What Spain can teach us about the UK housing market

There’s one factor more than any other that UK house price bulls use to back up their views. Supply and demand.

There are plenty of variations on the theme. But the general argument goes like this: “We live on a small island, our population is growing, and there just aren’t enough houses to go around.”

And the rebound seen in the market last year simply seems to confirm this view. There aren’t enough houses – so you can’t go wrong with bricks and mortar.

The bulls have got it right in one sense. House prices are indeed all about supply and demand. But it’s supply and demand for credit, not houses.

If you want the proof, just look at Spain…

What’s propping up Spanish house prices?

Spain has had a horrendous recession. It’s on the infamous “PIIGS” list of threatened peripheral eurozone countries. It has unemployment of around 20%. And there are myriad horror stories of Britons who bought property in the country only to find that their homes were subject to legal disputes, or simply that their pensions couldn’t sustain them when the pound slumped against the euro.

And yet, just as we’ve seen in the UK, the market seems to have managed to take the strain. In the second quarter of 2010, house sales in Spain rose by nearly 25% to just under 150,000, according to the Housing Ministry. The rise was driven mainly by growth in “second-hand” home sales – up nearly 50% on the quarter, compared to just a 4.6% rise for new home sales.

That may sound impressive. However, sales are nowhere near their bubble-era peak, when figures would have been more like double that. Yet, the toll on house prices hasn’t reflected this. As Fiona Maharg-Bravo puts it on Breakingviews.com, “the Spanish housing bubble isn’t in a hurry to deflate. Prices have held up and are now just 12% off their 2008 peak.” That’s comparable to Britain – if you use Nationwide figures, we’re around 10% off the 2007 peak price for the average British home (and closer to 16% if you look at Halifax).

Yet there are estimated to be about a million empty new-build homes in Spain. Says the FT, “most experts say it could take another three to four years to absorb surplus stock.” And that’s despite a collapse in the number of homes being built, from 800,000 in 2006 to fewer than 100,000 this year.

So what’s behind the surprising resilience of Spanish prices, if not a physical shortage of property? Obviously there are pockets where things are worse – all those horror stories from expats having to sell at huge discounts, for example.

But by and large, what’s propped up prices in Spain is the same as what saved the British property market from harder falls – interest rates being slashed.


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Just as in Britain, home loans in Spain are generally variable, says Maharg-Bravo, “and interest rates are ludicrously low – sometimes less than 2%.” So people who might otherwise be forced to sell find that their home loans are cheap enough that they can sit on their property, rather than take an “unacceptable” price.

Compare that to the US, where payments on home loans were generally fixed or in many sub-prime cases, rising, and suddenly it’s easy to see why Europe’s crash has been nowhere near as severe as America’s.

How long can the market hold out?

So how long can this state of affairs last? The trouble is, while prices have held up, it’s been at the expense of market liquidity. Put simply, people aren’t moving home the way they used to. And first-time buyers are a rarity in Spain as well as the UK. As Maharg-Bravo points out, Spanish net new home loan lending fell in the second quarter. “This suggests a shortage of first-time buyers, with activity reflecting existing home owners trading up or down among themselves”.

Without new buyers coming on to the market, it’s hard to see where the fuel for further price gains can come from. It might be cheap to borrow, but it’s not going to get any cheaper.

Indeed, the biggest threat to Spain’s market might be the fact that Spanish banks own so much of it. As Mark Mulligan notes in the FT, “after three years of bankruptcies, defaults, foreclosures, debt-for-equity and debt-for-asset swaps, and the winding up of several property funds, Spanish banks have become the country’s biggest landlords and property agents.”

The Bank of Spain reckons that lenders now have €60bn worth of land and property on their books. However, says Maharg-Bravo, “new rules will force banks to set aside provisions of 30% of the property’s value if they haven’t been sold after two years. This is a powerful incentive for banks to dump the inventory.” She estimates that roughly 175,000 properties are in banks’ hands, “not all of which have hit the market.”

