HOW much is your house in Cyprus worth? Well, frankly it doesn’t really matter because if you can’t sell it then it’s worth nothing.
Replace the “house” with “collateral” and “you” with “bank” and this little example sums up the situation that many banks find themselves in – holding illiquid assets as collateral.
Are valuers at fault? Well, yes and no. The job of the valuer is to determine the probable transaction price of a property on the day of valuation; not how quickly that can be achieved.
On the other hand, valuers are taking their time in adjusting their valuations to where prices are, mainly due to a lack of comparable transaction evidence.
Lack of transactions means lack of market signals, and thus arbitrary adjustments on the part of valuers or “linking” new valuations to previous ones (in “tech-speak”, autocorrelation).
So how much are valuers off in their valuations? The Property Price Index of Greece’s Central bank shows a decrease in residential property prices of 14% over the past three years.
The Property Price Index of Cyprus’ Central bank shows a decrease in residential property prices of 8.3% over the past two years.
Both indices are based on valuations carried out for collateral purposes. Anecdotal evidence suggests that in both cases the decrease is at least double.
So if valuers aren’t doing their job right, what could they be doing? In some cases the problem lays in not using more advanced methods in carrying out property valuations.
Methods like Discounted Cash Flow (DCF) and the Income Method derive their inputs from markets which are continuing to function, e.g. bond market, deposit rates, etc, although they may not show the “pretty picture” that we all like to see.
For example, if the Cyprus government’s five year bond is currently trading at 11.59% why are shops being valued at an initial yield of 6.0%? This yield implies that either valuers expect capital values or rental values to rapidly increase, or that they don’t want to halve the value of the property compared to what it was two years ago.
So with valuations being uncertain at best, what about the actual worth of the property to its owner (or to the bank which is holding it as collateral)?
Assuming that valuers are doing a fantastic job and that they correctly value two properties at €200,000 each, are those two properties of the same quality as collateral? If one is a field in the middle of nowhere and the other a flat in the city centre then the answer becomes a lot more obvious.
Yet banks tend to treat collateral pretty much the same, regardless of its liquidity (which is something not reflected in the asset’s value in any event).
If you think that liquidity doesn’t really matter, read this:
Question – if you can’t sell a property for even a quarter of its acquisition price then what is it worth to you or to your bank?
About the author
Pavlos Loizou MRICS is the lead consultant at Leaf Research.
Leaf Research is a leading real estate consultancy firm, providing high quality real estate market research, valuation, feasibility studies, financial modelling and strategic consultancy.