Lands End

Lands End

The Land that Banks Forgot

As first Greece, then Ireland and now Portugal deny, then bow to the markets and are forced to request an EU bailout, commentators inevitably fear that a domino effect is creeping through Europe and all eyes switch to the other Iberian economy that could hold the future of the eurozone in its grasp, Spain.

Fairhomes, a private property holding group based in Gibraltar, who daily watch the Spanish market, remind us that much attention has rightly been given to the role that property debts held by the banks have in the crisis. The unfolding property bust continues to hog the headlines with the Bank of Spain declaring that 15 billion euro will have to be found to meet new capital requirements set by the Bank of Spain. Other commentators, meanwhile, such as Moodys calculate that figure to be nearer 50 billion euro whilst Fitch calculated that this could even rise to nearer 120 billion euro. If the higher of these figures is valid, then Spain will be lining up behind Portugal?

Fairhomes report that one element that could prove crucial to the outcome is only now becoming apparent after requests from the Bank of Spain for details of lender's exposures – that of land. Nestling at the heart of the worries is the massive exposure of the Spanish banking system to collapsing land prices and the knock-on effect this has on their solvency. "The main issue for the banks isn't excess housing, it's land," says Carlos Ferrer-Bonsoms of Jones Lang LaSalle, a consultancy.

Banks now hold the most land

According to Goldman Sachs almost 80 billion euro in loans to developers are backed by land and land makes up nearly half the 70 billion euro of assets now held by Spanish banks and regional savings banks. It all adds up to nearly 120 billion euro of exposure for the Spanish banking system. The problem is that, as The Economist magazine rightly identifies, "Land has gone from being the safest bet to the riskiest".

A situation arose that when faced with problems developers chose to default and relinquish assets that were the most problematic, the furthest from producing an income and those which would also require the greatest amount of credit to bring to market – which in most cases were their land holdings.

Like other property assets in Spain the value of this land was wildly over estimated and based upon inflated boom-fuelled 2007 prices. Back in those heady days the optimistic developer assumed that Spain's construction boom would continue forever and was encouraged in this by compliant lenders and enthusiastic local councils, looking to profit from lending and collection of property tax. Vast tracts of poorly located land outside of metropolitan areas were purchased and in some cases even unproductive farmland was landbanked in the hope that rezoning would be granted. (This was a favourite source of revenue for corrupt and ambitious councils alike.)

However when the Spanish property party ended it wasn't only the headache of the unrestrained building boom that required medicine – the longer term sickness in the system was the largely invisible element – the collapse in land prices.

Research highlights the collapse in land prices

Recent research by R.R Acuña & Asociados, a specialist real estate consultancy, estimates that urban land prices in Spain are down by 65pc since the peak. But it gets worse. "The price of poorly located land outside of metropolitan areas is symbolic" says Acuña. This means that "everything but well situated urban land has lost most of its value, in some cases by 100pc," is the conclusion of respected industry insider Spanish Property Insight. Land prices have fallen as much as 80pc in the past four years, according to Jesus Encinar, founder and chief executive officer of property website Idealista.com. But with continuing turbulent economic times ahead the value of land is set to decrease further. Indeed, the recently released figures for Q1 2011 show that the fall in property prices has gathered pace with prices falling 5.1% as against 3.4% in Q4 2010.

Some with vested interests in preserving the artificial valuations have contested Acuña's findings but comparative research and harsh economic logic seem to show that these deniers have little evidence to support their claims.

Florida provides a worrying example

A glance across the Atlantic to the situation in Florida would seem to bear out the fears of those who see a total collapse in prices. Florida has many similarities to Spain in that it experienced a massive construction boom fuelled by immigration and a perceived demand for second homes from those fleeing colder northerly climes. Here too the developers banked vast tracts of poorly located land and drastically overpriced agricultural land (the value based not on the crop value but upon what could be earned if the land was rezoned for housing). On top of this Florida too has a massive oversupply of completed or near completed homes that could take years to be absorbed into the market.

