August 1, 2011

The financial and economic crisis had its origin in the US housing markets. However, up until 2007 there were serious distortions also in the performance of the European housing markets which, in many countries, culminated in sometimes substantial declines in house prices. Since then, the pattern of recovery has been uneven. We can roughly distinguish between three dynamics.

At first glance, the price dynamic in Europe’s housing markets offers impressive confirmation of the bon mot: “You only recognise a bubble after the event.” In fact, there is a close negative correlation between house price growth since summer 2007 and the trend in the years leading up to that date. The stronger the uptrend had been in the boom years, the heftier the price correction in the course of the financial and economic crisis.

Of course, this approach oversimplifies the matter. The problem becomes apparent if one takes a closer look at the price trend in the individual countries, and specifically in 18 countries of Western Europe. We can roughly distinguish between three differently performing groups: the first group includes countries in which the economic crisis had little or no impact on house prices. Among these countries one would find, for example, not only Austria, Belgium, Sweden, Germany and Switzerland, but, interestingly enough, also Portugal. Germany is an outlier in this group, of course, since German house prices slightly declined up to 2006 and did not start to pick up again until 2007. Nonetheless, Germany does belong to this group, precisely because house prices there were not dragged down further by the crisis, but instead have trended (slightly) upwards again since 2007. The second group comprises countries in which the crisis only led to a substantial slowing of house price upcreep or in which house prices have now almost returned to their pre-crisis levels after having suffered temporary declines. Think here of France, the UK, Italy and the Netherlands, for example. Finally, in the third group of countries, house prices came under huge pressure and prices there are still falling. This group includes Spain, Greece and Ireland.

Now, real estate markets are regional markets. When making investment decisions it is not enough to merely identify country groups. Instead, the investor has to focus on local and of course also property-specific aspects. Nonetheless, this highly aggregated view does allow interesting conclusions to be drawn, and four aspects are important here:

First, the national institutions governing the housing markets obviously continue to play a major role. Otherwise there could not be such differences in the development patterns before, during and after the crisis. This compels risk-averse investors to seek diversification at the international level – at least as long as there is no Europe-wide harmonisation of housing policy instruments and framework conditions and as long as housing market policy remains vulnerable to rapid changes of tack at the discretion of national policymakers.

Second, people often grossly underestimate the significance of the supply side of the housing markets: while the housing stock in Portugal, for instance, was expanding before the crisis by roughly 1% per year, in Spain it was growing by 3% per year, and in Ireland by no less than 4%. Investors as well as makers of housing policy obviously considered these differences to be warranted or – worse still – unimportant for much too long.

Third, in the course of the crisis there were increasing calls to attach greater weight to the growth of asset prices in the context of monetary policy analyses. Given the severity of the crisis, this is understandable and quite reasonable. However, an analytical toolbox is still not a proper mix of instruments. While analysis can take comparatively good account of the heterogeneity of national housing markets and their respective financing structures, this holds for monetary instruments at best to a very limited degree. This limitation also results in the fact that a Europe-wide harmonisation of housing market policy, i.e. as regards funding policy, tax policy or direct regulatory intervention, will not be able to produce the desired effects as long as there are regionally differing price dynamics.

Fourth, neither the moderate price declines in some Group 2 countries nor the corrections in the Group 1 countries offer proof that further downside risks may be ruled out there. To do so would be irresponsible since in some countries the price upcreep has already intensified considerably: in France, house prices have picked up by 12% within six quarters, and in Finland and Norway by over 20% no less. Let’s hope that in the medium term this will not take us back to the lesson of the bon mot cited at the outset.

Tobias Just (+49) 69 910-31876

 

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