SPANISH HOUSING COSTS: A GROWING ECONOMIC AND

UNCLAS SECTION 01 OF 03 MADRID 000604

SIPDIS

E.O. 12958: DECL: N/A
TAGS: ECON EFIN EINV SP
SUBJECT: SPANISH HOUSING COSTS: A GROWING ECONOMIC AND
POLITICAL CONCERN


1. SUMMARY: Recent public opinion polls show that rising
housing prices are a serious concern of the Spanish public.
Between 1997 and 2002, housing prices rose 78% in real
terms. A hot real estate market based on strong demand and
low interest rates has fed the sharp increase. Government
regulation, which restricts the development of available
land, has also impacted housing prices. The economic
consensus is that prices are overvalued. Some conclude
that a property bubble has been forming, but government
officials and the majority of private sector analysts
believe a gradual correction is coming without a "bubble
bursting". Still, given the economic implications of a
sharp fall in housing prices and public anxiety over
affordable housing, the ruling Popular Party (PP) and the
opposition Socialist party (PSOE) are both making housing
policy a central plank of their economic platforms in the
upcoming national elections. END SUMMARY.

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HOUSING COSTS--A BIG ISSUE IN SPAIN
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2. The price of real estate in Spain has become a key
issue in the run up to the March national elections. A
survey from the Center of Sociological Studies (CIS)
published in December noted that 22% of Spaniards consider
rising housing prices a serious personal concern, and 19%
of the population considers housing to be one of the
nation's most critical problems. Both percentages have
risen significantly in recent months. Housing concerns
were identified as the third most important personal issue
in Spain after unemployment and economic problems, and the
fourth most important issue facing the nation.


3. Press coverage has focused on Spaniards' growing debt
and the challenge of paying mortgages. In Madrid, the
average family requires 70% of its salary (EUR 37,383 per
year - USD 47,103 at an exchange rate of EUR 1=USD 1.26) to
pay the mortgage over fifteen years at an interest rate of
4.3%. Housing payments vary in other regions: 65% of
average salary in Catalonia, 68% in the Basque Country, and
on the low end of the spectrum, 39% in Murcia and Galicia.
In 2003, Spanish personal debt reached historic levels, and
mortgages accounted for four-fifths.

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THE SPANISH PROPERTY BOOM
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4. The average price of new housing has doubled in Spain in
the last eight years, rising 78% between 1997 and 2002.
The increase in property values in 2003 alone was an
estimated 17%. The causes of the boom, according to recent
studies by the Spanish Savings Bank Confederation (FUNCAS)
and the Bank of Spain, include a scarcity of homes in the
housing market, the Spanish preference to buy rather than
rent, a poor rental market and a lack of transparency in
government real estate regulation.


5. What is clear from the significant rise in housing
prices in the past few years is that the supply of housing
is lower than existing demand. More buyers are appearing
in the Spanish market: single Spaniards, divorced
Spaniards, immigrants and foreign retirees. Low interest
rates and easy credit make these customers eager to
purchase. The resulting construction boom has failed to
satiate demand or slow the rise in prices. Spain is
currently on track to construct over 500,000 new homes for
the fourth consecutive year, a quantity that accounts for
40% of total EU new home construction over that period.
Despite additional supply, housing prices have grown three
times as fast as salaries over the most recent four-year
period. Spain now has a housing price to wage ratio among
the highest of EU countries.


6. Spanish investment habits add additional fuel to the
property boom. Real estate is the chief form of investment
in Spain, even though the Spanish stock market was one of
the world's best performing in 2003. According to Miguel
Blesa, Chairman of Caja Madrid (Spain's fourth largest
bank),80% of Spaniards put their savings in ladrillo
(bricks and mortar) and only 20% in financial assets. This
compares to a North American profile of 60% in financial
assets and 40% in property.


7. Unlike in many developed countries, Spanish owners often
let their investment property go vacant rather than renting
it out. Some say the Spanish cultural preference to own
rather than rent creates a weak rental market. Others
point to Spanish rental law as a disincentive to
prospective landlords. As Norman Flynn, retired President
of the U.S. National Association of Realtors, pointed out
during a recent Madrid visit, it takes two years to evict
delinquent renters under current Spanish legislation.


8. Regulation and local government real estate policy also
contribute to the rise in Spanish property costs. Local
governments control the amount of property available for
new housing, creating a patchwork of policies across Spain.
Many critics feel that local government decisions, which
are often made without public input, are influenced by
landowners who want to see their land values rise. Other
critics see the scarcity of land zoned for development as
designed to maximize the local governments' property tax
income by artificially restricting supply. Flynn noted the
need for greater flexibility and transparency in Spanish
real estate regulation, and he urged the Spanish to work
towards a freer property market that can self-regulate.