Why the British housing market is a losing bet

So what’s the equivalent in Britain? Well, banks and building societies are still having difficulty lending. There’s still a large ‘funding gap’ hanging over them. The Bank of England is planning to withdraw its support for the banks gradually by the end of 2012. This means that next year alone, banks will have to find £190bn of support from somewhere else at a time when funding is hard to come by, and that’s on top of the £200bn of maturing bonds and residential home loan-backed securities that Nomura reckons will need funding. Meanwhile, the Financial Services Authority is cracking down on both self-certification home loans (also known as liars’ loans) and interest-only loans.

But perhaps more importantly, the housing market looks like a losing bet either way. Deflation is bad for asset prices, we know that. However, if inflation picks up strongly – normally good news for ‘real’ assets such as houses – then interest rates will have to rise. That’ll knock out the only prop keeping prices afloat right now.

If you are buying a property to live in, then of course it’s a far more personal decision. A whole other set of considerations come in, although at the very least you should make sure you could afford your monthly bills if interest rates were to shoot up rapidly. But as an investment, property looks a lot like the government bond market – very little upside and a great deal of downside if things go against it.

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  • Mark Parker

    The only problem with your one-way bet against housing is that the BoE and the MPC show every sign of being prepared to let inflation rise without raising the base rate to match, ie, they want to inflate away our national debt, both the private and private sector components.

    If that’s their plan then NOT owning an inflation proof asset such as a house would be a bad idea.

    It’s a dangerous strategy but inflation is generally popular with voters; which is the only real consideration.

  • DrGrumpy

    I totally agree with your conclusion about the little upside and high downside of the property and bond markets. Mark also has a point but I think he may be wrong because if inflation expectations rise the BOE will have to raise rates. Good article, keep them coming.

  • Peter

    Good article John.

    I got a financial newsletter this morning from a fairly well known analyst, which basically said that since the UK’s population was going up, house prices would not fall back to the traditional 3.5x earnings ratio.

    The trouble was that he was making exactly the mistake you highlight: overlooking the key importance of the supply of credit. It just doesn’t matter how many people might fancy a house if they can’t finance the purchase. Such people are NOT in the market and can’t influence it.

    The other problem with his analysis was that it did not explain why the price of the house I used to own went from £50,000 in 1998 to £150,000 in 2008. The missing factor, of course, was cheap and plentiful credit.

    Well it is neither cheap nor easily available now, and this means that there is indeed a big downside to house prices -without even considering the possibility of interest rate rises.

  • jonathan davis

    However, the Bank and the Govt do nopt really set rates. The global lenders do. If we let infloation rip, IRs will inevitably rise, inexorably.
    At the moment the govt are into cutting. Again house mkt will suffer.
    About bleedin’ time too.
    Housing not worth investing in, at all.

  • pwilliams

    House prices only 12% off their peak in spain? That looks like estate agent spiel. More like 30%, even around Marbella. Dont know where Ms Bravo is getting her stats from. Perhaps advertised prices have only fallen 12% but I dont know anyone who’s bought lately for less than 25% discount from peak and I’ve been there for 25 years. Spain cant keep an overpriced housing market propped up as easily as in England. There are many forced (holiday) home sales. When trouble hits, first to go is the yacht, then the sports car, then the holiday villa…only then does the family home in england have to be sold, so Spanish house prices deflate easier and correlate faster to economic conditions.

  • P-T worker

    I would agree with Mark Parker except for the fact that wages in decline set against rises in prices is a recipe for disaster in the medium term and this is what’s happening.

    Making the same monthly payments from a declining income would mean having to live a life of real poverty but at least everyone will be in the same boat!

  • Brian Williams

    I agree with Mark parker.

    I believe that with the amount of housing debt that the UK (Government) banks hold the BOE and MPC will not allow interest rates to rise sufficiently to fend off inflation. They simply cannot afford to allow house prices to find their true market level.

    Until recently I did think that house prices would fall significantly (say 20%). That also was my view on the stock market. But I now believe that neither house prices nor stocks will be allowed to find their true value simply because there are more debtors that vote than savers that vote. More money will be pumped into the system every time to avoid this happening.

