Strategic Response of Prosavi to the Changes in the Real Estate Market - Research Paper Example

 The Strategic Response of Prosavi to the Changes in the Real Estate Market in Spain Abstract The report discusses the strategic response of the real estate giant Prosavi to the changes in the real estate market of Spain after the real estate slowdown. The present real estate market scenario of Spain is detailed. Additionally, a number of feasible management and promotional options available to Prosavi are evaluated in the report. Introduction Prosavi S.L. is a Spanish company, which recently gained success in the property promotion sector. At the moment, we are focused on two main projects, Cubics Santa Coloma (Barcelona) and La Medina de Banus(Marbella). Both developments consist of luxury apartments finished in the finest quality materials. They are strategically located in prestigious areas nearby an extended amount of facilities. The prices we offer are not overestimated and fairly represent the quality of our product. The company consists of its own Commercial, Technical, Financial and Administrative Departments. Within my placement in Prosavi I took part in each one of them. My work was diverse and flexible. While contributing to the Administrative Department I was finalizing documentation and mainly writing the Contracts of purchase of the properties in La Medina de Vanus. From another side, the help of the Technical and Financial departments were necessary for me all over the period. One of my main tasks in Prosavi was to make a research and a deep study on a project in Colombia we are planning to take part in. Therefore, in order to fully complete my research I was expected to know the main terminology and to efficiently operate with numbers. I also increased my experience in face to face communication, and as a consequence my self esteem. In Santa Coloma de Gramanet I was assisting customers, giving them information on Cubics and promoting our product as a whole. Methodology The Product Cubics is situated in Santa Coloma de Gramanet, Barcelona. Its constructed area, which makes a total of 12.960,58m2 is located next to a cinema and a 3 star hotel, that will be the only once in the area and gardens occupying 6.000m2. The project presents an innovative and singular architecture based on excellent views, open spaces and brightness. The 25 floor residential tower offers 4 types of accommodation (from 1 to 3 bedroom flats) suitable mainly for middle class, small families. The minimum price of 720 euros/month includes a parking space (and storage room for the top floor apartments), 24h concierge, community expenses and the service of a common zone with dryers and snacks machines. Furthermore, there are six commercial spaces on the underground floor, comfortably located to serve some of the needs of the residents of the tower, such as supermarket, pharmacy, kiosk, etc. Findings Current situation in the real estate market in Spain The residential real estate bubble in Spain rise 201% from 1995 to 2007. The rise in price times over the country’s GDP was caused by external factors as the scarcity of land, the speculation on it, the fiscal benefits granted on the acquisition of housing, the immigration, as also the exceeded number of credits given. The result of the explosion of the bubble is the sharp fall of the demand and predictably of the short-term prices, produced by the initial incapacity of the market to absorb the enormous supply of housing. The change in the real estate cycle in Spain has appeared as a consequence of two main external and internal factors: from one side, by the lack of liquidity in the financial system (caused by the mortgage crisis in US), and from another side, by the internal deterioration of the Spanish economy. Therefore, in 2010 the number of unsold properties in Spain exceeds 1.5 million with an average price fall of 8,28% compared to last year resulting to 1.573euros per sq. meter in Barcelona. While most of the countries are expected to recover in 2010, Spain’s GDP continues to fall by 1%, with unemployment of 20%. The interest rates for mortgages, from another side, are among the lowest in Europe (3.5%), which together with the low taxation and capital repayments. At the moment, some Spanish real estate companies are pursued by competing creditors and have had to suspend their debt payments and others have negotiated with financial institutions so they can achieve a reasonable refinancing of their debt. From another side, consumers don’t like the idea of buying at exorbitant prices and they’re waiting for prices to drop to levels where they can afford to buy. Nevertheless, Prosavi has been flexible, as it has rapidly adapted to the situation. With a bit of fortune, apart from strain Cubics initial plan from 2004 was replaced with a new one. While doing this, its main advantage was the lack of columns on the construction, which allowed the total modification of the spaces. Instead of the planned 107 apartments, which should have been lately given on sale, Prosavi decided to increase their number to 150 and logically to decrease their dimensions. Bearing in mind the crisis in Spain and the especially in the one in the property business, Prosavi has decided to change its commercial politics and rent the flats in stead of selling them. The construction firms in Spain are going through a major ordeal. The Spanish market had been in a major crisis, which caused several important real estate companies to get alarmed. The stock prices of all the major real estate companies including Prosavi has fallen significantly. The Spanish people who have invested in the real estate sector are worried as