By 2007, the market is forecast to reach a value of $6.9 billion, having grown with a CAGR of 4.3% since 2002. Year-on-year growth rates are expected to rise from 77% to 5.4% in 2007, although this is nowhere near the 13.7% experienced in 1998. Within a European context, the Spain is one of the smaller markets accounting for 5.2% of value generation in 2002, a figure that is expected to decline slightly to 5.1% by 2007, despite the market growing by 23.2% between 2002 and 2007!
1.2.2 A fragmented market
The Spanish real estate management and development market has achieved strong growth rates in the last few years. This has attracted significant new investment into the market, resulting in a large number of new development projects and the entry of a number of new players into the market.
The Spanish market is already considerably fragmented, with hundreds of small to medium sized businesses holding insignificant market shares. Most companies within the Spanish market focus on specific market sectors and possess limited spheres of influence. However, there are also a number of large competitors, which have national presence and operations in two or more sectors. The leading market players include Metrovecesa, Immobiliaria Urbis and Immobiliaria Colonial.
Metrovecesa is the largest domestic player, in terms of revenues generated from real estate renting activities. The company has a diversified portfolio, which includes shopping centres, business parks, industrial building, hotels, car parks and third age housing. In addition, the company deals with town planning and provides property services for third parties as well as for its own properties. Metrovecesa’s portfolio contains properties in virtually every major metropolitan area in Spain.
1.3 What about other Western Economies?
In year 2003 housing prices increase continues to be higher than inflation in main European economies.
Since mid 90’s the real estate market revaluation above inflation is a common phenomenon in the western economies. Except Japan where the little economic dynamism of the last years is having a very negative incidence in the real estate market, the majority of the families in western economies have significantly bet on the residential investment. Real estate assets are overweight in household portfolios.
Low interests rates, employment rising and the evolution of the demographic variables are some factors which support today the price appreciation in the US and European economy.
A change in the interest rate could imply a redefinition of the assets of households portfolios, reducing the residential investment. However this predictable decrease could be also mitigated for an higher growth than expected and for positive evolution of the employment in western economies. In the European Union (EU), growth has not been as profitable as expected. But prices were launched to a revaluation of 4% higher than inflation for the same period. The low interest environment has been an important factor of the demand.
An intensive advance of the European economy in 2004 and the change of the employment tendency will be the incentive to impulse the housing demand which should adapt to a interest rate increasing environment.
Figure 1- Source: Deutsche Bank
The different situations of the main European economies are also reflected in the real estate market, with a distance in the price evolution. By the time prices are growing in a much higher ratio than inflation in countries such as the UK, Ireland or Spain and prices are stabilized or going slowly down in Germany or France.
II/ Main Factors of demand in the Spanish Market
As we have seen before, the Spanish Real Estate Market is going through a long period of expansion which is caused by different factors.
2.1 Second residences on the coast
A big part of this “boom” is caused by the second residence on the coast. As figure 1 shows, the number of second residence on the coast has been multiply by 4 in the last 7 years. Investors are looking forward to buying a second residence to rent for the income or to use as a vacation retreat.
In the Spanish traditional style of life the coast has always been their chosen paradise to relief and spend a pleasant vacation. In the last decades their destination have not changed, however the type of accommodation has. Taking advantage of the good Spanish economy balance, many families decided to move from renting to buying. As prices are not as high as in the main cities, purchasing a second residence is very profitable investment. Revaluation rate increases each year and families can also gain money off the rent from the coast residence during the winter.
But not only Spaniards are awarded of the advantages of the sun and beach in their coasts. Foreigners are also focusing part of their investment in a second residence in the Spanish coast. Even sometimes, they move definitely and establish themselves in those houses.
Cataluña, Valencia, Baleares, Murcia, Andalucía and Canarias are their main destinations. In the present the number of residences in those places are above 10 millions. Around 1,1 million have foreign owners which represent 10%. Future forecasts expect an increase of the phenomenon to 3 million houses hold by foreigners. The main part of the demand comes from Germany and the UK (70%).
Figure 2-Source BBVA
2.2 Stock Exchange instability
Disillusionment and uncertainties given by the stock market and the low returns on other investments like government debt, have increasingly turned the small investors to the real estate as a way to keep their portfolios growing.
According to , Wharton professor of real estate, the housing market tends to lag other more efficient markets in responding to economic change.
Figure 3- Source: Bank of Spain
As it can be seen in figure 3, market returns tend to be greater at the onset of expansionary phases (1984-87 and 1996-98) and negative in slowdowns (1990-92 and 2001-02). This type of behaviour might also contribute to explaining in part house prices, especially in the last cyclical expansion, in which household investment on the stock market was more widespread than in earlier periods.
2.3 Convergence process with other developed countries
In 2003, GDP growth in Spain stood 1.3 percentage points higher than the Eurozone average. Since 1990 Spanish nominal GDP per capita has increased by 112%. This conduct marks a significant break with the pattern of the past, when the Spanish economy paid a higher down cycle toll in production and job losses because of lags in adjusting to external and supply shocks, the rigidity of markets and the use of policies to bolster income and demand, which undermined Spanish competitiveness.
