Residential property market in Spain: COORDINATES AND COURSE

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Residential property market in Spain: COORDINATES AND COURSE

  1. 1. Residential property market in Spain: COORDINATES AND COURSE Julio / July 2010 El mercado inmobiliario residencial en España: COORDENADAS Y RUMBO
  2. 2. Beagle Consulting © 23 Residential property market in Spain Is your company ready to face the change in the real estate cycle? This report is addressed to all property and companies owners and managers who are committed to remaining in the property sector in the medium and long term. In this paper we present an overview of the current property crisis, principally from the standpoint of the recovery being forecast for the Spanish housing market and also the actions and attitudes that managers and owners of property and related companies take advantage of the real opportunities that are evident today. Our assessments and conclusions are the result of objective and thorough analysis conducted by a group of highly specialised property consultants who have extensive professional experience in sector companies and in consultancy work and analysis for these firms. The analysis we are providing here focuses on the essential factors that explain the behaviour of the market. It provides an objective and professional vision that stands out among the vast amount of information (and misinformation) that proliferates in the market, while it also questions the majority of official and unofficial sources which for a variety of reasons are systematically misconstrued. Essentially we have two goals. Firstly, we seek to assist with the difficult task of distinguishing between serious and thorough analysis as a foresight exercise in order to keep ahead of the market on the one hand, and expectations based on intuition or simple projection of the present on the other. Secondly, we also hope to provide thought-starters for owners and managers in the sector and, just as importantly, encourage planned action as an essential tool for successfully addressing an immediate future that will be full of change. Ferran Gonzalez Feliubadaló Founding partner & CEO – Beagle Consulting fgonzalez@beagleconsulting.com
  3. 3. Foreword Markets behave cyclically, and the expectations of players in the sector, particularly those that make up supply and demand, have a strong impact on how they evolve. The property sector is no exception to this. However, one thing that does set it apart from many others is that its cycles are long and slow to mature, i.e. there is a long time lag between when decisions are made and results are produced. Hence actions that originate from mistaken expectations have a much greater impact than they do in more flexible sectors. Thus when in 2005 the sector was still experiencing strong artificial growth (leveraged inter alia by expectations which from a technical standpoint were barely if at all reasonable), there were only a few who foresaw the coming debacle and took decisions that just about no-one else agreed with. The general behaviour of the sector helped to worsen a profound crisis which only the minority who swam against the tide managed to escape. In general, expectations based more on desire and herd instinct than on objective analysis indicators landed both supply and demand in deep water. It is understandable that demand in the housing market, made up as it is mostly of private purchasers, does not rely on technical and objective analysis. In the case of supply, perhaps the explanation lies in the fact that it is heavily fragmented and consists largely of small enterprises in which strategic management is based for the most part on intuition and looking at what everyone else is doing. Contents Foreword 24 The market up to the presenT 26 Transactions 26 Stock 30 Prices 32 Market prospects up to 2012 35 Recommendations for PROPERTY AND COMPANIES OWNERS and managers 37 Final conclusions 41
  4. 4. Beagle Consulting © 25 Residential property market in Spain Expectations not only prolong market inertia when times are generally optimistic but also in market situations like the present one. It is easier to think about the future based on present reality projections than on a forecast that contradicts it (no matter how accurate the analysis that foretells the change may be). This is especially true when collective behaviour seems to justify what we are doing, even though this unfortunately ends up being cheerless and inadequate consolation. Just as there was unwarranted optimism at the end of the last period of growth, we believe that the current disproportionate pessimism does not tally with foreseeable market developments. We know that the market is cyclical and therefore the relevant questions are: When will it bottom out and reach a turning point that marks the start of recovery? What decisions do we need to make and when should we start making them? In this respect, another of the especially decisive factors in the property sector is that it behaves in a particular way depending on the location and product being observed. General analysis makes it possible to interpret the main currents which we will have to navigate, but detailed examination of areas and products of specific interest will still be required. At all events, the analysis presented in this paper points to an improvement both in general and also in specific areas and products which suggest a change for the better is in the offing, even though expectations continue to be pessimistic and especially so among those who have been hardest hit by the consequences of the recessionary period that is beginning to come to an end. The present is the turning point and some companies will be able to identify and exploit it. This will enable them to think ahead and be ready for the day when the recovery has become obvious to everyone else. In our view, the decisions and actions put in place over forthcoming months will have a decisive impact on medium and long-term success in a sector that is undergoing major change and in which the management practices that have been widespread in recent years will not guarantee positive outcomes, but rather the reverse. Alex Sixto Aira Founding partner & Report Technical Director Beagle Consulting asixto@beagleconsulting.com
