Among Southern European countries, Portugal is the most at risk, with Norway, Sweden, and Luxembourg also facing severe conditions.

Authors: Vicente Nieves/Mario Becedas/Javier Barriocanal
Source: El Economista

The historic rise in interest rates in Europe is having significant consequences for asset prices. Stocks and bonds reacted with drastic drops almost instantly, reflecting expectations of higher future rates. Now, stocks and bonds seem to be ‘reviving’ with the anticipated end of rate hikes. However, other assets, such as real estate, adjust more slowly. Unlike financial assets, which fluctuate daily, housing prices adjust when monetary policy fully impacts interest rates and the real economy, which is currently happening. Housing prices are already falling in several European countries. Although the sector has shown some coordination in recent years, it seems that this time price corrections will be concentrated in specific countries.

Recent data from the European Central Bank speaks for itself. The average rate for variable mortgages in the Eurozone has exceeded 3%, compared to 1.3% in December 2021. Additionally, recent surveys from Eurozone and EU central banks reveal that mortgage lending for home purchases is experiencing the largest decline in its history. It appears that housing will face either a slowdown (at best) or a severe correction (at worst) in countries where property prices have diverged most from their fundamentals.

An Uneven Correction

Mathias Pleissner, Deputy Director of Mortgage-Backed Securities at Scope, notes that “housing price growth in Europe is finally trending downward. This is not surprising, as residential activity in some countries had already indicated a slowdown and lower values. However, the outlook in the EU, UK, Switzerland, and Norway is uneven.”

“The annualized average growth in prices over the last four quarters remains in double digits, but the trend is reversing: some countries, particularly the Nordic ones, experienced quarterly declines in the third quarter, and this trend strengthened in the last three months of 2022,” the expert explains.

Nordic countries had seen the largest increases in housing prices in recent years. These economies grew relatively strongly; however, their central banks maintained very expansive monetary policies to prevent their currencies from depreciating against the euro. This created significant risks: strong economies with expansive monetary policies often lead to asset price bubbles. Now, these countries are suffering the ‘burst’ of these bubbles, while economies that needed expansive monetary policies (mainly in Southern Europe) are more balanced and not at risk of significant price drops.

Thus, the main factor behind this divergence is clear: “The dynamics of the housing market are highly sensitive to mortgage rates,” according to a study published in the ECB’s Economic Bulletin in September 2022. The study confirms that a one-percentage-point increase in mortgage rates results in about a 5% decrease in housing prices (over two years) and an 8% drop in housing investment.

This historical trend is even more pronounced in a low-interest-rate environment. This means we can expect a 9% drop in average values within two years because that’s where we are: mortgage rates have risen sharply from historic lows, according to the ECB, with the most significant increases occurring in the first half of 2022.

However, the real effect of mortgage rates on housing prices across Europe is uneven. While the Swedish state mortgage lender SBAB Bank reported a 17% decline in prices across the market from the peak in early 2022 to January 2023, prices in Spain increased by around 7.1% in 2022, according to a report by Sociedad de Tasación, a property valuation company. Although Spain doesn’t have significant imbalances, some experts warn that these movements resemble a bubble.

This is because the housing market is also influenced by factors other than mortgage rates, such as structural elements within a local mortgage market. Some markets are more vulnerable to rate hikes than others. Key factors include household debt, which is above average, variable interest rates, and unsustainable housing price growth over the past decade.

Scope’s Heat Map Shows Norway and Sweden as Most Exposed

Combining these factors, Norway, Sweden, and Luxembourg exhibit the highest structural vulnerability to mortgage risks stemming from affordability crises and declining values. To some extent, this risk has already materialized. Denmark, the Netherlands, and Portugal also face greater structural challenges compared to other European countries. Sweden is a prime example, where housing prices have already fallen by 15%. The banking sector has long warned of tightening credit and forecasts of falling property prices.

Peripheral Eurozone countries (Spain, Italy, and Greece), which have only slowly recovered from the significant value corrections experienced during the global financial crisis, show relatively solid metrics. Meanwhile, the real estate sector in Eastern Europe presents moderate structural risks, mainly due to lower household debt despite observed unsustainable growth, as noted by Scope Ratings.

Álvaro Antón, Country Head of abrdn for Iberia, agrees and states in a note that “global real estate markets are experiencing significant changes due to new economic cycles and strong thematic trends. We believe that global economies and how we use real estate are driving different global outlooks. In this context, looking beyond national markets might offer investors greater diversification benefits.”

A Near-Global Correction

Housing prices have fallen sharply in several economies in recent months and are likely to decline further in 2023. The speed of these declines is comparable to the worst period of the global financial crisis, raising concerns about a potential global real estate crisis, according to Adam Slater, Chief Economist at Oxford Economics.

According to the British analysis firm, historical data on housing cycles are not encouraging. Since 2012, global housing prices have increased by around 40% in real terms, faster than pre-financial crisis increases. But in the last three cycles, about 50% of the real price increases worldwide were reversed in subsequent declines, and in individual economies, the decline was often much greater, between 70% and 100%.

The expert notes that the average level of housing transactions in a sample of major economies was actually quite high in 2021, similar to levels before the global financial crisis, indicating a significant number of vulnerable borrowers. “Homeownership levels for sale are low, but this may only provide limited support for prices if housing demand continues to fall. Labor markets seem strong now, but this could change. Additionally, mortgage problems could precede rising unemployment: before the major crisis, mortgage delinquencies started to rise before unemployment in the US and UK,” Slater lists. With interest rates likely to continue rising, the potential for further and more significant price declines is considerable, according to the economist.

“Even with a limited supply of homes for sale, prices can still fall if demand continues to decrease. And the trajectory of demand certainly seems to be markedly downward now,” the analyst warns. Apart from the significant drop in mortgage applications and approvals in the US and UK, new mortgage loans in some parts of Europe have also fallen sharply. In Germany and the Netherlands, they have plummeted by between 50% and 60% from recent highs, driven by rising interest rates. In the Netherlands, this drop is comparable to that following the major crisis, and in Germany, it is somewhat worse. Specifically, these two housing markets were among the most risky in previous Oxford Economics studies.

A Diverse Mortgage Market

Returning to focus on Europe, the Scope Ratings expert explains that the European mortgage market is very diverse. Most homeowners in Eastern and Southern Europe own their homes outright, without a mortgage. This contrasts with Northern European countries such as Norway, the Netherlands, Sweden, and Denmark, where over 75% of homeowners have mortgages. “As a result, households in these countries are also the most indebted in Europe. But even here, the situation is uneven. While Danish and Dutch households managed to reduce their debt-to-income ratio over the past decade in line with the European average, Norwegians have become even more leveraged.”

“If we look at new mortgage lending in Europe, only 16% were at variable rates in 2022. The rest have adjustment periods of at least once a year; in most cases, fixes are every 5 to 15 years. This means that rate hikes to levels last seen in 2013 will only affect a minority immediately. This is reassuring, given that underlying inflation is adding additional pressure on European households,” concludes the Scope Ratings expert.