Vol 5 (2008) - Issue 5

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The Spanish Construction Crisis and the Financial Institutions

For almost a decade, Spain’s economic boom has been strongly supported by the construction industry. There are various reasons for this: the Spanish culture of property ownership rather than lease, the boom in retired people seeking sunnier places to live and the demand for new houses due to the population increase caused by a significant influx of immigrants who, very soon after their arrival, become ‘contaminated’ by the Spanish property culture and also want to own their own houses.

This has meant good times for developers, constructors and real estate agents, with annual increases in earnings of over 30%. Real estate investments have been more attractive than any other, particularly compared to the stock market. Banks were reluctant to be excluded from such profitable business and the situation meant that they breached some of the traditional rules they had always followed when lending money to land promoters and constructors. The main rule that was breached was that a land developer would always finance the acquisition of the land with its own resources and the banks would only finance construction.

Banks began to finance 100% of developers’ land acquisitions and offer mortgages to house buyers covering 110% of the transaction cost. In a market where the rise in the price of land and real estate seemed to have no end, this was an easy game and no bank wanted to be left out. Companies became highly overindebted, owing to banks billions of euros, but no-one seemed at all concerned by it.

In late 2006, concerns were raised about the viability of such a model, and experts began to predict a soft landing for the construction industry. It was estimated that the market would take two to three years to absorb the excess construction and prices would fall by no more than 10%, but that there would be no crisis. This was wishful thinking indeed.

The market would probably have suffered more than predicted, but then the American subprime crisis occurred and, although Spanish banks did not seem to be seriously affected, they started having difficulties raising finance on the international markets and suddenly, almost from one day to the next, they started to refuse to finance land acquisitions and to reject mortgages for more than 60 or 70% of the purchase price. This provoked a situation in the market where there was a demand for new houses but banks refused to finance it. At the same time, banks started to ask construction companies for repayment of their loans.

The crisis had arrived. Developers could not raise enough cash from sales to repay their enormous debts, and at the same time had to halt projects that were already under construction. Faced with this situation, companies urgently needed to renegotiate their huge debts with financial institutions.

However, not all of them succeeded in doing so, either due to lack of viability or because they started moving when it was too late.