Every year
in December we reflect on the past year and provide an outlook for the property
market in the year ahead, 2016. As expected, trading conditions for real estate
have improved over the past 12 months. Looking back we can say that the market
bottomed out in 2013/2014. During this period transaction volume steadily
increased but property prices remained weak for most of this period. However by
the end of 2014 we saw some price improvement which continued more broadly in
2015 making this the first time in 6 years that vendors started to benefit from
the recovery too. In addition the overhang of unsold, newly built properties is
getting smaller by the month. Supply and demand is more balanced, however in some
property/price categories supply is drying up fast. For instance, it is becoming
very difficult to find villas with a pool below the Euro 300.000 threshold. The
construction of new properties is also picking up, albeit from a low base and includes
previous approved developments which were put on ice due to the crisis but also
complete renovations of old properties/ruins in town centres. This is a positive
sign in light of a moderate economic recovery in Europe.
In Europe we are still very much at the beginning of a new
credit cycle. When compared with the USA we are miles apart. Despite
provisions for bad loans over the past years, European banks exposure is twice
as big compared with banks in the USA according to figures recently
released by the European Banking Authority. The figures show that approx. 6 %
of European loan books are impaired, with only 3% in the USA.
However,
some banks are better capitalised and are gaining market share in the
Portuguese market for mortgages. The recovery in new mortgage origination by
banks in Portugal
confirms the beginning of this new credit cycle. There is a clear distinction in
activity between the better capitalised banks versus the weaker ones. Actually,
some banks have seen the volume of new mortgages in 2015 triple versus 2012 and
are gaining market share. As a result interest rates have come down too. Only a
year ago spreads were around 4% over Euribor, now they are down to between 1,5
and 2,5% depending on which financial institution you use to apply for a
mortgage. This spread is to be added to the 3 or 6 month Euribor rates, which
are currently in negative territory. This extraordinary situation is due to the
quantitative easing (QE) program of the ECB.
And there is more good news to come in 2016. We expect competition
between banks to intensify leading to a further narrowing of spreads. To put
this in perspective, before the start of the financial crisis banks were
charging between 0.5 and 0.9% over Euribor.
As the Algarve is a
melting pot of cultures and has always attracted buyers from all over the world,
it is important to watch how other economies are performing when analyzing
trends in property prices. The big themes for 2016 that could have a negative
impact on the property market are a slowdown of economic growth in Europe, deflation and the need for further strengthening
of banks balance sheets. To start with the first, the recovery in economic
activity has been very moderate and as such disappointing. One would have expected
a more robust economy after the great recession. The inflation outlook is weak,
which is what the ECB is focussing on. The ECB is way off the 2% inflation
target. The slowdown of global economic growth is not helping either and the
ECB assessment is that there is risk to the downside. Hence, it is well
anticipated that the ECB at the next meeting in December will not only extend
the length of the QE program but also the monthly volume in order to add
further support to Europe�s economy. The current program runs until September
2016 and is likely to be extended by another year. In other words, interest
rates are staying low for longer. QE and low interest rates have had an effect
on the currency too. Of all major currencies, the Euro has been the weakest in
2015. This may well continue in 2016 as the world?s two big central banks are
heading in opposite monetary policy directions.
In
addition, the Euro zone GDP will start
to benefit from the following tailwinds:
- Low
energy prices
- Easing of
credit conditions
- Weaker
currency
- Fiscal
policy
Fiscal
policy is likely to turn stimulative in 2016 for the first time since 2010. There
has already been slippage on government budgets in several countries including France, Italy,
Spain and Portugal. With
a left wing coalition now back in power ruling Portugal, the likelihood is that
anti austerity measures are being reversed. Hopefully budget rules will be
obeyed as fiscal recklessness was the root cause leading to Portugal�s
bailout.
Debt to GDP
is still very high at 130%. When Portugal signed up for the bail out
program, the Troika (ECB/IMF/European Commission) demanded structural reforms.
