The Market Seen From Street: Why is there a shortage of houses in Portugal?
The last few weeks have been "intense" regarding the discussion on the Housing Problem in Portugal.
Different perspectives, highly divergent positions, and the creation of an atmosphere of great uncertainty and mistrust between the State and Private sectors.
But then, what is the underlying problem? There is a lack of houses on the market. For rent and for sale. Moreover, demand far outstrips supply at all levels, which determines the significant rise in sale and rental prices. If there is demand and it absorbs the supply that is being added to the market, why aren't more houses being produced?
It is necessary to take into account that the Development of Residential Real Estate Projects (as well as other asset classes) results from Real Estate Development activity, which is heavily dependent on Intensive Capital. What is this Real Estate Development thing? In my opinion, and barring a better definition, it is the art of planning, coordinating, and developing all the activities and processes that enable the development of new real estate assets or the rehabilitation of existing assets, according to market needs and desired financial performance.
The need for Intensive Capital and the Long Production Cycle create many imbalances in "cash flow management", raising the business risk to a higher level. If we add the lack of labor, inflation instability, and rising interest rates, we have all the ingredients to "scare Capital" (not to mention the constant changes in the rules of the game and the consequent lack of fiscal and legislative stability in Portugal, which greatly affects Business Plans).
One thing is certain: housing production can occur in two ways:
Rehabilitation/Renovation/Recovery of Existing Assets (Residential or Other Asset Classes where the change of use is allowed) without habitability conditions - There is not a great possibility of producing on a large scale, allowing for better control of production costs and a significant increase in supply.
Construction of New Housing Units or New Construction - Possibility of building on a large scale but with a high dependency on urban planning rules completely misaligned with the current needs of the Market. In this case, the associated development cycle can be even longer, increasing the project's risk due to the behavior of demand whose needs change at a completely different pace than in the past.
According to data published on the PORDATA website (https://www.pordata.pt/portugal/fogos+concluidos+em+construcoes+novas+para+habitacao+familiar+total+e+por+tipologia+do+fogo-189), we can see that between 1995 and 2008 (Year of the Subprime) about 1,287,114 New Housing Units were completed. However, there was a sharp decline between 2009 and 2021, with only about 149,405 New Housing Units completed, meaning, for similar time intervals, there was a reduction in the number of completed units of around 88%.
It is true that the “Subprime” financial crisis brought many challenges to the sector, causing the disappearance of many companies and forcing many qualified professionals to seek other countries to continue their careers. This meant the massive disappearance of much knowledge in the art of producing houses. Furthermore, access to financing only began to improve in 2015, with the sharp drop in Euribor rates.
But it is also true that our Residential Sector has had a very positive performance in recent years, especially since 2017, attracting capital from various geographies (both demand and supply-side), becoming Global and a reference at the European level in terms of performance. Off-plan sales (or "upfront sales") broke all records, allowing some Business Plans with shorter margins to be successful.
It should be noted that the focus of Real Estate Developers has been the development of Residential Projects for a medium/high segment. This reality indicates a behavioral change in Developers, "fleeing" from a segment more exposed to economic fluctuations and betting on a more resilient "niche", with incomes well above the country's average. It is a mistake to think that the available supply is absorbed only by the International Market. The National Market has represented the vast majority of residential market transactions. That said, the "raw" interpretation of the data indicates that Residential Real Estate Development activity has lost attractiveness concerning New Construction, or Construction focused on the middle class (Large Scale Construction).
I am fully aware that I am taking my first steps in the world of Real Estate Promotion and still have many doubts and questions that I face daily. However, there is one question that has been with me since I had the opportunity to start participating in the development of Residential Projects:
Taking into account the “realities” of our market (Bureaucracy, Tax Burden, Legislative Instability), does developing Housing for the middle class pay off the risk involved? The answer seems simple. There is a clear imbalance between the Risk/Return ratio.
According to Eurostat (https://ec.europa.eu/eurostat/web/products-eurostat-news/w/DDN-20221219-3), the average salary in Portugal was €19,300 in 2021, that is, about €1,600 per month (let's not complicate whether it is net or gross, etc.). Let's imagine a young couple (between 25 and 40 years old) with a family income of €3,200 and who should not allocate more than 30% of this amount to their housing cost, i.e., €960. What is their borrowing capacity? €270,000? Let's assume so. What can they buy with this amount?
If they have a child, they theoretically need a 2-bedroom apartment with an average area between 75m2 and 100m2, meaning they could pay between €2,700/m2 and €3,600/m2. This is assuming a perfect world where the bank finances 100%, as the capacity to create savings is very low compared to current living costs. If we check the price of land where "people want to live" and the other costs associated with the real estate development process, we quickly conclude that profit margins do not exist or are very short for all the risk involved. In the current context, it is practically impossible to develop projects for the middle class unless they are on a large scale. I am fully aware that there is a social context that must be properly assessed when we talk about Housing. It is a right of citizens according to the Portuguese Constitution. Totally agree! However, it is necessary to invest and attract Capital to develop projects for this segment. You cannot invest to lose money, or the solution would be worse than the problem.
What is the solution to this problem? Increase people's income or reduce the production costs of houses?
If I could choose, I would choose both.
Do companies have the ability to increase their employees' salaries? I believe that some organizations might be able to do so. However, I do not think that the majority have that capacity. There is a significant difference between what the company pays the employee and what effectively reaches their pocket. There is a high tax burden.
Is it expected that house production costs will decrease? It doesn't seem likely. Land prices remain too high. Construction costs will not fall back. Despite the stabilization in the price of raw materials, the production costs of materials have also increased. There is no way around it. Moreover, the tax burden is extremely heavy, as we all know, and no major changes are foreseen.
In both cases, we have a common denominator: the high tax burden. Since taxes are the only revenue for the State, I don't think they can decrease them, considering the current level of Public Debt relative to GDP. Although I do not have enough knowledge of Economics, I am of the opinion that tax relief could encourage economic growth. Mere grocery store calculations. However, I believe that the issue is not as simple as it seems when the imbalance between the active and inactive population is increasingly larger, and birth rates remain very low (because there is no money to have more children).
Lastly, I am left to address the issue in a different way. If the production costs of houses will not decrease and the average income of people who buy and rent houses will not increase either, we have to build smaller houses with quality and reduce their production cycle. It seems to me the only way to make houses where people want to live (or at least, with a "sustainable" proximity). It is not necessary to be a genius to reach this conclusion. It would be fantastic to see a reduction in the tax burden. The issue of VAT (23%) on New Construction is glaring. Some argue that reducing VAT to 6%, as is the case with Rehabilitation, would be enough to boost Investment in New Construction and increase supply levels.
Society's needs have changed. Why doesn't urban planning change? Why doesn't bureaucracy change?
Changes today occur at a completely different pace than in the past. We cannot have rigid urban plans without sensitivity to the actual needs that exist today and will exist in the future.
A profound revision is needed at the level of Urban Planning.
A profound revision is needed in the way houses are planned, designed, and built.
We need to discuss more solutions and fewer problems.
At the end of the day, if conditions are not created for investment in the Development of Housing Projects for the middle class to be attractive and properly remunerated concerning the risk involved, we will have LESS HOUSING AND MORE PROBLEMS.
Answering the title of this reflection, there is a shortage of houses in the market because the investment in their development is not attractive.
See you soon!
André Casaca
