Focus real estate Austria: Years of consolidation after decades of boom
Everything comes to an end. This also applies to the Austrian real estate cycle. At 18 years, it is the longest-serving of all ongoing cycles globally. Although, the 18 years are unlikely to turn into 19 years; we expect noticeable nominal price declines (in the overall market) of up to 5% yoy in 2023 and 2024. After the steep climb of the last few years, the market will thus lose some of its height (potential “overvaluation”); a deep drop in prices, however, is unlikely to occur.
2022: A "divided" year, Q4 with sharpest quarterly decline since 2011
If the year 2022 on the Austrian real estate market had to be summed up in just a few words, it would probably be described as a "divided" year. For some time now, we have been assuming that the past year could have been such a year for the real estate market. In the end, the split could hardly have been even more pronounced.
In the first half of 2022, price momentum accelerated even further compared with the already dynamic year 2021. Uncertainty and inflation caused the market to shift into fifth gear. Pull-forward effects in the face of the shift in interest rates and the regulatory changes have also helped. However, the shift in interest rates and the regulatory changes have, of course, long been in place by now. The wind has turned, and the tailwind has become a solid headwind. The market has therefore been exposed to a "perfect storm" for several months, which has already left clear traces. In the third quarter of the previous year, the market came out of fifth gear and put the brakes on prices (+0.3% qoq). In the fourth quarter - the price data for which were published on January 13 - the market finally shifted into reverse gear. Residential property prices fell by 1.9% across Austria in the last quarter compared to Q3, the sharpest quarterly decline since the beginning of 2011. As was already the case in the third quarter (+0.2% qoq vs. +0.4% qoq) Vienna recorded weaker price developments than the rest of Austria (-2.4% qoq vs. -1.6% qoq).
The carefree period of "good weather" has thus come to an end. The price-related "weather reversal" we saw in the second half of the year 2022 should be seen in this context as a turning point and not as a stopover from the peak storm of recent years: We expect moderate nominal price declines of around 5% yoy in both 2023 and 2024, the first full-year declines since 2004. Combined with continued higher inflation in 2023 (6%) and 2024 (3%), this will result in tangible real price declines, possibly even in a double-digit range. However, the price increase recorded since the beginning of 2020 alone still amounts to 28%, even after taking into account the aforementioned decline in the fourth quarter. Thus, despite the expected correction this and next year, residential property is therefore likely to remain more expensive than before the pandemic. This is because we still do not expect a phase of longer-lasting or deeper price corrections. After the steep climb of the past few years, the market will now lose altitude, but will probably not nosedive. There are three reasons why this would not be the case:
"Forced" supply expansion not likely
Of course, interest rate risk is the biggest risk for the real estate market at the moment. The shift in interest rates has come faster and more forcefully than generally expected a year ago. With its monetary policy refocusing on a “robust inflation control mandate,” the ECB could raise the key interest rate to 4% by summer 2023 (deposit rate 3.5%) in “German Bundesbank fashion.” Variable real estate lending rates are likely to climb to around 5% as early as the first half of the year. And this will not be without consequences for the real estate market. The interest rate shift means that for a loan-financed purchase of a single-family home in the current year, interest and principal repayments will amount to 47% of an average monthly net household income this year (loan-to-value ratio 90%, 30y term, variable financing) — compared with a monthly burden of 30% of net income in 2021 (2022: 34%). However, while the impact of the rise in interest rates on affordability currently occupies a large space in the discussion, an equally important aspect is almost completely ignored: the strongest rise in interest rates in many decades is followed by the strongest rise in nominal wages in many decades. According to the latest (December) OeNB forecast, nominal net household income will rise by no less than 20% between 2022 and 2025. Significantly rising household income means that the monthly burden on purchases in 2025 will still fall to 43% simply as a result of the increase in household income that will have occurred by then (according to forecasts). If the expected price declines and slight interest rate declines (variable mortgage rate 4.25% at the end of 2025) are also taken into account, the monthly burden falls to the 37% as depicted in the chart below.
The fact that the volume of newly granted mortgage loans plunged by more than 60% in the period from August to November is thus hardly surprising and suggests that new demand for (credit-financed) housing is declining. However, it cannot be concluded on its own that the market is faltering and moving from an (expected) decline to an (unanticipated) more drastic correction. Such a "free fall" would be difficult to avoid if existing real estate owners were forced to sell their properties due to rising monthly instalments, i.e. if they were no longer able to afford their own properties. In that case, the reduced demand would be accompanied by a higher supply. However, such a "forced increase in supply" is unlikely on a larger scale. In this context, it is important to note that borrowers are not all the same. The extent to which borrowers face headwinds from interest rates depends to a large extent on the time of purchase. For example, someone who bought an average single-family home in 2015 should not face a higher monthly burden (gray bars) in the next few years than in the year of purchase (yellow bars), despite increased interest payments. The longer ago the purchase (financed by a variable-rate loan), the more relaxed households can be about the interest rate change. And there are three reasons for this: A lower purchase price, interim repayments and interim income growth. Only those who have purchased property from 2016 onwards will have to reckon with higher loan instalments than in the year of purchase as a result of the interest rate change, at least temporarily. It is likely to be painful for all those who have financed a property with a variable real estate loan since the start of the pandemic. Especially in recent years, however, an above-average number of households opted for a mortgage loan with fixed interest rates and thus opposed variable real estate rates. As a result, a good half of households (share of fixed-rate volume in new business: 55% on average since January 2020) who have purchased a property with loan financing since the beginning of 2020 are at least temporarily immune to rising interest rates. By contrast, this figure was only 5% at the beginning of 2015.
