Capital area house prices dip in May

After a rapid rise year-to-date, house prices in the greater Reykjavík area fell 0.1% month-on-month in May. The decline is due to a 1.2% drop in detached housing prices, as condominium prices rose by 0.2% over the same period. These figures were published by Registers Iceland yesterday.

nullHouse prices can fluctuate widely from month to month, and it is not uncommon that a steady increase like that the recent term is punctuated by periodical downticks. For instance, the last decline (0.5%) was in December 2013, and the one before that was in August 2013 (0.1%). In spite of these hiccups in the market, nominal house prices have risen by a handsome 9.6% in the past twelve months. The pace of the increase has been especially rapid in 2014, measuring 4.6% year-to-date.

We forecast a continued increase

This minor drop in May does not change our opinion that house prices in greater Reykjavík – and around the country, actually – will continue to rise quite rapidly in the quarters to come. In keeping with the recent pattern, the rise will be driven by real wage growth, an improved labour market situation, population growth, and a historically low real interest rate. Growth in tourism is another contributor, as a large number of flats in the greater Reykjavík area are being rented out to travellers. Expectations in connection with the Government’s debt relief programme have also been a factor. The measures, some of which are to be implemented this year, are expected to have a positive impact on households’ economic situation.

Housing market slack vanishing

 Housing market turnover has grown in line with rising house prices in recent months. According to Registers Iceland, the number of registered purchase agreements for residential housing in the greater Reykjavík area was up 8.2% year-on-year in May. Turnover was up 11.2% YoY during the month, totalling nearly ISK 17.5bn, and 525 contracts were registered.

nullTurnover in the market totals ISK 92.4bn year-to-date, an increase of 21.6% from the same period in 2013, and the number of contracts has risen by 8.8%. The most pronounced increase in both variables has been in condominium housing, with turnover up 24.6% and the number of contracts up 11.0%. Turnover can be expected to keep growing in the near future, in line with rising house prices and increased overall activity in the domestic economy.

Both turnover and the number of registered contracts in greater Reykjavík have grown strongly from the post-crisis trough. In spite of this strong growth, the housing market is still small in historical context – much smaller, actually, than it was when the banks entered the mortgage lending market in 2004. The recent growth spurt is therefore not a sign of an incipient bubble, in our opinion, but a sign that the market is shedding the slack that has been weighing it down and is moving closer to normalcy.

Increased investment in residential housing

House prices have risen well in excess of construction costs in the recent term. Construction costs have risen 1.6% in the past twelve months, as opposed to the above-mentioned 9.6% for capital area house prices. This is a clear sign of increased returns on new residential investment, as can be seen in the upturn in housing construction.

nullAccording to national accounts data from Statistics Iceland (SI), residential investment nationwide was up 30.8% YoY in real terms in Q1 – the strongest rate of growth in a single quarter since the crisis struck. Growth in residential investment has gained pace steadily in the recent past, as can be seen in the figures from the past three quarters: 18.6% in Q3/2013, 21.6% in Q1/2013, and the aforementioned 30.8% in Q1/2014.

In spite of this, the supply of newly built flats is small in historical context and, according to demographic projections, somewhat below the long-term requirement. The investment ratio in the residential real estate market has been low since the crisis, which is normal given the pre-crisis surge in investment and households’ difficult financial situation during and after the crisis. Therefore, growth in investment at this juncture is not an indication of a bubble in the making, but rather a sign that the market is rising out of its post-crisis slump and approaching some sort of equilibrium.

Growth in DMB mortgage lending

New mortgage lending by deposit money banks (DMB) totalled ISK 9,275m in the first four months of 2014, an increase of 16% YoY. Most of the new loans are indexed fixed-rate mortgages, which accounted for about half of all new mortgages in April. Second in popularity are indexed variable-rate mortgages. Indexed loans (fixed- and floating-rate) accounted for over 70% of new DMB loans in April, and non-indexed floating-rate loans accounted for about 20%. Non-indexed fixed-rate mortgages are therefore the least common loan form, representing less than 10% of new household mortgages from DMBs in April.

On average, indexed loans were somewhat larger than non-indexed loans in April. For example, the average indexed loan amount was ISK 13.6bn, as opposed to ISK 9.7bn for non-indexed loans. The general indexed lending rate offered by banks and savings banks is now 3.5%, as it has been since the beginning of 2013. This is a very low interest rate in historical terms, which has doubtless been a factor in the rise in house prices over this period.

General lending by the Housing Financing Fund (HFF) totalled ISK 321m in May, as opposed to ISK 532m in May 2013. This contraction is in line with recent developments in HFF lending, which totalled ISK 2,099m in the first five months of 2014, down some 40.4% from the January-May 2013 total of ISK 3,523m. Clearly, then, the HFF is losing its share of the new credit market to the DMBs.

Recent inflation due primarily to rising house prices

It can be said that the rise in house prices is a double-edged sword for heavily leveraged households. The majority of household debt is indexed to the CPI, and in the recent past, inflation has been driven primarily by house prices. In May, for instance, inflation measured 2.4%, but only 1.1% excluding the housing component. To add insult to injury, rising house prices trigger an increase in official valuations and property taxes.

However, because real house prices have been rising, homeowners’ housing equity is growing in spite of the negative impact on inflation. In this sense, then, perhaps the rise in house prices is one of the biggest windfalls experienced by leveraged households since the crisis struck.

Rent rising fast

nullRent has been rising rapidly in the recent term, in tandem with house prices, at least partly due to rising house prices – and therefore, due to the same factors that have been pushing house purchase prices up. There are a few additional factors, though, including the difficulty of negotiating leases on overleveraged property and the limited access to credit since the crisis struck. Furthermore, the exponential growth in tourism has doubtless played a role. In April, capital area rent prices had risen 9.2% in the past twelve months, according to Registers Iceland. According to a study by SI on household expenditures in 2010-2012, about 73% of households own their homes, while 27% live in rented property.

Current trend set to continue

We assume that house prices will continue to rise in the near term and that turnover will grow as well. We expect the pace of the increase to ease somewhat in the next twelve months, however. We also assume that inflation will hold close to the inflation target during this period, which means that there could be a considerable rise in real house prices.
If so, households’ position will continue to improve, as their housing equity will continue to grow in nominal and real terms. This will strengthen their overall equity position and reduce the percentage of households with negative equity. Furthermore, the first phase of the Government’s debt relief package will probably kick in later this year, reducing household debt levels by a full ISK 20bn before the year-end – at least, according to the authorities’ assessment of the scope of the measures.