The interesting thing, which Fairhomes points out, is that with Florida there exists a very good precedent that highlights where the market could be heading. In the 1920's land in Florida was the hottest investment around. Banks and individuals (even Groucho Marxs) invested their fortunes and were encouraged into believing that growth in the sunshine state would never end. New forms of marketing and promotion, such as high quantity colour printing of glossy brochures and radio commercials, revolutionised the property investment market reaching new audiences and peddled the "dream" in much the same way as the internet and TV programmes have recently revolutionised real estate sales.

But when the correction came the inflated land prices were exposed. Previously considered "prime" land plummeted in price from $300 to $2 per acre. Investors lost everything and the effects of the crash continue to distort the landscape today, nearly a century later, with projects still half complete. Isolated communities located in areas which once seemed ripe for expansion still stand as silent witnesses to the period of excess.

Since the turn of the 21st century Florida has once again been experiencing another rapid growth in land values. From 1999 to 2004 land prices doubled then in the consequent two years they increased by another two and a half times. (Unv. of Florida 2007) And again when the crash came land prices have plummeted – loosing 50pc in 2008 alone. Since then prices have continued to decline and land outside metropolitan areas is now being offered at a fraction of its previous cost – with even well positioned urban land now fetching only 20pc of purchase price. "In some cases it's almost like a fire sale" commented Rodney Clouser, Unv. of Florida Professor of Economic Resources.

Worthless landbanks disfigure balance sheets

In Spain the biggest stocks of land held by banks and developers are in Andalucia, Catalonia and The Valencian Community – all touristic areas where any available land was considered worthy of development due to the perceived never ending demand. Today half finished, so-called "cynical" developments litter the landscape and digesting this housing glut will take at least five years, according to the Acuña study, although given the poor growth in the Spanish economy and the record levels of repossessions currently running at 93,622 pa (according to figures from Spain's official judicial body Consejo General del Poder Judicial) some commentators expect this to be anything up to ten years.

This time lag and the lack of available credit would seem to indicate a further decline in Spanish land values is inevitable over the next few years. Santander has provisioned 35-40pc of its acquired land but like many calculations within the Spanish banking sector this seems unduly optimistic in light of current conditions and a brief study of Florida's experiences. The Bank of Spain factored a 60pc decline in land prices into its most recent stress tests but in light of the continuing economic decline in Spain this figure seems optimistic.

As with property the Spanish banks continue to deny the obvious. Distressed funds are willing to buy Spanish land at steep discounts but if banks and developers were to sell at these levels they would be signing their own death warrants as the credibility of their balance sheets collapses with consequent knock-on effects for the entire system.

Greg Butcher, Chairman of Fairhomes commented " With a glut of completed, new, empty, unsold houses and some 1,100,000 houses for sale on the private market and an estimated 1,000,000 homes empty but not for sale (as owners don't think they'd sell) and circa 300,000 stopped but part built homes, there's a 7 to 10 year delay until the excess is cleared. "As such the value of new land for development, unless it's truly in a prime position is therefore minimal. We feel an appropriate provision for this period of time is 80% to 95%, from peak to trough. This parallels with the ultimate price fall of land in markets such as Florida when they have had such a severe oversupply and consequential correction." If these assumptions  are correct then the funding gap within the Spanish banking system is much greater than the Bank of Spain is admitting and the capital required to plug that hole isn't likely to be available, even if the Government attempts to tap its bond market to re-capitalise Spanish lenders."

So for now the problem remains. If the banks and developers do hold 120 billion euro of virtually worthless land on their balance sheets at higher prices than can be justified then ramifications could well be terminal for Spain's banking sector. Transactions of large tracts of development land are almost non-existent, as the banks won't reduce to a price which potential buyers will pay. Without this necessary exposure to the market, investors will continue to be unsure of the true scale of the problem in Spain and a bailout becomes worryingly close.

About the Author

Gregory Butcher, is CEO of the privately owned Gibraltar property investment company Fairhomes. Gregory's modus operandi has been to buy assets at a discount in order to maximise gains, he follows crashes and has profited from being able to accurately read the property cycle.

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