FOREIGN CURRENCY ISSUES

Buyers and owners of Spanish property need to consider forex issues

Introduction to forex

Spanish property is priced in Euros and most British buyers have their funds in Pounds Sterling. This means they have to buy Euros before they can buy their Spanish property. Turning pounds into Euros can be a very expensive affair if you are not careful.

Assuming that you are starting off with Pounds Sterling (or any other non-Euro currency for that matter), then the timing of your Euro purchase and who you buy them from can have a major impact on the overall price that you pay in Pounds Sterling.

Our experience has shown us that many British buyers of Spanish property both overpay for the Euros they need to buy their property and take unnecessary risks with exchange rates once they have taken on a Euro exposure (obligation to pay Euros in the future). In the following sections we explain how purchasing Euros can have a big impact on the price in Pounds of your Spanish property.

What are exchange rates?

We will start with a few words on what exchange rates are and why they are constantly changing. If you are familiar with exchange rates skip onto the next section.

An exchange rate is the price tag for one currency unit if you wish to buy that unit using a different currency. In this respect exchange rates are no different to the price tags for ordinary products you find in shops and supermarkets.

Currencies are traded on the international foreign exchange market on a continuous basis and in staggeringly large volumes (the value of daily transactions is around 1.6 trillion Dollars). In the very short-term currency exchange rates move in a random way in response to immediate levels of supply and demand. In the medium term exchange rates reflect the differentials in interest rates between currencies, and in the long term they reflect the differentials in inflation rates between economies. However all you really need to understand is that currencies are sold by various types of currency dealers such as banks or currency brokers, that exchange rates are constantly changing (they change every 2 seconds) and that in the short term it is impossible to predict with any certainty which way they are going to move.

What impact can exchange rates have on the price of my Spanish property?

When you buy a property in Spain you take on a Euro exposure - an obligation to pay someone a certain amount of Euros at a specified date in the future. Unless you already have Euros (for example because you are paid in Euros and have all your savings in Euros) you will have to buy Euros using Pounds Sterling or another currency. Therefore it is the total price of your Spanish property purchase in Pounds Sterling that matters to you most.
But because exchange rates are constantly changing, the value of your Euro exposure in Pounds sterling is constantly changing as well. The fluctuations in the Pound Sterling / Euro exchange rate can have a big impact on the price in Pounds that you end up paying.

A likely scenario for buyers of Spanish property is a Euro exposure spread over an 18-month period and made up of stage payments. This is often the case if you buy Spanish property off-plan in a new development or when you have a Spanish house built to order.

Over a typical 14 to 18 month timeframe in which stage payments are made for an off-plan purchase the exchange rate between Pounds and Euros is likely to move considerably. This movement can have a big impact on the cost of the purchase in Pounds. However most buyers have to work within their budgets and need to be certain at the time of signing the purchase contract how much the property is going to cost them. The only way to achieve this is to use financial instruments that help you to manage your exchange rate risk.

If you want to buy a resale property that is already built and can be exchanged on straight away you might think that the speed with which you will complete takes out the exchange rate risk. However this will only be the case if you buy your Euros the moment you sign the sales contract and take on a Euro exposure (the obligation to pay Euros to someone at a specified date in the future). Very few people actually do this - it is just one of those things that most people overlook.

Typically when people buy a resale (ready built) property in Spain they pay a deposit of around 10% at the time of signing a private sale contract with the vendor (often buying Euros from their bank at extortionate rates), and agree to pay the remaining 90% at the time of signing of the deeds before Notary. In most cases the deeds are signed between 1 and 4 months after signing the private sale contract. This means that the buyer will carry a Euro liability for a couple of months and fluctuations in the exchange rate over even such a relatively short period can have a significant impact on the price in Pounds that the buyer has to pay.

The purpose of this section has been to show that exchange rate fluctuations over even short periods of time can have a big impact on the cost in Pounds Sterling of buying Spanish property. This introduces a significant element of uncertainty (called exchange rate risk) into your property purchase that you might prefer to live without. The next section will explain how you can eliminate this risk.

How can I manage my exchange rate risk?

When you buy a property in Spain and take on a Euro liability you become contractually bound to deliver a certain amount of Euros at a specified date (or dates) in the future, and will probably loose money (such as a deposit or payments to date) if you do not honour your side of the bargain.

