How long can the real estate sector’s upward trend last?
Despite the worsening economic situation there is a marked upward trend in the real estate sector with very strong demand and a notable rise in prices. For its part, the supply of new housing is being affected by the war in Ukraine as this has pushed up construction costs even further and aggravated the material supply problems due to bottlenecks in global value chains. Consequently, the misalignment between the demand and supply of housing has intensified, with the result that house prices are likely to continue rising. However, there are several counteracting factors that should help to curb the growth in demand and prices over the medium term, including the impact of inflation on real household income and the ECB’s interest rate hikes.
The war in Ukraine has brought about a change of scenario for the Spanish economy. When the conflict broke out, CaixaBank Research revised downwards its forecast for GDP growth in 2022, from 5.5% to 4.2%, while its inflation forecast has gradually been revised upwards, to 7.5% on average for the year. The Spanish economy has mainly been affected by these factors through higher energy and raw material costs, putting pressure on business margins and eroding the purchasing power of households.
Nevertheless, in spite of the worsening economic outlook Spain’s economy performed reasonably well in the first half of 2022, thanks mainly to the revival in tourism following the end of almost all restrictions associated with the pandemic, reflected in the good figures posted by the labour market. However, the inflation shock is becoming stronger and more persistent, resulting in an earlier and faster tightening of monetary policy than previously expected. This context has weakened the outlook for the end of this year and 2023, leading to a downward revision of the GDP growth forecast for 2023 (2.4%) and an upward revision of the inflation forecast (2.5%).
There is an upward trend in the real estate sector despite the worsening economic scenario but we expect this trend to moderate as interest rates rise.
For the time being, the impact of this change in scenario on the real estate sector has been very limited, mainly affecting the supply of new housing (due to higher construction costs and greater uncertainty). On the other hand, growth in demand and prices has accentuated its upward trend that began in 2021, although we expect these figures will moderate over the coming quarters due to the exhaustion of demand and as a consequence of the normalisation of monetary policy being carried out by the ECB to curb rising inflation.
Sales grew strongly again in April (12% year-on-year), although this is the first sign of demand dropping off, given that growth in sales had been closer to 30% year-on-year in previous months. The cumulative figure for the last 12 months reached 606,000 homes, a figure not equalled since August 2008. Since the beginning of 2021, a large number of factors have boosted demand for housing: the change in preferences following the pandemic (working from home, more spacious homes located further from urban centres, etc.), the «forced» savings during lockdown that have partly been invested in real estate, good employment figures, very favourable financing conditions, the rapid recovery in foreign demand, etc.
However, looking ahead to the coming quarters, we expect house sales to moderate to 550,000 in 2022 as a whole and 490,000 in 2023 (down from 566,000 in 2021). On the one hand, some of the factors that have recently supported demand are of a temporary nature and will tend to dissipate. On the other, several contrary factors have appeared on the scene which, although their impact may be delayed, should help to curb the growth in demand over the coming months, especially the impact of inflation on real household income and the ECB’s interest rate hikes.
Rising interest rates will help to curb housing demand
Rising interest rates will help to curb housing demand
In fact, growing inflationary tensions in the euro area have triggered a major shift in monetary policy.1 In mid-April, the 12-month Euribor was positive for the first time in six years, posting a significant increase from last year’s record low levels (around –0.50% on average in 2021). At CaixaBank Research, we predict this upward trend will continue over the coming months, although we expect the increases to be somewhat more gradual than those currently discounted by the financial markets and, moreover, we should remember that the starting point for interest rates is very low. Specifically, we forecast that the 12-month Euribor could reach 1.5% by the end of this year and rise to 1.75% by the end of 2023. Given this context of rising interest rates, investment in real estate assets could be diverted in the face of higher yields from fixed-income financial assets, such as Treasury bonds.
Foreign demand, on the other hand, may also be affected by the economic slowdown in the countries of nationals that are most likely to buy property in Spain (the United Kingdom, Germany and France). However, the most recent data are extraordinarily positive (foreigners bought around 21,600 homes in Spain in Q1 2022, a total that far exceeds the pre-pandemic figures). In addition, indicators for purchase intent, especially in the Nordic countries, continue to point to high numbers of foreign purchases this year. For more details, see the article «The strength of foreign demand for housing in Spain and its long-term outlook» in this Sector Report.
- 1. The ECB ended its net asset purchases (APP) on the 1st of July and is expected to begin a new cycle of interest rate hikes in July.
In 2021, the number of new building permits (108,000) returned to the levels of 2019, after the slump caused by the pandemic in 2020 (86,000). Data for the first three months of 2022 suggest this recovery in supply is continuing, with 28,000 building permits being granted, 18.4% more than in Q1 2021 but only 1% above the figure for Q1 2019.
