International real estate markets: low interest rates drive prices and risks of a correction higher

The international real estate markets have posted a very patchy performance over the past 10 years. In 2007 the incipient financial crisis interrupted the dynamic upside movement charted by many housing markets. Sharp downside price corrections followed in Great Britain, Ireland, Spain and the United States. While countries such as Finland and France were also hit by the crisis, their real estate markets more or less managed to sustain the levels they had reached. Prices remained stable in Germany, Austria and Switzerland as well. But these countries had not experienced the widespread rise in prices that occurred during the mid-nineties. The housing markets in Australia, Canada, New Zealand, Norway and Sweden, by contrast, bucked the crisis: apart from a few minor setbacks, property prices continued climbing unerringly and at a rapid pace.

 

But what is the situation in the international housing markets right now? Are low interest rates once again leading to a collective price boom? They have at least played a part in putting an end to the era of falling property prices. Almost all markets have returned to the growth zone. Only in Italy are housing prices still falling. Slightly positive growth rates are to be seen in France and Spain. At the other end of the scale, Canada and New Zealand are already chalking up double-digit growth rates again. Just behind them are Sweden, Great Britain and Austria with high single-digit price increases. These are followed by several countries with a strong – albeit not quite as pronounced – uptrend in prices with growth rates in the medium single digits. These include Australia, Denmark, Ireland, the Netherlands, Norway, Portugal, the United States and Germany. Indeed, the housing market in Germany is currently experiencing its strongest price increases since reunification.

Despite all the differences between the individual countries two factors may be identified as important drivers for the rising housing prices. The first of these is the substantial population growth. While the population count is stagnating in Germany with its comparatively slow property price growth – apart from the increase caused by immigration – in many countries it is increasing fast. This is reflected in a high level of demand for housing and correspondingly steep price increases, as is the case in Australia, Canada, New Zealand, Norway and Sweden. Unlike the broad range of population growth rates, the development of the second key price driver – the continuing fall in interest rates – is far more homogenous: interest rates have fallen in the past ten years by around three to four percentage points. However, at the international level there is a yawning gap between mortgage loan interest rates: in Germany they are lower than two per cent; Australians, by contrast, have to “cough up” over five per cent. But the effect of falling interest rates is now likely to fade. Bond yields have already risen somewhat. Another sign of this is the 25 basis points increase in the federal funds rate decided last December by the US central bank. Admittedly, the ECB is still a long way off taking such a step, but further interest-rate cuts are also unlikely in the euro area.

However, it is not bad news that the price uptrend is now flattening off. After all, house price-to-income and price-to-rent valuation ratios have increased – in some cases to very high levels – above all in countries where prices are still rising. This applies especially to Norway, Belgium, France, Great Britain, Australia, Canada, Sweden and New Zealand. The risk of a price correction in overheated property markets often goes hand in hand with a very high level of household debt. This combination can unleash a dangerous downward spiral in which financially overstretched households push prices in the property market lower and lower through fire sales. Whereas the risks of a correction have increased as a result of low interest rates, counter-measures have become more difficult. For this reason, the authorities are increasingly resorting to macroprudential measures in order to increase capitalisation requirements for banks or to tighten lending standards. The prerequisites for this were put in place in Germany shortly before the turn of the year. However, there is hardly any experience regarding the efficiency of such measures.

To sum up, international real estate prices will no doubt continue to rise in 2017. However, the pace at which they rise will probably be curbed by stable to slightly rising interest rates and the increasing use of “credit brakes.” So while the risks in the international property markets will not be reduced for the time being, they will no longer be increasing as much as in the past. The ideal case for the future would be a “soft landing”: appreciably slower price growth as a result of which the high valuation ratios could gradually be reduced over time. By contrast, ongoing sharp price rises would only increase the potential magnitude of the fall for the market.

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