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Every year in December
we reflect on the past year and provide an outlook for the property market in
the year ahead, 2019. The past 12 months have been very exciting as real estate
continued to be popular for both permanent living and investment purposes. The
total number of visitors to the Algarve decreased a bit year-on-year, but this
was to be expected after two consecutive years of record breaking numbers. Strong
demand for both residential and investment property saw prices of existing
properties rise by 9.5% which is just above the top end of our expectation of
9% made in December 2017.
There are various
reasons to be less bullish for the upcoming year.
The demand for
properties in 2018 continued to come predominately from buyers from
Scandinavia, France, Germany, Italy and The United Kingdom and often in
relation with the NHR program. The British continued to buy property seemingly
undeterred by a relatively weak Pound and ongoing Brexit saga for most of the
year, although in Q4 some buyers had second thoughts as poor visibility about
what the future will bring created uncertainty. However, the majority of buyers
from the UK did not want to put their life on hold and hedged themselves once
agreement has been reached over the purchase price of a property.
In general, the
majority of buyers in 2018 were cash buyers. For those buyers who needed a
mortgage to complete their purchase this was also a good year as banks are
competing again for business which helps to keep costs down and the historic
low level of interest rates proved to be a boon.
For 2019 we are
cautiously optimistic. A major factor is that the global economy is slowing
down. The IMF has lowered their economic growth forecast for 2019 and 2020 in
light of elevated political risk. Growth is still expected, however, at a lower
rate than expected 9 months ago. Trade wars, rising nationalism, Brexit, the threat
of interruption in global supply chains are all contributing to an increase in uncertainty.
In addition we are nearing the end of QE and interest rates can be expected to
rise to levels more suitable to where we are in the economic cycle. Higher
interest rates and increased levels of uncertainty are no friends to business. On
the other hand, the price of oil has dropped from $ 86 per barrel in October to
$ 60 in November which helps to soften the blow if the price stays around
current level.
On the 11th
of December the House of Commons will vote on Theresa May´s historic Brexit
deal agreed by European leaders. The agreement aims to offer a smooth divorce
to end Britain´s 45 year involvement in the European project, however, many
details will have to be ironed out before December 2022, adding to years of uncertainty
and potentially another cliff-edge. The deal is a compromise and is all about
damage control. As a result both Remainers and Brexiters are not very happy. If
Brexit was all about Britain taking back control of its own destiny, it has not
delivered. The truth is that a hard or soft Brexit would always come at a cost.
In order to provide clarity, the government will publish an economic analysis
of the cost of no-deal versus the current agreement. This may also make it
painfully clear that from a pure economical point of view it would be better to
stay. Ever since the referendum in 2016 the economic loss has been
considerable. The UK economy has grown below capacity as the strain on
resources of corporations, both financial as well as managerial, took its toll.
According to EPFR, a data provider, UK equity funds have had net outflows of
$1.01tn as investors withdrew funds on concerns about the impact of Brexit on
Britain´s corporate sector. (E.g., JP Morgan alone spent over Euro 400 million
to prepare for Brexit)
Demand for properties in
the Algarve outstripped supply in 2018 as strong economies bolstered both local
and foreign buyer´s confidence about the future. For some the Golden Visa and
NHR program was just the icing on the cake. The NHR program was first
introduced in 2009 and has been highly successful in attracting foreigners to
take up residency in Portugal, often allowing them to purchase a larger
property due to their increased purchasing power in light of the tax benefit.
The program has come under attack by tax authorities from Finland, Sweden,
Norway, France and the Netherlands as they deem the 10 year tax holiday
resulting from double taxation treaties unfair. Most people do not want to
dispute with tax authorities and as such it is good to know there are other tax
efficient solutions in Portugal for foreigners that make tax mitigation just as
worthwhile.