New building permits
Rising prices in global markets for energy and industrial metals
are limiting growth in the supply of new housing.
However, it should be noted that these figures do not yet reflect the impact caused by the Ukrainian conflict on energy and construction material prices, which had already been on an upward trend since the second half of 2021 and have merely accelerated (see the chart and table below). A more uncertain economic outlook, difficulties in finding skilled labour and the trend in prices are also negatively affecting the start of new real estate developments. As a result, we expect new building permits to eventually decline moderately in 2022 as a whole (100,000 homes) but recover slightly in 2023 (110,000), as the pressure on construction costs dissipates. In addition to new construction, the renovation of existing housing should gain momentum over the course of this year, as projects linked to the European NGEU reconstruction funds are implemented.
Construction costs are going up sharply
The upward trend in house prices, which started in 2021, accelerated in Q1 2022 according to the three main price indicators. For example, according to the National Statistics Institute’s index, based on transaction price, house prices rose from 6.4% year-on-year in Q4 to 8.5% in Q1. New builds saw the biggest growth (10.1% year-on-year) but second-hand housing also advanced significantly (8.2% year-on-year).2 In the short term, the dynamism of demand relative to supply and rising construction costs will continue to push up prices, especially the price of new builds.
- 2. In fact, this trend has already been observed since the pandemic: the price of new builds grew much more steadily (18.4%) than second-hand housing (9.5%) in cumulative terms between Q4 2019 and Q1 2022.
The dynamism of demand compared with supply and increasing construction costs suggest that house prices will continue to rise to some extent, although higher interest rates will tend to curb this upward pressure.
Nevertheless, as demand drops off, construction costs stop rising and interest rates increase, we also expect the growth in house prices to slow to some extent,3 specifically to around 2.0% in 2023 after advancing by more than 6.0% in 2022.
Looking at the different autonomous regions, this upward trend in prices is widespread among the country’s largest residential markets and in the most tourist-oriented areas. In particular, in Q1 2022 and according to data from the National Statistics Institute, the highest growth rates were recorded in the Balearic Islands (10.5%), the Community of Madrid (9.5%) and the Community of Valencia (8.2%), the most notable case being that of the Balearic Islands as, thanks to the boost provided by foreign demand, it has set a new record for the available series for the fourth consecutive quarter. In contrast, the most modest price increases were recorded in Asturias and Cantabria (both up by 1.6% year-on-year), regions that had already looked less dynamic in terms of their house prices before the pandemic. We take a closer look at this heterogeneous trend in house prices by zone in the next article in this Sector Report: «Where are house prices growing the most in Spain?».
- 3. According to our semi-structural model for the Spanish economy, the sensitivity of house prices to increases in the interest rate is –0.51; i. e. an increase of 100 bp in the interest rate implies a reduction of 0.51 bp in the rate of change of house prices.
House prices are growing more rapidly
The price for new housing is growing more steeply
Some people believe that the house price increases recorded recently are very high, bringing the risk of a real estate bubble in Spain once again into the spotlight. The article «Assessing the risk of a real estate bubble in developed markets» in this Sector Report, analyses this issue in detail and, although we conclude there is a risk of a real estate bubble in several developed economies, this does not appear to be the case for Spanish properties. Consequently, our scenario envisages a certain slowdown in the rate of house price growth but we believe there is little risk of an abrupt correction in the housing market.
In any case, more moderate price growth will keep in check the deterioration of the mortgage burden caused by rising interest rates. According to our estimates, the rise in mortgage interest rates will increase the stress ratio by about 5 pp in 2 years (from 33.4% of household income in Q4 2021 (latest available data) to 38.4% in Q4 2023). This is a considerable increase, although the ratio is still a far cry from the levels reached during the housing crisis. Nevertheless, financial markets are currently anticipating somewhat more aggressive action by the ECB. In particular, the implicit 12-month Euribor interest rate as of 20 June 2022 is 2.1% by the end of this year and 2.5% by the end of 2023. Consequently, if we use the implicit market interest rates as of mid-June, the increase in the mortgage burden ratio is much steeper, up to 40.6% by the end of 2023.
Theoretical mortgage burden
Finally, it is also worth commenting briefly on the rental market. The rental price indicators available on real estate portals also show an upward trend, although this is generally somewhat more moderate than the growth observed in sale prices. According to Idealista, rents increased by 3.1% year-on-year in May 2022 although they are still 3.9% below their pre-pandemic level. However, there are substantial geographical differences, with very significant increases of 17.1% in Barcelona city and 17.3% in the Balearic Islands, precisely in those areas where rents are already higher and where sale prices are also rising steeply, a situation that is exacerbating the problems of housing affordability.