  5. 5. 26 Beagle Consulting © Residential property market in Spain thE MARkEt Up tO thE pRESENt tRANSACtiONS The hardest hit indicator in the property sector has been transaction volume. It tends to go up and down before prices move in one direction or another. Even though the quality of real estate statistics is poor, they are nonetheless good enough to enable us to identify trends and examine how they change. Real estate transactions in Spain in the residential market experienced a 61% decline from their peak in the second quarter of 2006 to their low point recorded in the first quarter of 2009. Figure 1 shows that the year-on-year volume of market housing transactions declined sharply by 55% after 2006, when it reached its peak fi gure of 907.987. In the third quarter of 2009, transaction volume bottomed out and a turnaround began. A sustained recovery had become apparent by the second quarter of 2010. Figure 1 YEAR-ON-YEAR VOLUME OF TRANSACTIONS Source: Ministry of Housing * Second quarter is provisional 907.987 407.080 446.966 0 100.000 200.000 300.000 400.000 500.000 600.000 700.000 800.000 900.000 1.000.000 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 55% 2004 2005 2006 2007 2008 2009 2010 Transactions Quarters
  6. 6. Beagle Consulting © 27 Residential property market in Spain at 5.9%, little more than half the figure for the former period. “The decline in transaction volume has not been uniform and the island areas and the Mediterranean arc have been most affected, largely due to the importance of foreigners and non-residents in their demand.” Analysis of the type of buyer data that appear in Figure 3 shows that the decline in transactions carried out by Spanish nationals resident in Spain, foreigners residing in Spain and non-residents has been similar in all three cases and bottomed out in the first quarter of 2009. The decline in the number of transactions by foreign residents and non-residents has been proportionally much more pronounced: transactions by Spanish national residents have fallen by 55%, while the demand from foreign residents and non-residents has virtually disappeared. Comparison of the volume of transactions in Figure 2 shows that the fall in the volume of new housing transactions has been less marked than in the case of second-hand housing, although the latter has already begun to recover. “The recovery in second-hand housing transactions started in the second quarter of 2009 and it heralds an improvement in the new build market.” The largest number of second-hand housing transactions took place in the first quarter of 2006 while in new housing it occurred a year later (first quarter 2007). This gap is due to the fact that demand for second-hand housing is more sensitive to the market situation in the short term whereas new housing takes longer to react, mainly because of advance purchases and the greater reluctance of development companies to lower prices for new housing compared with sellers of second-hand housing. Transaction data also confirm the gap between new housing and second-hand housing when the trend changes. New housing transactions started to bounce back in the second quarter of 2010, while second- hand transactions had already picked up in the second quarter of 2009 with an accumulating growth of 35% Figure 2 YEAR-ON-YEAR VOLUME OF TRANSACTIONS Source: Ministry of Housing. * Second quarter is provisional 0 100.000 200.000 300.000 400.000 500.000 600.000 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 2004 2005 2006 2007 2008 2009 2010 Transactions Quarters New housing Second-hand housing 380.510 193.829 559.275 187.311 253.137 Historically the percentage of transactions carried out by foreigners in Spain has been high. According to the Ministry of Housing, foreigners accounted for 11.7% of transactions recorded in Spain in the first quarter of 2007, while in the second quarter of 2010 they stood Figure 3 RELATIVE WEIGHT OF TRANSACTIONS BY TYPE* Source: Ministry of Housing. *Does not include the buyer type "other" which accounted for 4.4% in second quarter 2010. Second quarter 2010 is provisional. 75% 80% 85% 90% 95% 100% Non-residents in Spain Foreign residents Spanish residents Transactions Quarters1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 2006 2007 2008 2009 2010 %
  7. 7. 28 Beagle Consulting © Residential property market in Spain Transactions by foreign residents and non-residents have an important relative weight in the autonomous communities along the Mediterranean arc and on the islands. Areas which have historically had more acquisitions by foreign residents and non-residents have been most affected (Map 1). As shown in Table 1, transaction volumes vary significantly between the autonomous communities concerned. Each of them had a peak quarter between 2005 and 2007 and then started to decline from that pinnacle to a low point quarter which in most cases came in 2009. It can be seen how the communities which had not picked up in the first quarter of 2010 have in fact done so in the second quarter of the year, with the exception of Murcia which has yet to reach its lowest point. It is important to examine how many quarters year-on-year transactions have fallen for in each autonomous community and whether they have begun to grow again or not. There are significant differences in where autonomous communities are in the cycle with respect to market housing transactions, although most of them have already begun to pick up. The Basque Country stands out in this respect, as it was the last community to begin to experience a decline in the number of transactions and the first in which they increased again, eight quarters after the peak. The Community of Madrid reached its year-on-year peak relatively early in the second quarter of 2006, but also began to recover its transactions level relatively quickly after twelve quarters. By comparison, Catalonia and Aragon experienced a decline in transactions a quarter earlier and begin to pick up a quarter later than the Community of Madrid, which means they have taken an additional six months to kick off their recovery. There are some areas where recovery has been delayed and which did not turn around until the first quarter of 2010. They include the Canary Islands, La Rioja, Castilla-La Mancha, Extremadura and Andalusia. Murcia has not yet reached its low point and has been declining for fourteen quarters from its peak recorded in the fourth quarter of 2006. The Spanish average stands at eleven quarters of decline from peak, starting in the fourth quarter of 2006 and with aggregate recovery beginning in the third quarter of 2009. 1%1% 1% 1% 1% 7% 10% 18% 2% 13% 2% 7% 18% 2% 2% 1% 4% +15% Map 1 PERCENTAGE OF TRANSACTIONS IN EACH AUTONOMOUS COMMUNITY BY FOREIGN RESIDENTS AND NON-RESIDENTS (SECOND QUARTER 2010)* Source: Ministry of Housing. * Second quarter 2010 data are provisional and do not include transactions in Ceuta and Melilla. 10 -15% 5 - 10% 0 - 5%
