Ignacio de la Torre, Chief Economist at Spanish investment bank Arcano, discussed ‘Why Portuguese and Spanish real estate markets will keep rising’ at an event organised by the Portuguese Association of Real Estate Investors and Developers (APPII) recently and dismissed fears of another looming recession or property bubble in the Iberian Peninsula. Both Portugal and Spain are in a stronger, more balanced situation financially concerning their housing markets than many other countries worldwide. Why? Because both countries are not relying on foreign loans.
The Iberian market
Ignacio de la Torre says that when looking at both housing markets, many people focus on the returns and how much property goes up. Too often, they forget about the associated risks with returns.
“If you compare both markets before the crisis, house prices were rising sharply but didn’t factor in the risks. Both countries’ systems were servicing huge current account deficits and relied on a lot of debt versus GDP. When you rely on debt over GDP, sooner or later you will create a big problem,” he says.
Looking at both markets today, they are growing in line with available income. In Portugal, wages are growing at around 3% while in Spain at 2.2%, with employment growth at 1% in Portugal and 2% in Spain.
“Risks are critical. Both Portugal and Spain, for the first time in 40 years, are enjoying an equilibrium in their current account balances. We are not building houses relying on German loans. If you analyse how much the total debt-to-GDP growth ratio is, nominally speaking (families + corporations), we have healthy growth (above 1% is dangerous; both were at 3% by 2006). Today both Portugal and Spain have an intensity below 0% which is very healthy,” says the economist.
De la Torre stresses that people and investors are now looking to finance their investments from savings rather than relying on foreign funding. Looking at the private sector in both Spain and Portugal, both corporations and families are saving. The total amount of leverage is coming down, which is healthy.
Long real estate cycle
Ignacio de la Torre predicts that the real estate cycle in both Spain and Portugal will be a long one – longer than the traditional 12-year cycle.
“Today, the reality is size matters when it comes to securing cheaper finance. When you study the development markets in France, Germany and the UK where five firms have 50% of the market share, in Portugal and Spain it is the other way around, with only 5-6% held by the big players. That was ok when you had banks supporting the development market. Now they don’t and consolidation of development companies is inevitable,” says the Arcano economist.
The answer to financing is issuing bonds in order to secure the money where the banks are no longer in a position to do so; and in order to issue bonds, a company needs scale. This leads to partnerships, mergers and consolidation.
Golden Visas bring benefits and liabilities
Advantages to encourage the buying of houses by foreigners were granted by the Portuguese government through the Golden Visa and NHR programmes.
“This attracts rich foreigners, house prices go up as a consequence – well above the income of the average middle-class buyer – to the point now in Portugal where people can no longer afford to buy a house in Lisbon,” he says.
“Portuguese people have been living in Lisbon for the past 2000 years and now they can’t afford to live in their own capital city,” de la Torre points out, adding that despite the lack of space in Lisbon for projects, everything is “overpriced to income”.
“The average house price should be worth seven years of annual income but that is no longer the case, which is why you don’t find many young middle class people living today in London (average house prices for 2019 in London: €550,000-€760,000) with similar patterns in Madrid and Barcelona.
“In Auckland in New Zealand, there are already laws in place prohibiting non-New Zealand nationals from buying houses in the capital because the Chinese bought so many properties, it drove up house prices and forced out the locals,” says de la Torre.
And in Portugal too, the government has ushered in controversial new changes to its successful Golden Visa programme, effectively ending the purchase of property by Golden Visa applicants in Lisbon and Porto in order to qualify for the programme from January 2021.
“There is a debate now in Lisbon around how a foreign investor buying a property through such programmes really contributes to Portugal’s GDP. On such programmes, we need this debate here. Canada, for example, is going to triple the stamp duty for non-Canadian property buyers. Yes, these programmes bring some benefits, but they also bring with them liabilities in that the people who were living in cities for generations can no longer afford to do so,” he explains.
“The fact that an investor buys a house in Lisbon does not really contribute towards Portugal’s GDP. If you build new houses, yes it does. Sometimes we need to distinguish between micro trend benefits and macro trend benefits, but I fear that if we don’t have a debate on this, sooner or later the discontent will grow and end up fuelling populism and anti-foreigner sentiment.”
