Spain in real trouble
November 06, 2009
Spain’s house price bubble burst a long time ago. The Bank of Spain’s figures say the peak was in early 2008 (based on official valuations). Realtors say the peak was in mid-2007 (based on offers-for-sale). Whichever is true, two years later, in Q3 2009, Spanish house prices continue to fall.
Official figures show the average price of houses in Spain at €1,903 per sq. m. in Q3 2009; down 0.94% from the previous quarter, 8% from the same period last year, and 9.45% lower than the March 2008 peak (Bank of Spain data). In inflation-adjusted terms, house prices were 0.52% down on the quarter, 7% on the year, and 10.58% from peak.
Realtors show bigger falls, based on offers-for-sale: Facilismo.com shows a price decline of 14.5% since the peak of July 2007.
Further house price declines can be expected in the next few years, due to weak economic growth. Most indicators show that housing market recovery is nowhere in sight. Demand remains weak, and there is massive oversupply.
The number of unsold properties in Spain now exceeds 1.5 million, according to a report by R. R. de Acuña & Asociados, a Madrid-based real estate firm, including 1.1 million unsold newbuild flats and houses, and roughly 518,000 second-hand properties. Around 327,350 units are under construction. The housing glut is most severe on the coast and in areas around Madrid.
Housing construction continues to contract. Housing starts dropped to 297,000 for the period from June 2008 to 2009, 47.6% lower than the same period last year.
Housing demand continues to fall with 112,886 housing transaction recorded in Q2 2009, way below the 220,000 average transactions recorded quarterly from 2005 to 2007.
Rapid economic growth, and foreign purchases, were the main drivers of the house price boom. Foreign investment in property (1 year sum) dropped by 20.8% y-o-y to Q2 2009. As a percent of GDP, it slipped to 41%, from 52%, over the same period.
New loans for house purchase in September 2009 amounted to €5.2 billion, significantly below the average of €13 billion released monthly from 2005 to 2007.
The Spanish economy is expected to contract by 3.2% in 2009, after officially having entered recession in Q4 2008. While most countries are expected to recover in 2010, Spain’s GDP will continue to fall by around 1%. Unemployment has shot up to 17.9% in the third quarter of 2009, from 7.95% in Q2 2007, and is likely to exceed 20% in 2010; more bad news for the housing market.
Nobody believes Spanish house price figures
The average of new houses was €1,911 per sq. m., 8.76% down from the March 2008 peak. However the house price figures published by the Bank of Spain show little variation in house price changes by property type and location. For instance, the average price of newly built-dwellings fell 7.75% y-o-y to Q3 2009 while the average price of existing dwellings fell by 8.32%.
“The official figures are hard to stomach” says Mark Stucklin of Spanish Property Insight. Even developers say that prices are down by 20% or more, he explained in a separate interview.
AVERAGE PRICE OF DWELLINGS (Q3 2009)
| New Houses
|Madrid and Barcelona|
|Source: Bank of Spain|
There was also little variation in terms of location. For instance, the official statics show that the average price of properties in coastal provinces (excluding Barcelona) fell by 8.77% y-o-y to Q3 2009, not far from 8.28% y-o-y price fall for Madrid and Barcelona and 7.55% fall for other interior provinces (excluding Madrid).
However figures derived from realtor site offers-for-sale are entirely different. For example, enormous differences between price falls in different provinces are shown by Facilismo.com. While prices fell 8.53% during the year in Castilla-La Mancha (January 1 to 5th November 2009), they were only 2.81% in the Canary Islands.
Most housing experts are skeptical of the “official” figures produced by the central bank. A major pitfall of the house price figures is that they are based on official valuations, and not on actual sales or contract prices.
In 2008, Beatriz Corredor, the Minister of Housing, fell in hot water after the figures she cited in a TV interview contradicted the official figures published by her department.
Massive housing boom powered Spain’s economy
For what they are worth, the official house price indices reveal the enormous house price boom Spain experienced from 1996 to 2007. The national average price rose by 197% 200% (117% in real terms), one of the highest price increases in the region.
Outside Madrid and Barcelona, house prices are highest on the Mediterranean Coast: Catalona, Andalucia and Valencia. These regions saw the highest house price increases during the boom, more than 200% from 1996 to 2007.
The average price of properties along the coast surged by 250% (155% in real terms) within the same period. A significant bulk of buyers was hundreds of thousands of foreigners, mainly from the UK, France and Germany.
On the other hand, the average price of properties in Spain’s two main cities, Madrid and Barcelona, rose 188% from 1996 to 2007 while prices in other inner provinces rose by 175% (101%).
Massive oversupply now pushing it off a cliff
The massive house price boom led to overbuilding especially in coastal areas, which is now depressing house prices.
The degree of overbuilding can easily be seen by looking at the number of housing starts from the National Statistics Institute (INE):
- From 1990 to 1996, an average of 240,000 dwellings were started annually.
