Spanish & Mallorca Property Market Report - December 2008
By David Novi
The Spanish property market was the European market most likely to crash when the credit crisis hit. Here we examine the ingredients of disaster
With Spain arguably the number one destination for British buyers of foreign residential property - for investment, second homes, or retirement in the sun - it is hardly surprising that there is so much interest in the Spanish property market. Hardly a day goes by without some ‘crisis on the costas’ story in the press, bemoaning the collapse of prices and demand, fully illustrated with images of half-built apartment complexes and swathes of empty sun-drenched villas!
Some interesting facts and figures
• Spanish house price inflation was 5% in 1998, rose to 17.75% in 2004 and slumped to 5% in 2007.
• Property prices increased 2.2 times in real terms between 1996 and 2006.
• Between 2005 and 2007 the interest burden on Spanish mortgages increased by, on average, two thirds.
• Housing investment alone accounted for 8% of GDP in 2006, making the Spanish economy very dependent on the residential property market and associated consumer spending.
• Over 50% of the banking sector’s loan book is associated with real estate.
• The oversupply of unsold new housing units stands at more than 1m.
• Spanish housing starts have risen steadily every year since 1996 - from 250,000 to 700,000 in 2006
• In 2006 the number of housing completions per 1,000 head of population was 15, some 4 - 5 times more than most advanced European nations
Background
Spain’s residential real estate market had been growing at an unprecedented rate, with average prices more than doubling in the last decade. A similarly unprecedented boom in construction saw year-on-year output of more than 650,000 units, and investor interest from both home and abroad. While no-one seemed prepared to call time on this boom, as if afraid to be the one that bailed out too early, the simple statistic of a construction output estimated at nearly one third of the total EU new-build output and an underlying demand of under 400,000 units, should have been enough to sound the warning bells.
The legacy is an estimated 1m unsold new-build properties; developers facing major cash flow problems; individuals with personal debt levels previously unknown in a country where people had always spent only what they had; an economy heavily skewed towards the construction sector; and banks with major bad-debt and liquidity problems, not all associated with the wider international credit crisis. But what is behind this seemingly black picture?
While no property market can operate in isolation of the international economic environment, local peculiarities and structural differences can be very important in influencing the extent, rate and timing of growth or contraction of any particular market. In Spain, these influences, while not all exclusive to the country, have been particularly influential and include:
1. The changeover to the Euro, which pushed up prices generally and, most significantly, drove a huge amount of undeclared or ‘black’ money into the system, much of which went into property.
2. Until recently, a low-interest-rate environment (2% for much of the boom period), due to the centralisation of interest-rate policy within the European Central Bank (ECB).
3. Loosening of bank-lending criteria from the top down - the Bank of Spain lending rules and individual bank-lending policies. The result was a credit boom that boosted both the supply side (construction activity) and demand (retail mortgage lending).
4. Permissive urban planning and a local-government income framework heavily skewed towards activity in the construction sector. The result was poorly controlled development, as local town halls cashed in on taxes arising from new construction.
5. A demand side heavily boosted by the presence of international investors. Spain has long been a favourite destination for foreign investors and second-home buyers. This, coupled with the popularity of ‘buy-to-let’ residential investment among buyers in countries such as the UK, significantly increased the demand for Spanish property during the boom years.
6. A weak approach to pricing and valuation. Historically, valuers and estate agents have had relatively limited input in establishing values for residential property in Spain, with prices generally set by owners and many marketed directly. In many cases, this resulted in over-inflated prices and expectations of growth. While this was not a problem in a rising market, over the last 18 months - with prices at best stable, but in many cases falling - vendors continued to raise or maintain prices, leaving a large percentage of the stock of available properties unsaleable, adding to the sense of stagnation in the market.
The market and the economy today
It’s easy to see why the Spanish real estate market grew so strongly and got into such trouble, but what national and international economic variables are influencing the prospects of the market now?
• Demand and availability of credit
There are a number of long-term demand-side considerations, which, on the surface, remain reasonably positive. The underlying domestic demand for housing remains strong, with a shortage of supply of affordable homes, despite the over 1m units of new-build property sitting on the shelf awaiting buyers. At the same time, population growth, most of it the result of immigration, is also bolstering underlying demand.
