May 2 (Bloomberg) -- From atop the stone walls of Avila, Spain, a medieval city an hour’s drive northwest of Madrid, beyond the parking lots and empty playgrounds and thousands of vacant new apartments, a construction crane can be seen moving on the horizon as building continues.
“Avila isn’t an exception,” said Jesus Encinar, co-founder of Madrid-based Idealista, Spain’s largest property website, and an Avila native. “It’s a small-scale example of the madness that gripped the whole real estate industry.”
In the stages of death of a real estate boom, Spain is still in denial. In Ireland, they’re moving toward acceptance. The first auction of one of 2,000 unfinished housing estates takes place tomorrow at the Shelbourne Hotel in central Dublin, with sales expected to fetch cents on the euro, showing the Irish may be closer to the end than the beginning.
“Ireland faced up to its problems faster than others and we expect growth there rather soon,” said Cinzia Alcidi, an analyst at the Centre for European Policy Studies in Brussels. “In Spain, there was kind of a denial of the scale of the problem and it may be faced with many years of significant challenges before full recovery takes place.”
Spain, Europe’s fifth-largest economy, is the current focus of attempts to contain the region’s sovereign debt crisis, as Prime Minister Mariano Rajoy struggles to quell speculation it will need a bailout. Developers are showing similar optimism. They continue to build even with 2 million homes vacant around the country, new airports that never saw a single flight being mothballed, and property appraisers and banks reporting values have fallen only about 22 percent, said Encinar, who estimates the real decline is probably at least twice that.
Legacy of Bust
Ireland, where home prices have fallen a record 49 percent since peaking in 2007, is making more progress as it deals with the legacy of a bust that crippled its economy, once the most dynamic in Western Europe, and required a 67.5 billion-euro international bailout in 2010. The state purged lenders of 74 billion euros ($98 billion) of mostly toxic commercial mortgages by creating a bad bank, and poured enough cash into the financial system to make it among the best capitalized in Europe. Building virtually halted overnight in 2008 after debt markets seized up globally.
Spain has so far rejected the bad bank model, even after Standard & Poor’s last week cut the country’s credit rating to BBB+ from A, on concern the government will need to provide further support to banks.
Truth About Spain
On the plain below the central walled city of Avila, a world heritage site and a popular tourist destination, the province with a population of 171,680 has about 19,000 apartments and villas empty or unfinished, according to Borja Mateo, the author of “The Truth About the Spanish Real Estate Market.”
Ministry of Infrastructure figures show 23,419 homes were constructed in the decade through 2007, with another 11,000 homes built there since 2008. The sprawling developments are dotted with thousands of empty parking spaces, while streets have makeshift barriers where the money has run out, others simply end in fields.
Miguel Angel Garcia Nieto, mayor of Avila for the past decade, disagrees that his city has been overbuilt.
“When we approved the first urban plan back in 1998 there was an unprecedented demand for homes,” Nieto said in a telephone interview on April 19. “Yes, there is oversupply at the moment because of the financial crisis and everyone’s gone back home to live with their parents, but it’s not because there is lack of demand. When the economy gets back on track I am confident the supply will be absorbed.”
That may take decades, said Encinar, after Spain’s jobless rate rose to 24.4 percent in the first quarter, the highest in almost two decades and the economy is mired in a recession that the International Monetary Fund predicts will cause it to shrink by 1.8 percent in 2012.
The Spanish real estate bust is the biggest test to date for European authorities with Spain’s economy almost twice that of Greece, Portugal and Ireland combined. Yields on Spain’s 10-year bonds climbed nine basis points to 5.86 percent from April, approaching the level of those countries when they had to be bailed out.
Spain and Ireland are “very similar,” said Angel Mas, president of European mortgage insurance at Genworth Financial Inc., in an interview in Madrid. “They had never experienced this cheap credit, same as here. And they experienced a construction boom that at the beginning was out of necessity, but they couldn’t stop it.”
Speed of Response
The key difference is the speed in which the two nations are responding to the collapse. In 2009, Ireland created the National Asset Management Agency, or NAMA, a so-called bad bank. It used bonds to buy commercial real estate loans from the banks with a face value of 74 billion euros for 32 billion euros. That left banks needing capital, leading the state to pour in cash and nationalize five of the six biggest lenders.
NAMA is now seeking investors for those assets it can sell, and forcing debtors to rent out some of the remaining properties to produce revenue.