  8. 8. Beagle Consulting © 29 Residential property market in Spain There are major differences in the fall in housing transactions between autonomous communities, with the Community of Madrid, the Mediterranean arc and the island regions being most affected. The evolution of transactions in the autonomous communities from peaks to lows (Map 2) compared with the difference between the peaks and the second quarter of 2010 (Map 3) shows a much more positive outlook, with recovery rates of up to 15 points in the case of the Basque Country and Madrid, and up to 7 points in Catalonia, Asturias, Castilla y León, Galicia, Aragon and Navarra. +60% 55 - 59% 50-49% 0-50% +60% 55 - 59% 50-49% 0-50% Map 2 DECREASE BETWEEN PEAK AND LOW POINT QUARTER Map 3 DECREASE BETWEEN PEAK QUARTER AND Q2 2010 Maps 2 and 3 CHANGE IN MARKET HOUSING TRANSACTIONS BY AUTONOMOUS COMMUNITY ∇38% ∇52% ∇52% ∇52% ∇38% ∇52% ∇52% ∇52% ∇60% ∇55% ∇70% ∇66% ∇46% ∇59% ∇40% ∇61% ∇61% ∇32% ∇45% ∇47% ∇45% ∇38% ∇50% ∇52% ∇49% ∇57% ∇49% ∇63% ∇61% ∇45% ∇57% ∇25% ∇48% ∇62% * Note: year-on-year value of market housing transactions between 2004 and second quarter 2010. Quarter in which transactions peaked 2005 2006 2007 Quarters 4 1 2 3 4 1 2 Quarterinwhich transactions reached lowestpoint 2009 2 C.Madrid (12) Basque Country (8) Basque Country (8) 3 Aragon (14) Catalonia (14) Aragon (14) Catalonia (14) Galicia (13) Asturias(11) SPAIN (11) Balearic Islands (10) Castilla y León (10) Balearic Islands (10) Castilla y León (10) 4 Cantabria (16) C.Valenciana (14) Navarra (13) Todavía no han repuntado (Mínimo en Primer Trimestre 2010) Murcia (13) La Rioja (13) Castilla La Mancha (12) Extremadura (12) Andalusia (11) Quarter in which transactions peaked 2005 2006 2007 Trimestres 4 1 2 3 4 1 2 2009 2 C.Madrid (12) 3 Galicia (13) Asturias(11) SPAIN (11) 4 Cantabria (16) C.Valencia (14) Navarra (13) 2010 1 Canary Islands (14) Canary Islands (14) La Rioja (13) Castilla La Mancha (12) Extremadura (12) Andalusia (11) Murcia (14) * Note: year-on-year value of market housing transactions between 2004 and second quarter 2010. Quarterinwhich transactions reached lowestpoint Have not yet picked up (lowest point in Q2 2010) Table 1 AUTONOMOUS COMMUNITIES BY NUMBER OF QUARTERS ELAPSED BETWEEN PEAK AND LOWEST POINT*
  9. 9. 30 Beagle Consulting © Residential property market in Spain Table 2 contains a cross-cutting analysis of the time that has elapsed between maximum and minimum transaction volume, and the percentage decline in transactions between peak and low point by autonomous community. Looking at these two axes shows there is a group of autonomous communities in which the number of transactions has already started to pick up. Some, like the Balearic Islands, have suffered a higher percentage decrease in transactions, whereas in the case of the Basque Country it has been smaller. The length in quarters of the decline in transactions is greater in Catalonia than in Castilla y León. Some autonomous communities have just reached their transaction low point and are close to recovery, with a rise forecast for the immediate future. They include the Canary Islands, Navarra, the Community of Valencia and La Rioja. In Murcia the adjustment in transaction volume has not been so pronounced and the region still has some way to go before it can begin its recovery. 16 quarters8 quarters Number of quarters between peak and low point Declineintransactionsbetweenpeakandlowpointquarters 12 quarters Basque Country Galicia Navarra Cantabria Murcia Its transactions have not yet picked up Their transactions picked up between the fourth quarter of 2009 and the first quarter of 2010 Their transactions picked up between the second quarter of 2009 and the third quarter of 2010 Castilla La Mancha Andalusia Asturias SPAIN Balearic Islands Catalonia La Rioja Aragon Canary Islands C. Valencia 70% 55% 35% Castilla y León Extremadura C. Madrid Table 2 StOCk If there is one thing that very clearly reflects what happened in the Spanish property boom, it is the country’s housing stock. The stock of new housing available for sale accumulated between 2004 and 2009 in Spain comes to nearly one million units. Figure 4 shows the volume of housing units started per year. In the period from 1991 to 1997 on average 229,418 were started each year, while between 1998 and 2006 the upward trend gathered pace to reach an annual average of 499,046 market housing units started. The volume of housing starts peaked in 2006 at 664,923, which is a higher figure than the total housing units started in the same period in Britain, France and Germany combined. The cumulative increase between 1991 and 2006 was 313%. “In 2006 the volume of housing starts in Spain was 313% greater than in 1991.” Nonetheless, there has been a dramatic change in the volume of housing starts during the last three years, which will certainly help towards a gradual reduction in this significant oversupply. In 2007 there was a turnaround in the trend and the number of market housing starts was reduced by 20% compared with the previous year. Since then there has been a cumulative decrease of 88%, meaning that this index has now fallen to below half the number of market housing units started in 1991. 664.923 80.230 0 100.000 200.000 300.000 400.000 500.000 600.000 700.000 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 50,6 % Annual change(1) 9,9% Annual change(1) 312,8% 87,9% Free housing started Years Source: Ministry of Housing. (1) Compound annual growth rate (CAGR) Figure 4 VOLUME OF HOUSING UNITS STARTED PER YEAR
