More than six years have passed since the real estate market began its dizzying ascent. Over the past six months, the market has seemed about to explode, without actually doing so. The main reason usually cited for the boom in bricks and mortar has been weakness in the stock market. Nevertheless, this year’s modest stock market recovery is not slowing down growth in housing prices. How can the upswing be stopped?


“What’s missing is a combination of factors that would put an end to rising prices,” notes Santiago Carbó, professor of economics at the University of Granada [in Spain]. “On the one hand, you need higher interest rates that restrain people when it comes time to getting a mortgage. You also need to eliminate tax deductions for buying homes. You need to construct more public housing, which means making more land available for constructing houses. Finally, a recovery in the stock market would divert investors’ interest away from real estate and into stocks.”


Thus far, improvement in Spain’s stock market has not managed to eliminate interest in real estate. The Ibex 35 benchmark index rose 16.16% during the past year, but housing prices nevertheless rose 17%. During the first quarter of 2004, prices for new housing rose an additional 3.5%. Prices for other housing rose 4.4%. In the United Kingdom, conditions are similar. Over the past 12 months, the FTSE 100 stock index has risen 7.23%, but housing prices rose 23% in 2003. This year, real estate prices are growing at a rate of 17%, according to a report by Deutsche Bank.


When it comes to real estate, Spain and the U.K. are the two ‘hottest’ countries in Europe. Both the International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD) have warned that the real estate bubble could burst. Carbó discounts that possibility, at least for the moment. “I don’t think there is a bubble, but we are in a vicious circle from which we have to escape. That will require some fundamental measures that will not begin to be felt within one year.” He warns, moreover, “Although prices are not going to go down, at least they might grow at a very slow pace — about 1%, 2% or 3%.”


First, Raise Interest Rates

The Bank of England is aware of the threat facing British real estate, and it has been stepping on the accelerator, raising interest rates. Last week, it raised rates by a quarter of a point for the second time in one month; for the third time in three months; and for the fourth time in seven months. With these moves, Britain’s leading financial institution hopes to restrain the trend toward buying homes merely in order to rent them out, and pay off mortgages that way. This phenomenon, which is also taking place in Spain, “is making demand for real estate much greater than the supply, and it is leading to higher prices. That’s why we have to cut down on demand.” In the U.K., there is also another problem — the scarcity of land available for housing in metropolitan London. That explains why, over the past 20 years, the U.K. has been the second-fastest growing country in Europe when it comes to land prices. According to “Structural Factors in the Real Estate Markets of the E.U.,” a report by the European Central Bank, land prices in the U.K. have risen at a rate of 5.2%, surpassed only by the 6.3% rate in Luxembourg.


Nevertheless, José Antonio Herce, director of the Foundation for Applied Economic Studies, and professor of economics at Madrid’s Complutense University, points out a recent article in Expansion, Spain’s business newspaper. That article noted, “Neither the 15% interest rates, nor the 23% unemployment rates that existed in Spain barely ten years ago led to a significant drop in housing prices at that time.” According to Pilar Gómez Aparicio, professor of financial economics and accounting at Complutense University, “It is not easy to solve the so-called ‘housing problem.’ If an easy formula existed, every government would use it to take action, because doing so would be extremely profitable, both politically and socially.”


One key, according to Aparicio, involves changes in tax policy that must be carried out. However, Aparicio adds, “These moves must be carried out carefully, in order to respect acquired rights.” Not only are these measures “not easy, from a political viewpoint. In addition, you would not notice any quick impact on housing prices.” Already, Spain’s new government, headed by the socialist party (PSOE), has announced plans to enact new measures that provide incentives for renting housing, and disincentives for purchasing.


“You have to get rid of deductions for those people who save, merely with a goal of acquiring real estate; you also have to get rid of incentives for home-buyers who have already bought other housing,” says Carbó. He adds that it would take about two years to accomplish this goal. “What I don’t want is to create incentives for renting, because artificial measures are not effective.” Carbó stresses, “The shortage of rental properties in Spain involves a cultural phenomenon more than economic factors. Having your own property gives people more security. Moreover, when interest rates are low, your mortgage looks cheaper than your rent, with the added attraction that you tell yourself, ‘This house belongs to me.’”