Irish home prices were unchanged in March, the first month values have not fallen since August 2010, according to the country’s statistics office. In Dublin, residential prices rose 0.7 percent in March.
“The big knock to the domestic economy was the fact that building and construction totally collapsed and that was over 20 percent of the economy and it was bang, gone completely,’” Finance Minister Michael Noonan said in a speech to a Parliamentary committee on April 25. “It is beginning to move, it is very tender shoots of growth at the moment.”
While the negative drag from construction in Ireland is largely over, Spain still has a ways to go, Alcidi said. The economy will barely grow next year after contracting in the fourth-quarter, entering its second recession since 2009. The Irish economy will expand 0.5 percent this year and 2 percent next year, the IMF said on April 17.
Still, the empty buildings that pockmark the landscape of both countries are testament to their similarities.
South of Dublin’s city center lies Sandyford, earmarked as a new residential quarter at the height of Ireland’s boom. Instead, two towers lie unfinished, with one covered by a fraying tarpaulin depicting imaginary residents drinking cocktails on non-existent balconies. A Bank of Ireland branch at ground level is one of just a few businesses open in the area.
A glass window in the South Central apartment block’s marketing suite there has been shattered and the chairs inside draped with dust covers.
Europe’s Poorest Countries
Sandyford and Avila are reminders of the booms that fueled both economies and the busts that crippled them. In the 1970s and 1980s, Spain and Ireland were among the poorest countries in Europe. Following the creation of the euro, both tapped into international money to fuel the growth in their real estate markets.
Prices doubled in Spain in the decade through 2007. Irish house prices more than quadrupled from 1995 to 2005 to an average of 303,247 euros, the fastest growth among 18 countries surveyed by the Paris-based Organization for Economic Cooperation and Development.
“It was avarice,” said James Nugent, managing director of Dublin-based real-estate broker Lisney. “You just had to get as much of it as you could possibly get your hands on. Credit wasn’t a problem, the banks were throwing money at people.”
Former Irish Minister Tom Parlon recalls putting a 2.1 acre site of the state’s veterinary college in Dublin’s embassy belt of Ballsbridge up for sale in 2005.
“We thought in our wildest dreams that maybe it might make 100 million euros, which was a crazy price,” he said. “When the bids were opened there was a bid of 171 million euros and the developer was backed up by one of our main banks. That was just a flavor of the madness.”
The site is currently being used by a local luxury car dealer, MSL Ballsbridge Motors, to store vehicles, mainly Daimler AG’s Mercedes-Benz models.
On the northern outskirts of Madrid, near Barajas airport and the Real Madrid soccer team’s training ground, is Valdebebas, a development project under construction covering more than 10.6 million square meters of space. About 5,400 of the planned 12,500 homes have been built and another 2,100 are under construction, according to a spokesman for the project who declined to be identified by name, citing company policy. The development, which belongs to private land owners who pooled their property, is backed by banks including Banco Bilbao Vizcaya Argentaria SA and Aareal Bank AG. There are bus tours on Saturday for potential buyers, and an open house of the model homes every Sunday.
“In Spain, there seemed to be an effort to smooth out the pace of activity rather than face the shock, as Ireland did,” said Alcidi. “That means the adjustment is going to take much longer in Spain.”
At the height of their respective real estate booms, construction accounted for more than 20 percent of the economies of both Spain and Ireland. In Spain, the figure is now about 14 percent, according to Alcidi. In Ireland, the figure is just 5 percent.
Both booms also were fueled by incentives. In Ireland, the government gave investors tax breaks to build in certain areas, and granted homeowners breaks on their interest payments. In Spain, there were incentives for municipalities to approve land for development because they could keep 10 percent of all the land they reclassified. The towns would get revenue from the developments and they could use the land they acquired as collateral for loans, said Encinar.
‘Drunk on the Revenue’
About 230,000, or about two-thirds, of Irish construction jobs have gone since 2007. Home building will hit an all time low this year, with just 1 house per 1,000 people being built, compared with 15 in the 2000s, according to the Society of Chartered Surveyors Ireland.
“It was a mania,” said Parlon, the former Irish government minister who now heads the Construction Industry Federation. “You could say the government was drunk on the revenue that was coming from all the construction taxes.”
In other respects, too, the Irish are moving to deal with the overhang of vacant properties. On Dublin’s north quays lies a half-completed, eight-story skeleton of an office block. Anglo Irish Bank Corp. had planned to use the tower as its headquarters before the company’s collapse helped push Ireland toward the international bailout the country agreed in 2010.
