Miguel Hernández. Professor. IE Business School
7 June 2010
It is the million dollar question of the moment. Just how are banks going to deal with all the properties they now have on their books without losing too much money?
Let´s imagine that Christmas is over and the January sales are about to begin. After a period of heavy consumer activity, the time has come to be much more demanding with the price-quality ratio. If we go shopping when the sales begin, we will find good products at good prices, but as time passes and stocks run out, the only sales goods left will be those that won´t sell even at very low prices. In the Spanish property world, the situation is similar: After years in which homes weren’t sold but rather sold themselves, as the sector admitted, price adjustments are now necessary, but we must not forget that, as in the January sales, good products will be sold faster and at only slightly lower prices, whereas bad products might not be sold ever (in Ireland, they are considering demolishing new developments that will never recover the investment value).
Housing prices in Spain are falling, but not evenly across the country. The problem is that the official statistics refer only to averages and the information is not segmented by product type, price or location, factors that are intrinsic to real-estate activities. The price adjustment is not the same for high-quality apartments in the centre of large cities as for small apartments on the coast. The law of demand and supply (in that order) is regulating the situation in a natural way.
However, is there room for lowering prices? How long will the adjustment last? The answers to these questions come from the financial world. Even though we know that not every developer has the same level of debt, it is true that the shortage of demand (or finance) has forced businesses to lower prices in many cases to the value of their mortgage debt with banks. From there, which is more or less where we are now, and assuming that developers have lost all their margins, banks would have two options: sell at below cost and make a loss or call in the loan and incorporate the asset into their balance sheet (in which case the Bank of Spain gives them a set time to sell the asset). I have not yet heard of any bank selling at a loss, even though 80-90% of court auctions are being declared void. If the Bank of Spain were to shorten the period for keeping banks to keep property on the balance sheet, they would be forced to sell below the mortgage level and make a loss. Housing prices would fall, but the financial system would be affected very negatively, especially at the present time.
Reason points to a blended solution: the Bank of Spain makes the allowances for allocated assets more flexible to adapt them to the present economic situation and banks assume certain losses after several years of very high profits. That would make it possible to sell the majority of stock at lower prices and avoid a lengthy “Japanese-style” digestion.