March 2005

Is there a bubble in the Spanish property market? Well it depends who you talk to.

In a series of recent classes on real estate marketing that I have been giving at Spain’s IESE business school I asked the assembled group of executives from many of Spain’s leading real estate developers for their opinions on this question. Surprise was not my overwhelming emotion when it emerged that none of them judged Spain to be suffering from a property market bubble. Pretty much all the different associations representing Spanish promoters, mortgage lenders and other real estate sector companies have consistently argued against the existence of a property bubble in Spain.

Meanwhile the Spanish government is flapping around trying to reassure people that no bubble exists whilst at the same time engineering a soft landing for the property market – not an easy job.

The previous Treasury Minister Rodrigo Rato (now head of the IMF) said shortly before his government was ousted “Nobody should think that we are experiencing a property bubble”. Since then Maria Antonia Trujillo – the socialist government’s Minister for Housing, hasn’t missed an opportunity to dismiss the existence of a bubble whilst suggesting that the property market is stabilising and price growth slowing, on the strength of very little evidence it should be said. The Government’s strategy to cool the market lies in stimulating the rental market through a new government-sponsored public rental agency (Sociedad Pública de Alquiler) that will rent out 25,000 or more private properties in the next 4 years at below market rents, and new initiatives to make consumers more aware of mortgage costs, including sensitivity to changes in interest rates and a move towards fixed rather than variable mortgages.

Several studies on the Spanish property market have been commissioned by real estate trade associations and banks. Analistas Financieros Internacionales (AFI) – a consultancy frequently commissioned to study the sector has recently said, “Under no circumstances can one talk of a collapse in demand for property”. Yolanda Fernández, a partner at AFI has been quoted as saying “One has to keep in mind the importance of future demand for second homes, which in 2002 was already 52% of total demand”, implying that foreign demand for Spanish property has shifted the demand curve and created a new paradigm in which present Spanish property prices are justifiable. Other studies, both local and foreign, often concur that prices are high and price growth likely to cool down significantly in the coming years, but that prices are still within a reasonable range and therefore not in bubble territory.

On the other hand The Economist Magazine has repeatedly warned of a Spanish property market bubble over the past 2 years, its latest broadside coming on the 3rd of March 2005 when it argued that Spanish property is 60% overvalued in relation to rents (along with the UK). The IMF, the OECD, the Bank of Spain, the ECB and the old chap who cuts my hair have also voiced concern over the level of Spanish property prices and the possibility of a bubble.

The ECB continues to single out Spain as one of the Euro-zone countries most at risk from a property price bubble, along with Ireland and The Netherlands, due to the fact that property prices in these countries have doubled between 1995 and 2003. In the bank’s monthly report for January 2005 (repeated again in February) it doesn’t mince it’s words, describing property prices rises in these countries, and to a lesser extent France and Italy where prices have increased by 50% over the same period, as “unsustainable price increases”.

The bank keeps it’s language sufficiently vague regarding the timing of the bubble (already inflated? Soon to inflate?) and leaves it up to the audience to decide. Excess liquidity and runaway growth in mortgage lending are the main drivers identified by the bank as causes of a possible bubble. The bank claims that liquidity in the Euro-zone (the amount of money broadly defined and including credit, sloshing around the economy) is higher than the level required for inflation-free growth in a country like Spain, so we can expect this liquidity to drive up asset prices, particularly property prices, in those countries like Spain with a strong property-ownership culture.

The noises coming from the Bank of Spain in recent days leave one in no doubt that they are very worried about a Spanish property bubble. The Governor of the Bank of Spain – Jaime Caruana – was reported in La Vanguardia on the 8th March as saying that low interest rates continue to inflate a property bubble in Spain. His team have consistently urged caution upon mortgage lenders and the sector at large, but the message has largely fallen on deaf ears. Mortgage lending rose 24% in 2004 and Spanish property prices official rose by over 17%. Mortgage lending in January 2005 was up by 23.9% over the same period in 2004 and property prices still appear to be surging ahead. The Bank of Spain has gone on record as saying that property prices in Spain are between 8% and 20% overvalued.

But in response to the Bank of Spain’s warnings over a Spanish property bubble, the Spanish Mortgage Association (AHE) has released calculations showing that repayments on the average mortgage in Spain will only increase by 1,000 Euros per year should interest rates increase to the maximum extent forecast by the Association (4.75% in 2 years and 6.39% in 6 years). Under these assumptions repayments on the average Spanish mortgage taken out in 2004 – 106,900 Euros over 25 years – would rise from 510 Euros monthly at present to 714 Euros monthly over a period of between 2 and 6 years hence. In other words in 6 years time average monthly mortgage repayments might rise between 78 and 204 Euros – hardly a huge threat to household finances. Therefore the AHE sees interest rate risks as larger in the long term than in the short, and does not expect rising interest rates to hammer the Spanish property market in the short term.

