The largest corrections are expected in Germany, France, and the UK. “The price drops will be insufficient to resolve affordability issues.

Source: El Economista

Since the beginning of interest rate hikes in developed countries in early 2022, analysts have been closely monitoring the real estate market. After years of rapid price growth, higher interest rates have the potential to crush this trend. Although the eurozone did not see rate hikes until mid-year, the impact on housing will come sooner or later, at least causing a drastic slowdown in price increases and some corrections in the hottest markets (where housing prices have deviated significantly from rental prices).

The insurer Allianz has published a report analyzing the real estate markets of major European economies. The conclusion is that housing prices will experience declines in real terms (adjusted for inflation). The price correction in Sweden serves as a warning, although it is evident that the situation is not the same across all markets, necessitating different analyses.

The real estate market will not keep pace with inflation and will lose ‘value’ in relative terms, although declines will be very moderate in countries like Spain and Italy, which do not present significant imbalances, as housing prices never fully recovered to pre-2008 crisis levels. In contrast, declines could be more severe in economies that have seen more intense price increases in recent years. This report does not analyze the evolution of the real estate market in the US, despite it being one of the most vulnerable to a possible correction.

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The German insurer’s experts explain in their report that “the tightening of financing conditions, the slowdown in growth, and the increase in inflation are putting pressure on the European real estate market… Although the overvaluation of real estate is a global concern, Europe is particularly affected by the current energy crisis and its impact on real incomes (which were decreasing even before the Russian invasion of Ukraine). As Europe slides into recession, the rise in interest rates and energy costs is making housing a good out of reach for most households,” Allianz states.

The correction in real estate prices will be a result of interest rate hikes, the looming recession, and the loss of purchasing power of households. Other organizations, such as the IMF, have also warned of this real-term correction in housing that will occur almost synchronously worldwide.

However, one should also not forget the responsibility of central banks that for years have ‘inflated’ asset prices to irrational levels in some cases. “The abnormal evolution of housing was supported by asset price inflation driven by quantitative easing (QE). Successive rounds of QE carried out by major central banks since 2008 supported high asset prices,” Allianz states.

These experts admit that the impact of these policies is more evident in the stock market, but it was also clearly visible in “housing prices in many countries… With QE failing to achieve its theoretical goal, i.e., to bring inflation to target and pull the Eurozone economy out of the ICU, residential real estate prices have grown faster than disposable income in all major European economies, except Italy.”

The higher you go, the easier it is to fall. Despite this, Allianz experts rule out a housing correction similar to that of 2008. Not only because the magnitude will be lower, but because the epicenter of corrections will occur in Central and Northern Europe, while countries like Spain and Italy will experience much milder real price declines.

Germany, France, and the UK

According to Allianz analysts’ modeling, the German real estate market is at the greatest risk among major European economies. Property prices have increased by more than 50% in real terms since 2015, while housing affordability has fallen by 30%. These economists project an 8% real-term price correction by the end of 2024, followed by around 5% in France and the UK.

“Looking ahead, we expect the largest real price correction in Germany due to pre-existing conditions and the impending contraction in economic activity, followed by France and the UK. Based on recent price trends and the panel’s estimates of changes in real housing prices, we anticipate a correction in 2023-2024 in the five largest eurozone economies, although it will be especially deep in Germany, France, and the UK,” Allianz’s team explains.

The study notes that the housing market in Germany and the UK, and to a lesser extent in France, is the most overvalued among major European economies. The report’s experts highlight that, in these countries, affordability has also drastically decreased over the years, more so than in other countries when measured based on the price-to-rent/price-to-income ratio. Economists also model the relationship between real estate-related equity performance and the evolution of official real price indices, finding that Germany and France are the most exposed to a correction, followed by the UK.

Regarding the transmission of official interest rates and bank loan rates (which takes time), the average time is longer in Germany and France (six months) than in Spain and Italy. Analysts point out that outstanding mortgages in Germany and France are mostly fixed-rate, but households have become more vulnerable to the dynamics of housing prices in 2023-24. “Loan interest rates have become more sensitive to changes in official interest rates, especially in Germany,” the report concludes.

Additionally, Allianz’s data indicate that the burden rate for housing costs in Germany is the highest in the sample at 15.5%, expected to remain relatively stable at 15.8%. The deterioration in credit conditions could create more pressure in other countries before Germany, where homeownership is not the norm (it has the lowest homeownership rate among the four largest eurozone economies at 49.5%). However, the burden rate is higher for younger people in Germany (23.9% for those aged 15-29) compared to the general population (19.9%), as well as in France (young people: 7.1%, all ages: 5.9%).

In a parallel study on the European real estate market, economist Andreas Steno Larsen, formerly of Nordea, emphasizes that the negative wave in housing will even affect “risk-averse countries like Germany, with a number of variable-rate mortgages in their adolescence and household debt relative to GDP around 60%.” The strategist develops a model predicting a 10% chance of rising housing prices in Germany and estimates a price drop of slightly less than 10%.

Mortgage costs in Germany have surged in recent months to their highest level in a decade. The cost of loans for purchasing real estate reached 3.03% in September, according to data from the ECB published on Thursday. This rate is among the highest in the eurozone and has doubled compared to the previous year, when Germany was one of the cheapest places in the region to get a mortgage. This will have a clear impact on housing demand, which could be reduced, at least for those needing financing.

In France, the growth of mortgage loans slowed in September to the weakest rate of the year. Outstanding loans for purchasing housing grew by 6.2% year-on-year, after a 6.3% increase in August, and the Bank of France said initial indicators show a further slowdown to 6% in October. The average interest rate on new housing loans is estimated at 1.79% in October, the highest since 2016.

In the UK, the latest data have confirmed the gloomy trend. In November, housing prices fell by 1.4% month-on-month compared to the 0.3% expected by analysts. “The 1.4% monthly drop in housing prices in November was much larger than expected, raising the risk that prices will fall more rapidly and to a greater extent in response to high mortgage rates than we anticipated,” says Andrew Wishart of Capital Economics. Excluding the price drops in May and June 2020, when data were unreliable due to limited mortgage approvals following the first lockdown, the November drop has been the largest since February 2009.

“The drop in housing prices is not surprising after the increase in offered mortgage rates, which have risen from less than 2% at the beginning of the year to more than 5% now. This has caused the cost of mortgage payments for purchasing a new home to spike to levels similar to those of 2008, making many potential buyers priced out of the market. However, although most accepted that demand would fall sharply as a result, the general belief was that the shortage of homes for sale would help keep prices up. So far, this does not seem to be the case,” explains Wishart. The expert predicts a 12% drop in prices by mid-2024. “Both economists and real estate market experts expect a 10-15% drop in housing prices in the UK,” Andrew Lennox, strategist at Federated Hermes, noted in an October analysis.

Mild Correction in Spain and Italy

“Pre-existing conditions are most important in Spain and Italy, where a smaller correction is expected, but it is true that these forecasts are the ones most likely to worsen due to the combination of a slow recovery expected for 2024, a persistently high output gap, and significant risks due to high public debt.” Allianz experts believe that the decline in housing prices could be around 3% (in real terms) until 2024, in both Spain and Italy.

Another financial firm, Bankinter, in its latest report on the Spanish real estate market, highlighted that “after a 2022 still seeing price increases (+5% estimated), the market should enter a phase of adjustment. We forecast declines of -3% in 2023 and -2% in 2024 (compared to previous estimates of +1% and 0%).