Why Spanish real estate must fall from between 50% and 70%

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  • #56106
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    Anonymous
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    This has been posted on Edward Hugh’s facebook blog. I thought it worth sharing here.

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    Why Spanish real estate must fall from between 50% and 70% versus the peak value
    by Alexander Winnipeg-Barcelona on Thursday, February 10, 2011 at 9:16pm

    Here are some back-of-the envelope justifications for why I believe that Spanish real-estate still has a very long way to fall before it will stabilize.

    Here is an article from Dec 30, 2009 that described how much property prices were over-valued at that time using rent to price ratios. http://www.economist.com/node/15179388?story_id=15179388. However, since rental rates have fallen as much as housing prices (in Spain at least), I would say that the conclusion of 60% (1.6x) over-valued by this metric is still valid (i.e. need to drop by 37.5% to correct if you believe this measure) , and in-fact is still optimistic since Spain has a huge number of empty properties that will continue to push down both rental and housing prices. — this metric only tells the imbalance between rental prices and purchase prices — it does not predict where the overall market is going except that these imbalances will eventually correct due to standard return-on-investment calculations.

    Additionally, here is another good link (an interactive application at http://www.economist.com/blogs/freeexchange/2010/10/global_house_prices that allows you to compare the 2010 housing prices versus historical values. In particular, if you select “Spain” (on the right side), and “Prices in Real Terms” (top left) to remove the effects of inflation, you will see Spain real-estate is 2X as expensive in real terms from 1997 to 2010. Given that there has been no real growth over the past 13 years (see my explanation in the following paragraph), and given that Spain is arguably in a much worse situation now than it was 13 years ago (20% unemployment, 1 million *new* unsold properties, and possibly 3 million unsold homes according to http://fistfulofeuros.net/afoe/three-million-unsold-homes-in-spain-update, I would argue that prices must fall *at least* 50% from where they were last year in order to correct. I explain why I say *at least* in the following paragraph (Note: I am just using the first numbers that I came across on the web to illustrate more or less what I believe will happen).

    If you consider the change in real GDP of Spain over the past 13 years http://www.tradingeconomics.com/Economics/GDP-Per-Capita.aspx?Symbol=ESP has been about 25%, and the subtract out the percentage of GDP from construction/real-estate which accounts (during the past few years) for about 20% of spanish GDP – and which I believe will go to close to 0% of GDP in the next few years — I would say that GDP without construction/real-estate has changed very little over this time period.

    Ie. Given that housing prices should be tied to per-capita GDP (which has not changed if you take out real-estate/construction) and population (supply/demand) which is not increasing, and will likely drop when all the immigrants start to go home .. In the best case, real estate should be no more valuable than it was in 1997. However, given that there is now a huge over-supply of real-estate in the market, it is not hard to imagine that prices will go dramatically below their 1997 level (in real – inflation adjusted – terms).

    Obviously, I have greatly over-simplified, and a real analysis would take a lot of work, but that is just my back-of-the-envelope guess as to where the market is going. However, you can look at Japan in the interactive graphs above to see what can happen in a real-estate bubble — notice that their prices are currently at about 50% of the value from the peak in 1990.

    Furthermore, the following video http://www2.lse.ac.uk/management/news-and-events/public-lectures/can-spain-overcome-this-crisis.asp shows that historically housing prices have been about 3x the salary of the purchaser (ie. you earn 50K euros, you should buy a house that is worth 150K) — this is also the historical guideline that was used in Canada for as long as I can remember. However, during the Spanish bubble this factor went up to 8x. Using this metric, and assuming that long term fundamentals have not changed, and assuming that people were not buying bigger houses, you would expect that if this number goes back to 3x that housing prices would drop by 63% versus their peak. Of course, that assumes that Spanish salaries don’t drop (which they must in order to re-gain competitiveness) and therefore I would consider a drop of 63% in real estate prices to be an optimistic scenario. Furthermore, historically there was not a huge over-supply of housing as is the case now.

