(Nicaragua, November 2020)
It is nothing new that COVID-19 came in like a hurricane in the middle of the summer. No one expected it, no one was prepared and most of the responses have been simply reactive to the situation.
In Nicaragua, even with the few self-imposed measures of social distancing, we have had the same secondary consequences as almost everyone else: a consumer crisis that affects many markets and industries.
One of the losers during economic downturns is the real estate market. But what is the real estate industry? Who are its actors? How do they relate? And how have these relationships been affected by the impact of the crisis?
At first glance, the seller and the buyer of a property are alone. The truth is that for these two people to reach an agreement, a developer or a builder had to have built the house, a real estate broker had to have made the contact; a financial institution had to have given its support to facilitate the purchase or construction, and this financial institution would never have been able to give the loan without having an insurance policy and an appraisal of the property.
Builders, brokers, financiers, insurers, and appraisers are all players in regulated sectors, with restrictions that do not give them much room for maneuver to face sudden changes.
The most obvious friction relationship is between brokers and developers. In times of crisis, a broker must close a sale, not always paying attention to the price or the margin that a developer may need to cover all his costs.
The bank that owns a mortgage on a lot that this year is worth less than the previous one, has at least two problems. On the one hand, the risk that the borrower, due to the effects of the crisis, may not continue to pay the mortgage. On the other hand, the level of risk on the loan has skyrocketed, since the guarantee used to secure the credit is no longer enough to cover the debt.
Regarding insurance, is it feasible for an insurer to modify the terms of an existing policy and change the insured amount based on a reduction in market prices? Or, can the insured request a reduction in their premium?
The complexity increases when we think that a property has insurance for X amount and that a bank required the insurance to be sufficient to grant a loan guaranteed by a mortgage for a Y amount. If the insurer considers that the value of a property has decreased, it may seek a modification in the terms of the policy. Upon receiving notice of this modification, the bank may rethink the risk level of its credit and, depending on the contract, modify the interest rates and the amount of the payment installments. In this scenario, an individual who does not operate in the real estate market would be directly affected by speculation in the price of properties.
Much is said about the decline in the price of real estate. And the price is determined by supply and demand, correct? Or is it the cost of materials and the innovativeness of the design, or is it simply a case of the famous maxim: location, location, location?
It is true that the fewer interested parties there are for a product, the greater the possibility that such product will attract new buyers through a reduction in value. It is also true that parts of Nicaragua have seen a rebound in real estate prices, often supported only by the beauty of the beaches and not necessarily by the conditions that could be offered to the buyer. So, how are prices defined and what role does the appraiser play?
In Nicaragua, both insurers and banks are required to use appraisers to define the value to be assigned to an asset, based upon which they will provide their different financial services. In practice, it is also normal for individuals to request appraisals to obtain an estimate of the price of a property.
The regulations on valuation experts dictate that these will be regulated by the superintendency of banks. The same regulations describe the factors that the expert must take into account when determining the price of a property and obliges them to calculate at least 3 different values.
Therefore, the customary market, realization, and replacement values are obtained. For market purposes, the appraiser must take as a starting point the prices of at least three properties with the same characteristics and in the same area that have recently been sold or offered. Then, this information must be processed to identify the differences between the properties studied and the object of appraisal, and finally, a value is proposed.
In conclusion, the real market value of a property should be measured based on similar transactions that have been closed or recently offered. Therefore, any reduction (in percentage terms) in the price of a property should only be calculated based on current and previous real estate market prices. If such comparable prices are not available, the evaluation should consider an aspirational and expected value, versus the price obtained by an emergency sale.
In a certain way, Nicaraguan financial regulation aims to protect the sector from the vagaries of the real estate market and forces banks to remain firm in the face of speculation. Whether this protects the private financial system or limits its ability to operate in the face of crises is a subject for another discussion, but the important thing is to know the structure of the regulation and its implications for the country’s real estate market.