Spain's property investment market has rebounded along with the country's roaring economy but investors and developers would do well to display a degree of caution and level-headedness, writes Nick Spiro.
Four years ago, Spain’s economy was contracting sharply while unemployment was veering towards a ghastly 27%, more or less on a par with the rate in Greece, still the highest in the eurozone.
In August 2013, the International Monetary Fund (IMF) warned that 'the outlook [was] difficult and the risks [were] high', adding that 'Spain’s outward spillovers through financial markets have been systemic for Europe' and that a recovery was of 'critical importance for the eurozone'.
Fast forward to 2017, and Europe’s fourth-largest economy has delivered the goods. After expanding more than 3% last year, Spain is expected to grow at a similar clip this year, its fourth year of growth. Unemployment has fallen to below 18%, helping the economy surpass its pre-crisis level in 2008.
The banking sector, moreover, has been cleaned up and is now stronger and leaner. Spain’s benchmark 10-year government bond yield has been under 2% for the past two years - down from nearly 7% in mid-2012 - and the economy has become 'more competitive, flexible and resilient', according to the IMF.
Make no mistake, from the standpoint of economic output, Spain is back - and back with a bang.
The country’s property investment market has been one of the greatest beneficiaries of this remarkable turnaround. According to CBRE, transaction volumes in the first half of this year exceeded €6 bn, up 70% compared with the first half of 2016. The retail and hotel sectors accounted for 31% and 29% of transactions respectively.
Spain is now home to some of Europe’s mega deals, including a 1 million m2 logistics portfolio sold by Blackstone to China Investment Corporation (CIC) as part of the disposal of its Logicor unit and the €30 bn property-backed non-performing loan (NPL) portfolio of Banco Popular acquired by Santander, a majority stake of which was recently sold to Blackstone.
Transaction volumes in Spain are expected to surpass the €10 bn mark this year for the third year in a row.
SOCIMI firepower
The sharp rise in transactions - which barely exceeded €2 bn in 2012 - stems partly from the firepower of the SOCIMIs, the Spanish equivalent of real estate investment trust (REITs), which are listed on the country’s stock market, have attracted significant foreign capital and have given birth to an increasingly popular indirect investment market.
The gross asset value of the largest SOCIMIs - Merlin, Colonial, Hispania, Axiare and Lar Espana - has surged 40% just in the last year to more than €24 bn, according to Expansion, the Spanish financial daily. JLL notes that domestic investors now account for nearly half of transaction volumes in Spain.
The outlook for rental growth is also improving.
Prime office rents in Madrid have risen a further 5.5% over the past year, according to Knight Frank, with the prospects for further rental growth in the Spanish capital now among the strongest in Europe, along with Amsterdam. Nearly 60% of respondents in a recent JLL survey believe office rents in Madrid will increase between 10% and 20% over the next three years.
Yet the strongest sign that the recovery in Spanish real estate is well entrenched is the surge in investment in the crisis-scarred residential market where prices have started to rise after plummeting 45% between 2007 and 2015. Private equity groups, including Lone Star and Varde Partners, have acquired development platforms. There is particularly strong interest in the Madrid and Barcelona markets where prices have already risen sharply.
But there are risks...
Yet, as is often the case when sentiment turns extremely bullish, risks and vulnerabilities are downplayed.
The scarcity of high-quality product has pushed prime office yields in Madrid down to just 3.9%, lower than in the City of London and Amsterdam, while those for shopping centres and logistics properties in Madrid and Barcelona have compressed by between 75 and 85 basis points just in the last 12 months, according to Knight Frank.
This is excessive for an economy that is hardly out of the woods. Public debt has soared from 40% of GDP in 2008 to 100% last year while youth unemployment is nearly 40% compared with an average rate of 19% in the eurozone. Spain also faces a potential constitutional crisis ahead of a high-stakes secession referendum in Catalonia scheduled for October 1.
Perhaps most importantly, the critical underpinning for the dramatic shift in sentiment - the ultra-loose monetary policies of the European Central Bank (ECB) - is starting to give way as the ECB prepares to scale back its quantitative easing (QE) programme.
While Spain is not about to lose its appeal, a degree of caution and level-headedness among investors and developers would not go amiss.
Nicholas Spiro is a partner at Lauressa Advisory
