The Spanish housing market is too rigid thanks to burdensome regulation and high transaction costs, just when it needs flexibility to help digest a debilitating housing glut.
Flexible markets react quickly to problems, and deal with them one way or another. The same cannot be said of the inflexible and inelastic Spanish property market, which struggles to adapt to new realities, according to Spain’s own National Commission for Competition (CNC). Supply doesn’t adapt quickly to changes in demand, which then distorts prices, thanks in large part to regulations that interfere with market signals, in particular when it comes to land.
Why did Spanish house prices explode during the boom, whilst falling in countries like Germany? Partly because of greater demand, but also because of structural limitations and regulations on the supply side. The more rigid the supply, the more likely price bubbles will form when demand increases.
“An elastic supply is vitally important for avoiding bottlenecks and reducing [price] volatility and ensuring greater macroeconomic stability,” explains the latest report from the CNC on the land market in Spain. The CNC recommend that, amongst other things, all land in Spain should be urbanisable unless it is specially protected.
Throttling price signals
Thanks to market rigidities, price signals don’t work well in Spain, according to research by the OECD. So when house prices go up in Spain, supply doesn’t follow suit in time, which sets the scene for a price bubble if there is enough credit around. The housing supply in other countries reacts much quicker to higher demand and prices, which prevents prices from building up. The UK is another country with a supply problem that blows price bubbles at the first opportunity.
What holds back supply in Spain? Is there a shortage of land, labour, or building materials? Nope. The problem, in the boom, was an artificial shortage of building land caused by excessive regulations that make the supply inflexible. Land is Spain is physically abundant, but legally restricted by regulations that make it difficult to bring to market in time to prevent a bubble inflating. It can takes years to get planning permission for even relatively simple housing projects, by which time shortages have worked demand up into a speculative frenzy, prices are exploding, and land speculation goes crazy (storing up a huge problem for when the bubble bursts).
Lead times in the home building industry are bad enough without land regulations delaying them even further, making the business much riskier than most people realise. Slow planning applications create shortages that drive up prices, and rising prices start attracting new entrants, especially speculators. Everyone jumps on the easymoney bandwagon, leading to an oversupply when all the new developments come onto the market at the same time. The pendulum swings from undersupply to oversupply, and the market crashes. This has happened before in Spain, but this time it also coincided with the collapse of Lehman Bros., sparking off an international credit crunch and Government debt crisis that has made the bust much worse: A kind of perfect storm if you like.
But right now, the problem is not land, it is high transaction costs on finished housing, which is just another type of red tape with a cost. Transaction costs including taxes and fees can be as high as 15pc in some regions, which is holding back demand. If Spain were to slash conveyancing costs to 5pc or less, I believe sales to foreigners would double in six months, and tax revenues would go up as a consequence.