Figure 4-Source: The Economist, IESE
In the past 10 years housing prices have been up to European average to integrate this convergence process to Western Economies which is very logical. However we have to underline that Spanish Average house price / GDP per capita is higher than richest countries’, such as France or Germany. This trend shows that Spanish prices could begin to be over evaluated.
2.4 Low interest rates
In 1998, the reduction of the average mortgage rates (from 6% to 4.8%), which followed the introduction of Euro notes and coins as well as keeping stable the economic numbers, partly explains the boom in real estate demand. At present time, the average in mortgage rates is 3,75% which represent less than ¼ of the early 90’s.
Figure 5 – Source: Bank of Spain
This turn is clearly in favour to the inflationist trends on the market with no special measure for the moment to stop these artificial increases.
2.5 Households buying capability
The analysis of the demand, when dealing with housing markets, should pay attention to unusual specific details only present in situations in which some sort of financing are essential in the acquisition of a good. This is, basically, due to the fact that buying a house is a costly and lengthily process. Therefore, not only the current state of the economy matters, in the study of the main variables that influences demand, but also how it will behave in the future.
In this context, typical economic variables such as price and income have to be viewed in other terms. So, as explained by Stoker (2000) for the case of durable goods, the current income and price have to be substituted by other concepts such as permanent income and the housing cost of capital. The permanent income is used because in the decision to buy a house not only the current level of income matters but also the expected level of future inflows. On the other hand, economic theory tells us that homeowners "rent the stock that they own from themselves" and assuming the existence of a homogeneous good called housing services it can be concluded that the owner's price of a house is the price of the services produced by a unit of stock at some length of time (a flow variable) that is called user cost of a unit of stock.
Thus, the majority of homeowners buy a house using accumulated savings and the financing of a loan. The mechanism used to buy a house contains specific features that should be stressed in order to get a better understanding of demand. In many developed economies consumers rely much more in mortgages than in retained earnings in the acquisition of houses. Following Fallis (1985), a mortgage contract determines the amount of the loan, the interest rate, the term of the loan, the amortization period, the method of computing the monthly payments and any other prepayment privileges. Each of these parts of the contract can interfere in the consumer's perception about the value of the commodity housing and alter the demand for mortgages and consequently also for housing.
A more complete expression for the user cost of capital can be found, for the Spanish case, in the work of Lopez Garcia (2001). There is different versions of such expression but most of them comprehends the opportunity cost of the accumulated savings that could be used in other investments, the interest paid in a mortgage, the maintenance, the insurance and the tax system. Also, it is important to subtract from the user cost any capital gains from owning the stock. In mathematical form:
User Cost = rAS + mMort + P1(ma + ins + ptax ) - [P2(1-d)-P1]
Where:
1) the parameters r, m, ma, ins, ptax and d mean respectively the interest rate that could be earned in retained savings, the rate of interest in the mortgage, the rate of maintenance, the rate of insurance, the rate of property taxation and the rate of depreciation;
2) the variables AS, Mort, P1, P2 mean respectively the accumulate savings used in the acquisition of the house, the mortgage loan, the price in the moment of the acquisition and the price in the moment of the sale)
Figure 6 –Source: Bank of Spain
Despite the aforementioned price increases, the affordability of the average household buying capability has been upper market housing prices curve since 1994 (Figure 5). That is on of the factors which explain the increase of demand during the last 10 years. Because even if prices where increasing more and more, households could manage to repay finance costs. However, there is no guarantee that buying capability will be able to offset the raising of prices in the future, because interest rates seem to be already at floor levels.
III/ Future Perspectives
3.1 Growth rates trend to decrease by end 2004
During year 2003, housing prices have raised by 17% which represents a real revaluation in real terms. Though the offer has increased, for second hand real estate as well as for the new built, the strong demand kept putting pressure on housing prices which rose with growing rate which reached up to 15% above inflation. The demand has been supported by low interest rates which even turned out to be negative in real terms, and a net increase of employment.
To this factors, have to be added the expectations generated by the prices’ changes, with revaluation above other markets’, which also attracted an investment oriented demand.
From the first term’s figures, expectations indicate a deceleration of housing prices down to around 10-12% by the end of 2004, which points out a price a decrease tendency of the prices during this year, which extends to 2005 and which will bring real estate prices to evolve to similar rates, or slightly above those during the inflation at the end of the year.
Such price evolution was carried out in a context of deceleration of sales. In the 2004 set, the trend indicates that a decrease by about 4,5% of sold houses will occur, though the sales’ speed will remain under a million houses, which turns out to be the average of the past ten years. In 2005, the expectable increase in mortgage interest rates will lead slight reduction of the demand for house, and therefore to a reduction in the houses’ sales.
An increase of half a point in the rates could reduce by about 4,5% the number of houses transactions.
Since the beginning of 2003 and early 2004, foreign investment in real estate has lightly pulled back, to such an extend that it presented negative variations at the beginning of 2004.
