Continued sharp rise in house prices

House prices have shot up in the recent term. According to figures from Statistics Iceland (SI), prices nationwide have risen by 9.4% in nominal terms and 7.7% in real terms over the past twelve months. The main underlying causes are the rapid rise in real disposable income and the Government’s indexed mortgage adjustment measures. 

Prices to rise 15½% in nominal terms and 7½% in real terms by end-2017 

We expect the recent trend to continue, although the pace of the increase will probably ease somewhat. We forecast a nationwide increase of 7½% in real terms and 15½% in nominal terms by the end of 2017. 

According to our forecast, the main factor in favour of a continued rise in house prices is a handsome increase in real disposable income, triggered by wage rises in excess of inflation during the forecast horizon and an increase in total hours worked. The effects of the Government’s indexed mortgage adjustment measures will be greatest in 2015. We expect nominal and real price increases to lose momentum over the course of the forecast horizon, as the effects of the debt reduction package taper off and growth in real disposable income eases. 

Steep rise from 2010 trough

Real house prices have risen 18.7% and nominal prices by 39.1% from the early-2010 trough. This massive rise in housing values has improved the financial position of homeowners, who comprised 73% of Icelandic households in 2013, according to SI. About 55% of households have mortgage debt, most of it indexed. Households’ equity has grown considerably in these cases, as inflation has been unusually low, currently measuring 1.6%. According to SI’s most recent figures, households’ housing equity amounted to just under 58.2% of their gross real estate holdings at the end of 2013, up from 48.6% at year-end 2010. 

Major driver of inflation

Rising house prices have played a dominant role in recent inflation developments. They account entirely for current inflation and more besides, as the general price level has fallen by 0.1% in the past twelve months, in terms of the CPI excluding the housing component. This has cut into the increase in households’ equity that rising prices have generated. We assume that house prices will remain a major driver of inflation over the forecast horizon, and we project that they will have an upward effect on the CPI in the average amount of 0.1% per month. 

Price rises differ by housing type and location

During the current upswing, condominium prices in greater Reykjavík have risen much faster than either detached housing prices in the capital area or house prices overall in regional Iceland. To illustrate: capital area condominium flats have risen in price by 47.4% from the early-2010 trough, while single-family homes in the capital have risen 22.5% and housing in regional Iceland by 31.0%. 

No signs of a bubble

Although real house prices have risen somewhat in the recent term, we consider the increase to be supported by fundamentals. House prices relative to income, rent prices, and construction costs are not far from their long-term average, for instance. As a result, we do not see signs of a housing bubble as yet, although the conditions for such a bubble do exist, as investment options are more limited than they would be without the capital controls. 

Prices rise in excess of building costs, and new construction is picking up

House prices have been rising in excess of construction costs in the recent term. This has bolstered returns on new construction, which has also been on the rise, growing 14.9% in 2014, on the heels of a 10.8% rise in 2013. We expect this trend to continue in 2015. In spite of the recent growth spurt, the residential investment level is not high in historical terms. 

House price forecast included in monthly inflation forecast 

Each month, we prepare a forecast of developments in house prices and publish it as part of our inflation forecast. As such, the forecast above is a part of our last inflation forecast, published on 9 April.