  10. 10. Beagle Consulting © 31 Residential property market in Spain reduce this stock in a significantly sustainable way. There are no figures for transactions prior to 2004, although the quantity of stock created is estimated to be significantly below stock for the period 2004-2009. For this reason, the absolute data presented here should be seen as approximate, although valid in terms of the trend they depict. The figure for accumulated stock in 2009 of about one million dwellings has been calculated based on the volume of building permits issued, although during a recession not all permits lead to the actual construction of housing units so this is an upward estimate. Examination of quarterly data (Figure 6) shows that between the fourth quarter of 2008 and the first quarter of 2010 the number of transactions fell by 39%, while the decline in market housing starts came to 56%. Figure 6 Source: Ministry of Housing VOLUME OF TRANSACTIONS AND MARKET HOUSING STARTS BY QUARTER Transactions Housing starts 63.358 49.806 54.227 46.250 51.443 38.83740.368 22.828 20.650 16.674 20.078 17.876 4Q 2008 1Q 2009 2Q 2009 3Q 2009 4Q 2009 1Q 2010 Quarters Therefore the gap between housing starts and transactions is diminishing, in spite of a decrease in the number of transactions, due to the strong decline in the number of housing starts. We estimate that the housing stock will be fully absorbed in about five years, with forecast annual transaction levels higher than in 2009 but lower than in previous years. Consequently real estate production has dramatically adjusted down to levels lower than twenty years ago. “As a result of accumulated oversupply, the annual number of housing starts has fallen around 90% over the last three years and in 2009 was less than half the figure for 1991.” Looking at the monthly data in detail, the decline in the number of housing starts becomes especially evident from October 2008 onwards. During the first quarter of 2010 17,876 dwellings were started, which is a 56% fall over the fourth quarter of 2008. The reduction in the number of housing starts over the last 12 months is mainly due to the credit crunch, high land prices and shrinking demand. Although the number of housing starts is being severely cut, we believe that the stock of new housing for sale that accumulated between 2004 and 2009 comes to 963,629 units (Figure 5), having fallen by almost 200,000 units since its peak in . Source: Ministry of Housing. * New market housing transactions. There are no figures for transactions prior to 2004, although the quantity of stock created is estimated to be significantly below stock for the period 2004-2009. Figure 5 VOLUME OF TRANSACTIONS*, MARKET HOUSING STARTS AND ADDITIONAL CUMULATIVE STOCK PER YEAR 267.540 306.060 377.156 364.506 291.478 201.726 621.257 635.608 664.923 532.117 237.960 80.230 353.717 683.265 971.032 1.158.643 1.085.125 963.629 0 200.000 400.000 600.000 800.000 1.000.000 1.200.000 1.400.000 0 100.000 200.000 300.000 400.000 500.000 600.000 700.000 2004 2005 2006 2007 2008 2009 Transactions Housing starts Cumulative stock Years Between 2004 and 2007 new market housing transactions were far below the number of market housing starts, and as a result a stock of 1,158,643 dwellings was built up. In 2008 and 2009 this accumulated stock was reduced by 17%, mainly due to the sharp fall in market housing starts that was sufficiently greater than the fall in transactions to
  11. 11. 32 Beagle Consulting © Residential property market in Spain The possible scenarios evaluated are shown below in Table 3: Based on the analysis of the scenarios, the highlighted ones are viewed as being more probable, with a forecast of an approximate national average of 4.7 years in them to absorb the additional national stock accumulated since 2004. At any event, this is not the time period that should be used as a reference for beginning property development operations as the key factor is the time taken by development from start to marketing, which is on average between one and two years. Moreover, this is an average figure for Spain as a whole and is unlikely to reflect the particular situation in each specific area or location. This is because there are housing areas and types in which the stock is being absorbed quickly, while by contrast in others it is unlikely to be absorbed in the short to medium term. In general, there is an excess supply in coastal areas and non-metropolitan areas that is far greater than that to be found in big cities like Madrid or Barcelona. Consequently it is expected that absorption in areas with a lower level of excess supply will take considerably less than 5 years. pRiCES One of the most important indicators for getting a complete picture of the real estate market situation in Spain is the level of housing prices (Figure 7). In our view, the majority of available official and unofficial sources need to be reinterpreted, if not corrected, in order to come to accurate conclusions. There are several factors that significantly affect the content of the various sources. Firstly, the price indicators in the various sources do not take into account the changes resulting from the time that has elapsed up to the moment of sale, for instance price changes since valuation. Secondly, as a general rule valuations, especially those for assets owned by banks, do not include all of the Forecast of average transactions per year* Pessimistic scenario Base scenario Optimistic scenario 200.000 Forecast of housing starts per year* Low base scenario Base scenario High scenario 80.000 120.000 160.000 275.000 350.000 Current stock of new market housing (2004-2009): 963,000 dwellings Most likely scenarios *Assuming that from 2009 numbers are stable year after year. 8,0 12,0 24,1 4,9 6,2 8,4 3,6 4,2 5,1 4,7 Table 3 NUMBER OF YEARS IT WILL TAKE TO ABSORB THE STOCK OF NEW MARKET HOUSING ACCUMULATED FROM 2004 TO 2009 (POSSIBLE SCENARIOS) Figure 7 CHANGE IN HOUSING PRICES IN SPAIN 2.320 Peak: 2.702 2.374 2.077 Peak: 2.101 1.849 1.700 1.900 2.100 2.300 2.500 2.700 2.900 3.100 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q Peak: 2.943 Peak: 2.905 Peak: 2.521 2.537 Price / m2 2006 20102007 2008 2009 Quarters Sociedad de tasación Idealista Fotocasa Facilísimo Ministry of Housing