Fundamental supply and demand relationship supported
The interplay between fundamental demand and fundamental supply also argues against considerably more pronounced price declines than expected. The demographic tailwind for the residential real estate market is weakening, but is still present. As the population grows, so does the demand for housing. According to the Statistics Austria forecasts, the number of households will grow by an average of 0.6% per year until 2030 - compared with 1.0% yoy over the past ten years. Consequently, Austria is growing at a lower rate than in previous years, but is still one of the most demographically dynamic countries in the EU. This is in stark contrast to Germany, whose population is only expected to stagnate until 2030 according to forecasts. At the same time, there are signs of a significantly lower expansion in supply. Building permits in the first three quarters of 2022 plummeted by 22% compared with the first three quarters of 2021. A decline of a similar magnitude should not come as a surprise with a view to 2022 as a whole. Due to the more difficult financing situation as well as higher construction costs, we expect a significant reduction in building permits over the next three years. And this will not leave new construction activity unscathed. It is true that in recent years (2017-2021) more new housing units were completed than were needed in the respective year. Nevertheless, an oversupply is unlikely to have been created. This is because the increased construction activity has only met demand that did not materialize in previous years (2013-2016) due to a lack of available housing. In other words, the cumulative excess demand was reduced. This process has now been completed thanks to the strong new construction activity in recent years, and the market is likely to be roughly in equilibrium across Austria. With an expected 10 completions per 1,000 households, this situation should not change fundamentally in the coming years.
Rental yields break through downward trend
And finally: the acquisition of property is becoming more difficult, and the “profiteer” of this development is the rental market. We are facing years with significantly rising gross rents. On the one hand, of course, because of inflation adjustments. On the other hand, however, it is also due to stronger demand for “housing for rent”. In other words, the downward trend in rental yields that has lasted for years will be broken in 2023 – we can expect rental yields to rise. In view of the assumed trend in rents (with inflation) and purchase prices, total returns including sales after a few years (IRR) are also likely to rise again in the next few years. From an investment perspective, this increases the attractiveness of real estate, which limits a downward price correction, even if real estate is no longer “unrivaled” as a safe investment in times of the interest rate turnaround.
Conclusion
Everything comes to an end. And that also applies to the Austrian real estate cycle, which is currently the longest ongoing real estate cycle in the world. The phase of rising real estate prices in Austria began as early as 2005, which means that the country can look back on 18 years of uninterrupted price increases — a record that is unparalleled anywhere else in the world. These 18 years are unlikely to turn into 19 years, and we expect nominal price declines of around 5% yoy in both 2023 and 2024. The domestic real estate cycle should thus join the ranks of the completed cycles and take the 3rd place in the “eternal best list”. However, the end of the steep climb does not necessarily mean the beginning of an equally steep fall. Arguments against this are, firstly, the detailed view of the credit burden of real estate owners, secondly, the fundamental interplay of supply and demand and, thirdly, the investor perspective. Moreover, unlike in many “real estate boom countries” of the early noughties, the previous price increase was not “bought” with structural undesirable developments (e.g. debt levels). The long party is over, but there is unlikely to be too long a hangover.
As the recent tangible price setbacks also have a regulatory component, their (detailed) provisions must be examined closely in the light of current market and environment developments (which were not foreseeable in this way) and with a view to overall market stability. After all, the regulatory measures were introduced and designed under a completely different interest rate environment than the one we are currently experiencing or that is likely to emerge in the coming months. At the time, there was no thought of a noticeably restrictive ECB monetary policy. It should also be noted that the nominal and real price declines we expect should not significantly ease the affordability of residential real estate, which is under strain for some sections of the population.
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Matthias REITH
Austria Matthias Reith is an economist at the Economics and Financial Analysis division (Raiffeisen Research) of Raiffeisen Bank International (RBI) in Vienna and looks back on more than 10 years of analytical experience at RBI. Then as now, he is the responsible analyst for the Austrian economy, and in 2020 he played a key role in setting up the Austrian regional real estate research. Furthermore, Matthias also has an eye on other euro area countries as well as on the monetary union as a whole, focusing on the business cycle and in particular on fiscal policy. Matthias has several years of experience in lecturing and presenting.
Gunter DEUBER
Austria Gunter Deuber is heading the Economics and Financial Analysis division (Raiffeisen Research) at Raiffeisen Bank International (RBI) since 1 January 2021. Since 2011, Gunter Deuber has held leading positions in RBI's Economic and CEE Research and has continuously expanded the cooperation with his research colleagues in RBI’s subsidiary banks in CEE. Since the early 2000s, he has been analysing economies, banking sectors and market topics with a focus on CEE and EU/euro area topics for RBI in Vienna, but also in the international (investment) banking context in Frankfurt. He regularly presents the views of Raiffeisen Research and his research team at meetings with investors and clients. He is a well sought-after speaker at landmark events in the finance and banking industry and a guest lecturer at several universities/teaching institutions. In 2019, he was nominated for the US State Department's IVLP (International Visitor Leadership Program). Gunter has published several edited volumes on Euro/EU crisis issues and published various articles in professional journals and industry magazines. Outside the office, Gunter enjoys travelling with his family and long-distance running.
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