Sunday, May 13, 2007

The Real Estate Burbuja

People are really excited in Madrid about the "Burbuja Inmobiliaria". First off, this term is of course borrowed straight from the English. We have had some experience with the "Real Estate Bubble" in Los Angeles - Hell, the term was probably invented here.

Check out this link to Idealista - 548 comments to this story! People are freaking! Some Spanish guy in charge of something, who of course can't really know what is going to happen, says that prices should be going down a lot more by now so that there will be a "soft landing" of the bubble. I wonder where he heard about the soft landing idea?

The last big run-up in Los Angeles real estate prices happened in about 1986 - 1989. People thought it would never go down. It was the same old story, building like crazy, houses worth more a week after you bought, etc. Nobody saw what was going to happen. Then, L.A. lost a bunch of jobs in Aerospace due to the end of the cold war. The market tanked, and houses did lose value, maybe 20% or so depending on where the house was. People who overextended themselves with loans, or who took money out of the homestead to go on vacation and buy cars (stupid), lost their houses - big surprise! This lasted until about 1995 - when prices started going up again and they kept on going.

Now house prices in L.A. are through the roof but holding, however with less sales - sound familiar? Everyone in L.A. and Madrid are wondering what will happen next, but they are much more agitated in Madrid. By the way, all the losses from the 1989 bubble in L.A. were completely erased and house values are much higher than before.

What's happening is the Spanish are in shock at the changes in their country and their city. Pisos (Spanish Houses) were way undervalued for way too long. In 1987 a modest piso in the Centro probably cost 5 - 7 million Pesetas, about $41,000 to $58,000 at 125 pts. to the dollar. In 2001 a modest piso cost about 22,000,000 Pesetas, about $115,000 at 190 pts. to the dollar (the dollar was real high then). Now, that same apartment costs about 50,000,000 Pesetas or 300,000 Euros.

The Spanish also are grappling with another "new" phenomenon - the mortgage. Before, nobody hardly ever had mortgages Spain. People paid cash. They saved their money or got it from a relative. Mortgages were very rare and with nasty interest rates - like 17%, no kidding! The 30 year mortgage is something they have a hard time wrapping their minds around too. Being in debt for so long for a house! Que barbaridad! Of course in the US it has been common for YEARS.

Dear Madrilenos - I'm afraid the old days are gone. Your city is a capital of a major European nation. People want to live there and more are coming. It is very nice and tons of cash is being poured into it by the EU. There is great transportation, entertainment, people, jobs, plazas, you get the idea. Owning part of it is worth Euros - and I say lots of Euros. Will prices go down? Of course! They will go up and down. But piso prices will always march upwards over time barring some nasty disaster or war.

The bottom line is I don't really know what is going to happen. But I do know that if the bubble bursts you gotta hold on until piso values come back - I believe they will - I just don't know how long that will take.


EuroMadrid said...

Another key difference between the U.S. and Spain's real estate market is that young Spanish people lack the same earning potential as their American counterparts. Temporary job contracts are the norm for many young Spaniards and there is a severe problem in Spain of underemployment. Too many university graduates and not enough white-collar positions/industries drive salaries down and make the labor market very competitive. If only some of these Spanish kids would consider becoming plumbers or electricians, they'd be sitting pretty. With the white-collar jobs, forget about getting steady raises that beat the rate of inflation.

Also, credit standards in Spain are pretty lax in comparison to U.S. and Spanish banks are lending money willy nilly without regard to the long-term solvency of their clientele. When some mileurista earning only 12,000€ a year is able to get a 50-year mortgage for a 400,000€ apartment, something isn't right.

I'd say Spain is headed for a correction and it's bound to be a severe one because it doesn't have a large enough base of solvent buyers to pick up the slack.

Carl said...

Thanks for the comment EuroMadrid.

I’m afraid it is a myth among Europeans that young Americans can afford a house any more than young Spaniards can afford a piso. The nasty, hard truth is the way things are going, in fifty years only the very wealthy, or those who inherit real estate will be able to own a house – in the US and in Europe.

In regards to the banks lending money “willy nilly”, I would say banks are the same everywhere - they are not in the business of losing money. They loan a bunch of money to a bunch of people, most will work their asses off to pay, some will be in over their heads, some will lose their homes, the banks will then keep their downpayment, the fees, the interest, and the real estate! Then they will re-sell the piso (yes at a lower price) and loan the next guy money and keep all HIS Euros. And prices will still march up over time and the banks know it. A correction is expected, but it won’t stop the upward march of prices.

In my opinion, the reason for the high unemployment in Spain is their obsession for “fixed jobs” – or a job for life where you can’t be fired (socialized employment practices). This is unthinkable in the U.S. (It was sort-of the norm for my father’s generation only due to a company being loyal to the employee – also unthinkable now). Spanish companies’ answer to getting around the problem of not being able to fire employees when they are not needed is “the temporary contract”. What company wants to hire people knowing they will almost be a lifetime responsibility? I’m afraid this will have to change in Spain.
Unemployment is pretty low in the U.S. but all of Europe is terrified of the “Americanization” of work. It will happen though.

A side note: California is known as an “at will employment state”. This means that you can be fired (let go) for any reason at any time. How many protests do you think that would incite in the Puerta del Sol?