  12. 12. Beagle Consulting © 33 Residential property market in Spain fall in prices because of the negative impact this would have on their balance sheets. Furthermore, the statistics of online real estate portals only include the starting price and ignore the whole process of further bargaining between seller and buyer, which at present may lead to a significant discount. Real estate portal statistics are therefore a good indicator of prices in times when demand is strong and there is little or no bargaining, but at times like the present, the final sale price may differ significantly from the price originally asked for. The fact that part of the price agreed in certain transactions is not reported officially reduces their register value and can also distort results, meaning that official statistics may give an average price that is less than the real one. As to the figures released by the Ministry of Housing, there are widespread doubts about them due to fears that they are “cooked” to produce implausible results, for instance that prices have only fallen by 12% from their peak to the second quarter of 2010. Finally, analyses of large geographic areas that look at aggregate data come to conclusions that are based on averages that are not representative for most of the areas sampled, except for those in which the local indicator coincides with the national one. As shown in Table 4, because of all these factors there is a high degree of divergence between published estimates of price trends, with differences of up to 45 points. Nonetheless, based on market research conducted by Beagle for sector clients we can state that the real fall in prices has been between 25% and 35% in general, and we believe that there is still room for a further fall of between 5% and 10% for certain types of products in certain areas. FORECAST FALL IN HOUSING PRICES IN REAL TERMS (ESTIMATES MADE IN 2010) Table 4 -60% Standard & Poor’s: "Although there are signs that the decline in market housing in Spain is coming to a close, prices could still fall another 12% from the second half of 2010 before stabilising." (June 2010) ESADE: "Housing prices will fall an average of 20% over the next two years, which will be in addition to the adjustment that has already taken place of between 10% and 15%." (January 2010) BBVA: “Prices must fall 30% from their peak to absorb unsold stock, i.e. two thirds more than up to now (10%)". (December 2009) Aguirre Newman: "Houses are currently overvalued by 30%". (December 2009) Eduardo Rodríguez-Losada (INMOAdjudica): “The future increase in the supply of properties from banks will generate discounts of up to 35% over the course of 2010." (November 2009) The Economist: "Prices remain overvalued by 55% in Spain." (January 2010) 0% -12% -15% -20% -30% -35% -55% It is by no means unusual to come across published interpretations of statistical data that come to mistaken conclusions about changes in prices. An example of misinterpretation can often be found in a combination of two factors. Firstly, in any type of real estate product there are disparate average prices per square metre in different regions or areas; it is obvious that, for instance, the average price per square metre for a dwelling in Madrid is much higher than for a comparable dwelling in, say, Badajoz. Secondly, the beginning of the recession and growth stages in the real estate cycle does not take place at the same time in the various regions; thus as can be seen in Table 1 in this paper, the Community of Madrid began its recovery in transactions nine months before the Community of Extremadura did. This means that the relative weights of the products sold in each area vary in the global average. The example in Table 5 shows that the average price per square metre sold has risen by 8.5% (from €3,500/m2 to €3,800/m2) in the time period covered, yet the unit prices per square metre at which the homes have been sold have not changed (€1,000/m2 in the case of Region 1 and €4,000/m2 in Region 2). In other words, in our example the change in the average relative weight of the products sold in the different regions leads to a change in the average price per square metre, yet in fact sale prices, that is to say
  13. 13. 34 Beagle Consulting © Residential property market in Spain the ones at which the transactions included in the calculation are made, have not changed. This effect is also to be found on a smaller scale even between neighbourhoods in the same town or city. Table 5 ILLUSTRATIVE CALCULATION OF THE CHANGE IN AVERAGE PRICES REGION 1 2 homes: 1.000 €/m2 REGION 2 10 homes: 4.000 €/m2 REGION 1 1 home: 1.000 €/m2 REGION 2 14 homes: 4.000 €/m2 Although prices in each of the autonomous communities have not changed, an incorrect interpretation of the data leads to a wrong conclusion, namely that prices have increased by 8.5%. First quarter sales (true) Average first quarter transaction price: 3.500 €/m2 Second quarter sales (true) Conclusion (false) Average second quarter transaction price: 3.800 €/m2 “Every type of real estate product calls for a different and suitably restricted local level of zoom which is essential for careful price analysis.” In Spain there is an ingrained predilection for buying rather than renting housing. This cultural factor essentially explains the difference between the curves for change in purchase prices and their financial equivalent in rent (discounted present value of an income for 25 years equivalent to the rental price). Ceteris paribus, from a strictly financial point of view this discrepancy would not make sense. The approach of the two curves seen in Figure 8 in 2008 reflects an anomalous and transitional situation that will soon be corrected by the market. This correction can only come about through better performance by purchase prices compared to rent. Market pressure will push sale prices upwards, while rent prices are unlikely to continue to decline or they will do so only moderately. We do not anticipate a significant deterioration in rental prices as they were less overvalued during the inflationary period than purchase prices, and indeed they have already undergone equivalent adjustment. Furthermore, during this recession period we have seen that the volume of rental transactions has continued to remain strong, which shows that there is sustained demand that can absorb the supply (significantly increased due to housing units formerly for sale now being let). As sales transactions increase, the supply which previously shifted over to letting will naturally and efficiently go back to the selling market, further reducing pressure on the supply of rental accommodation and strengthening resistance to falls in rental prices. Source: Idealista.com * The net discount rate is 4%, equivalent to renting a flat for 25 years. Figure 8 EXAMPLE OF THE CHANGE IN AVERAGE PURCHASE PRICE AND COST OF RENTING IN BARCELONA Price / m2 3.500 3.700 3.900 4.100 4.300 4.500 4.700 4.900 5.100 ENE '06 ENE '07 ENE '08 ENE '09 ENE '10 JUN'10 €/m2 (PURCHASE) €/m2 x 12 months x 25 years (RENT)* Years
