Spain’s Booming Housing Market And The Uncertain Future

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¶1. SUMMARY: The Spanish housing market in 2004 and the first
trimester of 2005 can be characterized by record growth, easy
credit, and poor rentability. In recent years, tremendous
demand for housing, coupled with insufficient supply has
resulted in rising prices and unprecedented construction.
Despite similarly high demand and lower costs for rental
housing, inadequate legal protection for landlords has
limited growth in the rental market. The GOS believes that a
more accessible rental market would help address the public’s
concern regarding affordable housing. Although the Spanish
government recognizes the shortcomings of the rental market,
it has done little to liberalize the rental code. In recent
years, increases in home prices have outpaced salary growth
and inflation. This fact combined with 2% interest rates and
easy credit has resulted in record levels of mortgage
indebtedness among Spaniards. Most public officials, private
analysts and press sources agree that the housing market is
overvalued and predict an eventual and gradual correction in
the medium term. END SUMMARY.

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Growing Demand, Price Increases and the Construction Boom
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¶2. The primary cause of high housing costs and booming
construction rates has been the growing demand for homes.
According to Juan Iranzo (Director General of the Institute
of Economic Studies in Madrid), sustainable increases in
demand can be attributed to both demographic and financial
factors. Iranzo listed four specific demographic reasons for
the high demand: the creation of five million new jobs in the
past ten years; foreign real estate investment (which has
more than doubled since the introduction of the euro); record
levels of immigration; and increasing frequency of separation
and divorce. On the financial front, Iranzo highlighted two
primary causes: record-low interest rates resulting from
fierce inter-bank competition and extended mortgage periods.

¶3. The cost of housing in Spain has grown exponentially in
recent years. Since 1998, the average cost to buy has
increased by 150%, compared to salary growth of 32.7%.
Spanish housing prices in 2004 rose by 17.4%; only Hong Kong
and South Africa registered higher increases. Spain now
possesses one of the highest “home price to wage” ratios in
the EU and Spaniards are spending more than ever on their
mortgages. However, this fact is somewhat mitigated by the
increasing prevalence of dual income-earning households.
Working women have played a large role in ensuring the
relative affordability of housing in the current Spanish

¶4. As a result of the high demand for housing, construction
of new homes has risen substantially. In the last ten years,
annual construction rates have increased by an average of
123.5%. In 2004, 756,000 new homes were built, 11.2% more
than the 675,000 constructed in 2003. In the past year
alone, more residences were built in Spain than in France
(340,000), Italy (200,000), and Germany (150,000) combined.
Since the year 2000, Spain has constructed more than half a
million new homes annually; a figure which accounts for over
40% of all new-home construction in the EU and 6% of Spain’s
GDP. Last year, 18 homes were constructed for every 1000

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Low Interest Rates, Easy Credit and Record Debt
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¶5. Despite significant increases in real estate prices,
Spaniards continue to buy. Low interest rates (around 2%)
and easily accessible credit have resulted in record mortgage
lending. Additionally, extended loan periods have made
mortgage payments more affordable, especially for young
adults and immigrants. According to the Spanish Mortgage
Association, the volume of mortgage lending increased by a
factor of 4.5 between 1996 and 2004. The same source states
that from 1990 to 2004 the average loan period increased from
12 to 25 years.

¶6. Easier credit has translated into greater debt among
Spaniards. A 24.1% increase in mortgage lending during 2004
brought the national volume of mortgage debt to 581 billion
euros ($777 billion), or 73.1% of the Spanish GDP. Divided
among the 43.1 million residents of Spain, this collective
debt averages 13,500 euros ($18,048) per person.

The Rental Market

¶7. According to Juan Justo Tinaut Elorza (Subdirector General
for Real Estate Policy of the Spanish Ministry of Housing),
only 9% of all Spaniards rent homes, compared to the European
average of 32%. The low supply of rentable housing in Spain
is primarily attributed to insufficient legal protection for
landlords. Bank of Spain economists Llanos Matea and Jorge
Martinez told econoff that it can often take up to two years
for a landlord to evict a delinquent tenant. They added that
stringent rent control policies and freezes have also
dissuaded potential landlords from renting their property.
Tinaut commented that Spanish law requires landlords to offer
tenants minimum five-year housing contracts and rents that
cannot be increased by more than inflation. Although tenants
are permitted to opt out of the contract after one year,
landlords are bound for the duration. Consequently, many
homeowners have and prefer to leave their property vacant
rather than rent. The fact that so many potential rental
properties remain empty in the face of such great demand is a
unique phenomena of the Spanish housing market. It is
estimated that up to 3.1 million properties in Spain remain

