INREV conference: Spain gets back on its feet after period of 'massive capital destruction'

Spain’s real estate sector is slowly moving forward as the workout of bad loans stemming from a period of overleveraging continues and new REIT regulations stimulate the introduction of new and viable listed companies.

That was one of the key conclusions drawn by Ismael Clemente, CEO of Merlin - one of the new wave of Spanish REITS – during a presentation at the INREV annual conference in Barcelona on Thursday. Spain’s bad bank Sareb, which was modelled on Ireland’s NAMA, took a major hit when the bad loans were transferred three years ago, Clemente said. ‘A new hit is expected when the loans are offloaded, but it will be minimal,’ he predicted.

As in the US in the 1990s, the Spanish banking crisis centred on its savings banks, which accounted for 28% of the total. ‘The banking entities that have emerged from the crisis are much stronger,’ Clemente said. ‘But,’ he added, ‘it is still harder to find credit in the current market.’

Nevertheless, Spanish companies are reacting to the new credit conditions. While banks accounted for 97% of all financing in Spain before the crisis, this is now rapidly changing, Clemente said. He added that it will take awhile before alternative lenders account for roughly half of all lending in Spain as in the US. ‘But things are moving.’

Spain’s listed real estate companies also experienced a period of ‘massive capital destruction’ after the outbreak of the global financial crisis due to a mountain of debt and plummeting asset values. At the time, the market capitalisation of Spain’s public real estate companies – which included the likes of Martinsa Fadesa, Colonial, Reyal Urbi, Sacryr Vallehermoso, Metrovacesa and Renta Corporacion - totalled some €44 bn. That figure has since plunged to €5 bn, Clemente said. ‘The size of Spain’s listed real estate sector has dropped by 80%. It’s a sad story, but it is what it is.’

He added that prospects for Spain’s listed real estate sector have improved following the introduction of a new SOCIMI regime modelled along the lines of the Anglo-Saxon REIT system. ‘It is very similar to the US system and it was a very smart and opportune move by the Spanish government. This move has helped the recovery of new investment into the Spanish economy.’

Institutional capital moves in
Another positive development, Clemente said, was the wave of international opportunistic funds that targeted Spain during 2011 to 2013. The opportunistic funds played a role that was extremely beneficial for the Spanish economy in general and the real estate sector in particular, he noted.

The market has now clearly shifted to institutional capital, he added, pointing to the likes of Singapore’s GIC and Canada’s CPPIB, European insurers like Allianz and AXA, German open-ended fund managers like Deka and local family offices. ‘The opportunistic funds will start offloading assets at a significant gain to institutional investors,’ he predicted.

Commenting on the recovery of capital values, Clemente said they were currently still below 60% of their peak. ‘Even if there was frothiness at the peak, capital values are still a long way from their pre-crisis levels,’ he noted.

So far yield compression has been strongest in the shopping centre sector as global investors have sent yields to the floor, Clemente said. The yield compression does not appear to be justified in terms of rental growth prospects, he added. ‘There is a big polarisation in the shopping centre market, some are well above water, but many are under.’

Residential sector
Nor is Clemente optimistic about prospects for Spain’s residential sector. At the height of the boom, Spain launched over 800,000 new construction starts a year, the total sum for Germany, Italy, France and the UK combined. That figure has meanwhile plunged to 34,580 annually but there is no need for new construction, he argued. Spain may be a large tourist destination, also for second homes, but there are serious problems in the urban areas, he added. ‘In Spain we have 1.7 inhabitants per dwelling. Compared to all the international averages, that is very high.’

Meanwhile the Spanish government is taking measures to tackle corruption and modernise its system of tax collection. All in all, Spain’s real estate sector has learned two very basic lessons from the crisis, Clemente said. ‘It is one thing to be a house builder and quite another to be a commercial real estate owner. These are different companies with very different capital structures.’

Another lesson that Spain’s corporate world has learned is how to operate with leverage. After the period of dictatorship ended in the mid-1970s, Spanish companies were prone to use and abuse leverage, Clemente pointed out. ‘Now they have learned how to deal with it. Land is no longer leveraged and the market is behaving more prudently.’