The consultancy Pricewaterhouse Coopers (PwC) has contributed to the debate with a new report on the first quarter of 2005 that suggests that Spanish property is overvalued by 20%. PwC interviewed 300 experts and business leaders in Spain in the course of preparing its regular ‘Economic Consensus’ report, 59% of whom believe that property is overvalued in Spain. However 64% also believed that property prices in Spain, though maybe overvalued, are sustainable. However it appears that there is considerable consensus amongst the participants that a rise in interest rates of over 100 basis points could put the Spanish property market in trouble, and that Spanish property prices will not rise by anything like the 17% achieved in 2004.

But what do the buyers think? After all aren’t they the most important actors in the whole drama? It turns out that, according to an online poll by the Spanish newspaper La Vanguardia, 83.5% of respondents (of which 90%+ are likely to be Spanish) think that there is a bubble in the Spanish property market. Meanwhile Spanish Property Insight’s very own online poll of property buyers (71% of which are British, 11% Spanish, 6% Irish, 12% other) shows that foreigners are more divided on this question, with 57% saying there is a bubble, and 43% saying there isn’t. When Spanish votes are included the figures are 61% saying there is a bubble and 39% saying there isn’t, almost the same as the British vote when isolated from other nationalities. The Spanish taken as a group on their own vote 82% in favour of a Spanish property bubble, in keeping with the results from La Vanguardia. Only the Irish, when isolated from other nationalities, vote against a bubble, with 67% saying there isn’t a bubble and 33% saying there is. Does that tell us something about the price of property in the Republic of Ireland nowadays?

So as usual there in no overwhelming consensus and we remain none the wiser, though there is a clear difference between what buyers think and what the experts have to say. But the bottom line is that some say there is a bubble and some say there isn’t.

For what it’s worth I let you have my opinion on the subject. I believe that Spanish property is generally overvalued and therefore tending towards a bubble. If you were to say “That’s not good enough, give me a straight answer” I’d reply, “Okay, in general there’s a bubble”. Unnaturally low interest rates that may be appropriate for Germany but that are like booze to an alcoholic for Spain are the main driver behind the present level of property prices in Spain. However it is also obvious that the Spanish property market is behaving in an increasingly heterogeneous fashion and one should not assume that all areas of Spain suffer from the same malaise to the same degree. I think that many domestic market areas (by which I mean areas where foreign buyers have little impact, for instance Spain’s major cities in the Interior) are obviously overvalued and have a correction in the post. Spanish incomes and property prices have become so divorced from each other and the building frenzy in Spain has become so crazed that I can’t see it any other way.

I’m also quite convinced that the most over-developed coastal areas where foreigners buy in great numbers, for instance large swathes of the Costa del Sol, where development has gone mad and amateur off-plan investors have distorted the market, are ridding for a fall in the short term, though they will recover over the longer term. On the other hand I do accept the argument that foreign demand has shifted the demand curve up significantly, and I believe that foreign demand for property in Spain will support prices in Spain’s attractive coastal and inland regions that have not been ravaged by over-development and crazed speculation, for instance some parts of the Balearics, the Costa Brava, the Costa de la Luz, the eastern and western tips of the Costa del Sol, the southern Costa Dorada and parts of the Canaries. And even in places like Barcelona, where property prices are frothy, I can see increasing foreign demand and a local obsession with buying property at all costs (plus some other local factors) keeping the market afloat even in hostile conditions.

So what? How does this translate into practical advice? I can sum it up thus: If you are an amateur investor hoping to play the short-term speculation game by investing in Spanish property, especially off plan property, the chances are that you will lose your shirt (whilst people who really know what they are doing might not). If on the other hand you are planning to buy a holiday home or main home that you will keep for the long term then go ahead and buy when you are ready (choose the area and property carefully, do a proper due diligence and don’t use a lawyer recommended by your estate agent). Prices may go down in some areas in the short term, which would be most annoying if you had just bought there. But in the long term they will probably go up, you will make a reasonable return, you will get value from your property as a home, and given that we just don’t know what prices will do tomorrow you could grow old in some cold northern country trying to second guess the property market in Spain.

© Mark Stucklin (Spanish Property Insight)