In a report on Europe's housing markets, Standard & Poor's says that it has been long in coming but finally, and overwhelmingly, markets are turning down. And in those countries where the housing bubbles have been expanding for longer, S&P believes the corrections could be severe and painful. Particularly at risk are the UK housing market, where the financial crisis is exacerbating issues of affordability and general economic gloom, and the Spanish housing market, which is coming to terms with a largess of new homes. At the same time, there are signs that housing in Ireland is becoming more affordable, while a combination of low indebtedness and fiscal stimulus should help support the market in France.
The US ratings agency S&P says that the latest data on the Irish housing market for January 2008 shows a yearly price decline of 8%, while the growth in housing loans has also eased substantially (see chart 6). House price inflation has been negative in Ireland since the middle of last year, the residential real estate market easing in early 2007 after years of rapid growth.
Current real estate market conditions largely reflect the potent combination of elevated house prices and higher mortgage rates. The latter -- 5.34% on average in December 2007, up from 4.81% a year earlier --are particularly significant in a country where most mortgages (76% of the total in 2007) are at variable rates. Ireland joins Spain, Portugal, and The Netherlands as an economy with one of the highest levels of household debt in the Eurozone: 175% of disposable incomes in 2007, compared with 164% a year earlier.
The report says that the Irish construction sector is reflecting these conditions. After a record 88,000 homes built in 2006, the corresponding number for last year was about 75,000. Looking forward, housing completions should continue to decline in 2008-2009 to about 50,000 a year.
At the same time, affordability for first-time buyers is slowly improving, which will support market activity in the longer term. Evidence of this improvement can be found in the housing affordability index computed by DKM, a consultancy firm, and published by the Irish Property Buyer magazine. The index ticked up in 2007 due to the decline in house prices, the doubling of mortgage interest relief from January 2007, and the increase in household disposable incomes (5% in 2007). Mortgage repayments amounted to 22.6% of net incomes on average in December 2007, compared with 26.4% a year earlier. Further increases in mortgage interest relief this year and increases in tax credits and tax bands should improve the index even more this year.
Even so, the report says that the current downturn will extend well into 2009. S&P expects house prices to decline by about 6% this year, and stay approximately flat in 2009. This extended and sharp correction in the housing market will weigh heavily on construction activity, causing a deep slowdown in overall economic growth in 2008. The construction sector currently accounts for almost one-quarter of gross national output and employs about 13% of the workforce. So a sharp and rapid slowdown in the sector will have major knock-on effects. The report forecasts that GDP growth will average 2.3% in 2008 and 2.9% next year. This is less than one-half the 7.4% average annual growth rate enjoyed by the "Celtic Tiger" in the 13 years spanning 1994-2006.
The Pain In Spain is Anything But Plain
S&P says that in August 2005, it warned that a red-hot Spanish housing market was growing at an unsustainable pace. It also cautioned that a slowdown was desirable in order to avoid a major collapse later on. That slowdown did not materialize in the following 18 months. But data released by INE, the Spanish statistical office, on March 26, 2008, strongly suggest that the market has now taken a dramatic turn. In the 12 months to January, completed house sales were down a staggering 27% on the previous 12 months. Sales of second-hand dwellings, representing 52% of total sales, fell 36% over the same period, while sales of new houses were down 15%. Not surprisingly, total lending to home buyers fell 28% over the period. The report notes that the average interest rate charged by savings banks was 5.09% in January 2008, up from 4.12% a year earlier, while the average term was 26 years (unchanged). Moreover, borrowers continued to show a very strong preference for variable-rate loans (98.3% of total loans, up from 97.6% a year earlier).
S&P says that the biggest concern at this point is the lag between housing starts and the most recent trends in the market, as reflected by house price inflation and the number of actual sales.Housing starts stabilized in the second half of last year (see chart 3), but at still very high levels (650,000 annualized). At the same time, house price inflation decelerated steadily to 4.8% year-on-year in the fourth quarter of 2007 (9.1% a year earlier).