    So my conclusion is that if you have saved cash with a view to buying a house, it may make sense to buy one (at the right price). But maybe a better option would be to buy assets that would increase more than houses in an inflationary world (when that happens). That would point to commodities and espcecially precious metals.

  • David

    I would love to buy a house, but just can’t get the finance and saving for a deposit is becoming impossible. It’s starting to get really depressing and I feel completely trapped by the system.

    How can anyone on a average income afford to buy a house?

  • Bob Roberts

    I am like you Brian – believed that house prices would crash and so would the stock markets.

    But now I am leaning more towards both being propped up by the Government and inflation eroding the mortgage debt hence that house prices will never fall substantially.

    I am a cash buyer and I am now more worried about my savings being eroded to nothing so buying a house in the coming months seems the way to go.

    The stock market is too risky and at least I will own a home which is what most of us want. Not investment in property but a home.

  • Neil

    Let us for a moment assume that keeping property prices high, thereby satisfying many many interested groups is a good thing and that more of this once great nation’s GDP than should be is tied up in financing this gargantuan debt.

    What will the mid to long term effect, or opportunity cost if you will, on the economy of this country be?

    Surely, and perhaps I am being far too naive here, surely the relatively short term pain of housing coming down 25%+ to more realistic levels that can generate real demand again is actually of far more benefit to Britain than keeping the electorate happy with notions of perceived increases in wealth??

  • Neil

    If the coalition had any integrity I feel they would make this a priority and say for the good of the nation, “we shall sacrifice a second term in office for longer term economic health”.

    Maybe, just maybe, we could have a return to politicians doing things for the long term good of the people??? And such a sacrifice would restore faith in our politicians and result in them winning the election again?!

    Maybe not!

  • Mat Jackson

    @David: There’s the true answer to this debate. Affordability.

    @Bob Roberts: If you ‘re worried about your cash being eroded to nothing, why would buying a house be the cure-all? that’s a huge assumption that housing is a one way bet…consider being stuck with interest repayments and declining house values in a market where there are few buyers if you want to see real cash erosion.

    @Brian: The MPC and BoE have limited weapons at their disposal and mostly they are fully deployed – what they will or will not ‘allow’ is irrelevant, the market WILL find the right level, and it may not be pretty, especially if credit is tightened even more which looks likely.

  • Mat Jackson

    Although personally a bear on UK house prices, a further issue to keep in mind is the sheer scale of the over build in Spain during the last decade.

    In 2007, 850,000 COASTAL homes alone were created in Spain, as opposed to 150,000 nationwide in the UK.

    I lived there for two years and saw entire towns ( Almerimar being a fine example) created simply on the back of speculators flipping. There is not a single apartment there now that is not for sale. And the 12% decline is simply not born out on the ground, it just reflects the average including hardy stalwarts such as Barcelona and Madrid where prices, as with most cities, weather the storm.

    If you could recoup €90,000 now for a property bought off plan at €175,000 in ’07 you would be doing very well to make the sale – not 12% from peak in my books…

  • John C

    This may be a “total Spain” picture but our family owns some quite good turf on the Costa del Sol, 1st hill back from Puerto Banus, nice gardens, secure underground car parking, great sea views, large sq.m apartment. All bar two or the apartments are the same size and layout. In 2007 prices were E495k to 525k asking. Three apartments were sold last year for “about” E300k, one is for sale at the moment ASKING E265k. This looks like a fall of over 45% and it’s not a final sale price, it seems reasonable to me that in less well located blocks and smaller flats prices will have fallen further. Of course lower prices are not necessarily a bad deal for selling Englshmen because of the exchange rate, if you need to move something on even a low local price may look OK when it gets home.

  • Brian Williams

    Mat Jackson:
    The BOE and MPC effectively control the amount of money in the UK Banking system.
    I believe that the only way the market will now find a new level is in a depreciated fiat currency. There is simply too much debt in the system and they have proved that they will not allow that debt to be written off. They have simply transferred it.
    I really wish and hope you are right, but I am not expecting natural justice to prevail here.

