Will European housing markets see signs of stabilisation or is there a squeeze ahead? Monika Bukowska reports
Not many European countries managed to avoid the large-scale falls in house prices in the latest recession. In previous downturns, global house prices corrected by, on average, 24% over five years, following a 50% increase over six years. This time around, house prices increased by over 120% over nearly 12 years - twice as long and more than double than in previous upturns - but have corrected much more rapidly, falling by 20% over a two-year period to June last year, which was the trough for the European housing market.
Although the extent of the fall from peak to trough is similar to that in previous downturns, house prices have readjusted more rapidly this time around. However, since June last year, we have seen ‘mini house price rallies' in some European markets, which might seem strange as the European recession was only just ending at that point.
European owner occupiers, as consumers, have been beneficiaries of generous government support over the last year, through tax cuts and a wide range of stimulus packages. In particular, interest rates have been reduced to exceptionally low levels and, in some countries, are even at historical lows. These factors have meant that a large percentage of owner-occupiers have actually benefited from the recession, boosting their disposable income net of mortgage costs. However, buyer beware - these are short-term measures. Looking ahead, there are potential triggers which could slow if not reverse these house price increases.
According to the FT European Housing index, house prices fell by 5% in the euro-zone and 3% in the wider European index during 2009. At a country level, the picture is mixed, with leaders and laggards emerging across Europe. Price falls in 2009 were most pronounced in Ireland, Slovakia and Denmark - markets that were heavily hit by the recession, and all experiencing falls in excess of 10%. At the other end of the scale, gains of over 10% were seen in Poland (where there was no recession), and Norway (an oil-resourced relatively resilient economy). Nonetheless, the turning points have varied across Europe during 2009, with the UK recovering earlier, with house prices increasing by 11% since May, while Sweden's house prices only started to recover in Q4 2009 but, by February 2010, had already risen by 9% over the year.
Housing is a political and sociological beast, subject to swings in confidence and national policies. The data are often unreliable with wide variations dependant on source. Even Eurostat has been trying for over a decade to create a uniform owner-occupied house price index to, ideally, include in the HCPI index - but with little success. National European housing markets are just not homogeneous and are compiled on different bases. A typical case is Spain where, despite official data showing only 11% falls from the peak, market evidence points to much greater repricing. According to AXA Real Estate Research, house prices in Spain have dropped by 40% from their peak, and are expected to fall by a further 5-10% in 2010, as Spain struggles with its oversupply of housing stock, with 1.6m of unsold properties on the market.
Studies have also shown that residential property is still overvalued in some markets, which might also dampen this recovery. One measure of fair value is represented by the ratios of long-term averages of house price to earnings. However, this is a crude estimate as it does not take into account interest rate movements, which alter the affordability of mortgages and can affect the purchasing powers of households.
The alternative, favoured by economists and housing advocates is to compare mortgage payments with house prices. The IMF took this analysis one step further to try to take into account the differences across countries and the cycles. Their model incorporated house price growth as a function of a wider set of drivers in each of the countries, including growth in disposable income per capita, working age population and migration, credit/equity prices, short-and long-term interest rates as well as construction costs (referred to as the house price gap). The conclusion was that house price corrections had further to run in Denmark, Spain and the UK, while house prices in Germany and Switzerland were close to bottoming and any corrections are likely to be small.
One element that has not been incorporated in the above fair value analyses are the political/regulatory risks. Housing stimulus and support packages have been very effective in some countries but might be withdrawn in the highly indebted countries as public finances come under strain. The OECD suggested in September that growth-orientated tax reforms would involve shifts from income taxes to consumption and property taxes. Exemptions from capital gains tax for owner-occupiers is the most popular measure effective in 89% of EU countries, while six EU countries introduced guarantee funds to support people facing problems with servicing their loans in 2009. There is a risk that some governments might want to temper the recent price increases by tightening incentives or increasing property taxes. Finally, closer to home, European lenders might be forced, under draft proposals from Brussels, to set aside more capital on mortgages with LTVs of over 50%.
It remains to be seen whether some of these house price rallies are sustainable, especially as we are moving into a period of below-trend economic growth, with unemployment in the medium term still expected to remain high despite reaching its peak this year. Mortgage credit remains tight, with the European Central Bank reporting a tightening in the credit standards on loans to households for house purchases in Q1 2010. This continued scarcity of credit will also limit housing demand in the short term.
It is unlikely that the momentum behind these house price increases can be sustained as affordability ratios come under pressure because of higher financing costs with interest rates expected to increase in early 2011 (if not earlier) alongside growing tax burdens. Worryingly, inflationary pressures are rising, nearly doubling since November in the EU27, while euro-zone inflation edges closer to its 2% ceiling. In October Norway was the first country in Europe to raise interest rates and then again to 1.75% in December, with the Norges Bank governor "worried" about the double-digit growth in Norway's house prices but also pointing to potentially another 100 basis point rise this year. Nonetheless, it seems unclear whether monetary policy alone can abate house price increases. A double hit of higher interest rates alongside tax increases and withdrawals of housing stimulus packages will lead to a squeeze on disposable income, which could potentially be triggers for house prices to come under pressure again, especially in the overvalued markets.
German and Swiss residential markets have reached their cyclical floor, while further corrections can be expected in Ireland, Spain and the Netherlands in 2010, and to a lesser extent the UK. Distressed opportunities are already appearing in Spain and Ireland and Denmark as these markets have repriced more rapidly. Future growth in these markets should focus on the larger affluent urban conurbations, especially at the luxury/high end of the market where there are less supply risks. In the medium term, large metropolitan areas with housing supply shortages - in particular, London, Amsterdam, Paris, Madrid, Hamburg and Munich - are likely to offer the best opportunities and will benefit from strong population growth prospects.
Monika Bukowska is senior research analyst at Axa REIM