The average number of housing starts in Spain over recent years totals 700,000 per year. Yet the population has only been rising by about 600,000 per year. Even allowing for some catch-up earlier this decade, the supply of dwellings has clearly outpaced demand (and obviously not every new addition to the total population requires a new home). Furthermore, U.N. projections indicate a slowdown in population growth in coming years, to about 500,000 per year.
By contrast, the US Census Bureau says that an estimated 1,978,200 US housing units were completed in 2006 - for a country with a population of almost eight times that of Spain.
UK Residential Real Estate Wrestles a "Triple Whammy"
S&P says that most indicators suggest that the UK residential real estate market has entered a phase of substantially lower growth since the end of 2007. In November of last year, the Royal Institute of Chartered Surveyors' monthly survey pointed to an abrupt deterioration in market sentiment, with surveyors at their most negative on prices and agreed sales since May 2005 and April 1999, respectively. Since then, that deterioration has become even more evident.
Gross lending declined to an estimated £24 billion in February, down 6% from a year earlier. And in the 12 months to February, house prices grew a meager 2.3% according to Nationwide and Halifax, two of the largest building societies in the U.K.
The report says that the UK real estate market has arguably experienced two mini-cycles since 2001: First, accelerating house price inflation between January and November 2002, followed by a period of easing of about 11 months. Second, a short rebound until June 2004, then a deceleration through to July 2005 when house price inflation reached a low of 1.7% year-on-year. Running alongside those mini-cycles, with a lag of about six months, were upward or downward trending interest rates. In that sense, the current deceleration, which began in August of last year, could be attributed to the rise in interest rates from August 2006 to September 2007. If that logic holds true, interest rate cuts since last December could see house price inflation bounce back in the second half of 2008.
"In our opinion, such a favorable outcome is extremely unlikely in the current circumstances. This is because the UK housing market is now experiencing three shocks at the same time--deteriorating levels of affordability, scarcer funding, and a cautious reaction from buyers to the domestic economic slowdown," author of the report, economist Jean-Michel Six wrote.
A Benign Outlook For Housing In France
The report says that according to calculations from the Organization for Economic Cooperation and Development, nominal house prices in France rose 208% between 2000 and the third quarter of 2007--far more than in the U.S. (166%), but less than in Spain (242%). Yet the French real estate market started to ease back at the end of 2006, house price inflation declining to 3.6% in the 12 months to December 2007 (7.2% a year earlier). The decline was even more pronounced in the fourth quarter of last year, with price inflation back to its 1995-1999 annual average of about 3.0%.
In 2007, interest rates on housing loans increased by an average of 90 basis points (bps), to 4.70% for 20-year loans and 4.80% for 25-year loans. Higher borrowing costs, along with a deterioration in consumer sentiment throughout
S&P says it holds a rather benign view on the outlook for the French housing market in the medium term, and for several reasons. First, there is a relatively low level of indebtedness in French households (47% of GDP in the third quarter of 2007, compared with 59% in the Eurozone, and 97% in the U.K.). This implies that households are relatively less exposed to the current financial crisis and have more breathing space in terms of house price increases and affordability. Second, S&P expects that the French economy as a whole will continue to enjoy mild and steady growth this year and next (1.5% to 1.8% GDP growth), largely because of resilient consumer demand and corporate investment.
Crucially, unemployment will continue to decline, albeit at a slower pace, to 7.0% at the end of 2009 from 7.5% in the final quarter of 2007. Third, the new fiscal incentives adopted in 2008 will provide some help to the housing market. In essence, the new measures reduce the interest burden for borrowers by an average of 25% over five years (after five years, interest payments are no longer deductible), with a front-loaded effect of 40% in the first year. Calculations made by FNAIM, the French association of realtors, suggest that those fiscal incentives will reduce the average ratio of mortgage payments to incomes by 7.0 points in the first year, and 3.5 points in the next four years.
That said, the French real estate market is unlikely to return to the heady rates of growth seen earlier this decade. S&P expects house price inflation to return to its mid-1990s average of about 3% in the medium term, after a year of flat to slightly declining prices in 2008, the report says.