Real estate: looking for the exit

Economic Monthly Report

House prices seem to be picking up in the United States. Rises have also been seen in Germany. However, the trend in real estate prices is still downward in the industrialized countries of the West. This reflects the bursting of a bubble that particularly affected Ireland, Spain, the United States and United Kingdom and that has had, or is still having, devastating consequences in terms of growth and employment.

After this latest experience, the effects of a burst real estate bubble have become even clearer, if possible: prolonged economic crises with serious financial repercussions. Property prices plummet, households see their wealth diminish in comparison with their debt, financial institutions weaken, unemployment spreads and it becomes increasingly difficult to meet mortgage payments.

Moreover, real estate bubbles are usually accompanied by a sharp rise in household debt (mortgages but also personal loans and credit card debt). In the bursting phase, the extent of this debt weighs heavily on household spending decisions for a period of time that can be very long, especially if no measures are taken to speed up the process (creditors writing off losses, restructuring debts, reduction of the financial sector).

Asset bubbles become a serious financial risk when banks are highly exposed to them. Balance sheets are contaminated by unpaid loans, the institutions’ solvency is called into question and credit shrinks. In the current crisis, some attempts made by authorities to stabilize financial risk have hindered the countries themselves, creating a damaging link between bank and sovereign risk.

As pointed out in one of the boxes in this Monthly Report, the adjustment in Spain’s real estate sector is coming into its fifth year. House prices have fallen to 2004 levels in nominal terms and the number of new homes started is one tenth of the figure for 2006, when building was at its peak. In spite of this severe correction, the situation has probably yet to bottom out. There is still an oversupply in the form of property on sale, although this is distributed very unevenly throughout the country, with a preponderance of tourist residences. Concerning demand, a diminishing population and an economy in recession are not encouraging sales to pick up. The affordability of housing for an average household (the price related to income) has substantially improved thanks to falling prices and interest rates. Nevertheless, this has been offset by the drop in disposable household income, tightening up of credit conditions and tax hikes.

The regulatory changes introduced in 2012 should help the sector to exit the tunnel of real estate shock. The initial aim is to boost the rental market, whose current importance is abnormally small in comparison with other countries around us. Eliminating tax incentives for property ownership should also contribute towards a more efficient, dynamic rental market, while the creation of an asset management firm to handle problematic real estate assets aims to sort out the balance sheets of bailed-out financial institutions to help restructure the system. Should this bank be properly set up and managed over the coming months, this will be a step forward in the quest for a sustainable recovery in the real estate market and the economy in general.

Editorial

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