Every year in December we reflect on the past year and provide an outlook for the property market in the year ahead, 2018. During the past 12 month’s real estate continued to be popular for both permanent living and investment. The total number of visitors to the Algarve continued to increase in 2017 and surpassed the all time high recorded in 2016. This is mainly due to the continuous popularity of the destination as well as the influx of hundreds of thousands ´newcomers´ from other holiday destinations in countries that are currently facing turmoil. The weather conditions have been very good all the way up to the end of November, much to the delight of visitors who will leave with fond memories of the Algarve. When back home, word of mouth will do the rest. Most reasons for the popularity of the Algarve have been the same for a long time: 300 days of sunshine, beautiful sandy beaches, reasonable prices, good flight connections, excellent cuisine and friendly local people. Having said this, in combination with tax incentives such as the Golden Visa and the Non Habitual Resident (NHR) programs as well as the relatively low tax on short term holiday rental income, there is a sense that the property market has found new momentum. This in turn has led to higher turnover for local businesses, lower unemployment and more revenue for the government. We believe that the property market will remain buoyant throughout 2018 supported by a solid and broad-based economic expansion in Europe as well as the continuation of a low interest rate environment. What could possibly go wrong?
The demand for properties this year came predominately from buyers from Scandinavia, France, Germany, Italy and The United Kingdom and often in relation with the NHR program. Where buyers of property with the Golden Visa program tend to favour areas like the golden triangle in the Algarve, Porto and the greater Lisbon area, applicants for the NHR program seem less focussed on a particular area and tend to have a preference for apartments, townhouses and villas in urban areas instead of rural areas. The British continued to buy property seemingly undeterred by a weak Pound and ongoing Brexit saga. The resulting unprecedented political and economic uncertainty is reflected in the volatility of the exchange rate. However, we see most buyers from the UK hedging themselves once agreement has been reached over the purchase price of a property.
Financially, Portugal is in a better position which is reflected in the 1.9% yield on 10 year government bonds, down from 2.3% last May. It peaked in 2012 at 18% at the height of the euro region debt crisis. The ministry of finance expects the debt to GDP ratio to come in at 126.2% in 2017 and to drop to 123.5% in 2018. The government aims to narrow the budget deficit in 2018 to 1% of GDP. Economic growth is expected to slow to 2.2% in 2018, down from 2.6% in 2017. The unemployment rate is expected to drop to 8.6% in 2018, down from 9.2% in 2017. Nevertheless, Portugal could have done more and faster to reduce the debt to GDP levels which is, even if the 2018 target is achieved, dangerously high. The reduction in the debt to GDP ratio is mainly due to an expanding economy, not because of a reduction of the absolute level of debt. The amount of debt has risen from € 72 bn in 2007 to € 249 bn (up from 239 bn in 2016).
For the first time since 2010 all leading economies are expanding in 2017 and Portugal benefits from this too. However, there is little sign that Portugal is using the opportunities offered during the recovery for structural reform of the economy and runs the risk of wasting a once in a lifetime opportunity to get its finances in order. The period of ultra-low interest rates and quantative easing will not last forever. Instead it seems to choose to be rather happy to enjoy the economic recovery and greater optimism after a period of austerity.
Foreign buyers continued to be attracted by the Golden Visa and the NHR program. Especially the latter as more and more people from Northern Europe learned 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 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 construction sector is also performing better than expected, with newly built residential property up by 8% year-on-year during the period of January to October 2017. Demand for good quality and newly built properties is outstripping supply, which we expect to continue in 2018. Due to the recovery in construction, there is an upward price pressure for building materials and skilled labour. Renovation of old properties/ruins in town centers are 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 reduce 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/restauration, repair and conservation of property for residential use.
We continue to be in a low interest rate environment. The interest margin banks charge their best customers is 1.15%, which is 10 basis points lower than a year ago. For those who prefer a fixed rate over a floating rate mortgage, the interest rate is 1.35% for 5 year fixed consisting of the interest margin of the bank and the 5 year swap rate of 0,20%. The current interest rate of a floating rate mortgage is 0.89% (1.15% - 0.33% / 3 month Euribor) but one would be exposed to interest rate fluctuations. The low rates and increasing availability of mortgage financing has resulted in a sharp increase in mortgage lending versus 2016. Unfortunately most banks in Portugal do not offer 10 – 20 year fixed mortgages. The question is for how much longer will interest rates stay low? The ECB has indicated that it is extending its economic stimulus programme (QE) until at least September 2018, although bond purchases would be halved to Euro 30 bn per month while at the same time saying that should economic conditions warrant it the program would continue. In other words, the ending of QE seems to be open-ended. It also mentioned to keep interest rates low well beyond the end of QE which suggest rates will stay at the current lows until 2019. The general perception is that interest rates are kept artificially low and in the future move back up. As a mortgage on a property is a long term commitment, the possibility of higher rates makes some people uncomfortable. They are in good company. Former fed chairman Alan Greenspan recently warned about bond markets to be in bubble territory, and when the bubble bursts, it will be bad for everyone. A study by economist Paul Schmelzing (Harvard University) of real risk free rates (The return on an investment with zero risk. Long dated government bonds of countries with a high investment rating are often used as benchmark) covering the past 700 years shows a decline since 1980, but is actually part of a downward trend covering 5 centuries. There have been 9 periods of real rate depression before, which on average ended after 26 years often triggered by geopolitical events such as the 30 year war and WWII, the Reformation but also the great depression in the 1930’s. We are currently in the 34th year, the second longest recorded during this period, which saw dramatic changes in technology, demography, globalization and a saving glut. It is not if but when this trend will reverse. If history is a guideline most upward corrections are sharp. Within two years from the trough rates on average move up by 315 basis points. For some this is enough reason to have preference for a fixed rate mortgage, just like one would take out travel insurance when going on holiday. 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.
Property ownership by offshore companies is about to become less attractive. Portugal is implementing the Beneficial Ownership Register regime, a recent EU directive which requires the name of the beneficial owner(s) to be shared with other countries. As usual, there are fines for non-compliance as high as Euro 50.000. Offshore centers will need to comply with new rules, such as implementation the Common Reporting Standard (CRS), have agreements in place for the automatic exchange of information with all EU member states before the end of 2017. This may cause a problem for companies registered in Delaware, as the United States is refusing to be part of the CRS. This could mean that Delaware loses its status as white listed jurisdiction in which case companies could face almost a 20 fold increase in their council tax rate. The normal rate depending on the location of the property/council is 0.4 – 0.5%, where as the punitive tax rate is 7.5%. The alternative is to redomicile the Delaware company to Portugal or to sell the property. Having said this, the United States may in the end decide to comply. If properties do come to market because of this, we expect that they be met by eager buyers.
Just like last year, newly built properties that came to the marked were quickly snapped up by eager buyers. The balance in supply and demand is changing more and more in favour of vendors as demand is outstripping supply. Some banks still own properties which they foreclosed on during the financial crisis and are now being able to offload on the back of a rising market. The residential property market in general is in pretty good shape with strong demand from buyers and renters alike.
In our base case scenario at the end of 2016 we expected transaction volume of residential housing to slow down in 2017 while prices of existing homes sales to rise between 4 – 6%. On average the price of a property over the past 12 months has appreciated by 7%, slightly above the top end of our expectation. We were cautious with our transaction volume outlook for the year as at the time the rise of populist and nationalist parties across Europe was a cause for concern with upcoming elections in France, Germany, The Netherlands and Austria. That could have been the start a period of uncertainty and hurt discretionary purchases such as a second home abroad. Although populist parties did gain ground they did not gain the majority of votes in any of the countries which proved to be beneficial for the market as transaction volume continued to exceed our expectations.
When forming a well informed opinion about the market outlook for 2018 one has to take into consideration not only the economic prospect of Portugal for the year ahead but also of other economies. The economic outlook for Portugal is improving on the back of a solid and broad based economic expansion in Europe which is likely to continue into the New Year as recent economic data shows that the European economy is picking up steam. Economic confidence in the euro zone has surged to its highest level since the introduction of the Euro in 1999. As such the Catalonia crisis in Spain and the difficulty of forming a government in Germany (the largest economy of Europe) is largely ignored. The positive economic data is overwhelming.
The Portuguese government has published their budget proposal for 2018. There is a possibility for taxation of short term rental income (Alojamento Local) as well as the NHR program to be changed. If this were the case it would send a negative signal to current and prospective homeowners. The government increased the tax on short term rental income last year saying it was a one time off. This was already controversial at the time considering approx. 80% of available dwellings are unregistered and operating illegally. Another increase it tax would add insult to injury to the homeowners who did bother to go legal and are paying their fair share in taxes. Regarding the NHR program, Portugal is under pressure by some European countries to alter the zero tax rate which is something the current government may consider changing as it increases income in the short run. One can not blame the left wing coalition to be true to form, after all it consists of socialist and communist parties. However, it would be a wrong signal. Due to the high transaction cost of property, one can not trade in and out easily. Therefore investment decisions are made on credibility and continuity. At the moment NHR applicants who buy a property are making their decision on the promise of a 10 year tax holiday. If this would change, credibility is lost. When conditions are amended once they can be amended again in the future. Although it is possible to trick part of the electorate every four years into false promises, it is not recommended to play games with investors. They have long memories tend to vote with their feet. Once the new budget for 2018 is endorsed and include changes to the AL and NHR regime that would be a negative for the property market.
For 2018 we expect another good year for real estate with a further pick up in new construction of residential property. The plans that various councils have announced are taking more time to start, but this is common in Portugal. They range from developments such as marinas with housing in the council of Olhao, Faro, Vila Real de Santo Antonio to the abandonment of a large, Euro 1 bn development in Vilamoura. The latter would have represented one of the largest real estate developments in Portugal and is now for sale.
In Tavira there is a project for a marina with housing on a prime location in the center of town, which has been in the offing for a long time. Highly desirable properties in prime locations are always in demand and we look forward to seeing these projects com to fruition.
In our base case scenario we expect transaction volume of residential housing to continue to be robust in 2018 while prices of existing homes sales to rise between 7 – 9%. Considering all of the above, we expect the year 2018 to be very exciting
Robert Bijker
Director