Over the past five years, Arcano has been operating in the Portuguese market with Portuguese partner Sofia Mendes, who is working on Portuguese deals in banking and insurance.
Arcano believes that the situation in Spain, where developers lack bank-assisted finance, is about helping Spanish developers get access to finance through issuing bonds, securing lines of credit through hedge funds. “All these ideas make sense for us to get involved in Portugal because if you want to build housing for the middle classes, you need the finance and we have the instruments to provide it,” he says.
Ignacio de la Torre says the best way to prevent house prices from spiralling up is to increase supply. However, he doesn’t believe that the banking system in Iberia will ever get back to the state where they will be lending huge amounts of money for real estate development projects.
“Today banks are no longer regulated by the Bank of Portugal, but by the European Central Bank and the ECB are not going to be very friendly concerning non-income producing assets in the property sector except mortgages and results-driven projects.”
In other words, banks can no longer be counted on to lend money to buy land as well as financing a large-scale development as a result of the financial crisis in 2008-2013, which in both Portugal and Spain saw many unfinished building projects and resorts handed back to the banks after developers went under.
“This means you need another type of capital and to use sophisticated capital instruments such as the ones widely used in the UK and US. However, the main problem in Portugal is the middle class. They can afford the mortgage, but they can’t find the downpayment for the property,” says Ignacio de la Torre adding that in Spain it represents a hefty 10% downpayment plus 20% stamp duty.
Affordable housing schemes
Ignacio de la Torre says the way to go may be the kind of revolutionary affordable housing schemes seen in cities like Berlin and Vienna, where, in the latter, 60% of its residents live in city-built, sponsored or managed housing and this could be replicated in the Iberian peninsula.
This means a system for working with non-profit development corporations that compete with each other for city-sponsored projects. The city acquires the land for a project, establishes the housing goals and project pro forma and publishes the amount of financial subsidy to be supplied. Stakeholder groups judge the proposals submitted in response and decide which project team, architects, builder, developer and management entity has the most intelligent response.
“I think it makes sense. If you look at Spain, we have unemployment rates of up to 14% and in Portugal around 7% despite being similar countries. In Spain, we have a high degree of homogeneity. In the south, you may own a house but be unemployed because the rate there is 20%. You don’t go to the north where the unemployment is much less because you are saddled to the house,” he points out.
He says that owning a house is good for political and fiscal reasons because most home-owners are neither populists or extreme left supporters. Property owners tend to behave in a mainstream way, politically speaking. However, young people today tend to move around and work in more and different places.
“I think in Portugal they could consider what the UK government has done, which is rent-to-buy whereby if you don’t have the 20-30% equity to get the mortgage, the government guarantees that to the bank and then your liability is with the government,” he explains.
The economist says that governments need to think long and hard about this kind of option because young people won’t have children if they don’t have secure housing; and in the Western world, where birth rates are low, particularly so in Portugal, providing incentives for young people to start families is vital to sustain the country’s social security and pensions systems,” he concludes.
Ignacio de la Torre rules out a property bubble in either Spain or Portugal for the foreseeable future because the numbers simply don’t point to that happening.
Property bubbles are more likely to occur, he says, once people commit more than 40% of their income to buying a house. This is not the case in Portugal now where the ratio is 25-26% of income which is extremely healthy.
The economist also doesn’t think that the world is heading for another 1930s-style Great Depression despite the doomsayers who have been suggesting that we are.
“A big crisis or Great Recession like we had in 2008, which led to a real estate, financial, sovereign debt and economic crisis, only happens once every 50 years.
We had one in 1929 and then in 2008 – it’s not going to happen for a long time. The origin of this type of crisis is when you have a sharp increase in private debt, meaning corporate and family debt. We are not in this situation either in Portugal or Spain,” he concluded.
Arcano was set up by investment bankers in 2003. Partner-owned, it advises on mergers and acquisitions, private equity and European high-yield credit investments.
Arcano has an asset management service with a portfolio under management of €500 billion, focusing on alternative investments, private equity and the Spanish real estate sector. It is currently looking at the Portuguese market.
By CHRIS GRAEME