The Eternal Alternative of Renting

Back in 1980, rental properties represented 21% of Spain’s total housing stock. Since then, rentals have fallen to 10% of the total, according to the ECB. Finland is the only country among the EU’s old ‘Fifteen’ in which the supply of rental properties has increased over the past 20 years. In Finland, rentals have risen from 31% to 32% of the total housing stock. Germany is the country where this approach works best. Rentals represent 60% of all properties there, and they have dropped by only one percentage point [since 1980]. Ireland and Italy are near the other end of the scale, with 16% and 19% respectively. Only Spain outdoes those two countries, with a rate of 10%. Luxembourg (26%), Portugal (28%); Finland and the U.K. (both at 32%), hold remaining spots on the list.


In part, the major role that rental properties play in Germany explains why that country is one of the few OECD members – along with Switzerland and Japan – where housing prices dropped between 1995 and 2002. In Japan, land prices have not stopped dropping after that crucial period in 1991 when the real estate bubble of 1987-1990 finally burst. According to the Asahi newspaper, commercial land prices have fallen by 67.6% since 1991. Meanwhile, residential land prices have dropped 43.2%, bringing current prices in Japan to their same level as in 1987.


Aparicio notes, “To develop a rental market in Spain, we’ll have to establish guidelines so owners can freely create a profitable and secure alternative for renting out the housing that they can own, and they don’t need to occupy.” But Aparicio warns we must “be careful when it comes time to encouraging agents to rent new property, through means of any legislative measures that have a clearly coercive character; for example, measures that penalize [owners for] vacant properties.” In Spain, there are three million such vacant properties.


Nevertheless, Aparicio criticizes the fact that “property is tax-deductible for any sort of housing (at any price); and for every sort of income source (not including possible fraud when obtaining tax abatements for unusual categories of housing). Meanwhile, on the contrary, ordinary rental properties are not tax-deductible. These tax measures provide advantages for property ownership, but not for the market in rentals.”


Carbó argues, “We badly need to take immediate legislative action to restrain purchasing.” He notes that in some countries, including Germany and Scandinavia, the Department of Housing provides subsidized rentals and social assistance for unemployed families.”


In his article, Herce says, “The shortage of rental properties and the scant supply of residential rentals stems from families’ obsession to own the property that they occupy. All this has been stimulated by tax incentives.” In addition, now that banks can no longer depend on declining interest rates to attract homebuyers, some banks are weighing the possibility of changing their credit conditions, so they can keep on feeding the home-buying habit.


Despite all this, Deutsche Bank analysts believe that, at least in the United Kingdom, rising rates are going to cut into the home-buying habit, in favor of rental properties. The impact of rising rates has already begun to be felt in commercial rentals in The City [district of London], which suffered a 12% drop in prices in 2002, and a 21% drop in 2003. This fiscal year, however, Deutsche Bank projects a rise of 0.7%, and continued increases in both 2005 (+0.4%) and 2006 (+1.9%).


Carbó warns against extrapolating these figures to the world of residential housing. “They are two different worlds that behave separately. In the world of commercial real estate, cultural factors have less impact.” Social and cultural factors explain why, for example, young Germans are more interested in rental properties. Young people in Germany generally break away from their families earlier than young people in Spain, and they are more mobile than their counterparts in Spain are. In Spain, young people have a tendency to stay at home longer, and they are more reluctant to move to another city.


Another alternative would be to raise the stock of state-subsidized housing. Carbó considers this essential for breaking the current vicious circle. “In countries like Germany, Italy, France and the Netherlands, the market [for state-subsidized housing] is highly developed. Meanwhile, this market has deteriorated in Spain in recent years.” In his view, to make this option viable, “We urgently need to designate more land for real-estate development. That kind of land is hard to find in many localities where land is the main source of local revenue.”


For Herce, a sound approach would combine “a determined strategy for liberalizing land, with substantive reform of the law governing rentals (as well as justice, which is not usually the same thing). If, in addition to all that, tax incentives for acquiring housing also disappeared, that would be icing on the cake. If we could create those conditions, developing a social policy for providing rental housing for disadvantaged families would have a limited cost – and not wind up distorting the free market.”