US embassy cable - 05MADRID1088

UNCLAS SECTION 01 OF 03 MADRID 001088 
 
SIPDIS 
 
TREASURY PASS TRACI PHILLIPS 
STATE PASS FEDERAL RESERVE AND DEPARTMENT OF HOUSING AND 
URBAN DEVELOPMENT 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, AMGT, SP 
SUBJECT: SPAIN'S BOOMING HOUSING MARKET AND THE UNCERTAIN 
FUTURE 
 
REF: 2004 STATE 00604 
 
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. 
 
--------------------------------------------- ------------ 
Growing Demand, Price Increases and the Construction Boom 
--------------------------------------------- ------------ 
 
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 
market. 
 
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 
Spaniards. 
 
--------------------------------------------- -- 
Low Interest Rates, Easy Credit and Record Debt 
--------------------------------------------- -- 
 
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 
vacant. 
 
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. 
MANZANARES