The ECB believes that the rate hike may cause a greater fall in house prices than on other occasions

House prices have risen extremely sharply in the euro zone in recent quarters. Although the trend is long overdue, demand gained traction after the covid crisis, with prices advancing at year-on-year rates of 0. This demand for housing has been supported, among other factors, by interest rates that have remained at down for years. Now the situation is drastically reversing. The European Central Bank returned rates to positive territory in a single movement in July, while e. This is leading to more expensive mortgages, which has historically been the prelude to a correction in house prices.

The ECB economists Niccolò Battistini, Johannes Gareis and Moreno Roma, which will be included in the central bank’s monthly report, in which they analyze current trends in the housing market. These experts do not hesitate to warn that, historically, increases in mortgage rates have triggered corrections in house prices.

In addition, on this occasion there are two factors that could aggravate this correction and one that could partially cushion it. The two aggravating factors are the low starting level of interest rates and the high valuations of house prices (both interrelated). While the buffer would be the higher value that families seem to give to housing after the covid-19 pandemic.

These authors begin by putting some context to the trends that have dominated the real estate market in recent years: “Mortgage interest rates have increased significantly since the beginning of 2022 in the euro zone, after hitting an all-time low in 2021. During For the past two years, the euro area property market has been buoyant and supported by favorable mortgage costs… However, mortgage rates have risen significantly (by 63 basis points) in the first half of this year, the largest semi-annual increase ever recorded”, explain the ECB experts.

According to the ECB’s own data, the average interest rate being paid in the euro zone for a mortgage loan has gone from 1.33% in January to 2.15% in July. This jump, , is greater than the one commented on in the ECB report, which only collects the data up to June. However, including the July rate, the mortgage rate has rebounded by 83 basis points. But the worst may be yet to come, since .

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What happens when rates go up?

The rate hike has not yet had a notable impact on the economy (credit does not dry up overnight and companies do not stop investing from Thursday to Friday), but the year is done. Last week, Luis de Guindos, vice president of the ECB also (after years of price increases): “Since the beginning of the year, the responses to household surveys on the intention to buy a home have decreased and the banks have reduced their expectations on the demand for mortgage loans, which points to a greater potential for a correction in housing prices,” it warned.

The analysis published this Monday by the ECB economists goes along the same lines: “Empirical evidence suggests that the dynamics of the real estate market is very sensitive to mortgage rates… According to the estimated model, an increase of 1 percentage point in the All other things being equal, the mortgage rate leads to a drop in home prices of about 5% after about two years.However, the same percentage point increase in the mortgage rate has a greater impact on investment in housing, leading to an 8% drop after about two years.

In addition, the impact this time could be even greater because the starting point for house prices is high relative to its fundamentals and the starting point for interest rates is very low. “The impact of rising mortgage rates on house prices and housing investment is greater in an environment of low interest rates suggests that the lower the level of mortgage rates (until this year they were at record lows ), the more sensitive house prices are to changes in interest rates, because lower mortgage rates lead to larger discount effects on rents and future prices.

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“The results of this nonlinear model show that, in a low interest rate environment, the estimated decline in house prices and housing investment in response to a 1 percentage point increase in the mortgage interest rate is approximately 9% and 15%, respectively, after about two years,” ECB experts warn.

The other key catalyst for this price correction is the high valuations that are starting in this new scenario. So many years of low rates have been noted and home prices have risen steadily. An investigation by the European Commission highlights this increase since 2010, emphasizing that the cost of buying a home has risen by 45%, while the increase in rents has been an average of 17%. The market changed in 2015 (rates start negative), when the price of home ownership began to rise much faster than the cost of rent. That trend has continued ever since, with the gap widening significantly over the last four years, according to the study.

These increases have caused the average house in the eurozone to be overvalued by almost 15%, and up to 60% in some countries, according to ECB estimates based on the relationship between house prices and income. The European Commission states that the cost of housing has increased in 24 of the 27 Member States since 2010.

The hot spots are Estonia -where prices have shot up 174%-, followed by Hungary (152% more) and Luxembourg (131% more). Prices have doubled in seven Member States since 2010. The only EU countries where house prices fell were Greece (23%), Italy (10%) and Cyprus (8%). But Greek property prices are still well above where they were in 2018, following sharp rises during the pandemic.

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shock absorbers

However, there are also buffers to this trend. The three ECB economists ask to look at more ‘human’ factors that can also influence this evolution of house prices. In their analysis, they highlight the influence of the pandemic on changes in people’s preferences when buying a home.

“In the aftermath of the pandemic, households seem to place more value on more spacious properties that allow work from home and find locations further from the office more attractive. Preliminary data points to a higher rise in single-family home prices since the pandemic in some of the eurozone countries for which data are available In addition, eurozone prices have risen the most since the pandemic, and the share of the region’s population living in single-family homes increased in 2020 “, they point out.

His thesis is that this preference for homes with more space could also support investment in housing and thus “counteract the increase in mortgage rates and in the housing market in the eurozone.”

Among other factors, they add, the attractiveness of housing for investment purposes is likely to decline, given the relative stability of rental yields compared to the rise seen in bond yields. However, they conclude, “increasing inflation, which tilts portfolio allocation towards ‘real assets’ such as housing, could partially mitigate this effect.

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