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Some reflections on the economic and real estate panorama in Spain31/08/2020

Vicenç Hernández Reche / Economist. PhD in Economic Psychology / General Manager of Tecnotramit and Treshabitat

At the beginning of the year everything indicated that 2020 would be marked by a sharp slowdown which, with the right actions, could avoid a recessionary scenario. But the COVID-19 attack has been an exogenous shock of supply and demand until now unknown, of indefinite duration, without precedent and with a strong impact on the health of people that will undoubtedly remain engraved in the memory of an entire generation. Furthermore, it is a global crisis and therefore not focused on a particular geographical area, which would allow other areas not affected to show economic and financial solidarity. Fiscal or monetary measures require strong and solid public and private leadership, as well as more imaginative solutions with little track record.

The prospects are therefore not at all promising. Commodity prices are expected to fall completely, capital movements and above all, international investment will be reduced at high rates.  The value chain relocation processes carried out during the last few years will have a return ticket, protected by trade wars and economic protectionism policies that will aim to embrace each of their national flags.

Mixing health and economic aspects does not help to resolve them. Firstly because finding a solution that balances the moral obligation to save human lives with the responsibility to manage an economy that can lead to social conflict is not a trivial matter. Moreover, from the health point of view, it requires no less time for research and from the economic point of view, the operations diagram for converting the vaccine into a mass solution that gives results and is capable of reaching everyone is full of obstacles.

For those adept at saving the economy above all else, their argument rests on the valuation of human life centred on the concept of opportunity cost.  In this way a person is worth his or her capacity to generate productivity in the future updated today.  Under this criterion, the life of any retired person or those with incapacity to work should not be saved, and therefore this criterion is not acceptable from an ethical and moral point of view.

All these complexities require, as I mentioned earlier, imaginative, and innovative solutions aimed at saving companies with viable business and liquidity problems, on the one hand, and allowing final demand not to
lose levels of consumption and savings.  These solutions are still part of monetary and fiscal policy mechanisms, but both options were already being used before Covid-19, generating a sharp increase in public debt levels. Once immersed in the crisis, more public expenditure commitments are being made as well as additional efforts by the main economic authorities to provide unlimited liquidity. But all this monetary overstretch will have consequences that will have to be compensated for by future austerity that will not be to anyone's liking, since managing - and repaying - the debt as well as trying to regain monetary balance are matters that will have to be on the table of the competent authorities sooner or later.

Therefore, the forecasts for the beginning of the year are going down the drain and we are facing a deep recession that will affect the vast majority of economies. There are indeed some optimistic scenarios for recovery - not fast as the timing is exceedingly difficult - but strong. However, until this happens we are going to move in scenarios dominated by fear of possible resurgence and a worrying uncertainty derived from business results and the unemployment situation which will lead to a strong contraction in income.

This reduction in income can only be addressed in two possible ways. Either production is affected or resource prices are affected. In the first case, a large part of the population could maintain its level of income but would have to compensate the rest who would inevitably become unemployed, and therefore suffer a drastic drop in income. This compensation through social transfers may not be sufficient to counteract the frustration of a crisis that combines economic and health misfortunes, so the risk of social tension is quite high. In this case, establishing more rigidities in the labour market is highly corrosive.

In the second case, and with the ultimate objective of maintaining employment, all members of the country’s productive activity should accept a proportional drop in their income through a reduction in dividends, real interest rates and, of course, salaries.   This would entail a number of consequences in terms of tax collection since, in the case of wages, taxes directly on labour as well as social contributions would be reduced accordingly, with a subsequent reduction in the social consideration for citizens. But considering the mismanagement of public resources there is much room for improvement in terms of efficiency. If we consider the current high unemployment rate and the crippling effect on wages in Spain, it seems that this second option is the most plausible.

The downside of this solution is that for this second option to be implemented in perfect conditions, a flexible labour market and a leadership independent of political colours that leads the negotiations between employers and trade unions are needed on the part of the public sector. For its part, the private sector must demonstrate exemplarity in the remuneration policies of companies in which the remuneration of many managers and boards of directors is not strictly
moral (which is highly debatable) but absolutely illogical in view of the company’s business results and asset situation.