Both newly built
properties and good quality resales have been quickly snapped up as they
appeared on the market. With limited supply it has become a seller´s market. In
some cases prices of new developments reached unprecedented levels as builders
aimed for a moon shot; some succeeded and others reduced prices shortly after
the introduction to more realistic levels. Renovation of old properties/ruins
in town centres continued to be popular amongst investors as there are several
benefits as part of the urban rehabilitation program, such as a lower VAT rate
(6%) on construction materials which effectively reduces building costs by more
than 10%, no cost for the building license, exemption of IMT (property transfer
tax) and exemption of IMI (council tax) for 3 years. Some banks offer
preferential (lower) interest rates to finance the renovation work. The
rehabilitation program supports the improvement, renovation/restoration, repair
and conservation of property for residential use. As demand for this type of
property is outstripping supply, it remains a financially rewarding opportunity
to buy and renovate a property in urban centres. However, despite these
favourable incentives and conditions, there are still many old properties that
remain unused and sometimes in ruin which is an undesirable situation in light
of the stress in various cities and towns for affordable housing. As such the
government has plans to allow local municipalities to dramatically increase the
council tax (IMI) in case a property has been vacant for more than two years
and could start with an increase in IMI by 600% as early as 2019. The IMI can
continue to increase 10% per annum thereafter, up to a maximum of 12 times the
original IMI value.
In this strong market
it is hard to comprehend why various banks still have many unsold foreclosed
properties on their books, especially in light of the speed at which they
repossessed homes at the beginning of the crisis. This may change over the next
12 to 24 months as Lonestar who owns 75% of Novo Banco has reached an agreement
to sell off a large chunk of foreclosed properties (a mix of almost 9000
residential and commercial properties) to Anchorage Capital Group, a New York based investment adviser for Euro 390 million while the
book value is 716.7 million. This is part of the clean-up of the balance sheet
of Novo Banco, with the balance to be covered by the resolution fund. These are
properties that can come back on the market sooner rather than later, likely to
be priced at a discount to similar properties, as ACG tries to reliquify.
We continue to be in a
low interest rate environment, although rates have started to rise. The
interest margin banks charge their best customers fell to 1%, which is 15 basis
points lower than a year ago. For those who prefer a fixed rate over a floating
rate mortgage, the interest rate is 1.31%
(almost unchanged from a year ago) for a 5 year fixed mortgage consisting
of the interest margin of the bank and the 5 year swap rate of 0,31%. The
current interest rate of a floating rate mortgage is 0.76% (1 % - 0.24% / 3 month
Euribor) but one would be exposed to interest rate fluctuations. Demand for
mortgages continued to increase in 2018 and we noticed a preference for fixed
rate mortgages.
The question is for
how much longer will interest rates stay low?
The ECB does not expect to rise rates until the second half of 2019. As
a mortgage on a property is a long term commitment, it makes sense to lock in
the current low interest rate for a fixed period of time. In Portugal most
mortgages have a floating rate based on 3 or 6 months Euribor. Rising interest
rates are therefore passed on to the homeowner hurting disposable income and
economic activity and may become an issue in 2020/2021.
We remain concerned
about the rise of populist and nationalist parties across Europe and the effect
this can have on financial stability in 2019, with Italy being a case in point.
Since the populist coalition government came to power, Italian sovereign bond
yields have gone up as investors are worried about the government´s plan to
increase public spending even after the EU rejected its draft budget over
concerns about the country´s vast debt burden. The yield on 10 year bonds is
currently 3.29%, up from about 2% before the general election in March 2018. If
the yield stays at the current level, the debt servicing cost increases by € 9 bn
per annum. The ECB keeps interest rates artificially low but eventually they
have to move up. When rates move higher it will be a bigger burden for nations
with high debt levels such as Portugal.
The economy of
Portugal has grown over the past two years and is in relatively good shape. The
Bank of Portugal expect GDP to grow by 2.3% in 2018, 1.9% in 2019 and 1.7% in
2020. We believe that the numbers for 2019 and 2020 will be due for a downward
revision in line with lower economic activity in Europe. Debt to GBP is still
high at 121.2 %, the third highest in Europe after Italy and Greece. This is a
major vulnerability as Portugal will need to stay on a firm downward trajectory
to bring the ratio close to or below 100% in 2025, especially when economic activity
slows down.