That said, wanting or needing to buy is not the same as being able to buy. The most obvious problem is the credit crisis and the severe restrictions on bank lending generally, and on mortgage lending specifically. These restrictions started to take demand out of the market in the autumn of 2007 and have been tightening ever since. The full effect is only now starting to feed through to the wider market.
• Supply
The depth of any supply-side crisis (and thus how much impact there will be on prices) depends on a number of factors, including the extent to which developers can reduce output; whether they need to cut prices aggressively in the face of liquidity problems; how long banks maintain a squeeze on credit/lending, and policies to deregulate the private rental sector, encouraging owners to lease their properties, thus reducing supply
• Affordability
It is estimated that the average household in Spain allocates 46% of net income to meet mortgage repayments, compared with only 31% in 2003. (Lenders normally seek a ratio of between 30 - 35% indicating how the risk burden has shifted for the banks and their exposure to bad debts has increased). Mortgage interest rates have continued to rise (particularly problematical in a market where the vast majority of households have variable-rate loans reviewed annually) with the end June 2008 Euribor figure (the main reference rate for Spanish mortgages) standing at a record 5.4%, its highest level since it came into being back in 2000. With the ECB making inflation its priority, rates seem unlikely to fall for some time to come and, along with pressure on employment levels, we are likely to see a significant increase in mortgage default levels in the coming months.
Thus, while demand may appear to exist, it is questionable how much will be converted into real transactions in the months ahead. For buyers from outside the Euro zone, e.g. the UK and USA, the recent strength of the European currency has pushed prices up by around 15% over the last six to eight months and, although this trend is likely to reverse during late 2008 and 2009, it is still a real issue effecting some buying decisions today.
• Consumer confidence
There is no doubt that, domestically, the Spanish consumer is experiencing a crisis of confidence. Evidence of consumer activity across sectors indicates that caution is the name of the game. This is only likely to worsen in the months ahead, as property owners face increasing repayments and other economic problems take a grip, particularly unemployment.
Associated with the issue of consumer confidence will be the ability of the government to tackle Spain’s over-reliance on the construction sector, by boosting investment and employment in new economic areas such as technology and R& D, where Spain has a poor record compared with other advanced European nations, and general levels of productivity, where again, historically, Spain has not performed well.
Market outlook and conclusions
Many of these variables affecting the market appear to have greater downside risks than upside potential, leading to the conclusion that uncertainty will be around for a long time. While some variables may improve in the short to medium term (weakening of the Euro, interest rate cuts etc), others look likely to continue well into the next decade (falling levels of unemployment, general economy weakness, the credit crisis, etc)
It would seem likely, therefore, that the housing sector will remain very weak for the next 18 months, before some stability, at best, returns around 2010 - 2012, while a more sustained recovery will need to wait until post-2012. Since price adjustments have only recently kicked in, they are likely to continue on a downward trend, both in real and nominal terms, for another 18 months. At a national level, it is quite possible that real prices will fall by up to 20% (inflationary erosion and actual price reductions).
Regionally, while it is unlikely that any area will escape the downturn, it is very probable that there will be quite significant differences in performance. Coastal regions, such as the Costa Blanca and Costa del Sol, where much of the unsustainable construction boom and investor demand was focused, along with inland towns and cities where construction was encouraged by local town halls and local-level demand has dried up, are likely to suffer most.
Niche markets such as the Balearic Islands, where planning has been relatively controlled, and where demand was much more lifestyle- than investor-based, are likely to perform better, although price weaknesses will still be found.
David Novi is founding Partner of Mallorca property agents, Novi Property Mallorca http://www.novipropertymallorca.com - Mallorca Chartered Surveyors, Mallorca Real Estate Search and The Mallorca Mortgage Business.
David specialises in advising private and corporate clients on all aspects of buying property in Mallorca including investment appraisal, property and site finding, development project management and funding and is a member of the RICS (Royal Institution of Chartered Surveyors).
David also writes articles on the Mallorca and Spanish property markets offering clients a detailed insight into market conditions generally and the attractiveness of individual investment opportunities. The Mallorca Property News web site displays a selection of these publications.
Before moving to Mallorca David was Managing Director of Thames gateway property investors and developers, Tilfen Land. He can be contacted on novipropertymallorca.com
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