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BUBBLE TROUBLE?
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9. Many economists agree current housing prices are
overvalued. The FUNCAS report estimates an overvaluation
of up to 28%, while the Bank of Spain's study calculates an
overvaluation of 8% to 20%. Antonio Cortina Garcia,
Assistant Director of Economic Research at Santander
Central Hispano Bank agrees that prices are overvalued
between 15% and 20%. Numerous opinion and editorial pieces
in the Spanish press have declared the existence of a price
bubble that might burst and lead to real price decreases
experienced during the 1990s and possibly even nominal
price decreases. (Note: Nominal housing prices have never
fallen in Spain. End Note.)


10. While most experts agree that market overvaluation
exists, Cortina agrees with the position of Bank of Spain
Governor Jaime Caruana, who predicted a gentle and
progressive correction in the property market. Continuity
of current low interest rates will be a key factor. As
consumers have acquired 98% of new homes through variable-
rate mortgages, an interest rate hike would have
significantly negative effects on household wealth and
savings, as many pension nest eggs are tied to home value.


11. The current PP government downplays the threat of a
real estate crash. At year's end, Spanish First Vice-
President and Minister of Economy Rodrigo Rato publicly
recognized housing in Spain as expensive, but noted "this
does not mean we are standing before a bubble that will
involve a sharp price correction." Only a sharp interest
rate hike would cause such a change, and Rato believes
rates will rise slowly and moderately from the current 2%
to 4 or 4.5% over the medium term. Bank of Spain Governor
Caruana commented that Spain's financial institutions have
"done a good job" of risk and resource management, and
would be prepared to weather possible loan defaults
resulting from interest rate rises.


12. A minority of analysts asserts that Spanish real estate
prices remain completely justified. Angel Berges Lobera,
Director General of Financial Analysts International (AFI)
and Professor of Finance and Accounting at Madrid's
Autonomous University, asserts that fundamentals fully
justify current prices. He cites the same inflationary
factors as other experts, but does not calculate any
overvaluation. Furthermore, household debt levels and
housing price-levels are not out of line, and have just
recently attained average EU levels. Not surprisingly,
Spain's largest construction companies also join in denying
any market overvaluation. Fermin Molina, Director General
at the Urbis construction company reflected the industry's
general position: Spain's housing bubble is fiction
"invented by a few journalists."

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ELECTORAL ISSUE
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13. The current PP government's denial of a housing bubble
has not kept it from addressing housing affordability as a
key electoral issue. According to Vicente Martinez-
Pujalte, PP Economic Spokesperson in Parliament, housing is
the economic issue on which the PP is most vulnerable in
the March general elections. PP presidential candidate
Mariano Rajoy pledges the construction of 900,000 new
government subsidized homes during the next parliamentary
term should he be elected. A new type of government housing
category will classify 200,000 units as purchasable at a
maximum of EUR 165,000 (USD 208,000) with a low interest
30-year loan for those that qualify. He also wants to
increase the amount of units available for rent. His plan
calls for the creation of a new state agency that would
work with regional governments to increase the amount of
public land available to build rental units. Rajoy also
proposes the movement of delinquent rent cases to courts
after 20 days rather than the current 2 years. Finally, to
address the difficulties of younger homebuyers, he calls
for house purchasing assistance from the government for
200,000 qualified buyers less than 35 years of age.


14. The opposition PSOE has also made the issue a campaign
theme. The Socialist party line accuses the Administration
of enacting legislation that encourages speculation,
failing to recognize that many citizens cannot afford
housing, and being content with the situation although
Spain is the EU country in which it is most difficult to
obtain housing. They also accuse the ruling party of
shunning debate by offering hollow responses to worries
over increased prices such as "When people buy homes, it is
because they have the money to do so." We expect the
Socialists to increasingly emphasize this issue as the
March election approaches.


15. COMMENT: Though most analysts bet that any housing
overvaluation will adjust gradually rather than abruptly,
the PP government and the opposition are keenly aware of
the political and economic issues surrounding the housing
market. On one hand, a large percentage of Spanish society
wants housing costs to come down. On the other hand, many
Spaniards' nest eggs for retirement are tied up in real
estate. With construction driving economic growth in
recent years, a steep decline in housing prices, connected
with a sharp slowdown in the market, would also drag on
economic growth. With interest rate policy outside of its
control, the next government will need to carefully manage
housing policy to assist those priced out of the market,
and to prevent a collapse of a key sector of the Spanish
economy.

MANZANARES