I should warn you that this month’s bulletin offers up some pretty depressing reading for anyone trying to sell property in Spain, though it might cheer up buyers. Many of this month’s news stories entertain a downturn in the Spanish property market, with scenarios ranging from a silky landing to a ‘perfect storm’. That the boom is coming to an end is beyond doubt; no boom lasts forever, and this one has had a great innings, with 10 consecutive years of property price increases. The Spanish economy has become a bit of a real estate junkie in the boom years, so a dose of cold turkey to get off the ‘bricks’ and re-balance the economy would be no bad thing. A downturn might catch short-term property speculators with their pants down, but the rest of us will benefit from a healthier economy in the medium to long term. I hope that buyers of quality property for long-term personal use have nothing to fear from this market, and if anything, could see it as an opportunity.
Spanish Property News
What comes after the boom?
2 Articles in the FT in March, one by Wolfgang Munchau, and the other by Martin Wolf, look what might happen to Spain’s economy if and when Spain’s decade-long real estate boom ends.
In an article published on 18 March, Wolfgang Munchau suggests that Spain is suffering from a real estate bubble, which cannot be justified by the bogus economic theory that “large immigration can maintain a construction boom indefinitely.”
Muchau explains that construction and housing account for 18.5% of GDP in Spain, about twice the Eurozone average; in Germany the comparable figure is 8.7%. (EU’s Ameco database). He recites the usual explanations for Spain’s GDP property bulge: immigrants getting onto the property ladder; lifestyle changes in Spain; and weather-migrants from Northern Europe looking for holiday homes 7 retirement homes in the sun. According to Munchau, these arguments are no reason to believe that Spain’s property boom is sustainable.
Munchau worries that Spain will be hit by a double whammy of higher interest rates (already happening), and higher spreads (already happening – see Bloomberg story) reflecting a reappraisal of risk in the light of the subprime mortgage crisis in the US. With so much of Spain’s GDP dependent upon property, Munchau doubts that the rest of the economy will be able to take up the slack in the event of a property market downturn. Amongst other reasons for expecting a real estate downturn in Spain, Munchau says, “German or British homebuyers may eventually find alternative and better priced homes in other parts of the Mediterranean.”
Munchau points out that “post-unification Germany experienced flat house prices for 15 years and a depression in the construction industry.” He suggests that Spain is at risk of a similar fate if the housing-related component of Spain’s GDP starts to converge on the Eurozone average.
In Munchau’s words, “It does not take much imagination to see that a perfect storm is building up.”
On 27 March, Martin Wolf wrote an article in the FT entitled ‘The pain in Spain will follow years of rapid economic gain’.
In this article Wolf discusses Spain’s “vast construction boom”, “huge current account deficit”, and “low productivity growth and deteriorating external competitiveness.”
According to Wolf, Spain’s economy looks out of balance, and the question is not “whether adjustment will happen, since it is sure to do so. It is how it will happen.”
Wolf explains how Spain’s economic imbalances can partly be blamed on the European Central Bank’s expansionary monetary policy from 2001 to 2005. This policy was meant to boost demand in a weak Eurozone economy. But according to Wolf, “the impact of low interest rates was greatest not where demand was weakest, but where conditions for a property boom were best: notably, in Ireland and Spain.”
Wolf goes on to show how the real estate sector has hijacked Spain’s economy. “On the demand side, domestic consumption and investment, particularly construction, have driven the economy. Between 2002 and 2006, construction grew at an average rate of close to 6 per cent a year, in real terms. By 2004, investment in new housing alone accounted for 8 per cent of GDP, a figure surpassed among OECD members only by Ireland.” He also points out that Spain’s current account deficit, at $107bn (just under 9% of GDP), is the second largest in the world after the US.
Wolf argues that in a currency union like the Eurozone, currency risk transforms into credit risk for countries like Spain. In Spain’s case this could mean that “lenders into a construction boom are likely to find that a downturn in the local property market affects the solvency of many debtors. They may then decide to withdraw credit or stop providing new credit quite suddenly. If so, that will lead to a regional recession, as construction activity contracts.”
As Wolf says at the beginning of the article, adjustment must happen. In flexible economies, wages and prices adjust, and lost domestic demand is replaced with foreign demand, taking up the economic slack. But as Wolf says, “it is hard to be confident that this would be true of Spain when the property and construction booms end, for six reasons, all of which emerge from the OECD report: first, Spain has suffered a sizeable loss in competitiveness; second, the technological capacity of Spain’s tradeable goods industries is weak, on many dimensions; third, much of Spain’s recent investment effort has gone into the production of non-tradeables, particularly buildings; fourth, Spain’s industries are relatively vulnerable to competition from cheaper wage producers in central and eastern Europe and Asia; fifth, underlying productivity growth has been low, which will make it harder to restore competitiveness; and, finally, wage bargaining is quite rigid and, above all, unresponsive to conditions in the Eurozone.”