- Between 1999 and 2002, with house prices rising rapidly, dwelling starts exceeded 500,000 units annually. The number rose to more than 650,000 annually from 2003 – 2004
- In 2005, dwelling starts exceeded 700,000 and peaked at 760,179 in 2006 due to rising demand from EU nationals
- Rising construction costs due to high global prices of fuel and commodities slowed construction to 615,976 completions in 2007
- Dwelling completions exceeded 630,000 in 2008, most of the units started before the crisis erupted. The global financial meltdown led to a drastic decline in dwelling starts in 2008, at 360,000 units
Real interest rates are negative
Spaniards traditionally did not finance house-purchases through mortgages. But the liberalization of the mortgage market in the 1990s, combined with a drastic reduction in mortgage interest rates, changed all that. In proportion to GDP, mortgages outstanding rose from 17% of GDP in 1995, to more than 61% by end-2008.
Mortgage interest rates fell from 17% in 1991, to 10%–12% (from 1995 to 1996), to below 3.5% from 2004 to 2005 - among the lowest rates in Europe.
Generous tax breaks for mortgage interest payments and capital repayments helped fuel mortgage growth.
Income tax deductions reduce effective interest rates on Spanish mortgages by 2 percentage points, according to an OECD study, and real after-tax interest rates have been negative since 1999 (the study was published in 2004). The subsidies effectively allow homebuyers to increase their total borrowings by 15% to 20%.
Housing savings schemes are also given tax breaks. Imputed rent for owner-occupied houses, and capital gains on the sale of the primary residence, are also tax-exempt.
Yet now, the mortgage market is asleep
Spain’s housing market should in theory be very sensitive to interest rate changes, due to the use of adjustable rate mortgages.
More than 80% of new mortgages have had initial rate fixations (IRF) of less than 1 year since 2004 (more than 90% of new loans from 2005 to 2006). In 2009, around 89% of new loans had an IRF of less than a year.
In October 2008, the European Central Bank (ECB) started cutting key rates reducing the key rate to a historic low of 1%, where it remained till November 2009.
The weighted average interest rate on new loans for house purchase dropped from 6.07% in October 2008, to 2.72% in September 2009, the lowest rate ever.
Despite that, Spanish new mortgage volumes were 3.2% down in Q3 2009 from the same quarter in 2008, at €17.56 billion. During the boom, an average of €40 billion of new loans were approved quarterly, from 2005 to 2007.
Rental yields in Spain are low
Spain’s rented sector is handicapped by rent controls. New tenancies were partially liberalized in 1985, but leases run for a minimum of five years, and it is difficult in law to recoup unpaid rents. As a result, only 10% of all housing units remained in the rented sector in 2004, down from 20.8% in 1981.
Landlords are often better off keeping their units unoccupied, because rental income is typically insufficient to compensate for the wear and tear of letting. In 2001, 14% of the total housing stock was vacant, more than the entire rental stock.
Gross rental yields are very low - gross returns on renting for Spain as a whole fell from 3.8% in 1Q-1998, to 1.97% in Q3-2008, according to the Bank of Spain. With house prices falling, while rents remain relatively unchanged, rental returns rose to 3.4% in June 2009. However, this remains low by international standards.
In June 2009, rental yields in Madrid ranged from 2.6% to 4.8%, with smaller units earning higher returns, according to the Global Property Guide. In Barcelona, rental yields are within the same range (2.7% - 3.8%), with smaller units earning more.
Unemployment rising, deficit rising
The construction industry is a key driver of the Spanish economy. Construction activity helped push unemployment down to 7.95% in Q2 2007, from 24% in 1994.
Spain’s economy expanded by an average of 3.6% from 2000 to 2007.
The situation is now reversed. Unemployment stood at 19.7% in September 2009, one of the highest rates in EU, and is expected to exceed 21% in 2010, the highest rate since 1997. Economic growth stalled in 2008 (barely growing at 0.86%) and is expected to contract by 3.2% in 2009 and 1% in 2010.
After growing by 7% in 2005-2006, gross fixed capital formation growth slowed to 5.3% in 2007, then contracted by 3% in 2008. It is projected to contract by as much as 14.7% in 2008, and 8% in 2010.
In October 2009, the government approved an additional €5 billion public spending programme, on top of the €11 billion stimulus package announced in November 2008.
But to pay for the program, the government is also pushing a €11 billion tax hike, including increases in VAT, capital taxes and dividends. The €400 tax rebate given to taxpayers in 2008 will also be phased out.
The Spanish government faces a tough policy dilemma. It has to stimulate the economy, but it also needs to control the deficit. Since the 1980s, the Spanish government has annually run a deficit. It only broke into surplus in 2005, 2006 and 2007, the biggest surplus being 2.7% of GDP.
However, the global recession has pushed the economy into deficit once more; at 3.8% of GDP in 2008. In 2009 and 2010, the deficit is expected to exceed 12% of GDP, way beyond the EU limit of 3% of GDP.
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