By José Luis Suárez and Jorge Soley, Professors at IESE In 2007, as the first signs of the real estate and financial crisis began to appear, we all started ruminating over what had happened and what we could do about it. Hoping to find answers to these questions, many of us turned to references from similar situations in the past, such as the crisis of 1991-92, only to discover that the related literature and studies were scant. That was when we decided to embark on this new research addressing what is perhaps the most important issue of this crisis: the relationship between the real-estate industry and the financial sector (credit institutions, commercial banks and savings banks).

With this new research, which will be published as a book, our aim is to define every aspect of the relationship between credit institutions and the real-estate industry as per the economic cycle of the past few years.

Reflections on a cycle

The study comprises two main sections. The first is basically related to the expansion cycle occurring in the 1997-2007 period. There, we analyze what has happened to the Spanish real-estate market, how the financial institutions have responded, and what attitude they have adopted with respect to loans and other industry-related activities.

To do that, we reexamine both the extent to which mortgage loans have grown and the interest rates of those loans, while also evaluating aspects such as: how the largest real-estate funds were promoted or belonged to financial institutions, and how many of the real-estate appraisal organizations, while regulated by the Bank of Spain, largely depended on banks. Another issue to be addressed is the investment of financial institutions themselves, not in industry loans, but rather in equity and real-estate developments. This type of investment was conducted in very different ways, such as participation in pre-existing firms and undertaking new projects with or without partners.

The second part of the book will delve into the cycle change as of 2007. A range of issues—such as increased delinquency rates, banks repurchasing assets from their customers in order to avoid arrears, the wave of non-performing loans that took place, the real-estate properties foreclosed by banks, and the entire situation in which we currently find ourselves—will be closely analyzed by focusing on some of the key drivers of the crisis.

Finding new models

We use a diverse methodology to perform this analysis.  First, through our in-depth interviews of the industry’s main players, analysis of an extensive bibliography, historical data series published, and a review of our own previous research. But, most importantly, we are conducting a thorough exercise of reflection on the evidence found, in order to build new models that can explain the relationship (or varieties thereof) between the banking institutions and the real-estate industry.

We hope that this research will provide answers to questions such as: what context would create a more stable, less vulnerable relationship between credit institutions and the real-estate industry vis-à-vis cycles; and how can we ensure successful outcomes for loans granted by financial institutions to real-estate developers.

Although the real-estate industry consists of two major segments—development (the building and selling of new real-estate properties) and investment (which in Spain is referred to as the capital venture of investing in rental properties), our study has focused on property development and, more specifically, on residential development, that has precisely shaped the cycle we have undergone. Thus, one of the models we aim to uncover is a guide to ensuring a more controlled loan-approval process that is less vulnerable to cycles.

We also attempt to establish criteria for managing loans in the troubled real-estate industry, asking the question: What can a financial institution do upon detecting that one of its customers, a real estate developer to whom a loan has been granted, is starting to have problems?

In conclusion, this book is intended to resolve numerous question marks faced by the financial and real-estate industries, but above all we hope our efforts will provide those facing problems in the coming cycle with some solid material that will explain what exactly happened and what solutions emerged from the previous crisis.