However, little progress has been made on this front and the newly elected
government is keen of undoing some. Portugal exited the 3 year bail out
program in 2014 and is no longer required to negotiate with its lenders. If
economic growth is used as a measure of success, then Portugal underperformed when compared with Ireland (another
bailout country) where in the first half of 2015 the economy grew by 7%. Expected
GDP growth for 2015 and 2016 in Portugal
is respectively 1,7% and 1,7%. For Ireland
this is respectively 6% and 4,5% and for Spain these figures are expected to
come in at 3,1% and 2,7%. Portugal�s
underperformance is nothing new. For decades it has not been able to reach it
potential.
The issues
hampering economic growth in 2015 are likely to be the same in 2016; a slow
judicial system, inefficient public administration (e.g. hidden unemployment),
restrictive labour regulations and a lack of competition in some sectors.
But the single biggest
risk to the local economy and recovery in real estate is also the one
that has brought more visitors to the Algarve. During 2015 there has been
an increase of vacationers who would normally have gone elsewhere. Due to
political instability and in some cases the risk of terrorist attacks they have
chosen to spend their holiday in the Algarve. Beauty is in the eye of
the beholder, you have to be there to experience the beauty of the Algarve. Once
here, some will consider purchasing a 2nd home or becoming a resident.
Programs
like the Golden Visa and the NHR (Non-Habitual Resident) continue to be
successful in attracting foreign buyers and we expect this to be no different
in 2016. Especially the latter as more and more people from Northern
Europe will learn about this program and the benefits. The NHR
program is a scheme for individuals who have not been a resident in Portugal during
the past 5 years. Once an individual has been granted the NHR status, he or she
will be exempt from income tax (work, royalties, pension, interest and
dividend) for a period of 10 years. This program in combination with an
undervalued property market is an attractive proposition for many foreigners
who like to capitalize on a recovery in property prices while having a 10 year tax
holiday. The market benefits more from this type of buyer versus flippers, as
they have a strong incentive to hold on to their property during this 10 year
period.
The local
lodging legislation was changed at the end of 2014 which made investment in
real estate more attractive, especially in a low interest rate environment. The
new legislation requires owners who rent out their property on a short term
basis to holidaymakers to register at the local tax department as a business
activity. The advantage of this so called simplified regime, is 85% of rental
income is automatically considered as expenses. In other words, you are only
taxed on 15% of your invoiced rental income. There is a flat tax rate of 25%
percent, which results in a final rate of 3.75% of total rental income. This
compares favourably with the tax rate on savings. Moreover, the rental returns
also compare favourably with gross yields varying between 5 to 8 percent
depending on the type of property, location and marketing.
To summarize,
despite change in government and economical challenges we expect 2016 to be a
good year for real estate. In 2015 property prices have increased on average by
5%. We anticipate a further recovery in property prices in 2016 and would not
be surprised if by this time next year prices on average were to be 7 to 9 %
higher. If correct, the market would still be approx. 30% below the previous
high of 2008. Furthermore, we expect new construction to pick up steam in 2016.
Over the coming 12 months it is likely that the balance between supply and
demand chances gradually in favour of vendors and thereby ending a buyers
market which lasted for 6 years. As a result the new construction hitting the
market can be easily absorbed. In addition, we believe banks will continue to
strengthen their balance sheets in 2016 - something we always considered to be
a process and not an event - which has already lead to a more liberal approach by
better capitalised banks towards the issuance of new mortgages and a reduction
in the spread. There is a good chance for a further reduction in spread as
competition between banks for customers will heat up. Foreign buyers of
property in Portugal
continue to enjoy a double whammy in 2016; a weak Euro and depressed property
prices. In addition to this for some the icing on the cake is the Non Habitual
Resident program. For those who consider the purchase of a property, it is not
getting any better than this.
Robert
Bijker Director
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