I also get concerned when people talk about cheap and good value, as concerns the price of property. If I paid 20euros for a mars bar and then tried to sell it to you for 10euros, would that make it cheap or good value? I see so many adverts for property that say 30k euros reduction, as if this somehow means you are getting a bargain. If the person paid 300k euros for a property that is worth only 150k euros, then 270K euros is still very poor value and represents no bargain what so ever.
The reality is that as soon as people started to treat property in Spain as an primarily an investment, rather than as a home, then the concept of the greater fool started to appear. The greater fool theory comes into play when I can convince you that an asset will definatley go up in price. If you become convinced that for instance if you buy asset A from me for 100 and later you can sell it onto another "investor" for 150, then you will be very keen. You will not care too much about the intial price of 100, only the ratio between the two ie a 50% increase.
In asset markets where the price has been riseing for some time, this process tends to feed on its self, as more "investors" get sucked into the market attracted by large gains. As long as there is a greater fool to sell to, and cheap credit to fuel the process, the situation can continue to astronomic levels. Obvious examples of this were the 2000 tech bubble and the tulip bubble in the 17century.
"In 1623, a single bulb of a famous tulip variety could cost as much as a thousand Dutch florins (the average yearly income at the time was 150 florins). Tulips were also exchanged for land, valuable livestock, and houses. Allegedly, a good trader could earn six thousand florins a month.
By 1635, a sale of 40 bulbs for 100,000 florins was recorded. By way of comparison, a ton of butter cost around 100 florins and "eight fat swine" 240 florins. A record was the sale of the most famous bulb, the Semper Augustus, for 6,000 florins in Haarlem.
By 1636, tulips were traded on the stock exchanges of numerous Dutch towns and cities. This encouraged trading in tulips by all members of society, with many people selling or trading their other possessions in order to speculate in the tulip market. Some speculators made large profits as a result."
The common aspect of all these bubbles is that people lose sight of the worth or value of the asset, the only concern is how much it can be sold on for. With property for example there is no thought given to aspects of supply and demand, desirability, quality, income yield, construction costs etc.
When the bubble finally ends, investors are left with assets, whose price bares little resemblance to their value. Once the greater fool theory is over, the asset tumbles in price to its intrinsic value. The longer the bubble, the greater the difference between the final price paid and the intrinsic value.
So how much is a property worth, how do you value it? The problem with an illiquid asset such as property is that the value is difficult to discern until you try to sell it. Estate agents like to tell people that prices have not fallen, but they often quote asking prices, and asking prices might be very different to selling prices, particularly when investors are in the denial phase.
The only way to really determine if a property is good value in an economic sense is to measure the rental yield. If the net yield covers more than your finance costs and the costs of maintenace etc then you may have good value and certainly you are in a postion of relative luxury in that your can sit out your investment indefinatly.
Its important to use nett yield however, as gross yields may be flattering, but are not much use to you as an investor. Historically property has been good value when gross yields have been 12% or more, altho of course this depends on the prevailing interest rate environment.
Had people bought property in Spain as a genuine first home, or holiday home, primarly for their own enjoyment and financed within their means, then the whole issue would be very different. Of course the numbers buying under this scenario would have been much smaller, and likely as a result there would have been no boom. Also the value of the property would have been to the individual owner, its enjoyment and lifestyle value, the price being paid as less significant.
It strikes me that if most investors are non resident, then achieving a decent nett yield is going to be very tough in Spain. Taking into account the rather punative rental taxes, tax that applies even if you don't rent, and then the agencies fees, most peple are going to struggle to make ends meet. Add in massive oversupply in many areas and you can appreciate the problem. If interest rates increase, this compounds the misery.
I do not know, but I suspect that most investors were told that the property would be a good investment, because they could rent it out to cover costs. I wonder how many people are discovering that this is simply not going to help?