How to play the eurozone break-up, second-home edition
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The lengths to which I’ll go for my readers: I’m currently sitting poolside in an Algarve villa, enjoying a perfect climate and gorgeous view of the Atlantic, and wondering if this could be one of the best ways for investors to play a possible eurozone collapse.
The WSJ recently ran a big article on the way that second-home prices in the eurozone periphery have been falling dramatically of late, especially in Greece and Portugal. And in Portugal, especially, they’re coming down from pretty low levels, since the country never had a property bubble to begin with. On top of that, the weakening euro is making prices even more attractive for dollar investors.
But wouldn’t a eurozone breakup be very bad news for second-home buyers? Here’s the WSJ:
Fear of a revalued euro, or even the extremely unlikely possibility of some countries losing their membership in the euro zone, continues—either of which could dramatically devalue any current purchase.
I’m not at all sure. Property is a real asset, which tends to hold its value reasonably well over time — even during devaluations. Look at home prices in Buenos Aires after Argentina’s devaluation — they didn’t fall much in dollar terms.
But the situation for investors could be much better than a modest decline. Here’s Nouriel Roubini, talking about how to structure a Greek exit from the eurozone:
This process will be traumatic. The most significant problem would be capital losses for core eurozone financial institutions. Overnight, the foreign euro liabilities of Greece’s government, banks and firms would surge. Yet these problems can be overcome. Argentina did so in 2001, when it “pesified” its dollar debts. America actually did something similar too, in 1933* when it depreciated the dollar by 69 per cent and repealed the gold clause. A similar unilateral “drachmatization” of euro debts would be necessary and unavoidable.
Major eurozone banks and investors would also suffer large loses in this process, but they would be manageable too – if these institutions are properly and aggressively recapitalised.
Nouriel’s point is well taken: there’s a long history of countries successfully devaluing their way to economic recovery, with Iceland being only the latest example. When that happens, lenders take losses. And when lenders take losses, borrowers gain.
Here’s my point: in the event of a Greek devaluation, Greek mortgages would be drachmatized. And similarly, if Portugal were to leave the euro, Portuguese mortgages would be escudified. Second-home owners, instead of paying interest on their mortgages in euros, would switch to paying in devalued drachmas or escudos — an enormous overnight savings, which would continue for the duration of the mortgage.
A devaluation by Greece or Portugal would involve a big one-off write-down by lenders to Greek and Portuguese borrowers, and a concomitant one-off gain by those borrowers. If you have a mortgage in Greece or Portugal, that’s a great way of becoming a borrower in that country. Yes, getting a mortgage is non-trivial, but it might well be worth it.
*The FT actually printed 1993, here, not 1933, but it’s clear what Nouriel meant.
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Unless the devaluation is anticipated by the markets and your Euro debt is converted to Drachmas at the devalued rate.
Your scenario only works if devaluation continues AFTER the breakup.
Do you have any reason to think that Greek mortgages would be drachmatized? If I were a Greek bank I would be writing mortgages in euros that would be payable in euros even if Greek government debt became payable in drachmas.
The Greek government has the ability to unilaterally change the currency of its debt. You don’t. And a mortgage in Greece is no more likely to be auto-drachmatized than a mortgage in Germany. Am I missing something?
“Your scenario only works if devaluation continues AFTER the breakup.”
Wouldn’t that be the whole point of the breakup? Whatever the conversion ratio (pretty much irrelevant since the currency doesn’t presently exist), it would necessarily continue.
“The Greek government has the ability to unilaterally change the currency of its debt.”
Does the Greek government have the ability to unilaterally change the currency of YOUR debt? If so, they would plausibly choose to do just that.
Perhaps I’ve missed something but this doesn’t seem sensible.
The Greek Euro debt you propose incurring will be over-matched by the value of the Greek property you’ve bought with it. In the event of a Greek exit from EMU both the value of the property in new Drachmas and the debt will decline similarly in Euro value. In other words your net asset value will shrink.
Either buy the property cheaply with Euros after the event in anticipation of an eventual recovery, or raise Greek Euro debt to buy German assets before the event. Greek home-owners might try the latter whilst the ECB is still funding Greek banks. Better still if they can borrow locally to buy holiday homes in Berlin or London.
But don’t use Greek Euro debt to buy Greek assets before the crunch.
Couldn’t there be another issue, if for example you bought elsewhere in Europe but not Greece? If Greece pulls (or gets “hoofed”) out maybe the Euro ultimately then strengthens without them. This would clearly work against you wouldn’t it?
FS
Not sure I follow either. Let’s sy you purchase a property worth today in USD 500,000 and take out a loan in the amount again at today’s exchange of 400K USD. Leaving aside any property value decline, in the event of a currency devaluation of let’;s say 40%, you now own a property valued at $300,000 and owe $240K. In other words, you may have “gained” $160K in debt reduction but you have still suffered a net decline of $40K in your equity. Ad in even a small fall in property values and this doesn’t seem like a smart move except for perhaps anyone whose reference currency is the new EUR replacement.
I think I follow:
So imagine we want to buy a house in Greece.
Ok so our funding currency is USD and the Liability currency is Euros (that eventually converts to Drachmas).
So imagine that the value of the house we want to buy is worth $500,000. We put a 20% down payment of $100,000 and take an 80% mortgage of $400,000. So we have a 20% equity stake in the value of the house.
Now imagine a redenomination happens so that all Euro liabilities are converted into Drachmas.
The Drachmas then depreciate by about 40% against a broad basket of currencies. (probably more against the US Dollar because there would be a flight to safety in a crisis, but for the sake of conservatism lets assume its 40%).
Our mortgage then becomes redenominated into drachmas and in dollar terms is worth (400,000*0.6)= $240,000.
Now since housing is a real asset and prices in Greece are already at rock bottom, the value of the house should stay more or less constant in dollar terms.
Our property is still worth more or less $500k in dollar terms (and by implication our equity stake is still worth $100k).
What in effect happens is a massive mortgage write down that is financed by Greek Banks. The net gain of $160,000 (160% of our initial investment) is substantial.
The gain would be even greater if:
Our funding currency appreciated in relation to a broad-basket of other currencies.
We are more leveraged. In other words, we put a smaller down payment and a larger mortgage.
A devaluation spurs growth in Greece and property values rise from their rock-bottom lows.
Reasons to worry
The Greek government might not re-denominate foreigner’s loans.
Political and Social unrest following an exist from the euro
Greece might be forced out of the E.U. (unlikely).