Value Investing

Marathon Asset Management: Spanish Real Estate Fiesta (2007)

Marathon Asset Management: Spanish Real Estate Fiesta (2007)

Spanish real estate fiesta by Marathon Asset Management, dated February 2007. This is discussed in their new book Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002-15 we think – anyway read it below.

Over the past few years the Spanish have gone property mad

“A tree that grows crooked will never straighten its trunk” – Spanish proverb

Our attention was drawn recently to Astroc Mediterraneo, a Spanish real estate developer which IPO’d in the early part of last year to little fanfare. Even by the standards of the current bull market in Spanish equities, the share price performance of Astroc has been nothing less than spectacular. Its stock has climbed 11-fold since flotation, giving the company a market capitalization of some Eur8-9bn, which makes it the fifth largest Spanish real estate company in Europe by value. Chairman and founder Enrique Banuelos, who has a 51 per cent stake, has suddenly become one of the richest men in Spain. Management is taking advantage of this strong market performance to issue another Eur2bn of shares.

Other Spanish real estate companies are similarly hot. Metrovacesa, Europe’s largest office landlord, currently trades at 100 per cent premium to its net asset value – a pretty hefty premium to other European property companies, although one partly explained by a battle for control of the company between its two largest shareholders. Rising share prices in the sector have attracted new capital. There were four IPOs of the Spanish real estate companies last year, which equals the total number of listings in the sector over the previous four years. These stories illustrate a feature of Spain which will be obvious to any recent visitor – over the past few years the country appears to have gone property mad. Cranes abound, and every major city center has turned into a huge building site. Depending on which estimate one believes, construction comprises between 15 per cent and 20 per cent of Spain’s economic output, compared to a European average of well below 10 per cent. And though it has less than 15 per cent of Western Europe’s population, Spain now accounts for fully half of the Continent’s annual cement consumption.

One reason for the construction frenzy is that Spain has been the grateful recipient of some two-thirds of the Cohesion Funds doled out by the European Union over the past few years, alongside smaller economies such as Greece, Portugal and Ireland. This money has been spent on roads, bridges, airports and other big ticket infrastructure projects. As the Spanish share of the EU funds begins to wind down in favor of worthier recipients, the Spanish government plans to increase its own infrastructure budget to take up some of the slack. Then there’s the booming market for residential construction. The sheer scale of building in Spain is fairly breathtaking; some 800,000 housing starts a year accounting for around one-third f the new houses being built across Europe. The Spanish housing stock has doubled since 1997. This partly reflects external demand, notably the number of second homes purchased by Britons, Germans, and Scandinavians, and strong immigration. Spain’s economic boom has attracted large numbers of workers from outside the EU, and immigrants have risen from 2 per cent of the population in 2000 to over 9 per cent today.1

With confidence high and immigrants still flooding across the borders, is there any reason to believe the boom cannot continue? For a start, the rise in house prices seems to be slowing. Household debt has reached 130 per cent of disposable income, up nearly 50 percentage points since 2001 and one of the highest levels in Europe. Since Spain is locked into the euro, interest rates are well below what would appear appropriate for such a strongly growing economy. While debt service costs remain relatively affordable, there comes a point when households simply do not want to take on any more debt. Another concern is that Spanish real estate is no longer such good value for foreigners looking to buy holiday homes – many might prefer cheaper alternatives in the Mediterranean as can be found in Greece, Turkey and Croatia.

Slower housing growth would be bad news for many Spain’s municipalities, which derive a significant chunk of income (no-one seems to know quite how much) from selling building permits to eager developers. Whilst most of this is above board, this is big business with some murky dealings – when a scandal broke over illegal development in the southern city of Marbella a couple of years back, the authorities’ investigation ended with the arrest of the mayor. A country in which it seems difficult to get anyone to accept a Eur50 or Eur100 note is said to host around quarter of the entire Eur500 note issue. No doubt most of this cash is floating around the construction industry in one way or another.2

Spain’s economy has become dependent on the construction industry which employs around 22 per cent of the workforce. Unlike Ireland, the other formerly peripheral European economy which has seen very strong growth for the past few years, Spain hasn’t enjoyed anything like the same productivity gains. While immigration has kept a lid on wage rises to some extent, unit labour costs are still climbing at twice the Eurozone average, which is making Spain an increasingly uncompetitive place, especially given the lack of productivity growth. One indication of this is the fact that foreign direct investment has more than halved from 4 per cent of GDP in 2000 to less than 2 per cent in 2005 as foreign companies look for more competitive places to invest. If Spain had a floating currency, one would expect this combination of relatively high inflation and low productivity growth to be offset by a decline in the exchange rate. Spain, of course, is stuck in the euro and can’t devalue to restore its lost competitiveness.

While Spain’s economy continues to grow at well above the European average, increasingly the growth has been funded by borrowing on the part of both corporations and households. The effect of this is that Spain’s current account deficit – which measures the amount an economy consumes and invests relative to what it produces and saves – has ballooned, reaching a fairly remarkable 8.8 per cent of GDP at the end of 2006, higher even than the US is percentage terms (the US current account deficit is 6.8 per cent). In absolute dollar terms, Spain’s current account deficit is the second largest in the world, worsted only by that of the US.

As European interest rates edge upwards, servicing Spain’s debt burden is becoming more painful, and it is difficult to see how it is sustainable. A soft landing scenario is possible, but that would require a long period of below average inflation and wage growth without overly damaging consumer and business confidence, a combination which is difficult to envisage. It may well be that much tougher times lie ahead for the Spanish economy, and indeed for Senor Banuelos.3


  1. As it turned out, much of this immigration was related to Spain’s housing boom. After the bubble burst, this migration trend reversed course and in 2013 more than half a million foreigners left the country.
  2. The collapse of Spanish real estate boom has opened a can of worms, which have writhed for several years under an increasingly hostile public glare. Several of corruption scandals came to light in October 2014. That month, Spain’s bank bailout fund approached prosecutors regarding Eur1.5bn worth of apparently irregular real estate and debt operations at two local savings banks (known as ‘cajas’). At around the same time, dozens of persons were arrested across Spain following an investigation into local government corruption involving councilors, civil servants, builders and sundry others. Adding to an already turbulent month, a former Chairman of Bankia (a financial conglomerate created in 2010 out of several failed savings banks) and a former CEO of one of the cajas folded into Bankia were summoned before a judge to answer questions about a scandal involving dozens of Bankia executives – all political appointees of local parties and trade unions – who had allegedly spent millions of euros of the bank’s money, using so-called “black credit cards.” Public disgust with corruption in Spain has contributed to the rise of the radical leftwing party, Podemos.
  3. Shortly after this article appeared, shares in Astroc Mediterraneo plunged by 70 per cent in a week following an auditor’s report which suggested that Mr Banuelos had purchased property from his own company equivalent to 65 per cent of annual turnover (Reuters, 26 July 2007.)

Spanish Real Estate

Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002-15 1st ed. 2015 Edition by Edward Chancellor