Spain's real estate collapse: A bleak outlook deepens the actual recession, affecting growth prospects.

Home sales in Spain in the first half of 2022 have reached their highest level since the real estate boom in 2007, which preceded the global financial crisis. However, the boom in home prices, which has been ongoing since the COVID-19 pandemic began, has begun to slow in recent months due to rising interest rates, which are driving up mortgage costs. Investors are wondering if real estate will suffer the same fate as stocks and other risky assets in a global recession. This article looks at what the slowdown could mean for the Spanish real estate market and the likelihood of a collapse in Spanish house prices.

Housing prices in Spain

Home prices typically rise and fall in cycles, with peaks or 'bubbles' - when average house prices exceed their fundamental value - eventually leading to a cooling of the market. Sometimes the cooling is rapid, and housing prices collapse very quickly. Real estate bubbles can occur due to excessive lending, causing owners to rack up mortgages they can't afford to pay. When the market changes, these owners are forced to sell their properties, increasing the supply on the market.

The real estate market in Spain

The real estate market in Spain is an attractive investment destination for European real estate buyers, and the Balearic Islands are among the leaders in sales. The real estate market in Spain has already experienced three price bubbles: 1985-1991, when average house prices almost tripled; 1992-1996; and 1996-2008, which ended with the financial crisis of 2007-2008 and a sharp drop in house prices in Spain.

The reasons for the collapse of real estate bubbles

What led to the bursting of the bubbles? Spanish government policies in the 1960s and 1970s encouraged homebuyers, which contributed to strong long-term price increases. According to a report by Banco de España (Banco de Espana), average house prices in Spain between 1976 and 2003 increased sixteen times in nominal terms and doubled in real prices. This placed Spain among the three or four Organization for Economic Cooperation and Development (OECD) countries with the highest long-term real house price growth.

The crisis in the real estate market in Spain

The U.S. real estate bubble burst in August 2007 due to a crisis in the insolvent mortgage market, and the contagion effect quickly spread to other real estate markets, ending the Spanish real estate bubble. Between 2007 and 2013, house prices in Spain collapsed by 37%. CaixaBank explains, "Typically, weakness in the housing market begins with an increase in the timing of home sales and a decrease in the number of sales (deceleration phase), which then transitions into moderation or even a drop in prices after a few quarters (contraction phase). The more imbalances accumulated in the preceding expansion phase, the deeper and longer term this phase of market regulation usually is. "

The current situation in the real estate market in Spain

According to the bank, this was the main reason for the long and intense recession phase from 2009 to 2013. "In contrast, real estate experienced a temporary adjustment in 2020 due to pandemic-related travel restrictions." Figures from the National Institute of Statistics (INE) showed that real estate sales in Spain fell by 16.9% in 2020 due to market disruptions caused by COVID-19-related restrictions. However, the market revived again in 2021, especially on the coast and in less developed areas, where sales rose 34.8% compared to 2020.

In the first half of 2022, sales rose by 23.1%, reaching the highest level since the 2007 Spanish real estate bubble. The number of foreignreal estate buyers hit a record in the second quarter.

The INE data indicates that overall real estate sales in Spain peaked in May, while the pace of sales slowed in June and July. Real estate sales in July were up 8% year-on-year, compared with a 31% increase in January.

Home prices in Spain, meanwhile, are still below 2007-2008 levels, according to the Ministry of Development's house price index, information from TradingEconomics shows. However, Spanish house values have risen consistently since 2015, only slowing briefly due to the pandemic in 2020, reaching a 10-year high by October 2022.

The impact of rising mortgage costs

About 50% of property sales in Spain are made using mortgage lending, but could the rapid rise in borrowing costs and continued high inflation lead to the collapse of the Spanish real estate market?

In terms of real estate prices in Spain, S&P Global Ratings believes there is a "convergence of factors" that are contributing to increased demand for housing. These include record high employment, rising wages, a trend toward working from home, and savings accumulated during the pandemic. The agency added: "Households will also continue to benefit from years of accommodative monetary policy, which peaked under the extraordinary measures taken by central banks during the pandemic. However, while some of these demand factors are still on the scene, they will be dampened by the normalization of monetary policy, which is moving at a faster pace than expected a few months ago, as a result of established high inflation. Higher interest rates could lead to a cooling in housing demand. "

The agency predicts that house prices in Spain will rise by an average of 4% in 2023, up from 4.6% in 2022, with the rate of growth slowing to 3.5% in 2024 and 3.2% in 2025. The agency believes a hard fall in house prices in Europe is unlikely due to "a combination of rising interest rates in nominal but not real terms, strong household finances and displacement due to war." "We therefore expect prices to slow down over the next year and beyond," the agency's analysts said, noting that the arrival of refugees from Ukraine - about 120,000 in Spain by the end of June - is also boosting demand for housing in Europe.

Spanish financial firm Bankinter predicts that house prices in Spain will fall by about 5 percent in the next two years after rising by about 5 percent in 2022. The firm has revised its forecast for 2023 with a projected 3% decline from the previous forecast of 1% growth, and the market is expected to fall by 2% in 2024 from the previous forecast of 0%.

The Spanish Property Insight analysis also indicates that a Spanish house price crash similar to the one that occurred in 2008 is unlikely. They said: 'Even if the post-pandemic boom in the Spanish real estate market slows down this year, there is no reason to expect a crash like at the end of the last boom in 2007. However, it will be more difficult to sell real estate in Spain amid the recession, rising interest rates and high inflation. "

Analysts at Spanish financial company CaixaBank also do not expect an immediate collapse in house prices in Spain, pointing out that the current economic context and market dynamics are significantly different from 2008. "The strength of demand is largely driven by changes in preferences after the pandemic, and part of the savings accumulated during the pandemic is channeled into the real estate sector. In addition, the balance sheets of both households and the financial sector are much healthier now, and there is no oversupply." However, the bank does forecast a slowdown in Spanish house prices due to rising inflation, which is destroying household purchasing power and causing monetary policy to tighten. "Inflation is expected to begin to adjust in 2023, and this should allow rates to remain at historically low levels. All of this should help mitigate the correction in the Spanish real estate market... In particular, we predict that the number of sales transactions will fall by just over 10% in 2023 and house prices will slow but still grow at a positive rate. "

In the end, whether there will be a new real estate crash in Spain depends on the scale of the interest rate hike cycle and its impact on mortgage rates. While the collapse of the Spanish real estate market would make prices more affordable for buyers, high inflation and rising interest rates will reduce the availability of mortgages. Remember that analysts' predictions can be wrong. Always verify information before making a transaction and never risk money you can't afford to lose.