Wolf wraps up with the observation that interest rates are rising in the Eurozone, increasing the cost of borrowing for a heavily indebted Spanish economy. “As the Eurozone recovers, monetary policy is being tightened. While Spain will benefit from the greater demand among its principal partners, its borrowers will face a substantially greater debt-service burden. That must bring closer the point at which the remarkable property-related borrowing and construction booms will end. Then adjustment will have to begin and Spain’s politicians will have to manage all the consequences,” says Wolf.
Paradoxically, better times ahead for the Eurozone could mean trouble for Spain.
Spanish ‘Vacation homes bust’ in the tea leaves
According to a March article at Bloomberg.com, “vacation home prices in Spain, a leading indicator of Europe’s property market, may face a slump that’s worse than the real estate decline in the U.S., based on the loan terms banks are imposing on developers.”
The article reveals that risk premiums charged on loans to Spanish developers are high and rising, indicating that the Spanish property sector is getting riskier. Leading Spanish developers are paying five times more to borrow than US developers, and “even United Airlines, which was bankrupt last year, pays a lower risk premium on its loans.”
“Banks are imposing terms on real-estate firms similar to those for defaulted loans,” David Malpica of CarVal Investor in London is quoted as saying.
“High property prices and rising interest rates sink property market” was one recent headline in the Spanish press, in response to news, from Spain’s property registry, that the number of properties sold in Spain fell by 7.4% in 2006.
The total number of property transactions recorded in Spain’s property register – the Spanish equivalent of the UK’s land register – fell from 989.341 in 2005 to 916.103 in 2006, an annual drop of 7.4% in unit terms.
Autonomous regions with more than 100,000 property transactions were (decrease in unit sales per region in brackets):
Andalusia 178,189 (-7.3%)
Catalonia 152,802 (- 8.8%)
Valencia 136,720 (-8%)
The biggest falls affected regions with smaller property markets:
Basque Country (-15.1%)
Resale property transactions fell by 4.97% to 526,509 units (57% of the total), whilst completed transactions on newly-built properties fell by 10.11% to 389,594 units (43% of the total). Judging by this data it appears that the demand for newly-built properties is falling whilst the number of new properties being built in Spain is hitting new records.
Spain’s dependence upon its real estate sector for economic growth, and the wider implications for Spanish economic growth of a property downturn, were in the headlines in March.
At the beginning of March an article in the Spanish daily ‘El Mundo’ pointed out that construction drives 10.9% of Spain’s 976 Billion Euro GDP, compared to a Euro-15 country average of 5.6%. 106.4 billion Euros worth of Spain’s GDP comes from the construction sector, and Spain is far more dependent upon construction for Economic growth than other European countries.
I did some further research on the subject, and discovered that the construction sector’s share of GDP has grown from 7.5% in 2000, to 10.9% in 2006, an increase of 45%. Spain’s booming real estate sector has created jobs and wealth for Spain, which most people would welcome. But the rise in construction has come at the expense of other types of economic activity, increasing Spain’s exposure to one volatile sector, and leaving Spain more vulnerable than most other European countries to a real estate bust.
This concern has been brought to light in a recent report from the Bank of Spain (Los precios de la vivienda y la reasignación del empleo: una evidencia internacional) highlighting the negative effects on Spain’s broader economy of the recent property boom. The report finds that the boom has taken place at the expense of other sources of economic growth, and that unemployment in Spain could rise substantially in the event of a construction sector downturn. The report explains that the lure of short-term profits to be had in the property boom have diverted investment from other sectors. “If investors have a short-term perspective, then high returns from construction reduce profitable long-term investments in other productive activities,” says the report.
SEOPAN – a trade body representing Spain’s biggest builders – warned in March that a real estate sector downturn could destroy 200,000 Spanish jobs in 2008.
Enrique Aldama – President of SEOPAN – argued that if housing starts fall by 100,000 units (15% of the total, according to SEOPAN) in 2008, unemployment would rise by 200,000 as a consequence.
Aldama warned the government to “think carefully about what to do, because I can’t see any sector that will take over from construction, which creates 25% of all new employment, and 30% of economic growth in the last 5 years.” To avoid a crisis in 2008, Aldama has urged the government to protect the construction sector, and increase the supply of building land.
When it comes to construction, the government finds itself between the devil and the deep blue sea. It certainly looks as if Spain’s construction boom is unsustainable, and has taken place at the expense of balanced, long-term economic growth. But once an economy gets hooked on construction for employment and economic growth, it is difficult to rebalance without serious economic distress.
Euribor – the interest rate most commonly used to calculate mortgage payments in Spain – rose again in March to 4.106% (to be confirmed by the Bank of Spain).
This is the 18th monthly increase in Euribor, and places it at its highest level since August 2001. Euribor is now 32% higher than it was a year ago. This means that variable-rate mortgage interest payments in Spain (98% of all mortgages in Spain are variable rate) have also risen substantially.
