Can Spain Sustain?

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Spain's phenomenal building spree is not merely froth. It is grounded in a number of demographic realities: Spain had its baby boom relatively late, from 1965 to 1975, says José Antonio Herce, chief economist of Grupo Analistas, a private consulting firm in Madrid. He attributes the flourishing real estate market in recent years in large part to that population joining the housing market. "We also discovered divorce, which has contributed to a big jump in the number of households," says Herce. "And we've seen the arrival in the last five years alone of some 4 to 5 million immigrants."

Some of those drivers will fade with time, but the greatest of them won't: the sun. An estimated 2.5 million residences in Spain — more than 10% of the total residential stock — are owned by non-Spaniards. Last year foreigners bought 20% of the 650,000 new housing units that went up in Spain. They are drawn more than anything by the prospect of vacations or retirement in "Europe's Florida." "It's a question of supply and demand," says Karl Morris, managing director of Simple Overseas Properties in Benalmadena, near Málaga. "Flights are getting cheaper and Brits, Germans, Irish or French, for example, can be in Málaga in less than 21/2 hours. Many of them come once for a month or six weeks and then decide to retire to Spain."

But the boom is flattening off. Housing prices, up by 17% in 2004 and a further 13.9% last year, are expected to grow by 9.8% this year and 8% in 2007. The competition is sharpening for foreign buyers: houses in Croatia and Morocco are cheaper. Spain's good schools, health care and modern infrastructure will keep European snowbirds coming, but foreign buyers are already scarcer. "Until last year we were selling 20 to 25 properties, mostly to British, but now it is down to 18 to 20 a month," says Francisco Toro, director of Mark-Sol real estate agency in Fuengirola on the Costa del Sol. "When we get a client now, we must cosset him and treat him like gold dust. We have to work harder and spend more money on publicity."

The influx of foreign cash has its darker side, too. Arrests earlier this year of 25 people in Marbella — including the mayor, her deputy mayor, two city councillors and the former chief of urban planning — offer a sobering glimpse of the potential corruption such a hot market can breed. Charges (which are denied) include influence peddling and kickbacks that politicians allegedly turned around into helicopters, thoroughbred horses and art collections. For the first time in modern Spanish history, the government ordered the dissolution of Marbella City Council and installed a temporary team to run the town. On taking office the new incumbents found the cupboards bare and thousands of unpaid bills, making the millionaires' jet-set resort virtually bankrupt.

If there's a silver lining to what can seem an unsustainable boom, it's this: Spain's property business has generally become more professional and sophisticated during the years of plenty. It's difficult to get a mortgage anywhere in Spain without a down payment of at least 20%, says Begoña Iturriaga, head of investment at IREA, Spain's biggest independent real estate consulting company. "Developers and banks are generally pretty conservative in Spain," she says. "There'd have to be a dramatic drop in housing values to endanger banks." In fact, expertise gained in Spain's fat years has propelled companies to seek success abroad — thus hedging their exposure to the domestic market. Metrovacesa's €5.5 billion purchase last year of French developer Gecina made it the largest publicly traded real estate developer in Europe, and the country's biggest banks are reaching out, too. "We haven't seen the end of the expansion of Spanish banks into the rest of Europe," says Herce, citing the Santander Group's 2004 purchase of Abbey National and Banco Bilbao Vizcaya Argentaria's continued search for acquisitions. "They've learned how to collateralize loans, as well as the ins and outs of personal retail banking, and they've gotten very good at it."
But what's good for developers and bankers isn't necessarily good for consumers, or for the Spanish economy as a whole. "Capital and investment going into construction isn't going into other activities," says Herce. Partly as a result, Spain's productivity gains in recent years are almost nonexistent. Spain has created more jobs than the rest of the euro zone combined over the last four years, but too many of them are low-quality jobs on construction sites. The country's infrastructure has profited greatly from European Union subsidies, which are bound to disappear in coming years as needier recipients in the east move to the front of the line.

And then there's inflation, which remains the Achilles' heel of the Spanish economy, currently running at an annual rate of 4.1%, almost twice the euro-zone average. "Since Spain entered the euro zone, its high inflation rate has been consistently weakening its competitiveness," says the o.e.c.d.'s Giorno. Largely as a result, Spain's net foreign balance has dived over recent years.

There's no easy solution in sight. Higher interest rates would reduce inflation, but could at the same time greatly endanger the already stretched household budgets of Spanish consumers. Some 90% of Spanish mortgages are variable-rate loans, so an interest hike would cause real pain. Squaring that circle would be a difficult task for any central bank. But the European Central Bank in Frankfurt can't worry too much about cooling down Spain when the economies of much of the rest of the euro zone — witness Germany and Italy — are in cryonic suspension.

Clearly, the Spanish government has to rely on its own efforts. Late last year it presented an ambitious National Reform Program that promises, among other things, an improvement to Spain's mediocre higher-education system and a doubling of the country's expenditures for research and development. The government wants to encourage flexibility in Spain's overly segmented labor market and encourage mobility by getting more Spaniards to rent instead of buy. "We need to promote rentals, not only because of the high prices of homes and high levels of mortgage debt, but because there is so much unoccupied housing, which the government sees as 'anti-economic,'" says Salvador Arancibia, spokesman for Spain's Housing Ministry. "In response we have created subsidies to help young people rent their own apartments, passed a housing plan that offers incentives to construction companies to build rental housing, and created a public entity designed to invigorate the rental market."

It won't be easy, even in San Sebastián de los Reyes. Earlier this year, the town put up 130 houses to purchase and received 3,500 applications; when it offered 118 units up at subsidized rental rates but without an option to buy, only 600 families expressed an interest. "We're growing, but we have feet of clay," Holguera says.

Yet anyone betting against the Spaniards' ability to change hasn't digested just how radically, even joyously, they've embraced it in recent years. Putting a basically healthy economy onto a better long-term footing is an enviable task. Spain is better suited than most of its neighbors to make it work.