  14. 14. Beagle Consulting © 35 Residential property market in Spain The property market cycle is similar to the business cycle in the sense that both feature periods of crisis and expansion together with neutral stages. All three of them can be seen by looking at the change in the level of prices in the property market over the last 25 years (Figure 9). Examination of the property cycle up to the present would suggest that we are beginning to enter a period of stabilisation with an upward trend in which opportunities will start to appear in the sector. “The property market reacts in transactions before it does in prices.The recent surge in transactions in most areas is a sign of incipient market recovery.” MARkEt pROSpECtS Up tO 2012 The association between the business cycle and the property cycle would give added impetus to the idea of recovery as the economic growth forecasts for Spain in 2011 from the IMF (+0.6%) and the OECD (+0.9%) are positive. Furthermore, growth forecasts for European Union countries which have historically generated a significant part of demand, and which has been one of the hardest hit segments in the Mediterranean arc and the islands, are higher than those for Spain. Figure 10 shows the different stages in the real estate cycle with respect to sales volume. Each point in the cycle has a specific level of four variables: market demand absorption capacity, developer margins, future demand absorption expectations and expectations about increases in margins. Figure 9 PERCENTAGE CHANGE IN THE REAL PRICE OF MARKET HOUSING IN SPAIN(1) -15 -10 -5 0 5 10 15 20 25 30 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (1) Source: Sociedad de Tasación Current crisis Growth Crisis (91-96) 2011? End of cycle? Price (% change) Years 16,9 24,1 20,3 16,9 2,9 -5,4 -6,3 -5 -0,3 -0,5 -1,9 1,4 3,7 5,8 8,2 8,1 9 14,2 14,7 6,4 7,1 1 -9,5 -5
  15. 15. 36 Beagle Consulting © Residential property market in Spain In the valley of the curve, expectations about demand absorption and increasing margins are positive, while demand absorption capacity and developer margins are not encouraging. At the following point expectations remain positive and the situation begins to improve with an increase in the stock absorption capacity of demand, albeit with no improvement in developer margins. All four variables are positive from the next point on until the following point is reached when the demand absorption expectation variable is reduced. From point 5 onwards the variables perform in the opposite way to what they did at point 1 until the cycle starts again. The current market situation is between points 8 and 1’. This point on the curve is the turning point where it is especially important to take appropriate decisions to seize the opportunities that are to be expected in the short to medium term. Figure 10 Absorption capacity (demand >supply) Developer margin Demand absorption expectation Increasing margin expectation (1) Illustrative about new market housing. 1 2 3 4 5 6 7 8 1’ Time Sales volume (1) 1999-2006 2008-2010 2011-?2007 The absorption capacity of current demand is in the early stages of recovery, especially in second-hand housing and urban areas. There has been an increase in demand for rented properties. In 2011 there will be improved access to credit because economic pressures will no longer be as strong and demand for use will be stimulated by low interest rates. This will make it possible to increase mortgage lending in 2012 owing to economic recovery and net job creation. We believe that interest rates will not rise significantly in the medium term given the macroeconomic situation in the European Union. As for developer margins, this year some developers will be buying land opportunistically while trying to keep very competitive prices. The banks will continue to prioritise the sale of their stock by offering better mortgage conditions for their own supply with smaller margins. In 2011 buyers will be more realistic about prices, and these transaction prices will be adjusted more to the price demanded, while areas with less stock will provide opportunities for selective development and land purchase. In 2012 margins will still be moderate, although a turnaround in price levels will begin in areas where prices still need to fall by cutting margins. “Gloomy expectations and inertia, which up to the present have been seen across the board, do not tally with our forecast analysis of market developments.” The expectations for demand absorption in 2010 are characterised by a deep-seated pessimism, especially in areas most exposed to foreign demand and second homes, although they should focus on proactivity with a view to the growth period that is approaching. In 2011 there will be signs of recovery which will foster optimism, and this in turn will lead to the selective start-up of new property developments. There will be some areas in Spain where net job creation will begin, and this will generate positive absorption expectations. In 2012, the expectation of economic recovery will make the increase in real estate activity more widespread. With something of a lag, expectations for increasing margins in 2010 are creating a demand for opportunistic investment while interest rates stay low, but the difficulties in obtaining financing still remain. In 2011, international investors will once again take an interest in the Spanish market due to favourable price expectations in Europe, against a backdrop of prices that will still be low in Spain. In 2012 there will be an expectation of prices rising in line with the rest of Europe, albeit at moderate rates, and the beginning of the growth cycle equivalent to point 2 will be consolidated.
