Bubbling Spanish Housing
Jose G. Montalvo
Universitat Pompeu Fabra
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."
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?)

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.
PER ratio
3
2.5
2
1.5
1
0.5
0
1987:01:00
1990:01:00
1993:01:00
1996:01:00
1999:01:00
2002:01:00
2005:01:00
Finacial return (no rents)
80%
60%
40%
20%
0%
-20%
-40%
-60%
-80%
198819891990199119921993199419951996199719981999200020012002
1T 1T 1T 1T 1T 1T 1T 1T 1T 1T 1T 1T 1T 1T 1T
Cash
Lev. 50%
Lev. 80%
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.
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.
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.
When is the bubble going to burst?
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
I
00 C
D
20 IC
01
D
20 IC
02
D
20 IC
03
D
20 IC
04
D
IC
20
D
IC
19
99
D
IC
19
98
D
IC
19
97
D
IC
19
96
D
IC
19
95
D
IC
94
D
19
93
19
19
92
D
IC
Others
Construction sector
Intermediaries
Mortgages families
96
M
19 AR
9
19 6 S
97 EP
M
19 AR
9
19 7 S
98 EP
M
19 AR
9
19 8 S
99 EP
M
19 AR
9
20 9 S
00 EP
M
20 AR
0
20 0 S
01 EP
M
20 AR
0
20 1 S
02 EP
M
20 AR
0
20 2 S
03 EP
M
20 AR
0
20 3 S
04 EP
M
20 AR
0
20 4 S
05 EP
M
20 AR
05
SE
P
19
Gross return on housing (rents)
4.5
4
3.5
3
Gross return
2.5
2
1.5
1
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?

Missing houses
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

Foreign investment growth rate
80
60
40
20
0
-20
-40
-60
1991
DEC
1992
DEC
1993
DEC
1994
DEC
1995
DEC
1996
DEC
1997
DEC
1998
DEC
1999
DEC
2000
DEC
2001
DEC
2002
DEC
2003
DEC
2004
DEC
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

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.
And them, what should we expect?
40%
30%
20%
10%
Spain
Madrid
Barcelona
0%
-10%
-20%
-30%
-40%
1991
1T
3T
1992
1T
3T
1993
1T
3T
1994
1T
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?