Spanish property market bubble?

When it comes to property, Spain is a Club Med country with an Anglo-Saxon behavioural disorder that drives up the price of property. Spanish house prices are at record highs, especially in relation to incomes, and it now looks as if Spain, like the Anglo-Saxon world, might be sitting atop a property bubble inflated by a long period of low interest rates.

According to The Economist’s Global House Price Index, Spanish property prices have risen by 190% in the last decade, not far behind the UK’s 213%, and almost double Italy’s 102%. Spanish incomes have not kept pace, and according to a recent report from The Royal Bank of Scotland, the average home now costs 7 times average earnings, similar to the level in the UK. The IMF, the OECD, and even the Bank of Spain have all warned that Spanish property is over valued.

So now that property prices have started to fall or stall in Anglo-Saxon countries like the US and the UK, will Spain follow suit? And if so, will the market float down to a soft landing, as the government insists, or hit the ground with a splat?

A Spanish real estate crash in 2008?

The early signs are not encouraging.

Although government figures show annual property inflation slowing steadily from a high of 18.5% in 2003 to 5.3% a the end of September 2007, these figures are notoriously unreliable. In many popular coastal areas where the British tend to buy, such as the Costa del Sol and the Costa Blanca, agents report that prices have been stagnant or falling for some time, in some cases by 20% or more.

Figures from Spain’s property register show that the market is shrinking. Property sales fell by 9.3% in the first 9 months of 2007, and by 12.1% in the third quarter compared to the same period in 2006. As a result estate agents are closing or downsizing in droves.

Developers are having a bad time of it too, as sales dry up (off-plan sales down by 70% say some), and the credit crunch drives up their financial costs.  High profile developers have started to go bust, and the share prices of developers quoted on the Madrid stock exchange fell by over 40% in 2007 (some by more than 70%) , in one case by 38% in the last 2 trading days of December. The Spanish press is now openly talking about a ‘property crisis’.

Bad as all this sounds, it doesn’t necessarily spell disaster. It might be just the beginning of a soft landing in which property prices stagnate or fall a bit, alowing the price-earnings ratio to return to normal over a period of years. With national elections in March, and unemployment, housing, and economic worries now the top 3 voter concerns, the Spanish government is desperately talking up this scenario.

But there are compeling reasons to worry that the Spanish property market might burst in 2008, particularly in popular coastal areas where the British tend to buy.

Reasons to be negative about Spain’s housing market

Firstly, the boom triggered a building frenzy that has lead to a glut of properties, especially on the coast. New homes have been built at a rate of between 500,000 and 700,000 per year since the start of the decade, compared to around 200,000 per year in the UK, and a recent study revealed that 25% of all new properties built in the EU in 2006 were in Spain. The Centre for European Policy Studies estimates that Spain has accumlated a housing ‘excess’ equivalent to 25% of its GDP. Sadly, many of the new developments that now cover the Spanish coast are unattractive affairs built by Moroccan labourers in a hurry.

Secondly, interest rates are on the rise. Euribor – the interest rate most commonly used to calculate mortgage payments in Spain – is now 4.79%, the highest level since December 2000. Higher borrowing costs and stricter lending criteria in the light of the credit crunch could hit demand hard, and drive up foreclosures, putting further pressure on the market.

And thirdly, many fear that Spain’s property boom has lead to serious economic distortion. The Centre for European Policy Studies estimates that construction investment in Spain and Ireland has risen to 18-20% of GDP, compared to 8.5% in Germany and 10.5% in France. Such a high level has not been seen in any other OECD country except Japan, where the property market subsequently collapsed and never recovered. The property boom partly explains Spain’s massive current account deficit – the biggest in the EU – and has been the main driver behind Spain’s economic growth and job creation. A construction downturn will mean hundreds of thousands of job losses in the construction sector, which could in turn lead to a construction lead recession.

Even if the overall Spanish property market muddles through 2008 without a major drama, the holiday home segement may take a beating. Holiday homes are a big and expensive luxury that depend on rising prices and buyer optimism to sell well. Optimism has evaporated amongst the two biggest groups of buyers  – the Spanish and the British (who are by far the biggest group of foreign buyers, almost double all other Europeans put together). Furthermore British buyers, who have been turned off by high prices, scandals, a deteriorating exchange rate, are now being lured away to an increasing choice of cheaper destinations. So the costal areas where many holiday homes and much of the housing overhang is located, and where the majority of Britons buy, is likely to suffer first and the most from any downturn in the market.

Advice for Spanish property buyers and sellers

 

What does this mean for foreign buyers and vendors of Spanish property?

2007 was a bad year for vendors, but 2008 looks like it could be even worse. There is just too much property for sale, and not enough buyers. Only attractive properties with unique selling points and a realistic prices are likely to sell, and estate agents will focus their energies on these. The rest will just languish on the market until vendors drop their pants, which could mean negative equity for many. From what I can tell there has already been a surge in the number of British owners walking away from their mortgages, and abandoning properties to the banks.

Buyers, on the other hand, will be firmly in the saddle in 2008. Vendors who need to sell will have no option but to take aggressive offers seriously, but buyers will need to research the market carefully before plunging in. Many vendors, especially Spaniards, are still holding out for the silly prices they have decided their properties are worth, though maybe not for much longer.

Buyers may also find that there is a shortage of attractive properties for sale, as vendors who can afford to do so take them off the market until the situation improves. The good stuff is always in short supply, even in a buyer’s market, so be prepared to pay a fair price for quality. Prices will fall, but I expect the price differential between attractive, legal properties in good locations and the rest to widen. In the boom even the rubbish sold quickly, so a beneficial consequence of the downturn will be re-pricing of quality, which I do not expect to fall anything like the rest of the market.

Furthermore, the downturn will have regional variations, with the worst pain reserved for the most over-developed areas . Property in relatively pristine parts of the Balearics like Formentera, and special cases like traditional stone houses in Asturias may even do okay.

Should you buy property in Spain in 2008?

Not if you are an investor, though I should add that holiday homes in Spain will always be a safer bet than places like Bulgaria and Morocco. With prices falling, the rental market flooded, and Spain’s high transaction and ownership costs working against you, investment returns are likely to be negative next year. Bottom fishers can stay at home too, as I don’t think we will reach the bottom in 2008. And anyway, the really juicy deals get snaffled up by insiders like bank managers and lawyers long before visiting Britons get near them.

Holiday home buyers should also think twice. Holiday homes make sense in a rising market, as they also increase your wealth. But does it makes sense to own a holiday home that you only use a few weeks a year if prices are falling? It will cost money to maintain, and costs will only increase as cash-strapped town halls raise property taxes to compensate for the fall in revenues from construction licences. The rental market is flooded too, so you can’t count on rental income to help pay the bills. You will be spoilt for choice if you choose to rent instead.

What about those thinking of buying a permanent or semi-permanent home? In this case utitility is the main concern, so quality of life after a troulbe-free purchase matters more than short term ups and downs in price. Spain is still a great place to live, and property will be cheaper in 2008 than at any time in recent years, so arguably it is a good time to buy. Of course prices may continue to drop into 2009, but over the long term, say 5 years or more, those who do their research and buy attractive property for a good price in 2008 should make a resonable return.

Careful with new developments though. In this post credit-crunch world, I expect a significant number of developers to go out of business. Do your research carefully, and only buy from well established developers with sound balance sheets and a reputation for quality.

© Mark Stucklin (Spanish Property Insight)