Housing Bubbles

The data below are from a Eurostat estimate of the Housing Price Index in all EU nations. 4 out the 6 EU countries in trouble (Spain, Ireland, Greece and Cyprus) can attribute all or part of their troubles to a housing bubble and the graph is indicative of this fact. Specifically, in the case of Ireland the rise and fall of housing prices is astonishing. The index which reached as high as 150 in 2007 is now looking to stabilize at about 75.

When beginning this article, I had in mind foreign purchases of housing units in each of the above nations. Foreign purchases, especially in relatively small countries like Greece, Ireland and Cyprus can significantly increase the level of prices, especially in a short period of time. I was only able to find some data for Spain which state that "Property sales made by foreign residents in Spain experienced an increase of 24.7% in the third quarter of 2011". In another article, 8.9% of purchases in Spain was attributed to foreigners. If in a country as large as Spain (with a 46 million population) foreign purchases of real estate can amount to that much you may imagine how much they could amount for in the aforementioned 3, which have a combined population of 16 million.

Compare this to Denmark, where the state law indicates that "Unless foreigners are permanent residents in Denmark and have lived in the country for a period of at least five consecutive years, Danish law states that they must obtain permission from the Danish Ministry of Justice (Justitsministeriet) to buy property. (unless they will use it as a permanent residence)" Even though the law is harsher on foreigners in Denmark than the rest of the Southern nations, we can easily question what it has done to prevent a housing boom in 2007 and 2008. Although the subsequent fall was not as sharp as the one experienced in Ireland, it was approximately like the one in Cyprus, and much worse than the one in Greece and Spain.

Then what is the solution for not experiencing housing bubbles you may ask? The answer is relatively simple: increased taxes in real estate combined with stricter mortgage regulations. Although Denmark's law did not stop the country from experiencing a rapid fall in housing prices, we cannot know what would have happened without it. However, when real estate taxation is high (and I do mean tax paid on the unit's value not transfer costs, lawyer fees and other costs relating to the purchase) less people would be willing to buy a house if they do not intend to live in it. Nevertheless, taxation should be lower for those who are buying their first house, with the purpose of living in it. As young couples are what is driving demand in most nations, with the application of such laws the governments would have taken specific measures to safeguard this demand. 

Also, when mortgage demands are stricter (forcing you to have at least 20-25% of the value of the unit you intend to purchase) demand will be more stable and the banks will face less problematic loans. With demand not rising and falling to extremes, it would be much easier for developers and real estate agents to predict the market's future needs and thus they themselves would be less inclined to fund projects which would take many years to yield profits, straining the banks and the economy. 

Nobody in their right mind could ever propose that bubbles can be left out of the system. Demand will always fluctuate and we can do our best to estimate it. Most likely our estimation will be wrong; and we can surely not expect strange phenomena like hurricane Sandy which caused some USD 71 billion of damages in the states which it hit. Nevertheless, it would also be a shame not to do what is expected of us to make this world less crisis-prone.

European Exuberance

After the Euro introduction, the EU research departments had stated that no major inflationary pressures had been made to the Member-States economies. Any discrepancies which may have been observed during the transitional period were eliminated very soon. However, if one looks at the HICP (Harmonized Index of Consumer Prices) data that Eurostat regularly publishes one may observe something different.

Take a look at the following. The graphs illustrate the monthly average inflation rate in the now crisis-ridden countries as well as Finland, Germany, Sweden and the UK (the latter two for comparison with nations which have not introduced the Euro to their economies) both before as well as after the introduction of the Euro in their economies. 

As you may observe the differences in average monthly inflation are significant. Germany, with a somewhat stabler transition than most other nations saw its average inflation rise from 0.1% to 0.17%. This would mean an average yearly inflation of 0.95% greater than before the introduction of the Euro. The same holds for all other nations, with the largest change occurring in Spain and France where on average they experienced increased inflation by 1.21% yearly. The lowest has been in Ireland where -0.98% was experienced, mainly due to the sub-prime lending crisis which brought the Celtic tiger to its knees. 

In addition to higher inflation, property prices had been rising rapidly until 2008 throughout the EA17, when the sub-prime debt crisis occurred. This led to a higher cost of living than the one experienced before the introduction of the Euro, when at the same time, in order to compensate for this increase, labor costs were rising as well, making the EU nations less competitive.

What we are witnessing now is that, as labor costs, pensions and other benefits are decreasing making the South more competitive than ever before, the cost of living and property prices will decline substantially, making way for more sustainable growth in the following 2-3 years.

Property Market: Cheap or not so Cheap?

A direct consequence of the EU crisis is that housing prices in South Europe have began to fall. For example take a look at the graph for Greece:

The downwards trend which started in late 2008 still holds strong pushing residential housing prices down. The same holds for Spain and Cyprus (Unfortunately I couldn't find data up to 2012 for Italy. All data and graphs are from the ECB)

Cyprus residential prices

Spain residential prices

The above and all current developments indicate that the severe inflation of housing prices which had occurred during the early and mid-2000's was something of a bubble. Mind you, these are data just for the first quarter of 2012. You may only imagine how lower the prices of the second quarter will be.

The housing bubble seems about to burst in the EU (it already has in some countries) and it's not just prices in the South that have gone down. UK prices have fallen for the first time in 3 months as Britain's economy shrank by 0.7% in the second quarter of 2012, the most in 3 years. (for more details on the UK's housing market read here)

If one looks at ECB it seems that housing prices all over the EU are either stagnant or falling, with a few exceptions. So, many people are faced with a dilemma? Should you buy or should you keep on renting? The answer is not so obvious. The reason is that during a crisis rents are higher while housing prices are lower, since most people cannot afford to buy (fall in demand, thus prices fall) but they have to live somewhere (rise in demand, thus prices rise). In more distressed economies like the South, many still choose to live with their parents and thus both rent and property prices seem to fall, although the latter seem to take the most hits.

True, prices have fallen dearly since last year. This, however, is only the beginning of the downwards spiral which will run its course for at least the full 2013 in strong economies and last even more in the weaker ones. (I hope you can tell which is which!) Moments of a rise in the indexes may occur but these seem more like an slight upwards move right before a severe downwards movement in the stock market.