Domestic real estate cycle: "best ager" rather than "over the hill"
Real estate cycles don't die of old age, they are "killed", i.e. one or multiple adverse events that lead to the end of the cycle are required. A significant and long-lasting recession with accompanying poor circumstances on labour markets and effect on income development or a noteworthy interest rate increase in a short timespan in combination with a preceding, unsustainable credit expansion could be possible catalysts for a price correction on real estate markets. Factors that are currently not present or visible on Austrian markets, which is why little is in favour of an impending end of the real estate cycle. At the same time, the domestic real estate cycle (corrected for inflation) started already in 2005 and has lasted over 15 years already, which makes it the longest still ongoing cycle in a sample of 34 industrialized countries compiled by the OECD. When taking into account cycles that already ended, the current cycle is the third longest in recent history. According to our calculations, only Belgium (1986-2013: 28 years) and the Netherlands (1992-2009: 17 years), have had longer price rallies, since the start of the dataset (1970). 40% of the 50 identified cycles had a livespan of 5-7 years. Noteworthy is that the current Austrian cycle, based on the length of the cycle, showed a below average price development in real terms, which is positive in terms of the long-term sustainability of the market.
|Long lasting cycle*, yet not very intensive|
|OeNB, Refinitiv, RBI/Raiffeisen Research|
|* definition cycle: Housing Price Index of a quarter is above the average of the preceding 8 quarters.|
Price-to-rent ratio speaks for fundamentally justified price increases
Nevertheless, the data support the subjective feeling of a certain decoupling of real estate prices from the income development. The price-to-income ratio has worsened more in Austria than in other countries since 2015. Despite Austria being in good company, with Germany and the Netherlands denoting similar developments, seen from the broader sample (34 countries) they are amongst the front-runners, which is partially due to the relatively muted income developments. The findings are different, however, when looking at the ratio of property prices to rents (price-to-rent ratio), where Austria is found in the lower half. The gap between property prices and rents has widened to a much lesser extent in recent years than the gap between prices and incomes. In contrast to disposable household incomes, rents have developed quite dynamically in the period under review (since 2015) compared to the other countries. While the attractiveness of the domestic residential property market from an investor's point of view has thus declined to a lesser extent than in other countries, the development of rents indicates a fundamental (demographic) justification for the price increases.
|Affordability measures strained|
|OECD, RBI/Raiffeisen Research|
Monthly costs, not price level, determine the purchase decision
The trend in the aforementioned affordability indicators shows a clear downward trajectory. Despite this, the ownership rate has remained fairly constant in recent years and mortgage lending growth has remained elevated for some years. It seems, these indicators do not show the entire picture, in particular, they fail to take into consideration one of the main factors of the decision to buy real estate. On the household level, the decision to purchase (over renting) is not based on the nominal — or even real — price of the property but rather based on the monthly costs of the mortgage required (vs. the rent level that count as the substitute). Hence, despite prices growing much faster than rents, as seen in the price-to-rent ratio, buying remains relatively attractive, as the decline in monthly mortgage payments makes up for the increase in prices. In the ideal case, the equation to find the maximum mortgage amount for a household is solved through calculating the monthly costs that can be borne given the households' income (i.e. within the guidelines for the debt service-to-income ratio), keeping the down payment constant. In doing so, it becomes obvious that due to the enduring and extremely low interest rate environment, although the bottom has likely been reached this year, interest rates play an ever-smaller role in the monthly debt service. Currently, mortgage lenders incur only minor costs in terms of interest. By correcting the housing price developments for these changes in the monthly debt service implied by the interest rate changes, we can shed new light on both the exuberant price growth as well as the affordability level and the trajectory that lies before us.
Lower interest rates compensate the price growth outside the capital
|OeNB, RBI/Raiffeisen Research|
|* maximum mortgage amount with constant monthly payments, assuming compliance with mortgage lending standards|
Traced back to the price levels prevalent in 2010, and taking into consideration the guidelines for mortgage lending, the average mortgage sum of an apartment of 130 square meters amounted to EUR 204,585. With the prevailing average interest rate for mortgages of 2010 — with a fixed rate period of 10 years or more for simplicity — (4.2% in March 2010) and using a mortgage duration of 30 years, the monthly debt service amounted to around EUR 1,000. As of now, the mortgage interest rates have declined to about 1.4%, reducing the monthly payment for a similarly sized mortgage by around 31% to EUR 692. Vice versa, this means that a monthly payment capacity of around EUR 1000, qualifies for a loan that is now 45% higher than the same capacity would in 2010.
With this, so to say, “inflation” of the theoretical mortgage sum we can correct the real price growth that we have seen in the past decade once more. First, we consider the case of the real estate markets outside the federal capital Vienna, where prices have risen nominally by around 86% in the last decade. In real terms (i.e. adjusted for inflation), price growth has reached 52% since the beginning of 2010. However, corrected once again for the effect of the decline in interest rates on the monthly mortgage payments and the maximum mortgage amount just described, this price increase is almost completely offset. The average monthly cost of debt has fallen so quickly that prices, represented in terms of monthly payments, have risen by only 5% since 2010.
|Austria (excl. Vienna): Price increases offset by interest rate cuts|
|OeNB, RBI/Raiffeisen Research|
|* Q1 2010 = 100|
The situation in Vienna is different. Here, the price increases of the last decade could not be compensated by continuing interest rate cuts. In nominal terms, prices have doubled since 2010; in real terms, the increase was 63%. Corrected for the lower interest rate level and the associated reduced monthly credit burden, growth since 2010 still amounted to a significant 13%, which represents a substantial deterioration in affordability despite the falling burden of interest payments. However, the extension of the average term of mortgages can still be seen as a mitigating factor in this context, which means that not only the interest rate payments but also the monthly repayments have fallen. In doing so, consumers were able to push their monthly payments down so far that they could afford a flat or a house despite the strong price increases.
|Vienna: Price surge only partially compensated by interest rates|
|OeNB, RBI/Raiffeisen Research|
|* Q1 2010 = 100|
Outlook: Affordability turns into restricting factor
In summary, we can see that the most recent price increases went, to a large extent, hand in hand with interest rate declines, that made ever-increasing mortgage sums possible. This "interest rate effect" also shows why many households still prefer buying over renting, despite real prices surging faster than rents. Whilst at the same time it shows that affordability will turn into an inhibiting factor for future price growth: although interest rates will remain “low for even longer”, the phase of continuing significant interest rate decreases is now in the past. The potential for future price growth on domestic real estate markets therefore likely to be curbed — at least in terms of interest rate tailwinds.