European Residential Real Estate: Are The Biggest Price Hikes Already Behind Us?
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We are positive on Europe’s core housing markets, as we believe rents and values will keep pace with inflation.
Apart from interest rates, many factors influence the housing markets, such as local supply and demand, employment rates, anti-laundering measures, fiscal treatment of mortgages, rents and capital gains etc.
But interest rates remain a key factor, at least in the short term. As a matter of fact, higher nominal interest rates usually impact mortgage rates and thus affordability. When fewer citizens can afford to buy their first home, housing values are negatively affected. Would-be buyers may withdraw from the buying market and turn to the lettings market (thereby pushing up rents, though not necessarily values).
We do not believe a housing catastrophe will occur in the event of higher interest rates, for the following reasons:
- Nominal long-term interest rates in Europe may rise very slowly (as at 11 August, they had edged down slightly instead of up). This would allow mortgage rates to continue to hover at around very reasonable levels. So investors would have a degree of ‘predictability’ with respect to their cost of borrowing;
- If nominal interest rates were to climb on the back of an improved economic outlook (implying higher core inflation), this would not necessarily be bad news for homebuyers. Economic growth may increase liquidity in the housing market and boost consumer sentiment in general, with real rates (adjusted for inflation) staying flat;
- Excess cash levels, coupled with the borrowing of additional cheap money, cannot continue to give impetus to housing values for ever. Some stability needs to return to the housing markets, which should be supported by ‘real’ factors rather than cheap money. This would bring stability to the various residential markets in the long run. For instance, the Czech central bank has asked the government for ‘tools’ to tame the property market (1). The central bank’s Vice- Governor, Mojmir Hampl, said that the euphoria would not last forever.
Consequently, Europe’s housing markets performed reasonably to very well during the 12 months to 31 March 2017, with many European countries posting decent real returns. Housing prices in Ireland gained almost 9% in real terms, closely followed by Montenegro, Romania, Norway and the Netherlands. Other countries, such as the Slovak Republic, Sweden and Germany, saw annual real housing prices soar by more than 5% over the same period. Capital appreciation returns must be supplemented with annual net rental income in order to determine annual total returns.
Last but not least, there is still a huge need for ‘affordable’ housing schemes almost everywhere in Europe. We project that values of medium-sized houses will hold up better than values carried by the high-end residential market. Obviously, ‘affordability’ is a relative concept and depends on geography. Annual rents per m², generated by this housing segment, typically vary from EUR 700 to EUR 1,000 per year.
We remain positive on Europe’s improving housing markets (Spain, Portugal, the Netherlands and Ireland) because domestic and international investors are still on a buying spree. Nonetheless, the biggest price hikes are most likely behind us.
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(1) Source: Reuters, 16 July 2017