well. A number of families need to pay off their mortgages. The homes of number Spanish people can be overvalued as well. Some experts believe that the homes can be overvalued by almost 30%. Since the real-estate market has been one of the pillars of the Spanish GDP growth in the recent past, the dip in real estate market would affect the country’s GDP as well. The collapse started with the plunge of the Spanish real estate giant Astroc. The shares of Astroc dropped to almost 64%. Other companies had the same fate. Companies such as Colonia, Urbas, Montebalito, Sacyr Vallehermoso, Inmocaral and Prosavi witnessed a dramatic fall in their stock prices. The company Cleop dropped 20.5% while Fadesa dropped 16.6%. Most other companies like Prosavi witnessed a drop of more than 10% of their stock prices. Earlier the prices of the real estate stocks had shot up. The reason for the drastic price shoot-up was the increased real estate investments in Spain made by foreign investors. The low interest rates as well as the growing number of immigrants led to an increase in the stock prices of the real estate companies. This price hike continued from 1999 to 2005. The annual rate of growth rate for the Spanish housing sector at that time was an amazing 15%. The major flaw in the prices was that the prices were not based on expectations but on the value of their assets. Haight and Singer (2005, p.5) comment “Another factor to consider in the valuation of commercial real estate is the impact of subjective perception. Certainly, a piece of property has an objective reality. However, that objective reality may not be as important as the subjective lens through which that property is viewed. An objective reality might describe 50 acres of rugged land surrounding a dismal swamp located 20 miles from the nearest urban area. A subjective perspective might be to consider land as a nature preserve, featuring select executive home sites surrounding ecologically important wetlands, which provide protection for a living environmental laboratory. The objective reality might be a rundown hotel adjacent to a metropolitan central business district whose desirability is threatened by crime in the neighborhood. The subjective perspective might be that the (refurbished) hotel could become a badly needed retirement community for area residents that is distinguished by its access to urban amenities and its significant architectural and historic significance. An investment in such a property could be thought of as a beacon of successful urban renewal that could revitalize the neighborhood.” The sudden fall off Prosavi prices had made many shareholders to move to the US for investing. However, currently, the US too is experiencing a real estate price drop. The minister of Spain however tried to calm the fears of the investors. The vice –president and Minister of Economics, Pedro Solbes, had said that stock market price drop was a significant correction in the real estate stock prices. In a report about Spain, the OECD had stated that the real estate prices were overvalued above the equilibrium level by 30%. In 2006, the prices of Prosavi continued to rise by as much as 10%. Hence, since the beginning of 1996, the prices of Prosavi had risen almost 130%. The strong demand coupled with ideal financial conditions as well as housing tax laws caused such a rise. In 2007, the growth rate of Prosavi had risen almost 8%, which is again very poor compared to the growth rats of other years. In fact, this is the slowest growth rate of Prosavi since 1999. Despite the number of positive figures which were released officially, a number of companies such as the Santander Group in London had suggested that the prices would once again fall in the Spanish real estate market. A report by idealista.com, a real estate website, mentioned that the prices in the used housing market in Spanish cities of Madrid and Barcelona has remained stable. They grow at a dismal 0.5% each year. Along with the slowdown in the housing market of Spain, it is expected that the old homes in Spain will also experience a slowdown. All these slowdowns in used as well as old homes would affect the real estate giants such as Prosavi negatively, as it has done in the recent past. Another reason to worry fro the Prosavi management is the news that the prices of houses in the major coastal destinations of Spain has continued to plummet also. With the fall in the price of the vacation homes, especially with figures such as a 4.7% drop in the Costa del Sol region, the management in Prosavi is in a dilemma. The prices of second homes are expected to fall by 10% too this year. Haight and Singer (2005, p.4) state “Understanding the commercial real estate market today should begin with an understanding of its historical context. In the late 1980s, a real estate boom was moving toward its peak. Interest rates and inflation were climbing. Real estate was widely seen as a way to “beat inflation.” The stock market was in the doldrums. When lenders became overextended and the monetary authorities contracted credit, the market collapsed. This was not a good time to buy. Sophisticated investors were selling, while neophyte investors were buying. By the early 1990s, the real estate market in almost all areas had collapsed. Many commercial real estate developers were bankrupted. A lot of office buildings, hotels, motels, houses, and apartment buildings were sold for pennies on the dollar. Real estate investors were completely discouraged. It was a great time to buy, but it required nerves of steel. Bottoms are hard to see when you are there, just as tops are hard to see just before you go over.” The loan restrictions are