When forming a well
informed opinion about the market outlook for 2019 one has to take into
consideration not only the economic prospect of Portugal for the year ahead but
also of other economies. Over the past 12 months the economy of Portugal has
benefited from a solid and broad based economic expansion in Europe. However, there
are clouds on the horizon. The IMF has revised downward their global economic
growth numbers from 3.7% to 3.5% in 2018 and to 3.5% for 2019 and 2020. For the
Euro area the ECB lowered its forecast due to global trade tensions that dampen
external demand. It now expects real GDP to growth at 2.1% (down from 2.3%) for
2018 and respectively 1.9 and 1.7% for 2019 and 2020 (which we believe could be
too optimistic in light of rising trade and financial risks). Despite recent disappointing data and signs
of weakening business confidence the ECB has indicated that it will go ahead
with its plans to end their quantitative easing program by the end of 2018 as it
sees enough evidence that inflation will rise gradually on the back of the
lowest levels of unemployment since 2008 and rising profitability of companies.
With tight labour markets the ECB expects wages to rise. The year 2019 will see
the start of quantitative tightening after a prolonged time of quantitative
easing and brings us in uncharted territory with possibly higher levels of market
volatility.
During the course of
the year there have been some measures introduced which we think are negative for
the buy-to-let investors, namely new restrictive rules for short term holiday
letting, additional red tape to comply with collecting of a tourist tax if and
when implemented by local councils in the Algarve, and the introduction of
additional price bands regarding the AIMI (Municipal Property Tax surcharge)
for properties (or property portfolios) with a value of Euro 600.000 and above.
The new rules
regarding short term holiday letting are not only a setback for the holiday
sector but also for other parts of the economy as it is adding uncertainty to
homeowners and prospective buyers interested in covering some of the expenses
by renting out properties. This is an issue which has been highlighted by
various property associations like the Association of Hospitality, Restaurant
and Related Institutions of Portugal
(AHRESP), Associaccao dos Profissionais e Empresas de Mediacao
Imobiliaria de Portugal (APEMIP) and the Association of Local Accommodation Portugal (ALEP). Councils are from now on allowed to restrict the number of
licenses in a neighbourhood. In addition, homeowners with a condominium can
also be stopped from renting out to vacationers in case a majority of
neighbours are against it, for whatever reason. In addition, condominiums can
also demand an additional and controversial payment of fees when a property is
rented out of up to a 30% to cover the increased use of communal areas by
holiday makers. Instead of a national law with clear rules and regulation,
decision making has now moved to a local level where subjective reasons can and
will come into the equation. Instead of unifying homeowners at condominium
meetings it will more likely divide them. It is public knowledge that the A.L.
legislation is a mess and as such it may not come as a surprise that out of an
estimated 200,000 available accommodations in Portugal only approx. 25% (51.000
properties registered by year end 2017; source Deloitte) are legal and
registered with the correct license.
Local councils are now
allowed to introduce a tourist tax, should they wish to.
Last September the
Algarve Intermunicipal Community AMAL approved the foundations for the tax to
be introduced of which 15 of the Algarve´s 16 municipalities gave their
approval. Only Silves was against the tax, which raises € 1.50 per person/per
night up to a maximum of 10 nights. Each council will still have to vote on
this at a local level, which could lead to some councils taxing tourist while
others do not adding to confusion to holiday makers. The relative small charge
can add up for a family of four. For those homeowners involved in short term
holiday letting on a legal basis (Alojamento Local) this is another cost burden
they just do not need versus the 70% illegal dwellings they compete with. An
exact launch date still has to be decided.
The AIMI comes in effect when a person owns residential property worth more
than € 600.000 (€ 1.200.000 for couples), with 0.7% tax up to € 1 mln, and 1%
in excess of € 1 mln to 2 mln. For property above € 2 mln the rate is 1.5%. This
is in addition to the annual IMI (council tax) of 0.4% of the value of a property.
In our base case
scenario we expect transaction volume of residential housing to show a small
decline in 2019 due to a lack of supply, increasing interest rates and global
tensions, while we expect prices of existing homes sales to rise between 3 to 4%.
We also expect healthy demand for good quality newly built properties when
priced right. Over the past years the abundance of cheap and easy money from a
loose monetary policy has benefited economic growth and employment and indeed
inflated prices of financial assets as a rising tide lifts all boats. As we are
slowly moving away from a loose monetary policy to a more normalized monetary
policy it is likely that the biggest increases in property prices are behind
us.
Considering all of the
above, we expect 2019 to be another good year.
Robert Bijker
Director
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