Spanish real estate and construction firms are suffering a significant correction in their stock prices. This has sparked questions about the health of the sector, and alarmed investors and families that have mortgages to pay off. According to some organizations, people’s homes could be overvalued by as much as 30%. The construction sector has been one of the country’s motors of growth, so its cooling down could also affect the Gross Domestic Product (GDP).

The collapse of the stock market began with Astroc, the Valencia-based real estate firm, whose shares dropped by more than 64% in barely five sessions beginning in mid-April. Other companies followed, including Cleop, which has dropped by 20.5% since April 18. Fadesa has dropped 16.6%, and other companies such as Urbas, Colonia, Inmocaral, Montebalito, Sacyr Vallehermoso and FCC have all seen their share prices drop by more than 10% during this period.

Share prices for all of these companies had shot up along with housing prices. The factors responsible for that rise include the [increasing number of] foreign buyers of vacation homes, affluent immigrants and low interest rates. More specifically, prices for apartments and houses accelerated at an annual rate of 15% between 1999 and 2005. “What happened is something normal within this market,” notes Miguel Hernández, director of the real estate management program at the Instituto de Empresa in Madrid. “We had been quite surprised by the share prices of some companies, and how much they had gone up in recent years. The prices of these companies should be based on [the value of] their assets, and not on expectations as in other sectors. Astroc is a clear example of this.”

Explanations for the Collapse

Shares of real estate companies have traditionally been priced below the net value of their assets. According to Sergio R. Torassa, professor of finance at European University, it was common until a few years ago for share prices in this group to be 40% to 50% below the value of their assets. “There was then a break from normalcy. In other words, their share prices are higher than what they would be worth if they sold all of their real estate.” Nowadays, shares of leading real estate companies sell at an average of 14.57% above the value of the assets they control.

Pilar Gómez Aparicio, professor at the Complutense University and researcher of the school of cooperative studies, says that “the market is very sensitive to expectations, and this sector is evidently at the end of a boom. Real estate firms and construction companies have taken on a great deal of debt in order to finance their growth, which has increased their financial risk. Add to this the potentially higher economic risk derived from the gradual exhaustion of the current growth phase of the sector and the fall in demand.” For Gómez, it is clear that “the stock market is very sensitive, and the sector had already shown signs of weakness. The crisis of Astroc, which spread to other companies, has made it clear that expectations are changing, and that people fear that the slowdown in the real estate market will be greater than anticipated.”

This situation has caused many shareholders and property owners to turn their attention toward the United States, which is currently experiencing a significant slowdown in its residential and construction market and a marked slowdown in its economic growth. This crisis has put the mortgage sector at high risk, and led to a sharp drop in the price of used homes – the highest drop since 1989 – as well as declining prices in the U.S.

The government of Spain has attempted to calm these fears. Pedro Solbes, second vice-president and Minister of Economics and The Treasury, has said that the drop in the Spanish stock market is not something “anomalous” or “worrisome.” He said it is merely a “significant correction” in the stock prices of real estate companies, although “some people are jumping to that conclusion.” Solbes also commented on the current condition of the Spanish real estate market. “Should this market give people good cause for general concern? My response is no, because I believe that families are enjoying higher incomes, and there are good job opportunities,” Solbes told the Spanish Senate.

Is This a Bubble?

Nevertheless, some observers, such as the Financial Times, believe that this market shows “all the signs of a bubble about to burst.” The British newspaper used the word “unfortunate” to describe the possible burst, and warned investors about the need to avoid the riskiest investments. “It will be interesting to see if panic among investors irrationally travels to other real estate markets in Europe and beyond,” the newspaper said.

In its latest report about Spain, the OECD warned that housing prices are “overvalued by about 30% above the long-term equilibrium level.” The organization notes that in 2006, prices continued to rise by almost 10%, which means that they have risen by a cumulative 130% since 1996.

Gómez Aparicio notes that prices have risen in recent years “to a significant degree, sparked by strong demand and other factors such as good financial conditions and tax laws regarding housing property, among other things.” As a result, she added, rising prices “are not caused by a change in psychology but can be explained by concrete economic and demographic factors.”

The latest official data provide reasons for the government to begin an “orderly and gradual” slowdown in housing prices, to the point where they begin to behave in line with the Consumer Price Index. According to the government, the average price of real estate in Spain rose 7.2% during the first quarter of this year, compared with the same period in 2006. That represents the lowest growth rate since 1999.

Altina Sebastián Gonzalez, professor of finance at the Complutense University in Madrid, believes that real estate prices will be the key to the future of stock prices in this sector. “If prices for housing continue to gradually slow down, as they have up until now, the worst phase may already be over. However, if there is a sharp drop, it will have a great deal of impact on share prices. In that sense, data about this sector for the first quarter, which will be published in a few days, will be critical for estimating the magnitude of the slowdown.

Falling Prices

Despite positive official figures, some experts believe that prices could begin to fall. International analysts and investment funds made that assertion at a recent conference hosted by Santander Group in London. Along the same lines, BNP Paribas forecasts that excessive supply on the Spanish market, along with a gradual rise in interest rates, will produce a deflation in real estate prices and a crisis in the construction sector.