one of the reasons for the dropping prices. For example, Prosavi is paying five times more for its debt than its US based counterparts. According to the former head of Don Piso, a real estate firm, the first sector that gets hit in the real estate slump is the second home market. The primary home market is the second to be affected. The volume of new mortgages sold to Spanish families has dropped by 10%. The duration taken for a property of Prosavi to come out in the market to the time taken for that property to get sold takes almost three years currently, as opposed to the six month time frame in which Prosavi properties used to get purchased in 2005. Some other reasons for the Spanish real estate slowdown is the present financial conditions as well as the over supply that exists in the Spanish real estate market. The rising interested rates in Spain and other Euro zones also means that the Spanish families need to work harder in order to buy a new home. Haight and Singer (2005, p.21) state “Real estate properties are capable of functioning as an inflation hedge. That is, when prices in general go up, the rents or fees derived from owning real estate will also rise. This attribute of real estate combines with the use of leverage in real estate. Where the debt carries a fixed interest rate, the effect of inflation is to lower the value of the debt repayments. Under this scenario, creditors lose and debtors win. Real estate property may generate tax savings that augment the real value of the property. In general, tax advantages arise from the use of depreciation and the fact that interest expense is tax deductible. Many real estate investments are not profitable until the tax advantages are considered. Investing in real estate is not necessarily a passive business. Even if there are no operational demands on the investor, managing a portfolio of properties requires many administrative tasks that can amount to a full-time job. In addition, the investors may also elect to take on certain operational responsibilities with respect to the property owned. An office building owner may wish to take charge of the maintenance function, for example, or a shopping center owner may wish to find tenants on his or her own. Some investors may well consider the opportunity to support themselves by running their portfolio as their own business as a good thing. The framework used above treats the ownership attributes of a type of property as a good thing. One of the most important components of the wealth building process is the ability to compound earnings. As a general rule, real estate properties are very good for facilitating this process because of the opportunities naturally provided to reinvest in a property already owned or a similar property.” The European Central Bank began an interest hike in December of 2005. This hit the Spanish people since the hike of 3.75% was the biggest since 2001. This caused the rate tin Eurobor to go to 4.25%. The Eurobor is the primary mortgage price index in Spain. Hence, the average price loan in Spain has shot up by 0.7 points, and the average monthly installment has been raised almost 88 euros. The increasing number of arrears in payments is also another concern for real estate companies such as Prosavi. During the 2006 third quarter, the RMBMS index rose to almost 1.5%, which is 22 basis points. Institutions such as the UCI, BNP Paribas and Banco Pastor have been hit by delayed payments. Discussion Good news for Prosavi is that according to the forecast by Standard & Poor, the increased rates will not affect any family or their ability to comply with the commitments financially. However, the impact of the rising money prices has not affected the Spanish real estate as much as it has affected some other countries which belong to the euro zone. Haight and Singer (2005, p.104) quote “This is not to say that it is impossible to buy below the market. There certainly appear to be lots of opportunities available. Distressed property comes in many forms, such as pre-foreclosures, REO (real-estate owned) or bank owned properties, real estate auctions, probate properties, properties whose owners are going through divorce, and abandoned properties. Opportunities can arise, but they are the exception, not the rule. In any area, there are numerous opportunities to purchase residences that are in various stages of foreclosure, have been seized by creditors, have been seized by the government, or whose owners want to get rid of them quickly. It may be that among the chaff, there is a nugget of grain, but the investor will have to expend considerable effort to find it. The market for distressed properties is crowded with opportunists looking for the same thing. So there will be competition. With hard work and diligence, it may be possible to find a great buy, but it will not be easy. If it was easy, there would be lots of buyers and the price would be pushed up to market value.”   