Are house prices overvalued in Spain? A regional approach

Abstract

The collapse of the Spanish housing market during the global financial crisis highlighted the dire consequences of house price overvaluation on the real economy and the banking sector. In this paper we evaluate whether real house prices in Spain are justified by their long-run fundamentals, such as per capita real income, unemployment rate and population density. We account for heterogeneous provincial developments by using a regional dataset with an extended time span. We show that house prices were overvalued in most Spanish provinces in 2007, at the peak of the housing sector expansion, but there was substantial regional heterogeneity. By contrast, we find evidence that real house prices have been undervalued in most provinces in recent years. As overvaluation is mostly explained by high household leverage and the business cycle, it should be addressed with macro- and micro-prudential regulation of the banking system to prevent excessive credit growth.