It was constructed by Liam Carroll, one of the country’s biggest developers, who has seen many of his assets seized by banks.
The skeleton office block is “becoming a landscape photo for Ireland internationally,” Brendan McDonagh, NAMA’s chief executive officer, told lawmakers on Oct. 26. “Everybody who comes to Dublin to see us wants to see the Anglo Irish Bank building; they ask the taxis to bring them around,” he said. “It is a landscape eyesore and it needs to be dealt with.”
Ireland’s central bank has agreed to pay about 8 million euros ($10 million) for the office block, and will make the tower its headquarters, removing the most visible wound of the crash. In all, about 15 percent of Irish homes were vacant in 2011, the country’s statistics office. About 20 percent of office space in Dublin is vacant.
In places like Sandyford, NAMA is behind the rental of about 1,000 properties, as it seeks to make it more attractive to sell towers of apartments to investors. The agency is also enticing buyers for homes by effectively insuring against price declines.
‘Stabilize and Recover’
NAMA is finishing a plan to ask individual buyers for 80 percent of the purchase price at the time of the transaction and only collect the remaining 20 percent if the market value remained the same or increased by a certain amount. If the value fell, the purchaser would have to pay only part of the outstanding amount or, in some cases, nothing at all.
“The banking system is in a lot better shape than it was two years ago but there is a road still to be travelled,” McDonagh said in an interview. “What you’re trying to do is balance out and give yourself a chance for the Irish market to stabilize and recover.”
McDonagh has said the agency may end up bulldozing some of the ghost estates that litter the country. Two estates controlled by NAMA may be demolished, and the agency used laws for the first time last month to take control of a development to stop it from falling into a dangerous state.
‘Eyes on This Sale’
Others may end up at distressed property auctions run by Allsop, whose previous auctions have drawn crowds of hundreds. At one point, the company had to employ security guards to marshal bidders, and broadcast the sale to the overflow crowd watching at Doheny & Nesbitts, one of the city’s best known bars.
Now they are readying for their first sale of an unfinished estate at the Shelbourne Hotel, where the Irish constitution was drafted in 1922. The lot, in Cavan, consists of three unfinished houses and a field with planning permission for another 31 homes.
“There will be a lot of eyes on this sale,” said Robert Hoban, director at auctions at Allsop. “‘It is representative of a large number of unfinished developments across the country that people are trying to find a solution to.”
Shunned Bad Bank
Spain shunned proposals to create a bad bank like NAMA to acquire toxic real estate assets, with Economy Minister Luis de Guindos saying this week the nation won’t seek a European bailout for its lenders. Instead, authorities pushed banks to pay for the clean up by absorbing weaker lenders. Spanish banks hold about 329,000 foreclosed homes, helping to prevent steep price declines, and provide 100 percent financing on easy terms such as interest-only payments for up to three years, for buyers who agree to buy the banks’ properties.
“Banks are employing financing like a weapon of mass destruction to sell their stock and keep prices artificially high by using high loan-to-value mortgages,” said Mikel Echavarren, chairman of Irea, a corporate finance company that specializes in the real estate industry. “Today in Spain it’s easier to buy a 200,000 euro flat from a bank with 100 percent financing than buy a 150,000 flat from an individual homeowner where you have to have a 20 percent deposit.”
‘Coffee All Around’
The psychological shock in Spain stems in part from the length of the boom, which stretched more than a decade, said Encinar. After the country made the transition from the dictatorship of Generalissimo Francisco Franco, who ruled from the end of the Spanish civil war in 1939 until his death in 1975, to a modern European democracy, economic expansion and home price growth were driven by a succession of developments over the next four decades: women joining the workforce, slowing inflation, the adoption of the euro and the growth of tourism and increasing property purchases by foreign buyers, mainly in coastal areas.
Governmental authority also moved to regions and municipalities. The decentralization was nicknamed “cafe para todos” or “coffee all around,” and Spain’s autonomous communities demanded self-government and greater control over issues such as health and education, and taxes and financing. And many local governments were eager to build.
“It took 20 centuries for the center of Avila to be developed, and in the last 10 years they’ve developed twice that amount,” said Natalio Encinar, a brother of Jesus Encinar who still lives in Avila. Until demand collapsed, “the main industry here was building houses. And plumbers made more than engineers.”
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