8 May 2018
Swedish house price trends
After years of buoyant growth, Swedish residential price growth turned negative in the second half of 2017
After years of buoyant growth, Swedish residential price growth turned negative in the second half of 2017. While not unexpected, this shift occurred earlier than anticipated and sparked a wide reaching debate about the outlook for the residential market as well as wider consequences for the Swedish economy.
In this article, we discuss the drivers of residential prices in Sweden, contextualising them within the house price bubble of the late 1980s, and formulate the outlook. In our view, the correction was due as the market was close to overheating, but the preceding price growth was to a large extent fundamentally justified. While it may result in some weakening of confidence in the short term, longer term negative consequences for the economy are unlikely given the fundamental strength of the economy and a very solid financial standing of the consumers.
Swedish residential prices have been growing with only few interruptions since late 1990s. The only two instances of declines were during the financial crisis in 2008 and in the aftermath of the European sovereign debt crisis in 2011 and growth accelerated again after 2013. In total, residential prices were growing on average by 6.5% p.a. between 1995 and 2017 in the whole of Sweden and by 7.7% p.a. in Stockholm, and growth rates were even higher in the past five years at 7.8% p.a. and 8.7% p.a., respectively. Due to low inflation during most of this period, real growth rates were also very high.
Buoyant house price growth raised concerns about potential overheating of the market and formation of a house price bubble, particularly in the context of increasing mortgage debt. A series of warnings from the Riksbank and various international institutions, including the European Commission, culminated in regulatory measures aimed at cooling the market, in particular the limitation of interest-only loans. At the same time, construction activity started to increase rapidly from 2015 onwards after 20 years of very low levels. These developments finally led to a reversion of the price trend that became evident in autumn 2017. According to the Valueguard’s HOX index, residential prices in Sweden declined 9% between August and December 2017, while the drop was even higher for flats in Stockholm at minus 12%. However, the first months of 2018 have seen a counter-movement and the index regained 3% until March 2018. The shift was also accompanied by a slow-down in transaction activity, which dropped in the second half of 2017 to the lowest level in years and continued to be muted in the first months of 2018.
Drivers of residential prices
Low interest rates and the availability of cheap mortgages have been most frequently named as the key drivers of residential price increases in many European cities over the past decade. However, we believe that the reasons were much more fundamental in Sweden. Reviewing the key demand and supply factors, it is evident that Sweden has seen a significant increase in population since 2006, driven mainly by migration but more recently by natural growth.
At the same time, construction of residential units remained at historically low levels. In fact, population growth has been higher than the growth of residential stock for more than 10 years leading to an effective shortage of housing. 255 out of Sweden’s 290 municipalities reported housing shortages in the 2017 survey conducted by the National Board of Housing, Building and Planning (Boverket). Another analysis by Riksbank indicated that shortages are most severe in metropolitan areas, in particular in Stockholm.
The upwards pressure on house prices arising from the above fundamental factors was further boosted by favourable lending conditions. Debt-to income ratios of Swedish households doubled from c.90% in 1995 to c.180% in 2016, but the interest coverage ratio (interest payment as a percentage of disposable income) dropped from over 10% to 4% during the same period. At the same time, household savings increased to historically high levels from around 5% to over 10% of GDP, and the savings rate has been consistently among the highest in Europe over the several past decades.
The relatively sudden trend reversion in 2017 can be attributed to three factors:
- Rapid increase in supply,
- Changes in regulations to limit mortgage lending,
- Wide spread expectation of an imminent market turn, reflected in the rhetoric of major institutions.
Comparison with the 1980s
Economic commentators frequently compare the current situation with the house price bubble of the late 1980s, which eventually led to a severe financial crisis. Rapid deregulation of the lending market in a high inflation and low real interest rate environment led to an uncontrolled increase in mortgage debt levels and resulted in a pricing bubble on the real estate market. It was punctured by the restructuring of the tax system and an interest rate increase by the Riksbank in an attempt to protect the currency value. As a consequence, Sweden experienced a deep financial crisis and an economic downturn.
The profiles of house prices and household indebtedness in the last five years indeed resemble those in the years 1986-1990. However, there are also a number of significant differences that should be considered:
- The balance of supply and demand is entirely different today than it was 30 years ago. New construction was reaching record levels in the late 80s, only a decade after significant amounts of housing stock were added during the “Million Programme” of the 1960s and 70s. In contrast, current supply is much tighter, especially when compared with such strong population growth.
- The financial situation of households was more stretched in the late 80s and early 90s. Despite the lower debt levels, interest expenditures exceeded 15% of household incomes compared with 4% today. Also, the current high level of household savings provides a buffer against adverse mortgage market developments.
- The economic growth of Sweden during the late 80s was comparable with today’s levels, but it was below the average for developed countries at the time. In contrast, Sweden has been a clear outperformer in the recent years and business confidence remains strong.
- Finally, the central bank and Swedish authorities appear to be more concerned about the risks associated with the potential bubble, taking active steps to counter market overheating. Interest rates increases are therefore likely to be gradual and communicated well in advance.
While the lessons learned from the 1980s boom and the 1990s downturn remain relevant, the risks arising from the recent correction on the housing market appear to be smaller than 30 years ago.
Outlook and consequences for other sectors
Going forward, we might see some further declines of Swedish house prices during 2018 driven by more restrictive mortgage regulation, increasing completions and some negative momentum. However, we believe that most of the correction has already fed through, and growth will return in 2020. In the medium term, strong economic fundamentals and continued population growth should support a rebound in prices. The price correction should also slow down supply, which will additionally support future recovery.
As outlined above, we believe that despite some similarities, the current market situation is fundamentally different from the boom and recession of the late 80s and early 90s. Hence, significant consequences for the broader economy are not likely. In fact, Swedish GDP growth in the final quarter of 2017 was 0.9%, resulting in an annual increase of 3.3%. The forecast for 2018 is only slightly weaker at 2.6% and business confidence remains very strong and so far unaffected. However, consumer confidence has been trending downwards in the first months of 2018 according to OECD, albeit still above the long term average. In the context of high household debt, declining house prices might result in weaker consumption in the near term, but also this effect should be temporary.