IE Focus | By Barbara Huerta, Professor at IE Business School

Real estate promoters have been largely responsible for the crisis that has affected their sector so badly, and now they are finding out exactly where their business plans went wrong.´Own less to owe less´. With these words, Rafael Santamaria, CEO of Reyal Urbis, summed up his new business strategy at the end of 2008. The liquidity shortage and extremely high debt payment commitments meant that all real estate companies in the country had to let go of their assets. But how did this change in fortune come about in a sector that was heavily in debt only two years before taking on ambitious corporate projects? With a view to answering this question, I did a research project that led to my writing the book Promotores de la Crisis (Promoters of the Crisis) (Lid). In the book, I analyse the impact of the international financial crisis on the financial system and real Spanish economy and its impact on leading Spanish real estate businesses. 

When did they start to blow air into the real estate bubble and why? Everything began with a positive macroeconomic environment, low interest rates and consumers who wanted to consume. But could such an illusion ever have been maintained indefinitely? We would soon see that it couldn´t. Those responsible for the monetary policy, albeit somewhat late, took measures to prevent overinflation by upping the interest rates. What would happen when the higher rates translated into an increase in the financial burden on homes and enterprise? The highest rates reduced the amount of income available to families. In addition, from mid-2007, families that were overwhelmed by the credit crisis started to encounter difficulties in obtaining mortgage loans and consumer credit. Liquidity was short, prices were still high, there was a general lack of confidence and the outlook for the deceleration of the construction and real estate sector was less than optimistic. 2008 confirmed expectations: the situation was getting worse.

The supply of homes in Spain had grown spectacularly between 2001 and 2007. The first consequence was a drastic price adjustment in the midterm, especially in the residential sector. The shortage of credit would contribute to promoting the downward trend of construction in Spain and property prices. The bubble was beginning to deflate.

How did businesses in the sector react? If we had to point to any one financial characteristic of Spanish real estate businesses over the last four or five years, it would be their high level of leverage. Many believed that the high debt resulting from corporate and business takeovers would never be paid in the short term, but rather renegotiated so that a few more years of market expansion would finally settle the debt. The collapse of property prices broke down business plans and credit restrictions prevented renegotiation of repayment periods. Real estate businesses drowned in their own expansion plans. 

The higher level of debt was supported and encouraged by the banks themselves. Banks were the main drivers of the real estate boom of recent years. The capacity for reaction of the real estate companies when the crisis reared its head in the sector was very limited. The high debt that appeared on their balance sheets, together with the continuous losses suffered for more than a year, damaged their assets and threatened solvency.

The strategies implemented by the real estate companies to mitigate the impact of the crisis on their balance sheets were similar. They were all convinced that land would not be the best investment for the coming years and put their land portfolios up for sale, speeding up the drop in prices even further.

And now what? The answer is complex, but unorganised growth and financial imbalance will take its toll on businesses in the sector over the next two years. Measures such as the sale of assets could be an alternative in the short or mid term for real estate businesses. But where are those low-profit assets going now? The current situation shows that they are mostly on the balance sheets of banks and financial institutions and, rather than disappearing, the risk has been transferred. 

Will we have learned anything from the past? All we can do is trust in entrepreneurs’ sense of responsibility. That´s why it is of key importance to ask and answer the following question: will any of us ever get rich by selling each other increasing expensive homes financed by mortgages?