SO WHAT ABOUT THAT MORNING AFTER FEELING?
By Department Director Steen Bocian, Danske Bank
ECONOMY: The Danish housing market has seen massive price increases in recent years. It now looks like the good times are coming to an end
Since 1995, house prices in Denmark have almost tripled, apartment prices quadrupled – and in the capital, Copen-hagen, apartment owners have actually experienced almost five-fold increases.
However, it now looks like the good times are at an end. The first reports of a pronounced shift in the Danish market began to emerge in early 2006, and indeed the latest official statistics on house prices show a clear slowdown. After a couple of hectic years, house price growth slowed to just 1.5% from third to the final quarter of 2006 – a rather different pace to what had become the norm in recent years. Meanwhile apartment prices actually fell 1% compared to the previous quarter.
Falling house prices a rarity
When a prolonged period of rising prices is replaced by a slowdown and even modest price falls in some sections of the market, it is natural to ask if the house price bonanza that kicked off in 1995 was in reality a bubble and if prices on residential property are now on their way down. Falling house prices are, in fact, a relative rarity. In Denmark, there have only been two occurrences of falling prices since the 1950s – 1979-82 and again in the “seven lean years” from 1987-93. However, both cases were rather special situations where, in actual fact, it was perhaps mostly political intervention, rather than the market as such, that sent prices down.
In the late 1970s, Denmark pursued what could be termed an active policy of devaluation. The result was that the financial markets lost faith in the Danish economy – and interest rates rose above 20%. While inflation was also high, real interest rates were, nevertheless, double digit. High real interest rates combined with restrictive legislation on borrowing left its mark in the housing market during these years – a market that was already under pressure from the second oil crisis.
The market rules
Given all this, it was no great surprise that house prices dropped. The years between 1982 and 1986 were characterised by hefty price rises in the housing market, but 1987 saw the tide turn once more. Denmark ran into current account problems in the mid-1980s, with the deficit hitting 5% of GDP. The politicians were forced to act. They did so by tightening the legislation on loans and increasing taxes on owner-occupied dwellings. The move rocked the housing market, and prices fell over the following seven years. The point here is that it was political intervention – not the market – that presaged the two most recent downturns in Danish housing prices.
This time, however, there is no sign of political intervention; it will be more up to the market to find a balance. As this is a unique situation, at least this side of the Second World War, there are grounds for some caution when predicting what will happen in the housing market in the coming years – there is simply very little in the way of precedent.
Rising interest rates
But what could cause prices to drop? In the current macroeconomic climate of record-low and falling unemployment coupled with healthy rates of growth it will hardly be the economic cycle. Interest rates may, on the other hand, have more potential. The rise in interest rates seen over the past one and a half years would support a slowdown in the market – the effect of the rise, all else being equal, would be a fall in housing prices of some 10-15%. But all else is not equal! The economic upswing has meant a sharp fall in unemployment, and this is offsetting the negative effects of the higher interest rates. Looking ahead, we expect further increases in interest rates, but nothing that could be expected to seriously depress housing prices.
A second factor with the potential to move house prices radically is market expectations. An excessive number of market participants who bought property in the expectation of a capital gain would mean a shift in sentiment could easily send prices down by 10 or 20%. Such a shift in sentiment is difficult to measure, but perhaps more importantly it is worth emphasising that the housing market is generally not nearly as speculative in nature as, for example, the equity market. Housing is primarily a consumer good – a roof over one’s head.
Our basic expectation is therefore that housing prices will stabilise around current levels in the coming years. The outlook is for just modest additional increases in interest rates and, anyway, the Danish economy looks to be in robust good health. That said, and given the lack of insight into market expectations and the fundamental market mechanisms, we would not care to rule out that the market may have come so far out of kilter that prices could fall sharply. We see a 25% chance of a major price fall around 25%. In other words a risk that should be taken seriously, but that, on the other hand, should not be exaggerated.