  • Jase

    I agree with the post about converting cash into commodities in preparation for inflation.
    If you can rent/downsize whatever, and catch a lift on the next bubble
    (Precious metals) then it might just save your skin when real inflation/ currency devaluation, comes down the pipe.
    Any industry who’s customers rely on credit for its continued functioning are in the tank. Housing and cars are the two biggest examples. If people cant get cheap money they cant have ever more luxurious houses and cars. We have become so reliant on these industries to prop up our economies that our governments will come up with any wrongheaded idea in the book to keep the bandwagon rolling. (cash for clunkers good for the environment!!!!)
    The more we refuse to take the medicine, the worse the illness becomes.

  • Adrian

    I can’t believe some people are celebrating rising house prices as a good thing. I mean no one celebrates the high price of bread or higher fuel costs. Yet in reality houses are just the same – a necessity for life.

    I guess the difference is, is that most people don’t own shares in Hovis bread, or Shell oil. Yet to most of us a high house price is only good when you finally die and no longer need to live in it any more. Other than that then it’s of no use to anyone and serves to just gum up the market for the rest of us.

    Surely lower house prices would also bring further benefits to the economy? Increased cash for FTB to spend. A much more boyant housing market with increased needs for furnishing, the trades, retail etc, etc. Reduced demands for wage inflation perhaps making us more competitive in the wider world perhaps? General feel good feeling maybe?

  • Clark

    Another excellent article John, I always enjoy reading your comments. I have to agree with you inasmuch as the supply of housing is completely irrelevant if potential buyers cannot obtain finance, they are simply not in the equation. This is likely to become even worse when the austerity measures erode peoples disposable incomes and unemployment rises.

    I feel, as do many, that property prices are rediculously overpriced in the United Kingdom and have been allowed to become so because of easy credit. The reason we have not seen a major fall yet is because would-be vendors are holding out through the rough weather rather than take a hit. But ultimately the buyers will be able to outlast the sellers and then an increased supply will bring downward pressure on prices again.

    I also agree with comments about Spain not really being that good a comparison, I don’t remember hordes of Spaniards rushing to buy holiday and retirement homes in sunny Skegness!

    Kind Regards.

  • Joe

    The governments are trying to unwind the “long” position on property which they have allowed to happen by lack of control over asset backed lending. What they seek is an orderly adjustment for which they require time and steady growth to reduce relative prices. The tightrope between deflation on the one side and inflation causing a fall in the value of the pound on the other is made more precarious by the state of the public finances.

    Put another way, the government are trying to retain some freedom to run the economy before financial markets begin to dictate their every short term move.

  • Bob

    OK, this may sound a numpty question but with property prices plunging in places like the US, Eire and Spain I am amazed that more mobile Brits are not simply emmigrating and beginning a new life in such places.

    OK, the US makes it incredibly hard for Brits to live in the US long-term and even to become US citizens but, within the EU, I do wonder why more of us are not yet saying farewell to over-priced British houses and over-priced UK?

  • ACM

    There’s no shortage of houses in the UK. As the economy tightens, food prices soar, houses get more and more expensive to heat and wages stay flat, houses will be split – either down the middle or top and bottom into flats and then sold off as two [or possibly more] properties. It makes sense and will give the builders some much needed work. The 1930 ex-council houses [alone] in our area have massive gardens front and back. They are too expensive for most young buyers, but split down the middle, with maybe kitchen extensions and you would get two modest, cosy homes, with sizeable gardens at a more affordable price. Having ‘space’ is a relatively new concept which does not suit our present and future economic predicament.

  • Roberto Birquet

    7. Brian Williams
    But I now believe that neither house prices nor stocks will be allowed to find their true value simply because there are more debtors that vote than savers that vote. More money will be pumped into the system every time to avoid this happening.
    I disagree. I believe the Conservatives always meant to tackle the deficit and other out-of-keel factors early in the Parliament. And that includes the inflated asset values. By dealing with it early, the Tories could: get the pain out of the way early, and not near a new election; and blame the last government for that early pain, while showing the “corner has been turned”. Such is the mess, it would be a far-sighted strategy, if it proves the party was less than frank about its intentions during the election campaign. Frankly it lied, but in the above context could be forgiven that by an electorate.
    The call on supply and demand being about credit is spot on.

