Spanish property dream turns to nightmare

British holiday-home hunters once flocked to Spain for the hot weather and cheap property. But a house price peak and planning scandals mean buyers should be cautious.

British holiday-home hunters once flocked to Spain for the hot weather and cheap property. While the sun may still be shining, a ten-year property boom has seen the bargains vanish. Marbella is now the most expensive place to buy property on the Costa del Sol, with prices exceeding £2,000 per square metre. But now it looks like the party may be over. Spanish bank La Caixa reckons house prices have peaked, while a planning scandal in Marbella is forcing the government to crack down on corruption in the sector. "The result is an explosive cocktail that most investors would prefer to avoid," says Almudenda Nogues of Spanish newspaper Sur.

Property in Spain: is the expansion over?

The Spanish economy has thrived since Spain joined the EU in 1986. GDP growth has averaged more than 3% a year, compared to 2% in Germany, while GDP per head has jumped from 66% of the eurozone average to 92%. In recent years, a major driver of that growth has been the country's housing boom. The low interest rates brought by joining the euro made borrowing cheap for homebuyers and construction firms. A building spree ensued, and speculators piled into the market, driving double-digit annual growth in house prices for much of the decade.

Now, though, "everything appears to indicate that the long expansive cycle has hit a ceiling", says La Caixa. The construction boom has led to an excess of supply, with more than three million homes built in the last four years. Meanwhile, eurozone interest rates have risen sharply in the last year, squeezing overstretched borrowers. With further rises on the European Central Bank's agenda, the pressure is unlikely to ease anytime soon and the strain is showing.

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Estate agents say it takes three times as long to sell a house now compared to a few years ago, says Almudenda Nogues. Property pundits speak of "anguish sales"; fear is sweeping the coastline and "investors are selling below market value and looking towards other parts of the country", says Jose Antonio Perez, property professor at Spain's Business Practices Institute. UK property owners are not immune. "We have seen a 10% increase between 2005 and 2006 in the number of enquires from people selling their overseas property and moving back to the UK," says Denise Blackburn of foreign-exchange group Moneycorp.

Property in Spain: other reasons for homeowner anguish

But the sales slump isn't the only reason for anguish. A e250m planning fraud in Marbella could result in thousands of illegally built homes many owned by British investors being demolished. The scandal centred on Marbella city council's sale of building permits to developers for land that should have been set aside for green belt or agriculture. More than 30,000 homes were built illegally and local authorities are alleged to have pocketed a fortune in bribes. Seventy people, including the mayor, were arrested and the council dissolved in the fallout from the scandal. In total, £1.6bn worth of property was seized.

The trouble is, if you buy a house in Spain, you will almost certainly be asked to break the law. It is a well-established practice for buyers to declare a reduced purchasing price on their property and then to pay the local property dealer the difference in cash. Paying so-called "black money" so that the dealer can avoid taxes is part of the culture in Spain, says Expatica. But investors should be warned: the government has begun to take a dim view of such sales in the light of the recent publicity over corruption and has launched an anti-fraud campaign to combat black-money purchases.

Even if you manage to avoid the government's attention, there are other problems. If you can't convince the next buyer of your property to under-declare in the same way you did, then you will end up paying the capital gains tax of the previous owner. With non-residents in Spain liable for capital gains of 35%, you could pay a very heavy price for your dream home as some have already found. The British Consul in Malaga, Bruce McIntyre, recently revealed his office now spends much of its time trying to help old and lonely expatriots who can no longer cope. "Sometimes people have made bad property investments or have not budgeted their pensions and are living in extreme poverty." With the University of Barcelona warning that the price of the average home in Spain is set to fall 20% between 2007 and 2009, it seems more and more people could find their Spanish property dream turning into a nightmare.

Eoin came to Money Week in 2006 having graduated with a MLitt in economics from Trinity College, Dublin. He taught economic history for two years at Trinity, while researching a thesis on how herd behaviour destroys financial markets.

Eoin acts as managing editor of MoneyWeek's newsletters.