Oxygen for a flatlining sector

New housing began this week four percent cheaper than the last. In a bid to encourage home sales and, above all, reduce the huge excess inventory being held by developers and banks, the government slashed the Value Added Tax (VAT) on new home purchases by half for the remainder of 2011. This temporary reduction comes on top of a market price drop of over five percent so far this year, said José Manuel Galindo, president of the Spanish Association of Builders and Developers (APCE).

Since the onset of the real estate crisis, prices have fallen over 16 percent, "which, after the VAT cut from eight percent to four percent, means that housing is around 25 percent cheaper," notes Galindo.

This is good news for developers, he admits, but with some caveats. For one, the measure will have less impact because of its short duration. Experts consulted by EL PAÍS agree with this appraisal (the tax authorities say that it takes approximately six months for fiscal measures to be noticeable). However, this has served as an excuse for the opposition Popular Party (PP) to jump on the tax reduction bandwagon, and if the conservative bloc wins the November 20 elections, its leader Mariano Rajoy promises to maintain the lower VAT rate throughout 2012.

Days earlier, Rajoy had promised voters that he would bring back the tax breaks for home purchases that the Socialist executive of José Luis Rodríguez Zapatero eliminated early this year.

"The time has come to use taxes to try to get the real estate sector, which is currently flatlining, to breathe again. That's the lawmaker's tool," says the new president of the General Council of Notaries, Manuel López Pardiñas.

But the political game of tax hikes and reductions being played by the government (in June 2010, it raised VAT on housing from seven to eight percent) and by the PP in its campaign promises, is far from guaranteeing the legal security that all citizens need to complete their business deals, adds López Pardiñas.

Although Economy Minister Elena Salgado did not put an exact number on the impact the measure will have, she was optimistic and said that its effect on the public coffers would be positive. But specialists consulted by EL PAÍS disagree, saying that although home sales might rise slightly, it will not be enough to make up for the lower tax revenues collected by the state.

"In the short term, it will reduce tax revenues. A 50-percent cut to VAT does not increase home sales by 50 percent," says Julio Rodríguez, former president of Banco Hipotecario de España, Caja Granada and the European Mortgage Federation.

There are previous examples of this, and one needs look no further back than last year, when a one-point VAT hike was announced, while tax breaks for home buys by households making more than

24,000 euros were axed. During the second and fourth quarters of 2010, right before the changes went into effect, there was a spike in new home sales (50 percent and 100 percent, respectively) over the previous quarter.

"The effect of those tax changes might have meant between 30,000 and 40,000 sales operations," says María Romero, a consultant at Analistas Financieros Internacionales (AFI). "It was not very relevant, but it triggered earlier purchases by people who were already planning to buy. Now the increase will be residual, because the VAT drop is temporary in nature, and the high unemployment rate (close to 21 percent) and difficulties accessing credit are restricting decisions to buy."

All in all, it is wishful thinking to say that tax incentives will bring about a quick recovery of the real estate sector and a disappearance of the glut of empty housing. The PP's housing speaker in Congress, Pablo Matos, will not venture to say how much the public deficit would rise if the government reintroduced deductions for home purchases (with retroactive effects so that "people who bought homes in 2011 do not end up being punished by Zapatero, and at the same time, do not hold back sales this year"). Yet Matos is aware that in 16 months it is impossible to absorb the more than 700,000 new homes sitting empty in Spain, according to figures by the Public Works Ministry.

It is hard to estimate how many individuals might speed up their home purchases to benefit from the temporarily lower VAT (which comes out to a 8,000 euro reduction on a 200,000 euro apartment) and how many more might decide not to buy an existing home (which pays a different tax) and instead opt for a new one. Julio Rodríguez thinks the discount could coax consumers into making between 5,000 and 10,000 additional purchases toward the end of the year, a number that bank sources raise to 20,000.

It's not much for a market that is down in the dumps. In the first half of the year, the number of home sales was nearly halved with respect to last year (going from 214,500 sales to 119,000), according to the most recent notary statistics. This sharp drop has been especially felt in new home sales, which plummeted from nearly 99,000 in the first half of 2010 to barely 38,000 in the first semester of 2011.