  • LiveAndLetBuy

    House prices in Spain have also been propped up because much of the excess property that was built is simply not on the market. It is not for sale. Some of it might be advertised as if it were for sale, but the prices are too high for them to be realistically considered as “on the market”. There are flats owned by banks that have been sitting empty all over Madrid for years now, and the banks simply won’t drop the prices. How long they can keep the charade going is anybody’s guess – if interest rates remain low then maybe a few more years yet, but ghow many years does it take for a “new house” to become an “old house” regardless of whether anybody has lived in it?

  • Stephen B

    Re Bob – why more of us are not moving to Europe, jobs stands out as the main issue. Unless you set up a business, one that makes money, the job market is very hard to break into in countries like Italy, where family and personal connections rule. If you do land a job, the wages are typically inferior to south east of England, sometimes substantially so. Continental Europeans tend to live at home until they marry, and this is a way of life that is becoming more popular in the UK now.
    Saying this I think a move to Australia can lead to a better quality of life, and if you want to make big bucks, you can still earn a lot of cash fairly quickly in the Gulf.

  • Bertha Vanation

    t seems to me that our government(s) and the Spanish government will use every means at their disposal to prop up their respective inflated housing bubbles.

    To my mind, the reasons behind this perverse manipulation is principally to protect the banks who hold a lot of this toxic debt but also to prevent consumer confidence falling through the floor. Unfortunately a lot of UK psychology is linked to house prices (why?) more so than any other asset class.

    FTB and over-leveraged borrowers are way down the list of government priorities so don’t believe their weasel platitudes, it’s all BS.

  • aslan

    re comment 24

    It is difficult for Brits to move to Europe because so many of us lack the language skills – also gaining a job in another country in the middle of a recession is probably tough – many people are more comfortable in their own home country , however much they moan, it takes some guts to emigrate

    re comment 25 – Unfortunately a lot of UK psychology is linked to house prices (why?) more so than any other asset class.

    IMHO – because houses are the only socially acceptable way for Brits to show off how wealthy they are! – In Britain people are not comfortable talking about salaries, share portfolios or bank accounts – but a great big house in a posh neighbourhood shows that you have made it. Ditto with holiday homes, buy to lets etc.

  • Roberto Birquet

    Bob
    OK, this may sound a numpty question but with property prices plunging in places like the US, Eire and Spain I am amazed that more mobile Brits are not simply emigrating and beginning a new life in such places.
    —-
    People are not that mobile. Why? Language, loss of contact with friends/family, getting a job during what remains a recession/jobwise; all sorts of factors including natural fear and conservatism.
    Furthermore there is the British obsession with house prices. Many are in neg equity position so feel trapped into stayig put, others refuse to accept the market hs turned down and if they wait, and wait, and er wait, they’ll get a better price. All of which puts off a move.

  • Roberto Birquet

    ACM
    The 1930 ex-council houses [alone] in our area have massive gardens front and back. They are too expensive for most young buyers, but split down the middle, with maybe kitchen extensions and you would get two modest, cosy homes, with sizeable gardens at a more affordable price.
    ————
    Why wouldn’t prices of the whole flat just not fall?
    Credit – which is usually what fuels prices for 90% of purchases is scarce, and as you say there is a stragnant economy. Why would people large sums for a “cosy” place where there is no room for the kids. Or shall we just stop having families to please the house-price obsessive middle classes. What a great idea!

  • Lee Revell

    There are still properties out there that even with todays inflated buy to let rates, you can still get a very good return on your money.

    I have purchased four properties this year alone where I am getting between 13% and 26% return on my investment and thats at a 5.4% interest rate from the bank. OK you need a minimum 25% deposit but I’m still getting a massive return compared to saving or stocks and shares etc. Plus at the prices I’ve paid and the return I’m getting unless interest rates go up to 10% then it does not matter what property prices do.

