Recovery in house prices in the eurozone has been rather muted thus far and appears to be weaker than the typical increase observed historically during the initial phase of an upturn in the house price cycle.
A report by the European Central Bank said that corrections of previous overvaluations, together with favourable income and financing conditions, suggest that the current recovery has a better chance of being sustained than the short-lived upturn observed relatively soon after the crisis.
“House prices have been a key indicator in assessing the state of the euro area economy since the financial crisis. In a number of eurozone countries, house prices had increased at unsustainable rates and to unsustainable levels prior to the crisis, and the inevitable adjustments had subsequently led to declines in house prices or muted developments at best,” the ECB said.
“After some ups and downs during a protracted period of adjustment, there are now increasing signs that house prices in the eurozone are finally on the rise again. Measured in terms of the annual rate of change in residential property prices, the cycle reached a low point in early 2013 before the rates of change became successively less negative and moved into positive territory in the second half of 2014.”
House price growth from Germany and Austria remained solidly positive since early 2013 while there was a gradual easing of the negative contributions from the countries most affected by the financial crisis (Ireland, Greece, Spain, Italy, Cyprus, Portugal and Slovenia).
To a somewhat lesser extent, this also holds for the group of other eurozone countries (excluding Germany and Austria).
House prices have been a key indicator in assessing the state of the euro area economy since the financial crisis
In several countries, in particular those most affected by the financial crisis, large rises in house prices in the run-up to 2007 were followed by falls in the 2007-13 period. This suggests some correction of the imbalances that had built up in the pre-crisis period, when a number of countries saw very strong growth in house prices – double-digit in some cases. It also explains why house prices are currently rising again at a faster pace in some of these countries, such as Ireland and Spain, in an environment of improving macroeconomic and favourable financing conditions.
The report also found that house prices in metropolitan areas have been growing faster since the financial crisis than in the economy as a whole. There may be geographical reasons for this, such as less availability of land and a correspondingly lower elasticity of housing supply in metropolitan areas than rural areas.
“However, this may also imply that house price dynamics in metropolitan areas could pick up faster in response to the economic cycle and then provide false signals if the latter is not sustained,” it cautioned.
Since 2010 the imbalance in the house price-to-income ratio for the eurozone as a whole has progressively unwound. In 2014, it was only around three per cent above its fundamental level, suggesting that house prices were broadly back in line with fundamentals. The house price-to-income ratio is a crude measure of housing affordability.
When the indicator lies above its long-term average, house prices may be seen as overvalued – at least from the perspective of prospective new buyers – which should lead to downward pressures on prices.
Average house prices may currently even be moderately below historically normal valuation levels.
However, the boost to housing affordability coming from the current low interest rate environment may not be fully sustainable if interest rates were to normalise further out, the report said.