This may be the umpteenth write-up on Spain's real-estate bubble’s burst, but let me assure the reader that my intentions are not to dissect its causes, (which should be evident by now), but rather to reflect on how to act in the face of the facts some two years later.
In all honesty, as I thought about the content for this post, I felt short of ideas and reticent to convey a conformist message.
However, reading yet another of those “buy-real estate-now-before-the-inevitable-rise-as it’s-the-best-asset-ever!... has given me both the content and the motivation to put my thoughts down on paper.
How can it be that “supposedly” informed people in academia and in business still convey the message that was passed on for generations before, pointing to residential real estate as a fail-safe investment? Are these people immune to the laws of supply and demand? Or have they not heard about the “mean-reverting” nature of asset prices?
Allow me to explain the reason for my indignation. Spain has by all accounts over 1.5 million homes built and yet unsold, which if you assume an average annual demand of 200,000 homes per year will take over 7 years to work through. Add to this the fact that this demand will most likely drop in the near future due to:
1. Extremely high unemployment rates resulting in very low disposable income
2. Interest rates that are at historic lows and hence bound to rise at the first sign of inflation in the Euro-zone (a true time
bomb if we take into account that over 90% of mortgages in Spain are variable rate.
If this were not enough, historical data states the ratio of home prices to average family income at somewhere between 3 and 3,5 to 1. Given that wages in Spain are notoriously low compared with most of our neighbours and a family unit comprised of 2 salaried adults, (an increasing rarity with unemployment teetering 20%), results in a grand annual total of 50 k €, average home prices ought to be in the range of 150 to 180 k €. As of December 2009, the average home price in Spain for a single family home is around 300k €.
One does not need to be a genius to conclude that in order to just return to the historical average (and there is no real rationale to divert from it), home prices have to adjust downwards some 40% to 50% from their current prices!.
Returning to my original intention, that is, to reflect on how to act in this market (where by the way real prices, not nominal ones have only come down some 8-10 % since their peaks in the summer of ’07), I venture a few suggestions.
1. Do not assume that things will be as before (it will not take 2 years of minor price reductions to correct over 15 years of
excesses in the real estate market).
2. Remain vigilant of inflationary threats. Although nominal house prices will, (at some point in the future anyway)
appreciate, said increase will likely be marginal after inflation erodes the gain.
3. Plan for the worst and look to safer assets such as long-term, diversified equity investments in order to hedge inflation
risk.
4. Return to the real-estate market only after prices stop defying economic logic (remember the mean-reversion feature we
talked about…)
Happy 2010!
2 comments: