Spain | Real Estate Sector Analysis

Sector Analysis. Real Estate

Building housing, a high-risk, low-return endeavor

Félix Lores

Expansión (Spain)

Spain needs more housing, but investment in the sector is not taking off. Demand remains solid, driven by employment, household formation, and mortgage rates that are stabilizing at attractive levels for purchasing. However, supply is growing slowly, and it is estimated that the unmet demand over the last 5 years could exceed 600,000 units. Investment in the sector is not increasing, largely because it is not profitable: although margins have recovered, it takes companies years to be able to build, keeping assets (land) on their balance sheets that do not generate income. Moreover, they have to finance their purchase primarily with their own resources, which puts the sector at a disadvantage compared to others that are more leveraged.

In Spain, the profitability of construction has varied significantly over time: between 2000 and 2006, it was one of the sectors with the highest return on equity (ROE); however, since the bursting of the real estate bubble, it has become the worst performer. Despite the recovery observed since 2015, current profitability remains low compared both to historical levels and to other sectors in Spain, as well as to construction companies in neighboring countries: in 2023, the sector's ROE was only 3.1% compared to the 16.6% observed on average for German and French companies during the 2000-2023 period. This is important because economic literature points to a close positive relationship between profitability and investment.

What factors explain these differences in construction profitability with the rest of Europe? In part, this gap reflects the small size and fragmentation of the Spanish productive fabric. While large companies show ROEs relatively similar to those obtained in other countries, small companies, which are the vast majority in the sector, barely reach 50% of the profitability of similar companies in Europe.

What factors explain these differences in construction profitability with the rest of Europe? In part, this gap reflects the small size and fragmentation of the Spanish productive fabric. While large companies show ROEs relatively similar to those obtained in other countries, small companies, which are the vast majority in the sector, barely reach 50% of the profitability of similar companies in Europe.

To be more specific, ROE depends on margins, asset turnover, and the weight of equity versus external financing. Regarding the former, the increase in prices in recent years has allowed for a recovery after a long period in negative territory. In any case, the increase in costs associated with the rising prices of raw materials and labor keeps them around the average observed in the rest of Europe and below that observed in the period prior to the global financial crisis.

Therefore, the differences in profitability are explained by the other two factors. On one hand, with 2023 data, the value of sales would not reach 40% of that of assets, while in other countries they represent 80%. On the other, companies in the sector have deleveraged considerably and show levels of debt relative to equity up to 60 or 70% lower than those observed in the rest of Europe.

The common explanation for both gaps lies in the slow promotion process. The procedures to turn land into buildable land are long, costly, and often uncertain, with a complex chain of authorizations distributed among different administrations. Each delay increases financial costs and reduces the viability of projects. Financial institutions are reluctant to support projects that may remain blocked for years without certainty about deadlines or returns. Thus, developers are forced to take on more risk with less margin.

The consequence is an accumulation of land on company balance sheets that does not generate value. These are idle assets that tie up resources and reduce debt capacity. In a capital-intensive sector, this immobility acts as a brake on investment.

The challenge is not minor. Without an environment that allows companies to invest with predictability and reasonable returns, supply will remain limited and prices strained. Spain needs more housing, and to have it, conditions must be created so that investing becomes profitable again. Because as long as building remains a long, uncertain, and costly process, capital will continue to seek other destinations and the market will be trapped in its own imbalance.

LEGAL NOTICE

This document does not constitute an "Investment Recommendation" as defined in Article 3.1 (34) and (35) of Regulation (EU) 596/2014 of the European Parliament and of the Council on market abuse ("MAR"). In particular, this document does not constitute an "Investment Report" or "Marketing Communication" for the purposes of Article 36 of Commission Delegated Regulation (EU) 2017/565 of April 25, 2016, supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organizational requirements and operating conditions for investment firms ("MiFID II").

Readers should be aware that in no case should they take this document as a basis for making their investment decisions, and that the persons or entities that may potentially offer them investment products will be legally obligated to provide them with all the information they need to make this decision.

This document, prepared by the BBVA Research Department, is for informational purposes and contains data or opinions referring to the date of the document, of our own making or coming from or based on sources we consider reliable, without having been subject to independent verification by BBVA. BBVA, therefore, offers no guarantee, express or implied, regarding its accuracy, completeness, or correctness.

The content of this document is subject to change without notice depending, for example, on the economic context or market fluctuations. BBVA assumes no commitment to update such content or communicate those changes.

BBVA assumes no responsibility for any loss, direct or indirect, that could result from the use of this document or its content.

Neither this document, nor its content, constitutes an offer, invitation, or solicitation to acquire, divest, or obtain any interest in assets or financial instruments, nor can it serve as a basis for any contract, commitment, or decision of any kind.

The content of this document is protected by intellectual property legislation. Its reproduction, transformation, distribution, public communication, making available, extraction, reuse, forwarding, or use of any nature, by any means or procedure, is expressly prohibited, except in cases where it is legally permitted or expressly authorized by BBVA on its website www.bbvaresearch.com.