

This is a really exciting time to be buying residential property in Spain. Why? Because, in a nutshell, the fundamentals are strong but a price correction is taking place. In saying this I find myself in pretty good company. I attended the CULS Real Estate Finance Forum on 7th February when both Jim Garman of Goldman Sachs and Noel Manns of Europa Capital both put Spain on their shopping list for a £2 billion pound imaginary portfolio.

They didn't specify the details and perhaps they were talking about office investments in Madrid and Barcelona, but my guess is that they might both be interested on their own account in a luxury villa valued at ?900,000 in 2006 which recently sold for ?415,000. This kind of price correction signals 'opportunity'.  Apart from making money, what turns most people's lights on is that Spain is the California of Europe and many people want to live, retire, or holiday there. Now, for the first time in ten years, we are entering a buyers market. Astute investors will be able to make money and also enjoy themselves hugely in the process.

Don't Let the Headlines Put You Off

What about the scare stories: land-grabs, demolition of illegal buildings, dodgy lawyers, oversupply of boring identikit apartments, an economy hooked on cement and heading for a hangover, corrupt mayors who wind up in jail, and mindless urban planning? Well it is certainly enough to put you off and it seems to have put off a lot of the UK market. 

If you talk to agents they will tell you, anecdotally, that whereas the Brits may have been responsible for 60% of the foreign demand in 2006 now it is more like 20%. My opinion is that scare stories are a great way to sell newspapers and make superb headlines, "The Pain In Spain Will Always Remain" but, as property professionals, especially those advising individuals and companies making investments, apply basic property investment skills and take advantage of the turn of the business cycle, there is a real opportunity arising.

It's the end of the yield play - so what?

One way of interpreting the current state of the residential property market is to say that the era of technical investment   buying anything because the whole market is going up   is over. A technical investor, as opposed to a fundamental investor, only cares about whether the price is going up or coming down.

Over the last 10 years in Spain prices have been going up. It almost didn't matter what you bought you made money because yields were falling. You didn't have to think very hard. Many inexperienced investors waded in on that basis and made a lot of money. However, many others who bought off plan two years ago intending to flip it on are now left with an un-saleable, un-let-able property with an unaffordable mortgage. This is the stuff of bank repossessions and a price correction that will affect the whole market.

So how can we make this work for us? A fundamental investor looks at the underlying reasons why an investment may do well. Good reasons for investing in a company or buying its shares could be a strong management team, a growth industry, and a patented product.

The Fundamentals

The fundamental growth factors of residential property investment in Spain are particularly strong even when compared with a global market. The Costa del Sol has the best climate in the whole of Europe with an incredible 325 days of sunshine each year, a beautiful coastline (except for the quite small bit that looks like a cross between a council estate and a car park) and some of the cleanest beaches in Europe measured by the Blue Flag initiative. Spain has an inspiring interior, and a population of happy lively people who just want to have fun.

Perhaps more important is the communications network of airports, motorways and an improving high speed railway network. The government and EU are spending vast amounts of money on yet more infrastructure (motorways, etc) which will off-set to some extent the shrinking of the construction industry. Reaching Spain and moving around within it has never been easier. Spain has a large established market with a significant ex-pat community who are well catered for. It is a democracy within the EU. Now the occupier market is strengthening as people who may previously have considered buying, rent instead. So there are strong fundamental reasons for the population of Europe to continue to want to enjoy Spain and many of the economic pointers look good.

The Natural Turn of the Cycle

Chartists, investor types who ponder over graphs, also point out that we are simply going through a cycle. All markets go through cycles. The last 10 years has seen 197% capital growth (a three-fold increase) in the Spanish residential property market. A slow down now is a law of nature and, in property, market cycles go nice and slowly so everyone gets an opportunity to participate.

The question is how far will the curve drop and when will it turn? As you would expect at the turn of a cycle, there is a variety of different expert opinions. Jim Garman, in the CULS seminar I mentioned, suggested we need to wait a little longer for the curve to bottom out. He talked about vendors being either in acceptance or denial. He wasn't necessarily talking about their deepest subconscious fears. He was suggesting that those in denial believe, mistakenly, that the underlying value of their investment is more or less intact. Maybe he is right and we do need to wait a little longer.

