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The MoU and its impact on banking and real estate

As the Cyprus economy has been in a downward spiral for two to three years, it would be unfair to argue that the MoU with our international lenders is responsible for the fall in property values and demand.

THE banking sector will be severely affected by the deflation in prices and activity in the real estate sector, both at retail and corporate levels.

Property prices rose significantly between 2004-2008 as banks over-lent to local households, overseas investors and property developers by looking at asset/collateral values rather than the repayability potential of the loans. The combination of a decrease in overseas demand in 2008 with a significant amount of stock in the development pipeline, resulted in a decrease in property prices especially post 2009. The latter has had a negative knock-on effect on a number of construction related companies, a number of banks who financed them and the buyers of the end-product. The situation has been further complicated by delays in issuing title deeds and the use of properties that have been developed/sold by their original owners for collateral purposes, often cross-collateralising assets across loan facilities and companies.

All of these have (and will) have a negative impact on business activity and employment. It will also affect confidence among mortgage borrowers, the ability of companies to borrow against property and use it as collateral to finance investment, and the ability of property developers to service existing loans. Thus, a large number of borrowers (developers, investors and individual buyers) are currently entering into ‘negative equity’ causing significant structural and economic implications.

Today, many borrowers are repaying mortgages that are essentially higher than their asset value. To the local banks, this means that their exposure to potential loses has increased further, especially when more and more loans become problematic and in arrears. What is worrisome is that if banks are forced, as envisaged in the Memorandum of Understanding (MoU) with our international lenders, to foreclose on properties, this will open Pandora’s box as procedural/legal issues will appear, losses will be crystallised, and collateral values may drop further due to the number of units coming onto the market as forced sales.

As the boom in the real estate sector was supported by strong credit expansion, this significantly increased the exposure of domestic banks to developments in the real estate sector. Loans to individuals for housing increased considerably in recent years (Cyprus has the highest household debt/GDP in the EU). Therefore, over-lending in the domestic real estate sector created several structural problems. Many property developers and investors are not in a position to repay their loan obligations as they struggle to dispose of their properties/assets, mainly due to uncertainty caused by the turmoil in the local and international markets and lack of financing from local banks to potential buyers (as banks are undercapitalised and are pursuing deleveraging strategies in tandem).

The decisions of the Eurogroup on March 25 outlined a number of prerequisites in order for Cyprus to gain assistance from the troika (ECB, EU and IMF). Through the MoU, several structural changes will positively reshape the financial and real estate sectors in the medium to longer term. Firstly, administrative hurdles and the legislative framework currently constraining the foreclosure and sale of loan collateral will be amended so that the property pledged as collateral can be foreclosed within a maximum time-span of 1.5 years from the initiation of legal proceedings. In the case of primary residences, this time-span could be extended up to 2 years.

It is stated in the MoU that the necessary legislative changes will be implemented by end of 2013, macroeconomic conditions permitting.

Secondly, the government is in the process of raising the Immovable Property Tax (IPT) and it has already announced that it’s going to revise it further over the next six months. It is widely acknowledged that real estate is one of the easiest assets to tax, as there is a central registry of owners and assets (the land registry). Such taxation and the limited access to funding (as banks are unable/unwilling to lend) will push prices and demand to even lower levels.

Thirdly, the central bank will implement a property price index that establishes the average property market valuation by square metre of habitable surface and land plot. This index shall be operational to provide imputed market valuations for each non-agricultural cadastral plot.

Fourthly, amendments will be made to provide for mandatory registration of sales contracts for immovable property and eliminate the backlog in issuing title deeds to less than 2,000 cases.

Fifthly, the authorities will also enhance cooperation with the financial sector to ensure the swift clearing of encumbrances on title deeds to be transferred to purchasers of immovable property, and implement guaranteed timeframes for issuing building certificates and title deeds. The government will also need to implement electronic access to the registries of title deeds, mortgages, sales contracts and cadastre for the financial sector and government services.

Finally, the authorities shall assess the need for additional measures, including if necessary legislative reforms – to eliminate court backlogs by end of the programme.

Cyprus’ economy was in a downward spiral for two to three years, so it would be unfair to argue that the MoU is to blame for the decline in property values and demand. Before the memorandum, compared to 2007, property prices in Paphos, Famagusta and Larnaca had fallen by up to 40-50 per cent, while Limassol and Nicosia had a downward path from 2011 onwards with reductions of about 20 to 25 per cent (Leaf Research, 2013). With the signing of the MoU the market has been ‘frozen’ and it is anticipated that the prices will drop further as the affordability ratio of net income to house prices is further strained.

Nevertheless, all these MoU reforms are in the right direction towards creating a reliable and dynamic financial and real estate sector. Yes, heavy austerity and recession might be in place for the next few years and everyone agrees that after such a severe blow to Cyprus’ lucrative banking sector the country will be pushed into a deep recession. Perhaps the issue one should consider is what would have happened had all these reforms that Cyprus needed for years already been undertaken, making its financial and real estate sectors stronger and more transparent.

