Bubbling Spanish Housing
Jose G. Montalvo Jose G. Montalvo
Universitat Pompeu Fabra Universitat Pompeu Fabra
What’s a bubble?
""If the reason the price is high If the reason the price is high today is only because investors today is only because investors
believe that the selling price will believe that the selling price will
be high tomorrow
be high tomorrow - when - when
'fundamental' factors do not seem 'fundamental' factors do not seem
to justify such a price
to justify such a price - then a - then a bubble exists
bubble exists."."
Is there a bubble in housing?
Difficult to assess: Difficult to assess:
Do the fundamentals justify the prices?Do the fundamentals justify the prices?
Are expectations of future increase in Are expectations of future increase in prices driving the demand?
prices driving the demand?
Economics is not so advance as to estimate Economics is not so advance as to estimate with a good degree of confidence the
with a good degree of confidence the existence of a bubble. Main problem:
existence of a bubble. Main problem:
expectations (remember the tech bubble?) expectations (remember the tech bubble?)
Are there signs of a bubble?
YES. Many of them:YES. Many of them:
Fundamentals (income, employment, Fundamentals (income, employment, demography, etc.) are unable to explain demography, etc.) are unable to explain
most of the variability of house prices most of the variability of house prices
(28%-35%).
(28%-35%).
PER (price to rent ratio) in historical PER (price to rent ratio) in historical maximum.
maximum.
PER ratio
Finacial return (no rents)
Are there signs of a bubble?
Expectations:Expectations:
65% of recent buyers confirm that the 65% of recent buyers confirm that the investment side of buying a house was investment side of buying a house was important for their decision
important for their decision
94,5% of recent buyers believe that there is a 94,5% of recent buyers believe that there is a bubble (40% of them think that it is more than bubble (40% of them think that it is more than 50% of the price). But the same individuals 50% of the price). But the same individuals believe that prices will grow 20% yearly over believe that prices will grow 20% yearly over the next 10 years. Economic experiments.
the next 10 years. Economic experiments.
Are there signs of a bubble?
Close to 40% of recent buyers know a friend or a Close to 40% of recent buyers know a friend or a close relative that got into the housing business (at close relative that got into the housing business (at
leas as a part time job) leas as a part time job)
Taxi drivers tell you how much they are making in Taxi drivers tell you how much they are making in the last two houses they bought. Remember Joseph the last two houses they bought. Remember Joseph
Kennedy and the tips of the shoe-shine boy Kennedy and the tips of the shoe-shine boy
Taking about the prices of housing and the Taking about the prices of housing and the incredible profits you can make has become a incredible profits you can make has become a
major topic of conversation in any meeting with major topic of conversation in any meeting with
friends, relatives or fellow workers.
friends, relatives or fellow workers.
When is the bubble going to burst?
Ask banks and savings and loans.Ask banks and savings and loans.
Suicidal competence for mortgages. Very small Suicidal competence for mortgages. Very small spreads. Lowest mortgages rates in the EU. Are spreads. Lowest mortgages rates in the EU. Are
Spanish banks so efficient?
Spanish banks so efficient?
Reduction in the requirement to get a mortgage: Reduction in the requirement to get a mortgage:
temporary contract OK, extended mortgages (40- temporary contract OK, extended mortgages (40- 50 years), more than 100% of the price, no extra 50 years), more than 100% of the price, no extra
guarantees, etc.
guarantees, etc.
Weakest link: credit to intermediaries in the Weakest link: credit to intermediaries in the housing market.
housing market.
When is the bubble going to burst?
Gross return on housing (rents)
Simple (optimistic) calculation
Houses initiated in 2005: 812.000Houses initiated in 2005: 812.000
Spanish new households (net): 275.000Spanish new households (net): 275.000
Immigrants new households: 75.000Immigrants new households: 75.000
Secondary houses: 75.000Secondary houses: 75.000
Foreigners demand: 100.000Foreigners demand: 100.000
Where are the missing houses?Where are the missing houses?
Missing houses
How would the bubble end?
Increase of interest rate. 9Increase of interest rate. 999% of new % of new mortgages are at variable rate.
mortgages are at variable rate. r=3.1% r=3.1%
Cyclical downturn of employment and Cyclical downturn of employment and economic activity.
economic activity.
Overproduction and problems to return Overproduction and problems to return credits for the new developments
credits for the new developments
Change in expectations of profitability of Change in expectations of profitability of the housing sector in Spain
the housing sector in Spain
Foreign investment growth rate
And them, what should we expect?
Wealth effect going south.Wealth effect going south.
Economic growth compromise since most Economic growth compromise since most of it in recent years, has relied on the
of it in recent years, has relied on the construction sector.
construction sector.
Problems for the financial system because Problems for the financial system because of the high proportion of risk concentrated of the high proportion of risk concentrated
in the sector and the overconfident risk in the sector and the overconfident risk
management management
And them, what should we expect?
Would prices go down (burst) or inflation Would prices go down (burst) or inflation will erode slowly the real value of the
will erode slowly the real value of the housing stock?
housing stock?
Just look at what happen in the past in Just look at what happen in the past in Spain.
Spain.
Look at what happen in this sector in Look at what happen in this sector in
other countries. IMF report on volatility other countries. IMF report on volatility
of prices.
of prices.
And them, what should we expect?
It is your call!
Would you buy an illiquid asset with a Would you buy an illiquid asset with a PER=50 when you cannot even calculate PER=50 when you cannot even calculate
the return on the average and the production the return on the average and the production
of the sector is double the demand?
of the sector is double the demand?