One thing to look at is whether there are good numbers of buyers. Talking to agents the picture is confused. Many agents say there are few buyers but also claim there are a lot of bargain hunters putting in ridiculous offers. One man's ridiculous offer is another man's correct price based on the growth prospects.  Agents also say they had a good month in January 2008 with demand from the Scandinavians. They say that vendors accepted sensible but not ridiculous offers. Perhaps the estate agents are just trying to talk the market up.

The PIMS Index of Market Sentiment (www.clickpims.com) measures, objectively, estate agents' subjective impressions about the state of the market. Although the index as a whole is showing, as you might expect, a fairly pessimistic outlook, the interesting thing is that all the agents are optimistic about the numbers of enquiries they expect to receive over the next few months. Some are very optimistic. So perhaps there is plenty of counter-cyclical demand. Perhaps the curve will be shallower than we think. Maybe we are already nearing the bottom of the cycle. This wasn't the view of the panel of experts at the CULS seminar who, although talking about pan European investment, discussed Spain in terms of a pocket of trouble in an otherwise not-too-bad-a-picture, and who proposed waiting for the shift in vendors' consciousness to take place in order to pick up some real bargains.

But might we miss the bottom of the cycle if we dither about waiting for a shift in sellers' consciousness? The answer is  that the time has come to return to sound fund management skills. It's back to basic property investment skills so that your investment performs whatever the market as whole does and whether you exactly hit the bottom or not doesn't matter.

Basic Property Investment Skills

The key thing about investing in property is that you're not buying a homogenous product like, say, shares in ICI. While every share you buy in ICI is the same, every property is different. And while you personally can't do anything to improve the performance of your investment in ICI you may well be able to do a great deal to enhance the performance of your property investment. To continue the point of comparison with shares, now is the time for stock picking rather than buying the index.

The wonderful thing about property is that there's nearly always an angle to make money: build an extension; put in a swimming pool; paint the guttering; sell off the garden; throw your second-hand Porsche into the deal! And often there's something you know which isn't necessarily known to everyone: there are plans for a new housing estate which will impair the lovely view (sell), or a new motorway linking your property to the beach cutting the travel time from 1 hour to 10 minutes (buy). So local knowledge and professional advice are essential.

Spain is a vast and diverse country and there are large regional variations and pockets where local supply and demand forces have a big effect on growth. You must bear in mind the local dynamics which may affect performance more than general market forces. In fact you need to become an expert in the market where you intend to invest, or find a professional you can trust, so you can recognise a bargain when it comes up.

Be prepared to move fast i.e. have your professional team and finance lined up. Nothing seduces a distressed seller more than the prospect of money in the bank today, so you don't want to be making offers subject to finance. By the way did you think about asking your bank to put up 80% of the costs of your ICI shares? Well they will, even today, for your property investment assuming you are not sub-prime.

Remember to look at your proposition in terms of let-ability if it needs to be income producing (holiday lets must have a pool). Don't forget to identify, before you start your search, what kind of property is going to bounce back hardest (maybe avoid the vast swathes of cheap box apartments that stain the Costa del Sol unless you're a holiday company and can make them income-producing) and, above all, find a motivated seller.

Find a Motivated Seller

It is clear that for those sellers who can't wait out the buyers market, 2008 is going to be a disastrous year. Distasteful as it may be, there are always those who, for whatever reason, can't wait and have to sell. Divorce, ill health, death, redundancy may feature among the reasons and as we know wherever there's trouble there's an opportunity. There are likely to be a number of bank repossessions too. It is predicted that the number of repossessions will overwhelm the insiders who normally snaffle up the bargains. Making friends with bankers is not a bad fund management skill to cultivate. Bankers are often the first to know when there is a deal to be done, and they may have sated their personal appetite for off-the-market deals.

Make Money and Have Fun Doing It

Here is an example that I know of personally. You can buy a charming 4 bedroom chalet, with a pool and a good piece of land and panoramic views over lake Viñuela, 16km from the Mediterranean, and 26km from Malaga airport, for around ?300,000. This is a divorce settlement and the owners have to sell. Done up (it has been neglected recently) you could be asking around ?600,000 even in today's market. Buy it, and have some fun making it into a swish and stylish bolt hole from the UK.

There is space for another 3 rooms and lots of verandas and terraces. Let it if you want to. Let on short term holiday lets it could yield around 10% gross. Then after 5 years of sipping a cold white wine on the terrace enjoying the view and your tapas, assuming you don't let it all the time, sell it. Make some money and have loads of fun doing it. Certainly in my view we will look back in 5 years time and say that 2008 was when the smart money went into Spain.