Some researchers and private sector analysts have already begun to find support for that theory. The latest report by, a real estate web site, reveals that prices for used housing in Madrid and Barcelona have remained practically stable during the first quarter of this year; they grew by only 0.8% and 0.5%, respectively. Along with this slowdown, the latest numbers “confirm a slowdown in the prices of old homes in Spain, which will be more rapid than initially foreseen. If the growth rates registered in the first quarter were to be maintained for the rest of the year, price rises would already be around the Consumer Price Index or even below it,” said

Meanwhile, prices of vacation homes in the principal coastal destinations have begun to decline, and could face a drop that exceeds recent figures in the United States. Over the past 12 months, the cost of residential homes has dropped by 4.7% along the Costa del Sol, according to a study by Aguirre Newman, a real estate brokerage. Meanwhile, Acuña and Associates, a Madrid-based real-estate consultant, believes that it is likely that prices for second homes will fall by as much as 10% this year.

The reasons for dropping prices can be found in the loan restrictions that are being imposed by banks on real estate developers.  Significantly, for example, real estate developer Martinsa y Habitat is paying five times more for its debt than such U.S. real estate developers as Dallas-based Centex, according to reports by Bloomberg. Even United Airlines, which suspended its payments last year, pays a lower risk premium for its loans.

Daniel Álvarez, former head of international sales at Don Piso, a real estate firm, explains that whenever sales drop, “the first area that suffers is second homes; then, primary residences are the next to be affected.”

Already, the volume of new mortgages sold to Spanish families has fallen by 10%, according to the Spanish Mortgage Association. In addition, developers have observed a slowdown in the time period it takes to make a sale. From the time that a property comes out on the market until it is purchased, the delay is already more than two years; in some cases, it is three years. That compares with the six months that it took to find a buyer at the beginning of 2005.

Analysts cite two key favors for the slowdown: The oversupply that exists in the market as well as current financial conditions, which have worsened as a result of rising interest rates within the euro zone. Families have to work harder and harder in order to buy a home.

Increasing Arrears

In December 2005, the European Central Bank began a new phase in its series of interest rate hikes. Since then, the price of money has gone up on seven occasions. It is now at 3.75%, the highest level since November 2001. This monetary policy has propelled the euribor, the main index for fixing mortgage prices in Spain, to 4.25% in April. That was the highest level since July 2001. The price of the average loan in Spain has risen by 0.7 points, and the [average] monthly installment payment had risen by more than 88 euros.

Another cause for concern is the rising number of payments that are in arrears. During the third quarter of 2006, the RMBS index, which measures the number of mortgages that are in arrears, rose by 22 basis points to 1.52%, the highest level in at least four years. According to this indicator, the institutions that have been most often affected by delayed payments are the UCI, a leading marketer of mortgage loans; as well as Santander, BNP Paribas, and Banco Pastor.


Nevertheless, the current situation does not seem to be alarming. Standard & Poor’s forecasts that increased rates will not affect the ability of families to comply with their financial commitments. It also asserts that the index of payments in arrears is at “relatively low” level. In its report Standard & Poor’s adds that “Variable rate products predominate in the Spanish mortgage market. Nevertheless, the impact of the rising price of money has been less than in other countries of the euro zone because inflation has been higher [in Spain], so real interest rates have been lower in comparison with other markets.”

Keys to the Future

Banks will provide the key to the future of the real estate sector, says Hernández. He anticipates that immigrants who now share rented housing will enter the real estate market. “They will start going to banks to apply for mortgages. Depending on the requirements imposed on them by financial institutions, a greater or smaller number of houses will be sold. That will determine whether the market winds up being strangled.”

In any case, Hernández notes that other businesses exist within the real estate sector apart from housing. These other businesses include offices, shopping centers and industrial plants. “The housing market is in the worst condition of them all, but the others, especially office properties, are doing very well. In some cities, demand even exceeds supply. This means that companies in this sector have another sort of business that enables them to move forward.”

Pilar Gómez believes that “the market will adjust gradually” in the future. “Demand will continue to drop, and real estate activity will also moderate. Nevertheless, this moderation in the market is nothing more than the end of a remarkable period of real estate expansion that could not and must not continue indefinitely. Actually, this adjustment in prices is something more moderate than in previous cycles. So long as there is disposable income for homes, and so long as employment levels remain at their current levels, the adjustment will continue to be smooth.”

For his part, Torassa argues that “It is unreasonable to expect the indiscriminate collapse of the entire real estate, or the equally indiscriminate spread [of this slowdown] to other sectors that have business ties founded on expectations that there will be a continued smooth landing in the sector. That [smooth landing] scenario seems more probable over the next two or three years.

What will happen to the Spanish economy, given the fact that the construction industry has been one of its principal engines of growth? Analysts at BNP Paribas note that the construction sector employs 14% of all manual workers in the country. They estimate that a cooling down of the housing market could have a negative effect on the economy. They say it could mean that Spain’s GDP will not grow beyond a rate of 2% to 3% in the [two-year] period of 2008 to 2009. At the moment, Spain is still expanding at a rate of above 3.5%.

Sebastián calculates that, independently of speculative demand, the balance between housing supply and demand is at about 400,000 to 450,000 annual units. “This level assumes that production of new houses will drop by 30%, which could mean the destruction of some 200,000 jobs.” According to her forecast, “This potential drop in the number of jobs should not be too traumatic for the Spanish economy given that redundant workers would be absorbed by the industrial and service sectors.”