Anyhow, the volume of foreign investment in 2003 was over 7 000 million euros, which represents about 0,95% of Spain same year’s GPD. In spite of these important investments, the tendency of this indicator shows a decreasing evolution, which suggests that foreign investment is reacting to the strong price rising. A decrease in foreign demand would have more severe effects on the coast markets, where the offer for such demand is focused. Real estate market is showing a better dynamism in big cities since the beginning of 2000, with growing rates over smaller ones’. In main cities, the lack of land is leading to a less important housing offer, with an incidence on a bigger demand, which leads prices to grow above the national average.
Ergo, in Madrid and Barcelona cases, the increases of prices have been superior to 20% since 2003, while in smaller cities advancement did not go over the average of 16%. Historically, the prices changes have been more stable in smaller cities than in bigger ones, which means that a drop in the demand would induce main cities’ prices to fall.
However, and though differences exist in the evolution of coast houses and inland houses prices, changes in the demand have had effects in both markets. Anyways, in Spain’s regions most exposed to tourism, in the last terms, the advancements are being more moderated than in the national average. The development of the recently announced housing plan will have an impact on a hard market to value with existing information.
Reaching the volume of negotiations announced before the elections would suggest the supplying of houses to an important part of the demand during a period of time long enough for it to have incidence on market prices.
In the short term, if the announcement of the housing plan from the new government changes buyers expectations, an important change in prices is feasible, for demanders decide to postpone the decision of buying, waiting to obtain better prices than actual ones. In this sense, if actual expectations cool down, the house prices dynamism will be conditioned by elemental economical factors again.
Figure 7 –Source: Deutsche Bank
- Housing buying capability ratio will cool-down from year 2004
The intense growth of housing prices is producing negatives effects on affordability rates to the residence. As prices increase faster than salaries go up, interest rates decrease during 2003 and beginning of 2004 could not compensate the financial effort of households to afford a house. After the 17% appreciation of the prices in the first term of 2004, the average price of a residence in Spain is the equivalent of more than eight years of the average wage. On a monthly basis this data is traduced as employing more than 40% of the salary to the payment of instalments. Those ratios show a worsening comparing to year 2003 and locate access levels as 1996 whereas prices where half the actual ones and interest rates were around 10% and the amortization instalments never over 15 years.
The increasing of the families capacity to be into debt is not being translated in terms of an improvement of the housing prices. Because of their high revaluation the difference between payment capacity and average prices of Spain’s residence prices could not be reduced.
During year 2004, if housing prices slow down until 10% rates at the end of the year and interest rates maintain actual levels, the effort to afford a residence will increase slightly to a ratio of 46% of the average salary.
In the actual situation where interest rates are at historical minimum levels in real estate market, the predictable increase of the residence prices will be more difficult to mitigate through financial variables which it will impact directly into the demand. In this sense, an extension of the period of mortgage instalments could reduce the affordability ratio to housing.
Observing the elasticity for accessing a residence in a possible change of the interest rates or of the average instalments length, we can conclude that one point increasing in the interest rates implies a deterioration of 3% of effort to afford a residence and a decrease of 8% of the capacity to get into debt. However, for each year that the amortization average of the mortgage increases, the import of the instalments decrease is equivalent to 1%, whereas the capacity to get into debt increases by 3%. Summarizing, to mitigate the negative effects of interest rate increase in instalments, mortgages length could be extended to obtain same affordability indicators with lower interest rates.
At present time, the mortgage amortization average of is around 22 years. Putting off to three more years, until 25 years, would involve an improve of 10% in the capacity to get into debt and to alleviate an 3% interest rate rise.
Conclusion
The housing market in Spain has known a significant cyclical expansion in recent years which accounts for high price increases. This paper has attempted to analyse this development and tried to associate the determinants. Inevitably in a market as complex as housing, various factors come into play.
After the analysis, it will not be exaggerated to say that the booming market is supported mainly by the low interest rates and the continuing influx of foreigners. But even with such bonus for the buyers as the cheap mortgages they now have to spend between 40 to 46% from their incomes to cover the bank instalments. Even the slightest interest rate increase could impede the demand bringing down the activity in the whole sector.
Therefore prices should begin to stagnate by end 2004 and government plan should be adopted to compensate social issues of the Spain’s major house price crisis.
References
Books
*N.Gregory Mankiw, “Principles of Economics”.(1998)
*Lopez Garcia Miguel-Angel. “Subsidios a la Vivienda e Imposición sobre la Renta Personal”. (2001) Work presented in the Seminar “Políticas Públicas y Distribución de la Renta.
*Stoker, Thomas M; "The Cost of Capital and Consumer Behavior". Econometrics - Econometrics and the Cost of Capital. Edited by Lawrence J. Lau. Volume 2, (2000), 165-186.
*Fallis George. “Housing Economics”. (1985) by Butterworths Toronto.
Articles
*Steve Bergsman, “High Demand Raises Cost of Second Homes”.(2004)
*Gérard Bérubé, “What bubble?”.(2003)
*Peter G. Miller,”Have We Paid Too Much For Real Estate?”.(2004)
Web Pages
Master in International Management Page
Cinco Dias (1st Spanish economist’s newspaper)
