A new report by S&P Global Ratings has revealed that European house prices proved more resilient than expected in 2023, leading the company to revise upwards its European house price forecasts.
However, despite this revision, S&P thinks that the price correction is not over yet and that demand will slow further this year, easing supply constraints.
Supply factors are the main driver of house price resilience, according to the report, alongside a strong labour market, backlog demand, government support, and still-high construction costs, leading to the price of new homes increasingly decoupling from that of existing homes.
While some mortgage rates reflect the lower 10-year bond yields at the start of 2024, S&P does not think they will see a sustained downward trend before mid-year, because it believes that central banks will cut rates later than markets are currently pricing.
The report states: ‘The extent of our upward revisions varies greatly from country to country, and is most pronounced for the U.K., Ireland, and countries in southwest Europe such as Spain and Portugal. Meanwhile, only Germany and Sweden depart from the general trend toward greater housing price resiliency in 2023.
‘The main driver for the change in our forecasts is improved price resilience across the European housing markets in the second and third quarters of 2023. Looking at the reasons behind this greater resilience, it seems that a mix of demand and supply factors are at play, with supply factors dominating.’
New demand weakened less than expected
One reason that demand did not weaken as much as previously expected is the European labour market has held up better than anticipated, with the European economy creating 600,000 net new jobs in the second and third quarters of 2023, while wage growth continued to accelerate.
Several European governments have also intensified their financial support to households, with net social benefits increasing and contributing two percentage points to the annual increase in household gross disposable income over the period in the eurozone.
In some cases, lenders have also resorted to forbearance measures to cushion the interest rate shocks for households, therefore avoiding a crash in demand. As a result, housing affordability - especially for current owners with mortgage resets - and therefore housing demand deteriorated less than expected over the period, leading to few forced selling transactions.
What’s more, even though new demand for housing is being held back by tighter financial conditions - new lending for house purchases has almost completely dried up since the European Central Bank (ECB) began raising rates by mid-2022, down to €16bn in the past 12 months from €240bn over the previous 12 months - the level of construction backlogs remains particularly high, keeping the price for new houses elevated.
European companies estimate that they still have close to nine months of operations ensured by the current backlogs. The backlogs situation is, however, very different from one country to the next, with Italian companies - whose business has been boosted by the government’s housing tax credit since 2021 - reporting a record 16-month order backlog, compared with less than four months for Germany.
Supply constraints remain key
The report states: ‘In our view, supply has been the main factor behind the resilience of European housing prices over the past two quarters. The European Commission survey suggests that supply constraints remain the largest factor limiting building activity across the EU. While material and equipment shortages have eased in the past six months, the labour shortage remains acute, and contributed to higher construction costs in a labour-intensive sector. Another aspect is that the price of raw materials used for construction, such as cement, bricks, or manufactured windows, has not dropped from the peak. As a result, construction producer costs in residential building increased through the second quarter of 2023 and increased further in the third quarter.’
Prices continue to adjust to higher interest rates
The better-than-expected resilience of European house prices in the second and third quarters of 2023 does not mean that the adjustment of prices to higher interest rates is over.
The report adds: ‘On the contrary, we think that the bottom of the house price cycle is still ahead of us. We assume in our baseline scenario that central banks won’t start cutting policy rates as early as financial markets are anticipating; we expect European central banks in developed Europe to wait until mid-year rather than start cutting in early spring.
‘This means that we are not convinced that the recent decline in 10-year yields is sustainable. Mortgage rates are still increasing in most of the countries this publication covers. In some countries, they reached a 10-year high. What’s more, for many markets we cover, variable-rate loans or loans with a short interest-rate-fixation period dominated the newly issued loans in second-quarter 2022, before rate hikes. Consequently, the adjustment of mortgage rates to the new rates environment is probably not yet over. We interpret the fourth consecutive month of outflows from European real estate funds up to November 2023 as a sign that investors do not believe the bottom has been reached in real estate prices.’