At the property level we must analyse different aspects.

As far as the recovery of the real estate activity is concerned, there is much talk of a U or V shape recovery, there are even more pessimistic voices that consider an L shape recovery. My opinion will be that we are going to live in a more or less optimistic present moment, in which we will be tempted to think about an immediate recovery due to a demand that has been restrained during these months. There is a percentage of the population who have not lost their jobs and do not anticipate short-term risk, and additionally during the confinement they have had time to make decisions regarding a change of house or mobilise their capital in search of a return without the volatility of other asset types. But that demand is short lived and the reality of a W will come, which will not be symmetrical in shape, as the peak will not be too high, but will produce a second, longer, less steep drop.

There will be a greater demand for it in the wake of this pandemic.  Aspects related to the layout of a terrace or garden, or simply in relation to the size within the circumstances of each family will be important and may lead to decisions to carry out reforms to adapt the properties to new needs.  There will be a greater predisposition to move to areas that are further away from large metropolitan centres and that allow for greater comfort and a higher quality of life, as long as the option of teleworking is adopted as a valid option. Again, making the company incur more additional costs will not help to promote this measure.

With regard to rents, there is still an imbalance between supply and demand, the latter being much higher.  Large investors and property developers are focusing their investments on Built to Rent, but as always, the qualitative aspect will be important and not all housing will have the capacity to generate rental income that can make the investment profitable. But there is no doubt that this is a very valid trend and that made with good prior information on market demand it can be a good option for the private sector to expand the supply in the rental market. Public-private collaboration and less political interference than has been shown so far in price control will be key to bringing affordable rental housing onto the market. Policies cannot be made to favour tenants while demonizing landlords. Restricting supply raises prices and incentives must be put in place to allow empty housing stock to be brought onto the rental market.

The large investment focuses are being avoided in the retail, hotel, and office sectors, taking refuge in the residential sector, which has a greater capacity to recover profitability via rent.  Another major beneficiary of the investment will be the logistics necessary for more local distribution in the field of ecommerce to the rise of this system of purchase. This type of investment requires higher volumes, so there will be investment vehicles related to crowdfunding and collective investment
to give access to small and medium sized investors. But we must not forget that the country will be less attractive due to the increased attractiveness of other geographical areas due to market momentum and the price situation, and on the other hand, political interventionism that makes large investors insecure.

The granting of mortgages will be more restrictive and there will be an increase in arrears due to the unemployment situation. This level of unemployment will mean that the next 3 years will see new NPL portfolios in the market and an increase in mediation processes. All this will generate a dynamization of sectors related to the outsourcing of services as well as new players in the market offering alternative financing options.

Many flats bought at high prices while waiting for rents that would allow for a good return are going to be left without tenants due to the decline in tourism. This conversion to traditional renting will push the price down, firstly because of the nature of this type of renting whose rents are lower, and secondly because of an increase in the supply of rent. This will also affect the buying and selling market.

If unemployment levels are high and structural unemployment is high, finding ways to support those most in need and bringing affordable rental housing to market will become a priority. This does not mean that one should not be incredibly careful with regard to the criteria for granting and maintaining aid. Support should be focused on rent and on a finite time basis for as long as the situation of vulnerability lasts. Establishing criteria that do not follow these parameters can lead to increased social tension and a slowdown in the improvement of unemployment.

There are no easy times ahead.  We may not be facing a deep crisis, but we may be experiencing a slow recovery, which could generate a serious feeling of impact on investment and consumption decisions.  But certain paradigms are going to change, especially in the way of working and interacting.

But fishermen make their day in troubled waters. There are many opportunities in the sector as the market for buying and selling will fall and prices will be adjusted according to areas, with some populations experiencing sharp falls of more than 20%. But in other areas there will be no significant price variation so the average could be around a 10% drop. Additionally, this crisis is accelerating technological innovation in the sector and the implementation of new marketing, financing, and management systems. So new players are entering the market bringing fresh air and competition that always results in an improvement for the final consumer.

We are moving from one way of living to a vastly different one, from one way of working to a completely unknown one. We do not know if the new destination will be better or worse than what we left, but for now ... let us try to enjoy the journey.