    Considering that there is over 440 billions of Euros http://ftalphaville.ft.com/blog/2011/01/20/464296/when-spanish-bank-property-losses-go-irish in exposure to property, real estate and construction, it would be interesting to see how such a collapse would affect the banking stress tests

  • #102505
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    logan
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    Recent City of London analysis indicated that if property values in Spain fall by 50% and land values by 70%, Spanish Banks will require a capital bail out of around 80bn Euros.
    The government maintains 20bn Euros will be sufficient to stabilise the system.
    If Edward Hugh is right and I believe he is what then?
    Spain does not have the resources on it’s own to rescue the banks to that level. They will have to receive aid from the European Stability Fund. Then watch their bond yields rise to further unsustainable heights.
    No wonder the Chinese were so happy to invest in Spanish sovereign debt. Money for nothing.

  • #102503
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    Anonymous
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    But if bond yields rise the Chinese investment falls in value, so I don’t follow your final point.

  • #102504
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    Anonymous
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    if historically this all works out the same then the uk market should also be inline for a massive correction when i bought my first house (2 bed with on block garage cost 48k) it was 3 times my wages in 1994, same house now even if my wages were double so 32k same house should be 96k but same properties are now 160k.luckily i change jobs as the job i was in would actually only be paying 24k based on this historical analasis we are all screwed

  • #102511
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    logan
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    @mark wrote:

    But if bond yields rise the Chinese investment falls in value, so I don’t follow your final point.

    Bond yields are confusing and depend on a number of factors but losing the investment is unlikely that’s why it’s relatively risk free. Here’s a short explanation I lifted from about.com.
    There are really three different types of yield to explain:
    1. Nominal Yield – This is the coupon or interest rate. Nothing else is factored in to this number. It is actually not very helpful.
    2. Current Yield – The current yield considers the current market price of the bond, which may be different from the par value and gives you a different return on that basis.
    For example, if you bought a $1,000 par value bond with an annual coupon rate of 6% ($1,000 x 0.06 = $60) on the open market for $800, your yield would be 7.5% because you would still be earning the $60, but on $800 ($60 / $800 = 7.5%) instead of $1,000.
    3. Yield to Maturity – Yield to Maturity is the most complicated, but the most useful calculation. It considers the current market price, the coupon rate, the time to maturity and assumes that interest payments are reinvested at the bond’s coupon rate. It is a very complicate calculation best done with a computer program or programmable business calculator. However, when you hear the media talking about a bond’s “yield” it is usually this number they are talking about

    The original bond investment is always returned on maturity at par rate.

  • #102495
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    Anonymous
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    Cassandras, let’s not forget that numbers of properties sold in 2010 was nearly 1/2 million units, UP 6% on 2009 – most people still have jobs whose salaries are index linked – interest rates are at all time lows and many day to day household goods are cheaper !!!!!

    of course many properties will go down by 70% BUT the buyers mentioned above are not buying in these areas –

  • #102525
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    @UBEDA wrote:

    Cassandras, let’s not forget that numbers of properties sold in 2010 was nearly 1/2 million units, UP 6% on 2009 – most people still have jobs whose salaries are index linked – interest rates are at all time lows and many day to day household goods are cheaper !!!!!

    of course many properties will go down by 70% BUT the buyers mentioned above are not buying in these areas –

    “However the Government later issued a statement which said that over the last year 471,000 properties have been sold in Spain, 2.9% more than in the previous 12 months.
    However sales are now firmly down, and that’s because of the end of the tax breaks on property for those who earn over 24,100 € from 2011.”

    Read more: http://www.typicallyspanish.com/news/publish/article_28288.shtml#ixzz1Dfz55u7B

    & included in that 471k , unfortunately, are all the houses the the banks have taken back, or repossessed. They are classed as ‘sales’ ??

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