¶8. Demand for rental housing far exceeds available supply,
especially among Spain’s growing immigrant population. In
fact, only one of every five people who wants to rent is able
to do so. Yet despite this high demand, rental prices have
not undergone the same increases as purchase prices.
According to the National Statistics Institute, rental costs
increased by 4.24% in 2002, 4.26% in 2003 and 4.1% in 2004,
only slightly more than inflation. In the last three years,
the cost of rental property has increased by 15.1%, whereas
purchase prices increased by over 17% in 2004 alone. The
average Spanish homebuyer devotes 43.7% of his annual income
to his residence, while the average renter only devotes
27.7%. (These figures jump to 61.6% and 36.5% respectively in
Madrid’s hot housing market).

¶9. Solving the problem of rising housing costs for young
people and moderate income earners was one of the Socialist
government’s main campaign promises. In early 2005 the
Socialists began to follow through on this promise by
establishing the Public Rental Agency to stimulate the rental
market. The Agency has two main functions: to offer
potential landlords legal safeguards and financial incentives
to rent their property; and to develop inexpensive rental
housing for low income groups. In most advanced economies,
the rental market is important because it acts as a balance
on home prices. When housing costs start to rise, rental
options become more attractive and demand to purchase homes
falls. A stronger rental market in Spain would help to
moderate growth (and decline) in housing prices. Tinaut
seemed to infer that the GOS is unwilling to liberalize the
rental code to facilitate renting. Instead the government
has put its faith in intermediary agencies that work to
increase the availability of rental property without
expanding the rights of landlords. He remarked that
intraparty political compromise on rental (and housing)
issues is difficult to achieve.

¶10. As Tinaut explained, much of Spanish housing and rental
policy is determined by the Autonomous Communities and
municipalities. This creates a patchwork-national policy
which inhibits flexibility, especially in the rental market.
Although zoning laws are oftentimes a part of the patchwork
confusion, Tinaut said that zoning should not be considered
one of the main causes of the recent price increases.

Overvaluation and the Inevitable Correction

¶11. Most economists agree that the Spanish property market is
overvalued by approximately 20%. Although a small minority
of analysts predict continued annual growth of over 15%, and
an even smaller group fears a sudden and catastrophic “bubble
bursting,” most experts anticipate a gradual and progressive
correction in the market. General consensus holds that
growth in the housing market will decelerate during 2005,
registering around 8% to 10%. In 2006, many analysts,
including economists at BBVA (Spain’s second largest bank),
predict that growth in the property market will fall into
line with inflation. In other words, by the end of next year,
nominal growth in the housing sector is expected to drop to
around 3% while real growth is expected to disappear.
Ministry of Housing Subdirector General Tinaut seemed to
cautiously agree with the BBVA’s prediction.

¶12. An increase in interest rates over the short and medium
term could have a dramatic effect on the housing market.
According to the Spanish Mortgage association, 99.2% of all
home loans have variable interest rates, leaving homeowners
vulnerable to even slight rate hikes. A moderate rise in
interest rates, from the current 2% levels to 4% or 4.5%
would increase monthly mortgage payments and decrease
consumer purchasing power. Reduced demand for housing and a
slowdown in the construction sector could result in a
consumption effect trickling through the economy.
Alternatively, interest rate hikes would probably not
increase rental costs.

¶13. Comment: After years of rising housing costs and record
construction growth, many analysts believe that a gradual
correction is about to begin. Spaniards without homes
eagerly await a fall in housing prices while others, whose
wealth is tied up in home equity, will be hard hit by a
decline in growth. In the past several years, booming home
construction, which accounts for 6% of Spanish GDP, has been
a linchpin of Spain’s economic growth. Reductions in
construction volume resulting from falling housing demand
will weaken the economy. The current Socialist government
has focused on improving the rental market in order to follow
through on campaign promises to increase the availability and
affordability of housing. Despite this fact, the GOS refuses
to enact landlord-friendly legislation. The government seems
to believe that public rental agencies represent the best
mechanism to increase rental availability without infringing
on tenants’ rights.

¶14. The key determinant in the housing market is the variable
interest rate mortgages most Spaniards hold. Even a slight
rate increase by the European Central Bank would result in
falling demand, lower home prices, reduced construction and
possibly, a general economic slowdown. The political
implications of a recessed housing market are also
significant. If the economy begins to slow in 2006, it is
widely speculated that the Socialist PSOE government will
call early elections.