Manuel Romera. Professor. Instituto de Empresa
26 October 2003
Debates have been buzzing recently around Spain’s supposed real-estate bubble, or price surge. Younger generations will have to work harder – and longer – than their parents to purchase a home.
Spain has experienced the highest percentage price rises of any of the European neighbors, and stands among the top five countries that make up the OECD. For the Spanish family, on average, a home accounts for two-thirds of its total wealth, which, as anyone can imagine, makes the home the major investment of a lifetime. Family conversations often revolve around who has to make the greatest effort to buy their home: the parents, who bought 20 years ago and now have it paid off, or their children, who are about to buy a home now?
The answer is clear: children will have to make the greater effort. Leaving aside the factor of 16 - by which house prices in Spain have multiplied since 1976 - and seeking a relative measurement, if we divide the cost of a home by the gross disposable income in the average household, the result in 1976 would be two and the current figure practically four. This means that, in real terms, the effort young people are going to make today is twice that of their parents.
There is an additional factor: families nowadays often bring in two wages, while in 1976 there was only one. So, if the comparison is made with respect to one wage and not to disposable income, we could be talking of multiplying the effort by four.
Due to the close relationship between the purchase of a home and its financing via a mortgage loan, comparing the debt in Spanish households with gross disposable income shows this has also doubled between 1986 and today. Many will ask: how then can young people manage to pay for a flat? The answer is obvious: to keep up a proportion of the mortgage payment with respect to their income similar to that of their parents, the average repayment period for mortgage loans has increased from 10 years in 1980 to nearly 30 years today. Mortgage interest rates have dropped from 16 percent to the current 3 percent, and employment has increased with the consequent greater ability to pay.
This is the panorama we are leaving to coming generations and I can assure you that they are going to have to pay off their mortgages over three times as many years as their parents. I try to encourage them to consider the tragicomic situation wherein they will be able to celebrate their retirement jointly with the end of their mortgage repayment. They must however bear in mind that neither member of the couple can afford a slipup in their professional careers throughout these 30 years without defaulting on their monthly installments. I also have to point out that – using a mortgage of € 240,000 euros at 4 percent interest as an example – their parents already owned their home after 10 years, while they will still have € 190,000 euros of debt around their necks.
[*D Many vested interests wish the status quo to continue *]
My heart sinks at this, and I feel we should do something to improve their quality of life. The difficulty lies in the fact that many vested interests wish the status quo to continue. There can be no doubt that, on one hand, prices have risen sharply due to many strictly market-related reasons, such as the need for homes for young people, the lack of alternative investments that offer confidence, expensive rentals, purchase of a second home or the culture that reigns in our country. However, on the other hand, there is also a tremendous influence from factors related to our legislation, such as the great fiscal benefits on home purchase and the lack of incentives for rented homes. As to supply, we can say things are approaching the limit of what could be considered constitutional, since town councils finance their operations by releasing land and are well aware that, if this land is drip-fed onto the market, prices will rise inexorably and relentlessly.
Let’s take a statistic that cannot be refuted: in the early 90s, the percentage of house prices that corresponded to the cost of land was 25 percent. It is currently 50 percent. It is thus self-evident that land speculation has been rife under the protection of the law.
It’s fairly easy to predict that house prices cannot rise to infinite heights, as popular belief would have it. There are many people who, given the many years they have to pay off their loans, convince themselves that if things do not go well, they can always sell up. And, as the price will always be higher, there will be no problem. This is a disastrous notion, since it is precisely what generates a property bubble. I do not wish to contemplate what will happen in Spain when interest rates rise for that vast majority of young people who have variable-interest mortgage loans, in an attempt to avoid paying a higher installment at a fixed rate, or simply through lack of knowledge of risks involved. In fact, returning to our example of a € 240,000 loan over 30 years, if the interest rate jumps from three to six percent, the monthly installment would rise from € 1,011 to € 1,438. These figures alone describe the trouble in which the average family could suddenly find itself.
People often ask what chance there is of interest rates going up. I see no clear answer. What we do know is that, in early 2001, the U.S. had an official rate of 6.5 percent, and by the end of the year, it had dropped to 1.75 percent. In 2000, the official rate in Europe went from 2.25 to 4.75 percent in just over 12 months. In 1991, rates in Spain were five times as high as today’s. Given such volatility, rates must inevitably rise sooner or later.
I imagine that the surge of the job market will, at some stage, slow and no longer offset property rises. Moreover, it would seem that the stock market is starting to be seen as an alternative for investment. Nor must we forget the possibility of some politician changing the legislation governing supply that is so pernicious for our society. Nonetheless, this possible drop in house prices does not eliminate the underlying problem: namely, that young people have bought their homes at a very steep price, with over 80 percent provided by financial institutions that, in their drive to grow, assumed considerable risk.
In fact, we cannot rule out possibility of a banking crisis, due primarily to an inability to pay a large proportion of their mortgage loans; and, secondly, because these young people would be left with an investment with a lower market value than the amount they owe. To all those skeptics who say that real estate never drops in price, I would argue that it has already happened in Japan and Argentina. They would realize that there have indeed been real-estate crises, even though from here we think they are a long way off.