Residential Finance: The Spanish revival

Residential development in Spain is back, with banks again willing to provide finance and reckless lending a thing of the past. 

Cranes on the skylines of Spanish cities, such a prevalent feature a decade ago, are returning. With housing demand picking up, Spanish developers are once more establishing pipelines and breaking ground at a quickening pace.

The resurgence of the Spanish residential sector has been underpinned by increased investment – up 117 percent year-on-year by the end of September, from €543 million to €1.18 billion, according to JLL.

Most of this investment has occurred in the country’s major cities and particularly in areas close to their historic centres, says José Juan Martín, CEO of Spanish residential developer Aelca.

There is still some way to go before new starts rival levels seen before the global financial crisis. New-builds are expected to reach a volume of 80,000 by the end of 2017, following minimal activity in the previous three years. However, this is far from the peak before the crisis, when an average of 600,000-plus houses were built annually from 2004 to 2008.

The increase in new-builds is seemingly warranted. As Spain’s economic environment continues to recover following the crisis, housing demand is looking increasingly healthy – global broker CBRE forecasts between 120,000 and 140,000 new homes annually for the next two years. Crucially, the country’s banks are increasingly willing to do their part, believing now that they are participating in a market recovery.

“The sector is being propelled by the tailwind of positive economic indicators,” says Juan Pedro del Castillo, residential financing director at Bilbao-based bank, BBVA, adding that most developers they are engaging with have business plans on well-located sites from which they can see potential demand for the next four to six years.

Also, critically, the indiscriminate lending practices seen before the crisis have not yet returned, Real Estate Capital’s sources say. Indeed, BBVA’s observation of banks selectively financing only projects in locations with tested demand and proven pre-sale levels is commonplace. Furthermore, Spanish banks currently require significantly more equity injected by developers than before.

They also have less appetite for financing land purchases. “Spanish banks are currently more active in construction financing, since it represents less risk,” says Arturo Marín, responsible for strategic analysis at Sabadell-owned real estate unit Solvia Real Estate. “Banks are not financing land actively, as they have already large stocks,” he adds.

The legacy of the banking crisis, including the failure of Banco Popular, which struggled under the weight of €37 billion of non-performing property assets left over from the financial crisis, looms large over the industry. The last Spanish housing crash hit domestic banks hard. In June, rival bank Santander acquired Popular for just €1, assuming in the process a distressed portfolio heavily weighted towards land assets, accounting for €12.6 billion of the balance.

Although banks have reduced “significantly” their lending towards land purchases, there is still some activity to finance land, especially through deals in which banks want to offload their land stocks, Julián Cabanillas, chief executive of loan servicing firm Servihabitat, notes.

“In these cases, the financing sometimes takes the form of a deferred payment that will be made when construction is finished, or a swap that transfers the land in exchange for the future finished product, or maybe a partial financing of the acquisition,” Cabanillas explains.

Furthermore, while land is largely off the menu for Spanish lenders, exceptions can be found where some of the country’s most popular areas are concerned – particularly if planning permission to develop is already in place.

Pricing of loans to fund land provided by local banks is understood to be in the range of 6 percent to 7 percent in Madrid or Barcelona, while those against land in other areas can be around 8 percent to 9 percent.

Building costs

Competition to finance construction, on the other hand, brings the cost of debt down to as low as 2 percent. Banks are now keener to provide finance covering building costs thanks to their short maturities, usually 18 months, and the access they provide to retail mortgages.

While construction is now being financed at about 75 percent to 80 percent of the costs of works, loan-to-cost levels reached significantly higher ranges of 100 percent to 110 percent during the housing bubble.

Consequently, land acquisitions are now often financed by the developers, particularly the larger firms that are capitalised with equity from international investors. Neinor Homes is one such example. Backed by the US private equity firm Lone Star, the house builder has been buying land portfolios at competitive prices since the financial crisis and now has several construction schemes in the pipeline.

“There is a golden rule: developers should buy land with equity and fund the capex with debt. The result, in principle, would be companies [that are] not very leveraged, with the ability to face the following cycle in a solid position,” says Juan Velayos, Neinor Homes CEO.

For Velayos, this is the “healthy model” that other residential developers should follow. Those with their own means to buy land will be the ones to survive in a market heading towards consolidation, he notes.

“As companies grow and their balance sheets become more sophisticated, we will see new financing formulas, such as convertible bonds. Obviously the bigger a balance is, the more room there is for debt,” Velayos explains.

Investment bank JPMorgan’s €150 million bridge loan to accelerate Neinor Homes’ Spanish land acquisitions highlights this capacity to bring debt financing into play from major developers. The two-year loan, written at an annual all-in cost below 450 basis points, is allowing the developer to bring forward its land acquisition programme for residential developments, initially scheduled for 2018, to the last quarter of 2017.

However, without comparable funding sources, Spain’s smaller developers face domestic banks’ aversion to providing land financing. Their alternative credit stream comes from the sector’s alternative lenders – namely more expensive loans from debt funds. In December last year, for instance, Spanish developer Qubait sourced a credit line of €60 million from US fund Avenue Capital to buy land to build 1,700 houses in Madrid and nearby throughout 2017.

“Debt funds are taking advantage of the gap between supply and demand for land financing to position themselves in a market that is becoming increasingly active,” says Alberto Segurado, JLL’s director of debt advisory in Spain.

He also points out that many of these debt funds are now beginning to see the possibility to offer, in a single debt package, lending for land purchases and funding for building costs – taking on the function of the traditional banks.

“Alternative financing is more ad hoc, depending on the needs of the developer. [Debt funds] can leverage more and even part of that loan payment can be linked to a percentage of sales,” Segurado says. Through residential development deals in the Spanish market, debt funds are understood to be targeting an IRR between 10 percent and 15 percent.

Spain reached an all-time high of 762,540 new houses in 2006, more than Germany, Italy, France and the UK together that year. A year later, José Luis Rodríguez Zapatero, the former Spanish prime minister, boasted that the country had joined the “Champions League” of world economies. Those times did not last long and one burst property bubble saw Spain’s banks saddled with hundreds of billions of euros of toxic real estate assets on their balance sheets.

Green shoots of recovery are clearly visible in the country once again and the signs are that while the banks want to take part, they will endeavour not to repeat the mistakes of the past while letting other lenders share the risk in building a national housing supply that meets its growing demand.