My finances, my projects, my life
May 24, 2024

Is housing still a good investment?

  Compiled by myLIFE team myHOME April 1, 2021 3506

House prices in many European countries appeared to defy gravity during the Covid-19 pandemic, much to the bemusement of analysts. At a time when economies experienced an unprecedented turbulence, it seemed incongruous that residential property should have remained so buoyant. However, there is evidence that in many countries the market has been negatively impacted by the recent resurgence of inflation and the abrupt end to nearly a decade and a half of ultra-low interest rates.

The European housing market appears to have benefited in 2020 and 2021, paradoxically, from repeated periods of restriction on personal movement, in terms of both transactions and price levels. The evidence suggests the market was affected less than during previous economic downturns. Many property investors will remain painfully conscious of the fallout from the 2007-09 global financial crisis, when Spain and Ireland’s property markets went into freefall, admittedly from very overheated levels. Only in Germany, Luxembourg and Sweden did markets prove relatively resilient.

In Luxembourg, which has been experiencing a boom in home prices for years, the pandemic appears to have caused little more than a hiccup.

In Luxembourg, which had experienced a boom in home prices for years, the pandemic caused little more than a hiccup. The cost of a house or apartment grew by 140% between 2010 and 2022, according to Eurostat, significantly higher than the EU average of 49%. By contrast, growth in rental prices in Luxembourg increased by nearly 20% over the same 12-year period, close to the EU average.

First slowdown in decades

However, since then the grand duchy’s residential property market has experienced its most significant slowdown in decades. According to online real estate listings platform Immotop, the average price of homes and apartments in the grand duchy peaked at €9,208 per square metre in July 2022; by May of 2023 it had declined to €8,626. Analysts attribute the stalling market to the impact of rising borrowing costs at a time when inflation is eating into earnings.

That marks a significant change; for most of the past two decades, buoyed by the ‘great moderation’ of inflation and interest rates amid steady economic growth and rising earnings, investment in Luxembourg houses and apartments has been a one-way bet. According to the BIL IMMO index compiled by Banque Internationale à Luxembourg until 2017, home prices have increasingly outstripped the country’s consumer price index since around 2000. Annual average price growth in the past decade has ranged from 4.4% in 2014 to a peak of 14.5% in 2020.

Although analysts have routinely described Luxembourg’s housing market as overheated in recent years, many industry participants believe that the dip in prices may well prove shallow and relatively short-lived, and soon reversed once inflation and interest rates drop back toward the trends seen so far this century. With a shortfall of new construction of homes estimated at around 3,000 a year, demand appears set to exceed supply for the foreseeable future.

Of course, Luxembourg is relatively atypical among European residential property markets – a small, extremely prosperous country whose economy is mostly based on services, closely interlinked with neighbouring regions and where almost half of the national workforce commutes in daily from other countries. These factors endow the housing market with intrinsic buoyancy – which extends to a lesser degree to neighbouring areas of Belgium, France and Germany.

Impact of inflation

Some of the factors that have influenced the end, at least for now, of the long housing market boom also apply to other European countries. In April 2023 the International Monetary Fund warned in its regional economic outlook of the risk of home price corrections across the continent linked to both the impact of levels of inflation unprecedented since the 1990s and the raising of interest rates by central banks to heights also unseen for decades to bring rising prices back under control.

The IMF says downward trends were already visible in some European housing markets, including the Czech Republic and Denmark; in Sweden residential property prices declined by more than 6% in 2022. It says the decline could accelerate as interest rate hikes continue, even if there is no broader financial distress within economies, notably if markets see longer-term inflation risks and lenders become significantly more conservative. This is also likely to have a broader economic impact by lowering households’ assessment of their own wealth and financial outlook.

Average home prices across the EU declined by 1.5% during the final quarter of 2022, the first quarterly drop since 2015, although they remained 3.6% higher than in the same period a year earlier.

According to Eurostat, average home prices across the EU declined by 1.5% during the final quarter of 2022, the first quarterly drop since 2015, although they remained 3.6% higher than in the same period a year earlier. However, the IMF’s analysts see at least a possibility of a vicious circle involving higher mortgage loan interest rates, constrained household discretionary spending, an increase in payment defaults and a further drop in the willingness of banks and other lenders to provide finance to would-be homeowners. It says empirical models linking home prices to their fundamental drivers point to an overvaluation of between 15% and 20% in most European countries.

That reflects to some extent the extremely high level of home price growth in some European countries over the past 25 years – 176% between 1996 and 2021 in Sweden, 145% in the UK, 142% in Denmark and 126% in France, according to the Organisation for Economic Co-operation and Development. But in other countries growth has been much more modest over the 15-year period – 31% in Germany (where prices had been lower than in 1996 until 2016), 27% in Portugal (where recent growth is attributed to its Golden Visa scheme to attract wealthy residents with tax breaks) and just 9% in Italy.

Persistent price decline?

A report in early 2023 from rating agency Standard & Poor’s concluded that this long period of price growth appears to be coming to an end, with a decline – although not a crash – in home prices in most European countries set to persist until 2024 and little prospects of a strong rebound before the end of 2025. It says prices as well as investment are set to suffer from rapidly rising borrowing costs.

Although residential property construction has been holding up well in many European countries – although not in France, Sweden, Germany or Luxembourg – S&P argues that construction is a lagging indicator of the housing market, given the length of time between housing starts and completion.

An important factor for residential property investors is that rental values have remained much steadier than purchase prices over the past decade.

An important factor for residential property investors is that rental values have remained much steadier than purchase prices over the past decade. Eurostat says average rents across the EU increased steadily, but not spectacularly, between 2010 and the fourth quarter of 2022 – with growth of just 19%, compared with 47% for home purchase prices over the same period. Luxembourg was just above the average at 20%.

What does this mean for property investors? If the forecasters are correct, there is little likelihood of the resumption of a Europe-wide significant surge in home prices – and therefore of substantial capital gains – before the middle of the decade. However, a large-scale drop in rental returns also appears unlikely since they have not raced ahead of overall economic growth over the past decade. And any drop in housing market sales could push more people toward renting rather than purchasing property in the coming years, supporting demand.

In the long term, investment in residential property is likely to remain popular simply because supply and demand factors are likely eventually to bring prices back into equilibrium, and rents can deliver the steady returns that many investors seek. But the days when houses and apartments were a one-way bet appear to be over – at least for the foreseeable future.