“Many families, scratching a living on badly-paid zero-security jobs, just cannot pay the sort of rents many landlords, especially the big funds, have been asking for.”
By Nick Corbishley, for WOLF STREET:
By buying up large numbers of rental properties in Spain starting in 2014, publicly traded Real Estate Investment Trusts (REITs) — or Socimis, as they’re called in Spain — played a leading role in the country’s multi-year rental boom. They’ve also helped to lure foreign investors, particularly from Latin America, into Spain’s real estate market. But according to a new report by Armanext, an advisor for the design, structuring and incorporation of REITs in Spain, the nascent market is already beginning to show signs of fatigue.
With just two weeks left to close out the year, Spanish REITs have attracted just €2.8 billion of fresh funds, down 45% from last year’s €5.1 billion. The share of residential properties as a percent of total assets in REITs has plunged from 38% in 2018 to 26% this year, as more money has flowed into commercial real estate, in particular offices and shopping centers, which together now represent 48% of total assets. Other popular assets in REITs include shops (10.4%), hotels (7.3%) and industrial warehouses (7.3%).
The main reason for the shift away from residential property, according to the report, is the Spanish government’s recent reform of Spain’s renting laws, which includes a measure that extends the minimum duration of rental contracts from three years to five years for private landlords and to seven years if the landlord is a company. “The rental reform has affected everyone who invests in property,” said the president of ArmanexT, Antonio Fernández.
For institutional landlords like Blackstone and the different property funds it owns, the reform also makes it more difficult to evict the existing tenants of newly acquired properties as quickly as possible in order to jack up rental prices for the incoming tenants.
The stated goal of the government’s rental reforms was to temper the blistering rate at which rents were rising in the country. In the hottest markets, such as Barcelona, Madrid, Palma de Mallorca and Malaga, rents are now higher than they were even at the dizzying peak of Spain’s madcap real estate boom, having risen by 50% or more since 2013 while salaries have all but stagnated, squeezing tenants while providing juicy returns for landlords.
In 2018, rental apartment buildings were the best asset class in Spain, providing landlords with an average gross accumulated profit of 4%, according to data published by the Bank of Spain. This year it has fallen slightly to 3.8%. But that’s still almost nine times more than the amount an investor could have earned on a ten-year Spanish bond, whose yield currently languishes at 0.43%. It’s also many times more than the risible interest available on bank deposits, if any.
Since 2013, a grand total of 91 REITs have been incorporated in Spain. This year alone, 22 had their initial public offerings. Four of the 91 were delisted in the last year, leaving 87. Most of the funds are listed on Madrid’s Alternative Stock Exchange (MAB) and seven are quoted on Amsterdam’s Euronext index. Between them, the REITs hold assets worth €20.4 billion — around 4% of Spain’s rental housing stock. Their combined market cap, at around €12 billion, is much lower than the combined value of their assets — a reflection of their high debt leverage. According to the report, the average leverage ratio in the sector is 35%.
Of 87 REITs or Socimis, 44 are owned by foreigner investors, including wealthy Latin Americans looking to “diversify” their exposure away from their local economies. They are also lured by the fiscal benefits offered by Socimis. Those fiscal benefits include exemption from corporate taxation. Although Socimis’ unit-holders have to pay some tax on the dividends they receive, it’s at a much lower rate than the standard corporate tax rate. Plus, Socimis pay far less in property taxes than private landlords.
These foreign-owned Socimis currently own just over €10 billion of real estate assets in Spain. But even foreign investors have begun to pare back their spending this year, having invested just €1.3 billion, compared to €1.8 billion last year, which will turn 2019 into the worst year for foreign-owned Socimis since records began in 2015.
There’s also the fear swirling around the possible formation early next year of a so-called “Frankenstein” coalition of leftist, regional and separatist Catalan and Basque forces that could sharply hike Socimis’ tax burden. In an absolute worse-case scenario, it could ban them altogether. “We expect 2020 to be marked by… political instability, especially if [the left-wing party] Podemos is given the Housing Ministry,” said Fernandez.
And there are indications that the rental market appears to be topping out. In some prime areas of Barcelona, where the national rental boom got going five years ago, rents are already beginning to fall. “The prices hit the roof last year,” a Barcelona-based real estate agent called Toni tells me. “Many families, scratching a living on badly-paid zero-security jobs, just cannot pay the sort of rents many landlords, especially the big funds, have been asking for.”
At the national level, rents are on track to rise this year by just 1% to 2%, according to the real estate agency Fotocasa, down from annual rises of around 10% just two years ago. If rents continue to “stabilize” and the returns available to the Socimis continue to fall while regulatory and fiscal pressures rise, investors may begin to look elsewhere for opportunities. If that were to happen, Spain’s property market could lose one of the main props supporting property prices. By Nick Corbishley, for WOLF STREET.
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