Bubbling Spanish Housing

1. Bubbling Spanish Housing Jose G. Montalvo Universitat Pompeu Fabra

2. What’s a bubble? • "If the reason the price is high today is only because investors believe that the selling price will be high tomorrow - when 'fundamental' factors do not seem to justify such a price - then a bubble exists."

3. Is there a bubble in housing? • Difficult to assess: • Do the fundamentals justify the prices? • Are expectations of future increase in prices driving the demand? • Economics is not so advance as to estimate with a good degree of confidence the existence of a bubble. Main problem: expectations (remember the tech bubble?)

4. Are there signs of a bubble? • YES. Many of them: • Fundamentals (income, employment, demography, etc.) are unable to explain most of the variability of house prices (28%-35%). • PER (price to rent ratio) in historical maximum.

5. PER ratio

6. Finacial return (no rents)

7. Are there signs of a bubble? • Expectations: • 65% of recent buyers confirm that the investment side of buying a house was important for their decision • 94,5% of recent buyers believe that there is a bubble (40% of them think that it is more than 50% of the price). But the same individuals believe that prices will grow 20% yearly over the next 10 years. Economic experiments.

8. Are there signs of a bubble? • Close to 40% of recent buyers know a friend or a close relative that got into the housing business (at leas as a part time job) • Taxi drivers tell you how much they are making in the last two houses they bought. Remember Joseph Kennedy and the tips of the shoe-shine boy • Taking about the prices of housing and the incredible profits you can make has become a major topic of conversation in any meeting with friends, relatives or fellow workers.

9. When is the bubble going to burst? • Ask banks and savings and loans. • Suicidal competence for mortgages. Very small spreads. Lowest mortgages rates in the EU. Are Spanish banks so efficient? • Reduction in the requirement to get a mortgage: temporary contract OK, extended mortgages (40-50 years), more than 100% of the price, no extra guarantees, etc. • Weakest link: credit to intermediaries in the housing market.

10. When is the bubble going to burst?

11. Gross return on housing (rents)

12. Simple (optimistic) calculation • Houses initiated in 2005: 812.000 • Spanish new households (net): 275.000 • Immigrants new households: 75.000 • Secondary houses: 75.000 • Foreigners demand: 100.000 • Where are the missing houses?

13. Missing houses

14. How would the bubble end? • Increase of interest rate. 99% of new mortgages are at variable rate. r=3.1% • Cyclical downturn of employment and economic activity. • Overproduction and problems to return credits for the new developments • Change in expectations of profitability of the housing sector in Spain

15. Foreign investment growth rate

16. And them, what should we expect? • Wealth effect going south. • Economic growth compromise since most of it in recent years, has relied on the construction sector. • Problems for the financial system because of the high proportion of risk concentrated in the sector and the overconfident risk management

17. And them, what should we expect? • Would prices go down (burst) or inflation will erode slowly the real value of the housing stock? • Just look at what happen in the past in Spain. • Look at what happen in this sector in other countries. IMF report on volatility of prices.

18. And them, what should we expect?

19. It is your call! • Would you buy an illiquid asset with a PER=50 when you cannot even calculate the return on the average and the production of the sector is double the demand?