Global Insight Perspective | |
Significance | Fears of a crash in the property market continue to cast a shadow over the Spanish economy. |
Implications | Such a crash could have serious repercussions for the economy as a whole. Construction activity has been an important engine of growth in the past nine years. |
Outlook | Global Insight does not anticipate a sudden collapse of the property market, but we do acknowledge that the conditions are in place for the market to slow notably in the next few years. |
Spain's housing market continued to cool in the second quarter of 2008. According to the Ministry of Housing, the average house price rose by 2.0% year-on-year (y/y), the lowest increase since end-1997, and down from increases of 3.8% year-on-year (y/y) in the first quarter of 2008 and 5.8% y/y in the second quarter of 2007. In addition, house price inflation has slowed from 9.1% in 2006, 12.8% in 2005 and 17.2% in 2004. We believe the latest house price data from the government continue to overstate the strength of the housing market, given that they are based on mortgage valuations which have tended to overstate prices so that banks can lend more. Other housing-related indicators appear to support the view that the real-estate sector is under greater pressure. A survey conducted by Idealista.com reveals that resale property asking prices in Spain's biggest cities fell by between 2% and 4% y/y in the second quarter of 2008. Madrid recorded its largest price fall since the survey began in 2000. Meanwhile, property website Fotocas.es suggests that prices of existing homes are now fallen by 4.3% y/y in the 12 months to February 2008.
Worrying Trends in the Property Market
- The demand for housing continues to fall: The number of housing sales fell by 7.1% year-on-year (y/y) to 55,802 in April 2008, compared to a 39% y/y drop in March. Meanwhile, mortgage lending contracted by 13.8% y/y to 12.24 billion euro, following a 42% y/y dip in March. This suggests that the downturn in the housing market has begun to ease, but we believe that the above data were distorted by the timing of Easter, falling in March in 2008 and in April in 2007. Meanwhile, the average size of a mortgage declined 1.9% y/y to 163,448 euro.
- There is an accumulation of unsold new properties across Spain: The supply of new properties being completed has just begun to adjust to softer demand. Housing completions totalled 800,000 in 2006 and around 600,000 in 2007. Consequently, there is a massive glut of unsold properties across Spain, which is set to escalate. It has recently been estimated at around 1 million properties: 500,000 newly built properties, and 500,000 resales. This is a conservative estimate.
- Real estate agencies fold in a challenging market: According to the El Pais newspaper, Spain's API real estate agents network has discovered that half of the 80,000 offices that operated at the beginning of 2007 have shut. The closures have led to over 100,000 job losses.
- The property market appears to be overvalued: The housing market is overvalued by around 30%, according to the latest estimates from the Bank of Spain. However, the International Monetary Fund (IMF) has a more conservative estimate, at around 15% to 20%. Affordability ratios (house prices to gross household income) have risen to record levels, from 4.0 at the start to 2000 to 7.0 in the first quarter of 2008. This increases the probability of an abrupt downward correction.
- More and moreconstruction companies and property developers are filing for credit protection. Property developers have seen their share prices fall sharply since late 2007. These falls were after property developers had enjoyed spectacular share price gains in 2006 when they rose by between 100% and 490%, driven up by Spain's prolonged real estate boom. This turnaround has been due to the growing awareness that Spanish property developers have taken on too much debt. The Bank of Spain estimates that the level of debt in the housing and construction sector is around 800% of its gross value-added. The sector's combined debt is estimated at 300 billion euro or 30% of Spain's GDP. Many property developer companies are struggling to meet their debt repayments in the face of rising borrowing costs and falling operational cash flows. Several construction companies and property developers have either filed for protection or have been absorbed by larger groups. The latest property company to file for creditor protection is Martinsa-Fadesa, with debts of more than 5 billion euro.
Outlook and Implications
Global Insight believes that Spanish house prices are now falling, despite official government statistics suggesting otherwise. In addition, house prices are set for a prolonged period of weakness, falling by 5-10% per annum, probably until 2011/2012. We expect house prices to post very sharp price drops in regions that contain popular tourist areas. However, demand for housing in city centres is expected to be more resilient, with price falls likely to be more modest. A sustained fall in house prices is a significant risk to the Spanish economy, given that housing equity constitutes around 90% of total household wealth, implying serious implications for both consumer confidence and spending intentions. In addition, households will feel more vulnerable, given that total household borrowing now stands at 120% of disposable income.
At this stage, we do not anticipate a sudden and steep collapse of the property market, but we do accept that the conditions are in place for the property market to register notable price falls in the next few years. The demand for housing has been hit by rising interest rates and tougher lending conditions. In addition, consumer confidence has slumped in the face of a deteriorating labour market and a steep pick-up in inflation. However, we expect the demand for housing will revive in the medium term, helped by positive demographics (net immigration and rising number of single person households). In addition, recent employment gains have encouraged higher female participation in the labour force, which has increased the number of two-income households, helping to offset affordability issues. Finally, a period of falling house prices will help to improve affordability, providing a welcome impetus to the demand for housing.
Nevertheless, Global Insight still accepts that the downturn in construction activity is likely to be quite steep in the next few years. Recent indicators suggest that the construction sector is starting to respond to faltering demand. Building permits for residential homes declined by 60.0% y/y in the first quarter of 2008, according to official government statistics. The number of permits issued fell to 87,427, down from 217,218 in the first quarter of 2007. In addition, the demand for cement has fallen to its lowest level in 11 years. This is a concern given that construction activity has been an important engine of growth in the past nine years. It has contributed around 1 percentage point per annum to overall real GDP growth, and now accounts for 15.7% of real GDP. In addition, the sector has been a major source of new jobs, directly employing 2.7 million workers in 2007, while many others are employed in services that surround it.
The economy is set to cool notably in 2008 and 2009, resulting primarily from deep-rooted problems in the housing market and construction sectors, coupled with the negative influence of the strong euro and record-high oil prices. In addition, the global credit squeeze could expose the high debt levels in Spain's household and corporate sectors. Consequently, growth is projected to slow notably to 1.4% in 2008 and 0.7% in 2009 from 3.8% in 2007.
With regards to the probability of a recession in Spain, it has now risen to 55%.This reflects the marked deterioration in industrial production, retail sales, service-sector activity, and labour-market data in the first half of 2008. The government will need to use extensive counter-cyclical fiscal policy to prevent the economy slipping into recession from the latter stages of 2008. The latest public spending figures suggest that the government is pumping money into the economy. In addition, the government plans to increase spending on education and infrastructure, and has introduced cuts for low-income earners, and higher state pensions. Meanwhile, higher public infrastructure investment should help to soften the blow of falling house building. However, we accept that high levels of private debt, a creaking property market, and an overextended construction sector are significant risks, which could be exposed should the labour market deteriorate more rapidly. Consumers would get nervous, personal and corporate defaults would rise, and the economy would plunge into recession.