Sunny outlook

A record of strict controls on mortgage-backed financing and robust demand for new homes means it won’t be too long before Spanish real estate firms are making hay again

Sunny outlookThe economic downturn is affecting all economies. In Spain this has been evidenced by slowing economic growth, rising unemployment, interest rates, prices and a slowdown in car purchasing. Real estate has traditionally been an extremely leveraged business and the real estate sector is suffering everywhere – with Spain no exception.

People often think that sun-related real estate investments are going to suffer more. However, Denmark proves this wrong. It is the first EU economy officially into recession – primarily due to the real estate crash – but it is not a sunny place.

It is true, however, that the second-home sector is facing increasing default ratios. People will only default on home mortgages after having defaulted on second home mortgages. And Spain has seen huge demand for second homes from Europeans.

On the other hand, mortgage-backed financing routines have been stricter and more conservative in Spain than in many other places. Interest-only mortgages, which were quite popular in the US, are unknown in Spain. Even in boom times, load-to-value ratios (LTVs) for first residence mortgages were no higher than 80 per cent.

Spanish banks have systematically and massively securitised their home mortgage-backed portfolios, and this is probably the reason why they are still out performing their overseas peers. The Spanish financing system’s exposure to subprime mortgages has been negligible.

Although exposed to the real estate market, Spanish credit institutions have been strictly supervised by the Bank of Spain and obliged to maintain their own reserves on higher rates than in other European countries.

So far, Spanish companies have still been very active: they have been shopping around (eg the announced bid for Alliance & Leicester by Banco Santander), financing themselves by issuing sophisticated new instruments (the Mediterranean Savings Bank’s issuance of the so-called cuotas participativas), exploring cross-border mergers (such as that of BA-Iberia), and refinancing their debt (as Ferrovial did with BAA). The Spanish infrastructure, construction and energy giants continue to invest in the US, Latin America (emboldened by the weak US dollar), and in Eastern Europe.

The corporate financing activities of Spanish real estate companies is slightly different. Fuelled by surprisingly low interest rates and continuing price uplifts, Spanish real estate companies have aggressively used bank finance to grow.

Listed real estate companies have experienced some of the most remarkable tender offers in the past few years – including Martinsa’s take over of Fadesa, Reyal’s takeover of Urbis, and Colonial’s takeover of Riofisa. These acquisitions have been highly leveraged. Similar expansion has followed in the mid and low ends of the market. Consequently, banks have assumed huge exposure, even to small real estate companies buying land portfolios in Spain and abroad (Portugal, Poland, Romania and the UK). These acquisitions were financed with short to medium-term facilities – corporates were then confident that they would be easily renewed at maturity.

Now things have changed: banks do not have the liquidity to keep the facilities alive, interest rates are climbing and corporations are not selling enough properties to service the debt. Western economic growth has significantly relied on the real estate boom over the past 15 years. It is true that real estate has been slightly more important in Spain than in the UK, for instance, but Spanish non-real estate companies – in particular, those in banks, utilities, infrastructure and communications – have overperformed in the past decade. There is no reason to believe that a real estate crisis will damage other businesses.

Spain is facing a liquidity crisis, not an insolvency situation. Even if we accept that real estate companies have been overpaying 25 per cent or even 50 per cent, their assets are still well above their liabilities. They just need interim relief – interest holidays, maturity extensions, etc – to ‘cross the desert’ over three to four years.

The fundamentals are still good. Not even the most pessimistic analyst forecast shows demand for less than 200,000 new houses per annum – the consensus is in fact between 250,000 and 300,000. The existing stock is estimated at between 800,000 to 1,000,000 homes. Spain is therefore facing a convulsive three to four-year period. Then, even if interest rates are still high, the sector will recover power.

Economists elaborate on the impact of high interest rates in the real estate sector. Less than 15 years ago, Spain suffered 16 per cent to 19 per cent interest rate scenarios and there were still real estate deals. Buyers and sellers will have to get used to the new environment. Yields will of course change, and there will be reprises, but after the market adjustment the sun will again shine.

Fernando Azofra and Juan Carlos Machuca are partners at Uría Menéndez