The crisis that the real estate market of Spain faces at the moment is immense. It is also very difficult to predict the scale and consequences of this crisis on a day to day basis. However, its true that the Prosavi group needs to make sweeping changes to the policies and spending of its upcoming projects, especially the projects of Cubics Santa Coloma (Barcelona) and La Medina de Banus (Marbella). The list of Spanish real estate companies which are being pursued by the creditors is ever on the increase. Names such as Jale, Lábaro, Prasi, and Seop are just few of them who are required to suspend the debt payments. Prosavi has the option of following the policy used by these companies. Hence, Prosavi can suspend the debt payments. However, the better policy to follow in this crisis situation for Prosavi would be to negotiate with some leading financial institutions, in order to refinance their debt and deal with the financial problem. Prosavi’s competitors such as Martinsa-Fadesa, Habitat and Colonial are presently negotiating with financial institutions. Experts believe that the current real estate scenario is only a tip of the iceberg. The sudden drop in the house prices of Spain has completely devastated a number of real estate companies in the US. Prosavi should learn from the US real estate market and try to initiate cost cutting practices which would enable Prosavi to reduce the capital and infrastructural costs on the construction of the Cubics Santa Coloma and La Medina de Banus, by replacing luxury materials with standard materials. Prosavi could also reduce the extended number of facilities which were first envisaged for the luxury apartments. In this way, the prices of the houses can be significantly reduced, thereby decreasing the financial pressure exerted on Prosavi as well as the financial institutions who are willing to bail out Prosavi at this crucial juncture. According to the director of the Instituto de Empresa’s real estate management department Miguel Hernández, the real estate companies kept increasing their prices without thinking about the future, and hence this crisis was about to hit Spain sooner or later. Certain promoters in Spain are presently offering financial assistance to the individuals who are having a hard time selling their apartments. Certain promoters are even giving them an option to buy rental property. This kind of offer would help Prosavi to sell the luxury apartments, since customers currently cannot afford buying apartments at such exorbitant rates as offered by the Coloma and La Medina de Banus. Hence, an number of potential customers would wait for the prices to drop. Therefore to survive this real estate sector crisis, the Prosavi has to adapt to the new change cycle. The marketing professor at ESADE business school, Juan Carlos Martínez believes that the real estate market has to move towards the area where the sales are. Marketing needs to be a management tool. He also believes that there’s no current sales technique in the prevailing situation, which can be termed as effective. Since the demand is subdued and the people are waiting for the real estate prices to drop, real estate companies such as Prosavi requires searching for solutions. Innovation, service and quality are the best management pillars which would help Prosavi to tide over the crisis. Although a number of promoters have made certain tempting offers, Hedandez believes customers may not fall for such offers. Hence, rather than making eye catching offers to sell the apartments in Cubics Santa Coloma and La Medina de Banus, Prosavi should facilitate buyers in paying extremely low monthly mortgage or monthly rent for the housing. Certain promoters are even giving away cars to the prospective buyers; however Prosavi should only adopt giving away freebies such as cars as a last resort. Haight and Singer (2005, p.82) quote “The general approach to evaluating a lease versus buy situation requires contrasting the viewpoints of the lessor and lessee. In general, the potential lessee has made the decision to go ahead with a capital acquisition. The question before the lessee is how to finance that capital acquisition. The answer to the lessee is thus, “The decision that costs the least.” Least in this situation involves minimizing the present value of all cash flows associated with the acquisition. The approach of the potential lessor is quite different. The decision to lease involves a capital expenditure that is evaluated on the basis of the cash flows it is expected to generate. The idea is to maximize the difference between the present value of those cash flows and that capital expenditure. This is the definition of net present value (NPV.) The decision of the lessor to lease is made on the relative magnitude of that value. It is not realistic to generalize that in a particular situation an investor should lease (or buy). Generalizations are precluded by the interaction of the different relevant variables in a given situation (tax rates, interest rates, timing of cash flows, length of life of the lease, terminal value, risk, and ability to raise capital). Lease versus buy needs to be approached on a case-by-case basis.” There have been reports that a number of competitors of Prosavi have used dramatic sales techniques to sell property. These real estate companies have used similar promotional techniques as is used by the companies in the consumer goods market. The problem with such promotional techniques is that it may spoil the reputation of prestigious brands like Prosavi, since people normally require certain emotional content to be associated with real estate marketing and promotions, unlike the products available n the consumer good space. Reyal Urbis is a Spanish real estate company which has created a subsidiary called Reurbe. This new company manages housing cooperatives as well as offer managerial and advisory services to the consumers who want to know more about the current housing market in Spain. This is an idea which can be adopted by the Prosavi Group, since by having open and protected housing cooperatives, Prosavi can improve the brand image exponentially, and they can also identify potential customers for the luxury apartments Cubics Santa Coloma and La Medina de Banus. Haight and Singer (2005, p.135) comment “Investing in apartments generally produces better returns and less risk than investing in residential real estate. This