  16. 16. Beagle Consulting © 37 Residential property market in Spain RECOMMENDATIONS FOR PROPERTY AND COMPANIES OWNERS AND MANAGERS Falling sales and prices, the credit squeeze and declining business investment, the drop in consumer spending brought about by the credit crunch and redundancies and cuts in expenditure of all kinds have been a regular feature of the Spanish economy since the first signs of recession became apparent. Ever since the first impact of the crisis was felt, the economy has been adjusting and this has led to a reworking of the current competitive map which will continue until the end of 2010. The disappearance of some competitors and the merging of others together with restructurings or integration in both directions in the real estate value chain are just some examples of the consequences, some more visible than others, for the property sector. Moreover, although the market is cyclical and is starting to show signs of stability and recovery, there is still a gap between reality and expectations which are usually built, more or less unconsciously, by projecting current reality into the future. Reality Expectations Time Just as the herd behaviour of supply and demand and the marked optimism of earlier expansive phases of the cycle clouded views of the obvious risk, today undue pessimism means that expectations are overly cautious or gloomy in a way that does not tally with the actual market situation. In fact, the cyclical nature of the property market and recent data suggest that recovery is beginning, even though the inertia of entrenched glumness among industry players may in itself be a factor that slows the rate of recovery. In the current business situation opportunities in specific products and locations are starting to emerge which can be used to anticipate the next phase in the upward cycle which is drawing near. Given the slow maturation of real estate product, doing this will involve taking some decisions early on and assuming a certain degree of controlled and duly evaluated risk. There are a number of external factors over which we have no influence but which we need to be aware of and analyse objectively. These factors, for instance changes in economic circumstances or in the competitive environment in the sector, variation in supply and demand or the evolution of stocks, have an exogenous yet nonetheless extremely relevant effect on us. Disregarding their probable development is a mistake that usually turns out to be an expensive one. By contrast, keeping one step ahead of them can be a source of opportunity and competitive advantage. In addition to external factors, company owners and managers also have available a number of management
  17. 17. 38 Beagle Consulting © Residential property market in Spain levers which they can, and indeed should, use to secure success for their enterprises. In current circumstances, the most significant management levers which combine indispensable short and medium-term approaches are strategy, corporate governance and operations. In this final section of the paper we present a series of recommendations for each of these three areas of management. STRATEGY OPERATIONSCORPORATE GOVERNANCE EXTERNAL FACTORS EXTERNAL FACTORS StRAtEGY Strategy is the functional area and internal factor which owners and managers need to think about in order to make decisions that have a major impact and also generate results in the medium and long term. This ability to weigh up and anticipate market trends is especially important in sectors like real estate where the time lag between making decisions and their consequences becoming apparent is long, because the nature of the business and the volume of resources committed mean that “changing course” is a slow and in most cases very painful process. Whatever our assessment may be as to how the sector will evolve over the coming years, it is imperative to have one that is both specific and as objective as possible. This is not so much because of how we can influence this evolution (unless we have a clear leadership position in the industry it will be very difficult for us to have a significant impact on it), but rather because we need to act in a way that is consistent with its probable course and anticipate it to the extent that this possible. In all probability we will not be able to influence the market sufficiently, but undoubtedly we can, for example, choose which market we want to operate in over the next few years or ask ourselves: Which locations will have the best market conditions? In which businesses should we have a presence (generating buildable land, development, marketing, operation, etc.)? Should we concentrate our efforts or diversify? What degree of vertical integration should we seek in the value chain? What products should we focus our resources on (first homes, holiday homes, state-subsidised housing, new builds, refurbishment, tertiary sector, etc.)? Which market segment should we address (domestic, foreigners, investors, purchase for use, etc.)? Appropriate strategic thinking should take into account numerous external factors and how they will change but also the particular features of the company and its access to resources. For instance, given the current squeeze on bank credit and the likely evolution of macroeconomic variables such as inflation and interest rates, what is the degree of leverage with which it is possible and advisable to carry out real estate developments? What will be the role of the financial sector and what are its implications for financing real estate projects? What will our competitors do in this respect? How can we turn what is at first sight a threat into an opportunity? How is the sector going to be reshaped? Who will our direct competitors be and what will they do? How can we differentiate ourselves? What is the best size for our business project? What is the critical mass and where can we find the synergies we need? Where are the financial resources and the knowledge we require? Who are the strategic partners we need in this new business ecosystem that is taking shape? There is a whole compendium of strategic uncertainties that must be cleared up in order to set business goals. Given the relevance of this subject for management and its long-term impact, it is essential that the owners of the company lead the strategic thinking process and build the highest concentration of specific knowledge, intelligence and common sense into it. It is also highly advisable to have an external
  18. 18. Beagle Consulting © 39 Residential property market in Spain and objective view as well as experience in this type of thinking brought by the necessary process and methods. Carrying out the actions necessary to turn strategic expectations into results requires turning goals into action. This calls for an appropriate system of corporate and executive operational governance. Corporate governance First-rate strategy is essential for long-term success, but it is useless if it is not executed effectively. Corporate and operational governance is a key management lever not only for taking the right decisions but also for implementing them through the organisational pyramid, minimising opposing forces and energy loss throughout the entire process. The formal and explicit component of governance in a company is made up of its decision-making bodies, policies and procedures, tools for setting goals and performance evaluation, internal communication mechanisms, etc.; in short, the organisation’s operational system from its highest organisational level, which includes its board of directors and related bodies, to the various units and mechanisms for making decisions and conveying them across the organisation. Issues such as what the goals of these bodies are and their composition and operation are crucial to their proper performance. Yet just as important for governance are less visible factors linked to human dynamics, organisational culture, attitudes, motivation and leadership. Hence just as both wind and invisible currents are important for any boat, both formal components such as leadership style and other informal aspects are important for any business. All of them need to be adapted to the situation. You do not steer a ship which has a tailwind in a calm sea in the same way as you would in the middle of a storm. Likewise you would not handle a small yacht as you would a large transatlantic liner regardless of the weather. Strategy Operations Governance structure Procedures Human dynamics Organizational culture Attitudes and motivations Leadership Human dynamics Organizational culture Attitudes and motivations Leadership Strategy Operations Governance structure Procedures Apart from the formal aspects of governance, which must be commensurate with size and the organisational model (which in turn must be built in keeping with the business project), there is a generalised need at present for a change in mindset and attitude which should start at the top of organisations. Organisations are receptive to informal aspects which have a strong impact on the motivation, commitment and attitudes of personnel. This receptiveness is all the greater when the influence comes from the top down, which means the change has to start at the apex of the pyramid that legitimises the power structure governing the organisation. Operations Guided by appropriate governance, efficient and aligned with strategic objectives as well as with the economic situation and the specific features of the organisation, operations are the basic instrument for the implementation of strategic decisions and the achievement of short and medium-term goals.