And yes, various investors from overseas have already started arriving on the island, looking at opportunities to invest in anything from large-scale real estate projects, operating hotels and acquiring non-performing loans, etc. They have seen this scenario play out elsewhere and they know that in two/three years the economy will start growing again, provided that the country streamlines its public sector, strengthens its supervisory bodies and restructures its banking industry. Cypriots will now be left to benefit from providing services to these new foreign end buyers, and, in time, are likely to realise that had they spent more time scrutinising their government and dealing with their problems rather than pushing them under the carpet, Cyprus would be a much better place to live.

Dr George Mountis
Partner | Banking advisory | Leaf Research
[email protected]
www.leafresearch.com

Readers' comments

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  • andyp says:

    Not only the taxes Jon.

    There are a lot of unpaid developer loans out there all secured on someone elses property/home.

  • petrocelli says:

    Spirit of Odd Job Bob has hit the proverbial nail on the head and makes some very acute and very pertinent observations!

    As for assertion in the article that the Cyprus economy will recover in two to three years………it’s nothing but sheer fantasy!

    I would suggest 10 is a more likely figure and even that is pushing it!

  • Interested kibbitzer says:

    My compliments on a very accessible tour d’horizon and analysis, thank you George. I’ve also enjoyed reading Pavlos’ analyses in previous issues of CPB.

    Good stuff, much appreciated, keep it coming.

    Cheers,

    Graham

  • Martyn says:

    There’s years and years of unravelling to be done before any serious ‘turnaround’ of property markets now, understandably, in free-fall. Can be achieved. Yes, many of the ‘rabbits’ are now out of the ‘hats’ but there is MUCH more turbulence still to come. Hard to factor in any possible ‘bounce’ as a result of MedGas but I’d say 7-10 years before an even ‘competent’ and ‘determined’ Cyprus government can get things back on anything like an ‘even keel’. Competent? Determined? We shall see!

  • jon frazer says:

    Please note that the stuff about nearly 130,000 deeds being issued by Q4-2014, only means in practice that scores of almost bankrupt developers suddenly have handfuls of deeds. As many developers cannot/will not pay their taxes, they will naturally require bail-outs.

    Guess who they will try and sting for the cash?

    You guessed right!!

    (And land registry and tax office don’t want to know, by the way- it’s all between you and your friendly developer!)

  • Spirit of Odd Job Bob says:

    A VERY good summary (although a bit obvious in parts) apart from the last paragraph. The “in two/three years the economy will start growing again, provided that…” is pure wishful thinking, as the proviso is totally unrealistic, even if the political will existed to implement the requested changes (which it doesn’t).

    Everything that andyP says is also completely true, apart from the “A totally coordinated fraud designed to sell property to foreigners” bit.

    How does one explain the loans to bankers who simply just put the money on deposit with no intention of ever building anything?

    How does one explain the oodles of money borrowed even by developers and not a single brick laid?

    How does one explain: the multiple loans allowed on a property; the permission of developers to not pay a cent in interest FOR YEARS; the restructuring of loans to hide that fact; the over-valuation of property to reduce loan to valuation ratios; the subsequent redefinition of what a non-performing loan was so the over-valuation was all that was needed for the NPLS to duck under the radar; the perfectly legal possibility that the non-issuance of title deeds allows to borrow against SOLD property; the continuing borrowing when there was NOT A SNOWBALL IN HELL’S CHANCE of selling any of the stuff you were allegedly borrowing money to build; the virtual abandonment of the nearer markets to which to sell property and dramatic increase in sales costs that the search for new victims further afield would definitely bring? Then the warning of those who had borrowed and not taken the money out of Cyprus to get it out in time before the inevitable axe fell?

    All miscalculation of the property market? All just bad banking practices? We should all know by now that there is NO WAY CONCEIVABLE that all the money borrowed (if any of it?) will ever be repaid, so, what was it all about (Alfie…)?

    It was all about the money. The “totally coordinated fraud” was designed to enable those in the know to borrow as much as they could (ultimately from the EU by way of their banks by way of Cyprus banks), when they could and sod the consequences. The property aspect was, and is, secondary. Resolution of it is not even a serious consideration.

  • Stuart says:

    A well-researched article but extremely optimistic in predicting that the Cyprus economy will start growing again in two/three years time, given all the attached provisos.

    Consider how long it is now taking the UK economy to start growing again and without many of the provisos that are being advocated for the Cyprus economy which relies so heavily on foreign investment.

    As andyp rightly observes, nothing much has changed so far and begs the question as to whether it ever will.

  • andyp says:

    This MOU is certainly not to blame for the woes of the Cyprus property industry.

    The blame lies with the industry itself and the Cyprus government who turned a blind eye to all the corrupt practices of those involved; developers, bankers, lawyers, estate agents, builders and Ministers (remember the Interior Minister telling everyone their contract was their protection).

    A totally coordinated fraud designed to sell property to foreigners at whatever cost that many would find hard to believe.

    Cyprus has been caught and despite everything still does nothing to help victims but rather continues with the scams as the Chinese have recently discovered.

    Cyprus deserves to reap the reward now on offer.

    Not bitter, well just a bit.

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