At the time of taking on the Euro liability - probably when you sign the private sales contract - you know how much the liability is worth in Pounds because the exchange rate of the day is known. However you cannot be sure of the value in Pounds of this Euro liability in the future. Depending upon how the exchange rate moves your property might cost you more Pounds or less than you have budgeted for. Of course you would be happy if a strengthening Pound were to decrease the value of your debt in Pounds, but you might be devastated if a weakening Pound were to increase the cost and leave you significantly out of pocket. For this reason British buyers of Spanish property general prefer the security of knowing exactly how much they will have to pay in Pounds over the chance that they will end up paying less. Fortunately there are several financial instruments that you can easily purchase to help you manage your exchange rate risk.

Forward contracts allow you to fix the exchange rate that you will pay in the future, be it on one date or on several different dates in the case of stage payments spread over many months. With a forward contract you know exactly how much your property purchase will cost you in Pounds regardless of the what happens to exchange rates. Obviously in a forward contract the currency dealer who sells it to you takes on the risk and therefore has to price this into the exchange rate you are offered. Nevertheless you benefit from the security of knowing how much your property will cost you and the peace of mind that this gives you. Furthermore a good currency broker will be able to offer you a forward contract at a reasonable price.

Although forward contracts are the most common way of managing exchange rate risk there are financial instruments even more exotic than forward contracts. For instance market orders that limit the downside of your exchange rate risk whilst leaving the upside open. This means that if the Pound strengthens against the Euro you will benefit from this but at the same time you are protected against the Pound weakening beyond a certain rate. So you know from the very outset how much your property will cost you in Pounds in the worst case, and can budget for this, whilst leaving the door open for a pleasant surprise if the Pound strengthens in your favour.

These types of financial instruments (and there are others too) might sound complicated. However they are actually quite simple, can be extremely useful and a good broker will be able to advise you on the most suitable instrument given your circumstances and requirements.

Who sells foreign currencies (forex)?

Specialist currency dealers and high street banks are the main suppliers of foreign currencies to British buyers of Spanish property. Both dealers and banks buy their Euros from the international currency market, add on their commission and then sell the Euros on to you.

Most people buy their foreign currency from their bank. However high street banks are likely to give you the worst exchange rates on the planet. So why do people still buy their Euros from banks? Partly out of habit - after all they have probably bought their holiday currencies from their bank in the past - but mainly due to a lack of insight into foreign currencies and who to turn to for the best rates.

Obviously any one of the big banks would fall over themselves to offer a keen exchange rate to big companies buying millions of Euros. However Mr. & Mrs Smith and their 100.000 Euro requirement don't get this royal treatment, and are likely to end up with uncompetitive rates from a high street bank. It is no secret that high street banks make large amounts of money on the back of fat profit margins and lacklustre customer service.

For Euros, British buyers of Spanish property are probably better off dealing with specialist currency brokers. Because they are specialists they know a great deal more about foreign currency purchases than your average bank branch manager, and can give you more informed advice. But most importantly of all they also offer much better exchange rates than most high street banks. Specialist currency brokers deal in high volumes of currencies that enable them to get good 'bulk' rates, and then work on thin profit margins that reduce the cost to you of buying Euros.

Specialist currency brokers also offer you other advantages over high street banks.

1. They charge very low fixed costs for transferring the Euros you purchase from them to any account you specify.
2. They can often help you avoid the outrageous Spanish banking charges (known as lifting fees) that banks charge for receiving funds.
3. They are extremely easy to use.
4. And most importantly of all they know all about currencies and can give you the best advice in the business on the question of how to go about buying your Euros.

How do I avoid overpaying for foreign currency?

Most British buyers of Spanish properties overpay for Euros by purchasing them at an expensive rate from a high street bank. A good currency broker will usually offer Euros at a better price (with better service and more understanding of you needs) so buying from a bank risks paying thousands of Pounds more than you need to for your Spanish property. Therefore we recommend that you buy your Euros from a reputable currency broker.

Because exchange rates are constantly changing, and can sometimes move quite dramatically in a short period of time, we also strongly advise you to take steps to manage your exchange rate risk the moment that you take on obligation to pay Euros, for instance when you sign a private sales contract for Spanish property. The moment you take on this Euro exposure is also the moment you should be talking to a currency broker about how to minimise the risk of your Spanish property becoming much more expensive than expected due to exchange rate movements. This is just as true of people who need Euros tomorrow as those who need them in a year's time.