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To better understand Spain’s economic conditions and its real Estate sector, we would need to explore the aggregate European Real Estate Market to establish a base for comparison since Spain is part of the European Market Union (EMU). Many European housing markets have seen rapidly rising prices in the last ten years. If we look at the graph to the left, Strong House Price Growth (Deutsche Bank, Dec. 2007), we can visually trace the exponential growth in prices of houses in many countries over the last 10 years.

According to Deutsche Bank (Dec. 2007), in the UK, Ireland and Spain, the leading countries in price growth, prices have even tripled. Upon further observance of the graph, we can see that there was stagnant growth in the German House market (DE). In fact German house prices actually had a negative growth of 1% over the last 10 years (Deutsche Bank, Dec 2007). Main drivers for the demand growth in the market are income and population growth. There is a close relationship between income growth of a country and the overall house price trend.

Simple supply and demand – In this sense, housing is a normal good, demand increases when incomes rise and if the supply side cannot react as quickly as the demand side, this rising demand must translate into rising prices. Interest rates, returns on alternative assets and institutional factors such as transaction costs or home ownership rates also have an impact on housing demand and house prices. The other factor that contributed to higher housing prices in EMU was the lowering of interest rates affording cheaper credit to flood the market.

As rates drop, they have a direct impact on housing demand, as the affordability of homes improves when interest rates fall. For private households the monthly mortgage payment is decisive for their ability to finance a residence. The lowered rates spurred the growth of the Flexible Mortgage System (adjustable rate mortgages). According to Deutsche Bank (Dec. 2007), empirical evidence was found that price increases were stronger in European countries with predominantly flexible mortgage contracts than in countries with mainly fixed-rate systems (graph on the left).

This bears the risk that flexible-mortgage countries will also see stronger corrections when interest rates stop declining, because affordability then deteriorates faster – Further discussion into the effects of this will resume in the section of Spain’s real estate sector. Net immigration of foreigners averaged 550,000 per year during 2002-05, equivalent to 1. 3% of the population. During these years, Spain accounted for 36% of all net immigration in the EMU. The immigrants are not just retirees from England or Germany.

Rather, they come from a wide array of countries such as Romania (11% of all immigrants during 2002-05), Morocco (9%) or Ecuador (8%). More than one-third came from Latin America. With the exception of Romania, these are countries with high fertility rates well in excess of two children per woman, which ensures a large pool of possible immigrants in the future. What contributed to this was: The law of 2000 on the rights and freedoms of foreigners which effectively made Spain an immigration country3; and, the early 2005 drive to legalize migrants.

4 Together with Ireland and the UK, Spain was one of the few countries granting full mobility to workers from new EU member countries in 2004. (These other two countries also had the highest house price growth next to Spain… greater demand due population growth). The unemployment rate plunged from 19. 5% in 1994 to 8% in mid-2007 as chart to the right shows. The upside is getting thinner as Spain’s unemployment is now only one percentage point above the Euro area average. Spain is also integrating more and more women into the labor market. According to research conducted by Deutsche Bank (Sept.

2007), – The employment rate of women had risen from 31. 7% in 1995 by more than 20 percentage points by 2006. At 53% there is still some upside potential compared to the EU-15 average of 58%. Similarly, the employment rate of 55 to 64-year olds rose from 32. 7% in 1994 to 43. 1% in 2005, bringing it in line with the EU-15 average, but still below best practice levels of around 70%. All in all, employment rose by 7. 3%. Another ingredient in Spain’s successes over the past years is the rapid improvement in the quality of its workforce (Human Capital). The average years of education of Spain’s working age population surged from 7.

3 years in 1990 to 10. 6 years in 2004 – the fastest increase of any EU country. About 38% of young Spaniards complete tertiary? Education, twice the share of those in the range of 45 to 54 years (see chart on left). The young people entering the labor force will therefore continue to be much better educated than those leaving it, enabling the average level of education to rise further. The third ingredient in Spain’s economic success is its rapid opening to the rest of the world – first to the EU, then to Latin America and now increasingly to Asia – complementing and adding to the migration flows that were previously outlined.

In general, increasing exchange with foreigners allows countries to specialize and to apply ideas and technology from abroad, thus accelerating learning. The fourth factor, though less significant in the past than it will be in future, is innovation. The 2006 Summary Innovation Index (SII) by the European Commission puts Spain behind Italy and the Czech Republic with a particular weakness in entrepreneurship and lifelong learning. Spanish patent applications are just one-tenth of the EU-15 average. Chart above illustrates the Spain’s position among the EU – located in the trailing quadrant. 5

The main driver of Spain’s economic success was the service sector. According to the pie chart to the left, Deutsche Bank Research (Sept. 2007), services accounted for 73% of value added in 2006. The construction sector (comprising residential, public and commercial construction) contributed 16. 5% to the volume increase – but not the main driver of the economy. Real estate services contributed significantly to the rise in service sector value added – due to the higher housing capital stock mentioned before that allowed more consumption. Energy & Industry bringing the rear of the contribution scale of 2. 5% & 7. 2%.

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