    So in essence putting your money into property is not as bad as you might think, if you buy right and get good tenants you still can’t go wrong and as long as you take a long term view I belive you will be safe

  • LibertyView

    People who buy property because it could save their money (honestly more debt than cash) are fooled.
    If living costs will rise (like food price, energy, water bills, gasoline) that represent inflation better then house price (house price is not even in the inflation basket, house price does not equal rent!) could dramatically fall. Because inflation takes away your nett earned money and paying down mortgage loans will be harder and harder. And I forgot mention that interest rates with rising inflation will not stay low. Another (unexpected cost) sign of housing price falling.
    Do you still think house could protect your wealth?

  • Supermarine Blues

    Lee,

    Plus as repos increase, you’ll have an even bigger demand from tenants!

    A lot of people are obsessed with property prices because they DON’T own any and are trying to justify missing the boat.

    You can bet that all the really BIG property-owning estates will quietly start buying again, once they believe the bottom is in sight. Funnily enough, they’ve not been selling on the way down.

  • Duncan

    Adrian wrote “Yet to most of us a high house price is only good when you finally die and no longer need to live in it”

    Definitely not true. Have you never heard of Mortgage Equity withdrawl ? A large percentage of the population think that when
    their house goes up £30K they deserve a new car for being so clever. I knew one person who on the basis of having an expensive house and a couple of BTLs gave up work altogether, taking his income from the appreciation on his properties instead.

  • Gordan Finch

    Many of your readers are unaware that most high street banks are insolvent, and kept alive by the taxpayer.

    Banks have legal privilege and trade on your money,deposits, savings etc.

    THE Money You Deposit with any bank-Is no longer your money, it belongs to the bank. This is the legal position.

    If just 3 or 4 customers per hundred withdrew their— oops the Banks money—- your money etc the bank would fold.

  • arthur Buchner

    cost to replace =cost to buy thats when prices are fair,try building a new home for what you can buy a second hand one.You will be surprised ,especially when you add all the hassle of dealing with bad work manship

  • Marco

    Lee, Could you advise me on the type and location of the property that can command such excellent yields?. Also, how one should go about searching for such properties. Am I right in thinking that one has to sacrifice location for yield, that is to say, only properties in down-market locations obtain relatively higher yields due to their relative price in comparison to what could be asked for in rent? If this is the case, is it not likely that the capital value of properties with current relatively higher rental yields (but in worse locations), will not rise as much/will fall further than properties in better locations but with lower relative rental yields? Thanks!

  • AndrewC

    Our rich landowners in the UK are pitting one group in society against another, they are drip feeding the sale of land and manipulating house prices, in reality, land prices to their advantage.

    Landowners have very much to gain from high house prices, the majority of us do not, some think they are gaining but are unfortunately deluded, at the very best any gains will almost always be wiped out in the grand scheme of things.

    This is life in the UK with our still unreformed country full of rich landowners, a tiny 1% of famillies owning over 70% of the land in the UK. Our real economy would benefit enormously if money was diverted out of housing, think of the small business opportunities, think of the saving possiblities, the extra holidays and spending capacity we would all have. But no we have to pay our rich landlords one way or another.

  • Peter Kellow

    I don’t think anyone has made the obvious connection between interests rates and the bond market.

    If interest rates are kept low the government will not be able to service its debt on the bond market. This will become increasingly necessary if the austerity measures fail – which they will.

    Also the word JAPAN has not been mentioned. Propping up property with monetary measures was the Japan response to their late eighties recession. This cannot work in the UK because we are not savers like the Japanese.

    Ultimately there are two scenarios:

    1. House prices to fall and someone (owners or banks) will take the loss.

    2. The coalition is right and the cavalry will ride in and save the day in the form of the private sector and this will revive the economy.

    If you believe 2. then you have hope. If not there is none.

  • cpm121

    The major thing about the housing market is that of time. It takes a long time for effect of deflation or inflation to feed through to the rest of the economy and there are other factors involved too, such as the investment v imperative argument (some use it for investment and some for living in, and some for both!) It don’t think we can be too simplistic about the state of the market or where its going.

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