is because apartments are less costly to construct, operate, and maintain on a per unit basis. In addition, apartments do not get caught up in the amenity value issues that characterize single-family homes. Apartments are bought and sold strictly on the basis of their economic value, which is determined by their ability to produce a net cash flow now and in the future. Apartments also have the advantage for investors that they do not require the personal attention of the investor. All areas have professional rental management companies who are willing to relieve the investor of the day-to-day responsibilities of managing the property. Moreover, apartments usually have enough economies of scale to make this cost feasible.” Another novel concept developed by the Bancaja Habitat group in Spain is the ‘Outlet’ system. The company is offering 40 homes, which are both new and used homes, which are made available at a huge discount. This strategy was deployed by the Bancaja Habitat group in the recent real-estate fair of Madrid. Yet another idea which the Prosavi group can integrate is the ‘Bucketful of confidence’ promotional campaign initiated by the Afirma Grupo Inmobiliaro. In the policy, the Afirma group will pay back the deposited money of the customers, in addition to 2% in payments on interest, in case the customer wants to back out before registering the property formally. However if the customer eventually buys the property from Afirma, they would reward the customer by paying him/her 20% of the initial instalment made by the customer. Even if the home’s market valuation declines a few years after the date of registration, Afirma would pay the fitting difference. Haight and Singer (2005, p.9) comment “Leverage is not unique to real estate. Stockbrokers typically offer “margin” financing on stocks bought through their brokerage. However, more leverage is generally available for real estate investment. This is because that while the commercial real estate market certainly has its ups and downs, it has nothing like the volatility of the stock market. Lenders feel more secure about their ability to recover their obligations when the value of those obligations is secured by a mortgage to real property whose value stays relatively constant. Successful real estate investors optimize (not maximize!) their leverage. The general rule is “Borrow to buy, sell for cash.” More leverage can make a good investment a great investment. Wise real estate investors generally look for those properties that provide the most financing. That is why single-family residences make such attractive investments. The government, in its desire to encourage home ownership, has created a set of institutions and policies to encourage individuals to purchase homes even with almost nothing down. While such programs are often targeted for the poorest and most disadvantaged in our society, there is a lot of carryover that can benefit almost anyone. Even outside residential properties, an eager seller can be interested in “taking back some paper” to minimize the investor’s up-front cash requirements. To optimize leverage, many investors have a specific strategy that they use in identifying investment opportunities. This involves acquisition strategies that minimize the cash necessary to get into a project and divestiture strategies that look to all cash exits. Such strategies would include minimizing the down payment, borrowing the down payment, extending the life of the loan, and borrowing interest only with a balloon payment for the principal.” Conclusion Unfortunately, in this real estate market of Spain, there will be some winners and some losers. The companies who fail to innovate and adopt, will be left behind. Some experts are of the opinion that the companies which develops strategies which are innovative and attractive, will succeed. Auctioning off homes is yet another drastic policy which some companies have implemented and have benefited from. In the auctioning process, the prices continue to fall until and unless a bidder accepts the price. The price does not go beyond a minimum established price. This process has been successful since more than 20 housing units as well as 2000 available units were sold off for 4 million euros. The discounts on these properties ranged from 20% to 30%. If Prosavi has requires to fund the completion or the promotion of the Cubics Santa Coloma and La Medina de Banus, it can auction off some of its other properties and utilize the collected money for promoting the two luxurious housing projects. The Spanish real estate story will definitely be one of the most researched topics. The ten year cycle which saw the beginning of Spanish real estate market boom to the recent collapse of the market, would give important insights into the inherent issues with real estate markets. The other countries of the world who are expecting such real estate collapses in the near future, are very anxious to know the strategic response which have so far been implemented by the successful real estate companies of Spain. The number of homes built in Spain would come down from 800,000 units of today to about 400,000 units in the near future as well. The current economic condition and the social changes in Spain have caused this slowdown. One of the vital lessons which the Prosavi group has definitely learnt is that one ultimately needs to pay for their excesses. This crisis is gradually on the decrease, however the lesson learnt from the crisis will forever remain with all major real estate companies of Spain, including Prosavi. References G. Timothy Haight and Daniel D. Singer, Real Estate Investment Handbook, John Wiley, 2005 Read More