It may come as a surprise to those trying to get on to the housing ladder but a study has shown that as at 2015, house prices were not overvalued but rather slightly undervalued by around 2.5 per cent.
A Central Bank of Malta analysis by William Gatt and Owen Grech, using a variety of models and techniques, showed that house prices relative to income peaked in 2005 and, following a correction phase, reached a trough in 2012. The revival of the housing market since 2013 gradually closed the gap, bringing house prices close to equilibrium levels by the end of 2015.
Between 2000 and 2015, house prices nearly doubled, increasing by 2.6 per cent in real terms per annum, on average, although with significant fluctuations.
“The notable rise in house prices over time has led to growing concerns about the possible existence of a housing bubble, a situation where there is a misalignment between the market price of an asset and its underlying value as determined by economic fundamentals, making the property market prone to price corrections that generate adverse macroeconomic consequences,” the report explained.
Another key metric is the house price-to-income ratio, which tracks the affordability of property over time. The authors found that house prices were undervalued relative to income between the mid-1980s and the early 2000s, with the degree of misalignment narrowing gradually. This was followed by a period of overvaluation which peaked in 2005. This equilibrium was gradually restored by 2009. Since then, house prices have been undervalued, although the trough was reached in 2012 and as at 2015 house prices stood close to their equilibrium value.
According to advertised prices, the market hit a peak in 2007, reflecting similar developments in many advanced economies but then hit a trough in 2009.
During this period, dwelling investment fell significantly to 3.5 per cent of GDP in 2010 – half that at the peak of the market. The report noted that investment continued to fall to a low of around 2.6 per cent of GDP by 2014, but has since picked up, mirroring the recent increases in activity and house prices.
Factors behind this recovery include the recent changes to the capital gains tax and tax on rental income, as well as the reduction of stamp duty paid by first-time buyers. These policies are believed to have boosted demand for property, mainly apartments and maisonettes. The current low interest rate environment may also have stimulated portfolio rebalancing, increasing demand for property as a higher yielding asset.
The study also looked at the correlation between rents and house prices, particularly since the former have seen a cumulative increase of about 23 per cent since 2012. However, both house prices and rents have risen by roughly the same amount since 2006, suggesting that the recent increases in the latter were not out of line with fundamentals. They also forecast that rents would continue to go up: “It is expected that the large influx of foreign workers over the past few years, as well as the societal changes discussed above, should have led to an increase in the percentage of the population renting at market prices in 2015, and continue to raise it further in 2016 and beyond.”
The most important aspect of the exercise was to determine what the macroeconomic impact would be of a rise in house prices of 10 per cent – whether the rise turned out to be permanent or temporary – but the complex models they used showed that it would be limited – only reaching 0.22 percent deviation from baseline levels, and even this was subject to important caveats.
The authors concluded with two main recommendations. They argued that more timely and representative data was needed on both house prices and rents, making it possible to identify misalignments and allow policymakers to take corrective action in a timely manner.
They also said that policies were needed to make the market more efficient when it came to matching demand and supply.
“For instance, easing restrictions on the sale of property boosts the supply of housing and reduces the stock of otherwise vacant property which dilapidates over the years. This, in turn, eases pressure off prices, contributing to a lower likelihood of unsustainable price increases,” they said.
The authors stressed the importance of understanding the sector because of its far-reaching implications on wealth and, in turn private consumption; housing investment; and collateral, which in turn influences non-performing loans as well as banks’ and borrowers’ ability and willingness to lend and borrow, respectively.
“Developments in house prices therefore influence macroeconomic performance and the stability of the financial system,” they warned.