  19. 19. 40 Beagle Consulting © Residential property market in Spain In the crisis we have just experienced business efforts have focused on streamlining costs, although in many cases this has been taken to the extreme. Many companies have “thinned down” to commit the least “muscle mass” required to face the future with reasonable assurance. Cutting costs was the “easiest” way to achieve a balance in hard-hit income statements (and in some cases was too late or implemented with insufficient energy). Nonetheless, once cost cutting has reached its limits it becomes important to turn attention to operations that need to start generating earnings as soon as possible to help balance the income statement on the revenue side. This will ideally be accompanied by a search for growth that makes it possible to negotiate the turning point and face the future with greater optimism. Smart management of operations that bring revenue into the company is always necessary, but it is especially important in the current circumstances if we are convinced that opportunities to develop business which had faded away in recent years will start to come back into view sooner rather than later. Hence it is essential to revamp the way in which marketing and sales have been managed so far. Pricing has become a critical tool for even having the chance of turning any potential sale into a reality. Identifying potential customers and how to reach them and get our message across will also be different from now on. The way we market our products and services in this sector also calls for a wide-ranging review so as to adequately assess the new realities which we face from the standpoint of demand as well as the rearrangement of supply and the restructuring of sales channels.
  20. 20. Beagle Consulting © 41 Residential property market in Spain In spite of some gloomy expectations anchored in forecasting inertia and the herd behaviour of industry players, analysis based on the evolution of the main indicators for the residential market in Spain (transactions, stock and prices) shows that the crisis in the sector has bottomed out. We would therefore hope that the recovery that is beginning to be seen in many regions will become consolidated and pick up speed across the country. This analysis of the property market forms the overall framework for the sector, but in order to come to the right conclusions about a particular product, analysis must be carried out in conjunction with an examination of its particular location and using the appropriate zoom level. Given the heterogeneity of the stock that has been built up in some areas and the varying rates at which demand changes in them, the rate of absorption will be uneven. This situation will generate immediate opportunities for property development in some areas. By contrast other areas will take many years to absorb surplus stock. The market is changing and its actors are adapting to achieve success in the new situation. Both supply and demand need to change their ways because the playing field and the players are changing. Owners and managers of property and similar companies have tools available for anticipating the foreseeable evolution of the market and opening windows of opportunity that afford competitive advantage. The first of these tools is to understand objectively the current market situation and its probable development, not so much to try to influence it but rather to act accordingly. This is the foundation for building a successful business strategy that ensures continuity and growth in the medium and long term. Mapping out this strategy calls for bringing on board the highest possible concentration of specific knowledge, intelligence and common sense. Proper foresight and good strategic design are necessary but not sufficient conditions; it is also vital efficiently to turn ideas into action. To do that it is essential to plan actions to be implemented, not only by assigning the required timescale, resources and responsibilities but also by providing the organisation with an appropriate operational system. The goals, development and composition of the different organs of corporate and operational governance need to constantly adapt to the situation and operate efficiently. Also highly significant are less explicit and obvious factors concerning human dynamics that determine staff attitudes and motivation. The change in attitude must start at the top of the organisational pyramid and “spread by gravity” across the rest of the organisation, legitimising and driving the change of course. Operations are critical to the outcome in the short to medium term and to turning strategy into a reality that is aligned with it. Over recent years cost restructuring has been inevitable and widespread, although in some cases it has either come too late or gone much further than would be recommended. It is now time to start up a business rehabilitation process which involves getting back the fitness required to take part in the “long-distance race” that has to be run. Revenue generating operations will regain their lost relevance but must nonetheless be redesigned to meet the challenges of the new market. This process calls for thinking ahead, and so it is now time to start focussing our efforts on this goal. FINAL CONCLUSIONS
  21. 21. Si tiene interés en ampliar o personalizar el contenido de este informe o desea recibir actualizaciones del mismo no dude en contactar con nosotros: Beagle Consulting www.beagleconsulting.com informeinmobiliario@beagleconsulting.com Tel. (+34) 935 535 656 Rambla de Catalunya, 18, 1º C 08007 Barcelona (España) If you would like to expand or customise the content of this report or want to receive updates to it, please do not hesitate to contact us: Beagle Consulting www.beagleconsulting.com informeinmobiliario@beagleconsulting.com Tel. (+34) 935 535 656 Rambla de Catalunya, 18, 1º C 08007 Barcelona (Spain)
  22. 22. Fundada en el año 2001, Beagle Consulting es una consultora de negocio que presta servicios profesionales a empresas y a la administración pública. Su actividad se centra en tres ámbitos: en el diseño e implantación de estrategias corporativas y de negocio, gobierno corporativo y marketing. Las valoraciones y conclusiones que exponemos en este estudio son fruto del análisis objetivo y riguroso llevado a cabo por un equipo de consultores de Beagle con un alto grado de especialización en el sector inmobiliario y que combina una amplia experiencia profesional tanto en compañías del sector como en proyectos de consultoría y análisis para éstas. Founded in 2001, Beagle Consulting is a business consultancy firm that delivers professional services to companies and government. It specialises in three areas: design and implementation of corporate and business strategies, corporate governance and marketing. The assessments and conclusions we present in this report are the result of objective and thorough analysis conducted by a highly specialised group of Beagle property consultants who have extensive professional experience in sector companies and in consultancy work and analysis for these firms.

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