Euribor is derived from the Eurozone base rate set by the European Central Bank (ECB). The ECB raised base rates in March from 3.5% to 3.75%, a move that was widely expected by the markets, and already priced into Euribor rates.
According to Jean Claude Trichet – President of the ECB – interest rates for the Eurozone are still moderate and expansionary, suggesting that there are more interest rate rises to come this year. Many analysts expect rates to rise to 4% this year (with another increase in June or July), though some financial institutions, most notably the Spanish bank BBVA, expect base rates to go as high as 4.25% this year.
Also in March, Spain’s National Institute of Statistics announced that the average mortgage value in January rose to 147,322, a 13.2% increase in a year. The Spanish Mortgage Association announced that mortgage default rates in Spain have risen to 0.41%, a level that is still close to historic lows.
But according to Spain’s Association of Independent Financial Advisors (La Asociación de Profesionales Asesores Independientes Financieros – AIF), quoted in the Spanish daily ‘La Vanguardia’ many Spanish households are struggling to meet today’s higher mortgage payments, which is why properties are now coming onto the market “20% cheaper than 3 months ago.”
Property boom starts deflating in Madrid and eastern provinces
Is this the beginning of the end of Spain’s property boom? asks the financial daily ‘El Economista’. Yes, at least according to the latest figures from Spain’s property register, showing a fall in property registrations in the Spanish Levant (the provinces of Castellon, Valencia, Alicante and Murcia), and large interior cities like Madrid. According to Eugenio Rodríguez Cepeda of the property registry, recent demand has been driven by the baby boom of the 1970s, which has now largely worked its way through the market. Rodríguez doubts that Spain will be able to absorb any more years of record housing starts, like the 883,000 housing starts in 2006.
Property investors in Madrid left with empty properties
The Spanish daily ‘El Pais’ reports that investors bought off plan a third of all properties built on new housing developments around Madrid in the years 2002 to 2005, but are now struggling to sell or rent these properties, with half of all new properties standing empty.
Plans for sustainable development of Spain’s coast
José Fernández – general director of the coastal department of Spain’s Ministry of the Environment has announced the preparation of a plan for the sustainable development of Spain’s coastline. The plan is expected to implement a construction moratorium in over-developed coastal areas with fragile environments such as La Playa de Isla Canela (Huelva province), La Manga del Mar Menor (Murcia), the Ebro River Delta (Tarragona), the beaches of the Spanish Levant, and some parts of the Balearics. The plan should be ready by December, presumably when there is no fragile coastline left to protect from mindless development.
30% of Spanish estate agents will be wiped out by downturn
An article in the Spanish financial daily ‘Expansión’ quotes Óscar Martínez – president of the Association of Property Experts (Asociación de Expertos Inmobiliarios – APEI) – as saying that some 30% of the 60,000 estate agencies estimated to exist in Spain could go out of business in the coming property market slowdown. According to Martínez, the fall in demand for property, and an expected increase in regulation by both national and regional authorities mean that we can “expect a radical change in the Spanish estate agency business in the coming months.”
New law to tighten up property valuations
In a draft bill to reform Spain’s mortgage market the government proposes tightening up property valuation practises, and punishing appraisal companies that produce biased valuations. The reform aims to increase the “independence and professionalism” of appraisal companies by addressing a conflict of interest between mortgage lenders on the one hand, and appraisal companies on the other. Appraisal companies, many of which are owned or heavily dependent upon mortgage lenders, are suspected of producing biased valuations to please mortgage lenders, rather than fair valuations reflecting true market prices.
The Costa del Sol pays the price for Marbella
An article in the Spanish financial daily ‘Expansión’ reports that Marbella’s corruption scandals are damaging the property market on the Costa del Sol. The article cites a report by property consultants Aguirre Newman showing that property prices on the Costa del Sol have fallen 4.7% in the last 12 months.
Developers abandoning the coast
And article in the Spanish daily ‘El Pais’ claims that the residential property market is fast losing steam, especially in coastal areas. As a consequence developers and investors are abandoning residential developments on the Spanish coast. The supply of land with planning permission and building licences is rising – a situation almost unheard of in Spain in recent years – whilst demand from developers and investors in falling.
Spanish property glut grows, prices under pressure
An article on ‘elconfidencial.com’ highlights the growing gap between the supply and demand for property in Spain. According to the data available, the supply of new property is growing at the fastest rate in years, as shown by the number of housing starts, and the record levels of cement consumption in Spain. On the other hand there are signs that demand for property in Spain is falling, which one would expect in response to rising interest rates. The result is a growing glut of Spanish properties, which will inevitably put pressure on prices.
Housing ministry forecasts quarterly fall of 1% in property inflation rate
María Antonia Trujillo – Spain’s Minister for Housing – forecasts that property inflation rates in Spain will fall by 1% per quarter during 2007. If correct, this means that annual Spanish property inflation will fall from 9.1% in 2006, to around 5% in 2007. “We are in a market that is beginning to stabilise, that is adjusting in the gradual way that we all want,” Trujillo is quoted as saying.