European House Prices: Time For Regulators To Hit The Brakes?

Eurozone housing pricesGermany housing market

Scope Ratings | European house prices increased on average by 6.2% in 2020. That was twice the annual rate of the last decade and even higher than growth in the economically very favourable last five years.

Given that economic fundamentals only partly justify price increases, the sustainability of these growth rates is in question. With household income and rents only increasing very moderately during the last year, we see increased pressure on housing affordability and profitability. But while these factors and the economic outlook point to a moderation of growth rates, ultra-low interest rates, housing shortages caused partially by a construction slowdown during the pandemic, and high-income buyers so far being spared income losses could even accelerate growth.

Despite the slump in business confidence and output, our outlook on the sector remains stable. We expect construction companies to be at the forefront of the expected recovery as companies are likely to be among the main beneficiaries of government efforts – for example through the European Commission’s ‘Green Deal’. This is targeting the renovation of 35 million European buildings to 2030 to increase their energy efficiency. The increase in renovations could lead to a crowding-out of new building activity, however, as the capacity of construction firms is limited. This could further hamper the supply of new housing.

On the housing demand side, ultra-low interest rates remain the primary driver, but the pandemic may have strengthened demand, as people feel a stronger benefit in owning property during the working from home phase and also because housing may also in some cases have become even more affordable as savings have hit the roof. Typical house buyers are, so far, less affected by unemployment; additional savings will most likely be used for asset accumulation.

With pandemic house price growth often close to 10%, calls for moderating over-exuberance are increasing. Increasing insolvencies and unemployment, especially when starting to impact the relevant housing target group, have the potential to force the market into a moderation of growth rates. But other factors could delay such moderation or even accelerate current growth, at least in the short-term.

Few banks have so far amended their underwriting criteria and, in most countries, previous macroprudential measures have been reduced and/or halted. As such, this may be the right time for regulators to become proactive, else banks and borrowers might be caught on the wrong foot when the tide turns.