Without taking into account the impact of the VAT rebate, groups like APCE, AFI and the notaries are forecasting that home sales will drop by at least 30 percent in 2011. And while there is no doubt that 5,000 or 20,000 new sales will be welcome, they are evidently not the magic solution to the sector's problems.

"In order to reactivate the real estate market, we must first reactivate the credit lines that banks have reduced in an arbitrary, whimsical fashion," says López Pardiñas. And of course, there is the matter of reactivating the Spanish economy, which would create jobs and enable youngsters to leave the family home.

"It is absolutely necessary to find an outlet for the excess inventory, so that developers can go back to work and create jobs," claims José Manuel Galindo. This year, builders will undertake even fewer housing starts than last year, which was already at a historical low. That is why the APCE is asking for a stay on the four percent VAT and tax deductions for home purchases and all levels of income (not just for households making under 24,000 euros, like now) until the sector readjusts.

This is being criticized by a significant number of experts. "The government mustn't reintroduce the tax deduction. That should only be in effect for low-income earners, like it is now. The real estate sector should not have greater fiscal advantages than any other sector," says Jesús Sanmartín, president of the Registry of Economists and Tax Advisors (REAF).

"The best housing policy of all is the one that lets the market operate without incentives, and focuses all its public efforts on subsidized housing, especially the rental type, because of the flexibility it offers while taking up fewer resources, and because it focuses all its energies on the lower-income earners," says Juan Fernández-Aceytuno, director general of the Appraisal Society.

"The PP likes ownership and discriminates against rentals. It wants to increase the budget outlay for this item, when that money could be used for something else," adds Julio Rodríguez, who also fears that, "after four years of barely building any homes, this could be the little push that reactivates the invasion of the territory."

In his opinion, if the reduced VAT rate is maintained, it could also result in greater construction activity, because it will favor the purchase of new housing over existing homes (the tax on the latter is between seven and eight percent, depending on the region). Another factor to take into account is that regional governments are in charge of land planning. "This will introduce a distortion," he adds.

In order to avoid, at least for now, discriminating against second-hand homes, and also to get rid of its inventory of 8,000 homes, the savings bank CatalunyaCaixa did not even wait one week to apply the VAT discount to its future home buyers, and not only that, but it has extended the same discount to existing homes, since the housing it holds, though just like new, is the result of foreclosures and therefore its original owners already paid the VAT. Those homes are now subject to the ITP (transmission of patrimony tax), unless they happen to be sold to companies, explains Eduard Mendiluce, CEO of CatalunyaCaixa Inmobiliaria, the savings bank's real estate branch. But that is not the case, as 90 percent of the 3,500 homes it has sold and rented between January and August went out to private consumers. Mendiluce hopes that between now and the end of the year they will sell a further 3,000 homes.

"The four percent discount will generate a sales increase of 10 percent, because placing a deadline on the tax breaks has a psychological effect on people and makes them decide to buy," he says. In Mendiluce's opinion, real estate firms and banks will benefit equally from the fiscal reduction, the former because it applies directly to them and the latter because "it will help us make loans to developers more liquid."

Nevertheless, bank sources who did not wish to reveal their names said that, "it is easier for financial entities to take advantage of the cuts, since they have the upper hand. They have the inventory and they hold the key to financing."

Banks, in fact, are currently "the best developers." Of the 700,000 unsold homes in Spain, an estimated 160,000 to 300,000 (depending on who is doing the counting) are in the hands of lenders. Mendiluce considers that this figure is closer to 200,000, after the sector sold off between 30,000 and 40,000 homes last year, a figure he hopes will grow this year to around 45,000.

Overall, most sources agree it does not look like the fiscal touch-ups, both the approved ones and the ones to come, will slow down the fall in housing prices. Although the pace of decline is slowing down (an average 5.5 percent so far this year, according to the Public Works Ministry), it could reach seven percent by late 2011.

An offer here, a discount there: if prospective buyers finally take the step in the four months left before year's end, the excess inventory could go down to 676,000 housing units, according to AFI's Romero. "This level is still high and will barely encourage housing starts or job creation in the real estate sector," she concludes. Much ado about such a small impact.