The European property market is on life-support; experts describe its condition as serious, but stable. Each limb seems to be afflicted with a different ailment: in Britain misguided stimulus might be causing a new property bubble that will doubtlessly burst before long; in Spain, the market is so stagnated it will soon go gangrenous; in France, once-opulent chateaus crumble like broken bones. Specialists have been consulted and are demanding action from authorities, but some governments have chosen to switch off the life support and hope for the best.
Since the onset of the crisis in 2007, the property market in European jurisdictions has taken a nosedive. The property slump has been a massive contributing factor to Spain’s enduring recession, and it may be holding back recovery in Britain and France. But as real estate and construction are two of the most vital industries for a healthy economy, a full recovery for Europe might still be a long way off. Though house prices in Britain are recovering, it has been widely reported that the sector is by no means fixed. In fact, there is a chronic housing shortage in the country, sending house prices, particularly in London, soaring.
The crucial issue is that house building has not returned to pre-crisis levels, but demand has been steadily rising. In a free market model, as prices of goods go up, production goes up with it. It is no different in the property market; as prices soar, this triggers an increased pace in the construction of new properties because it is clear to builders and developers that there are not enough suitable properties to meet the demand.
In Britain, however, the construction sector has been singularly unresponsive to rising demand. Britain has an historically strong property market as home-owning is seen not only as aspirational, but also as a way of securing wealth. Research by housing charity Shelter suggested that if the prices of household goods had risen at the same rate as property prices have over the past 50 years, the price of a chicken at a local supermarket would be close to £51.
Help to Buy
The British government has acknowledged there is a housing crisis, and has taken some steps to mitigate its effects, the biggest of which has been the launch of the Help to Buy scheme. Help to Buy is essentially a loan that will ensure suitable prospective buyers have access to up to 20 percent of the value of a new-build property as a five-year interest-free loan. It is also a mortgage guarantee scheme that insures banks on mortgages with a loan-to-value rate of over 80 percent.
The scheme is meant to boost lending and give buyers an opportunity to get on or climb the property ladder without having to save for an astronomical deposit. It is also meant to encourage banks to lend more, as the taxpayer will insure mortgages. However, since its announcement, the Help to Buy scheme has been almost universally derided as a failure.
“While the scheme is well-meant, it is not likely to do any good overall, and may do significant damage to the British housing market,” argues Sam Bowman, Policy Director at the Adam Smith Institute. “Help to Buy is likely to drive house prices upward without creating new demand, aggravating the housing crisis, it risks taxpayer money with no guarantee of a return, and recreates some of the perverse incentives that led to the US subprime mortgage crisis in 2008.”
Supply and demand
Most of the criticism seems to revolve around the fact that Help to Buy addresses demand issues, when in reality it is the supply side of the equation that needs balancing. Building in the UK has dropped to its lowest level since 1923, when the country was still recovering from WWI. Today, Britain’s building industry is at the mercy of an antiquated set of planning restrictions that prevent the supply of housing keeping up with the growing demand. “Since Help to Buy does nothing to make it easier to build new houses, it will have a negligible impact on the availability of houses. The extra money made available by the scheme will just drive overall house prices upwards,” says Bowman.
There are proponents of the Help to Buy scheme out there though. Lloyd’s bank boss Antonio Horta-Osorio described the scheme as a “game changer” for the UK economy, dismissing suggestions that it could cause a housing bubble. “A temporary scheme is the right thing to do as long as it is designed, as this one is, to support first-time buyers. That will lead house builders to increase the construction of new houses and that is one of the biggest drivers of employment in this country,” he told Sky News. Despite its flaws there are those that will be encouraged to join the property market by the scheme, especially since interest rates in the UK remain extremely low, which is favourable for those thinking of borrowing.
In the summer new Bank of England Governor Mark Carney announced a policy to keep interest rates low to incentivise banks to lend more and boost the economy. However, he has admitted that the Help to Buy scheme, when coupled with such low interest, could lead to unrestrained lending and a bubble. Carney stated that he is “very alert personally to this issue. I saw the boom-bust cycle in the housing sector, the damage it can do, the length of time it took to repair,” before revealing that the bank has a toolkit of measures to deal with such an eventuality. He did, however, refrain from specifying what exactly was in that toolkit.
Another worrying aspect of Help to Buy is the mortgage guarantee, ensured by the taxpayer. It is a similar model to Fannie Mae and Freddie Mac in the US, in which the government supported mortgage-backed securities, eventually leading to the emergence of sub-prime loans. “By guaranteeing up to £130bn worth of borrowing, Help to Buy’s mortgage guarantee socialises the risk between bank and borrower, with the taxpayer on the hook if something goes wrong,” explains Bowman.
Despite working hard and saving what they can each month, today’s young people face life-changing choices between starting a family or buying a home of their own
So while the UK government recognises the housing market is ailing, Help to Buy suggests that it does not fully understand what is actually wrong, and has misdiagnosed the problem entirely. There has been a huge backlash from the British press against Help to Buy, because it fails to address a very real problem. Further research by Shelter has concluded that house prices are going up so fast in the UK – particularly in London – that people in their 20s could take up to 30 years to save an appropriate deposit to get on the property ladder.
“This is the first time research like this has been conducted at a local level to reveal the harsh realities that ‘generation rent’ is having to confront because of our shortage of affordable homes,” explains Campbell Robb, CEO of Shelter. “Despite working hard and saving what they can each month, today’s young people face life-changing choices between starting a family or buying a home of their own. Imagine a 28-year-old couple weighing up their options: they can save for a home now and put off starting a family until they’re 35, or they can start a family now but accept they’ll be renting until their child is a teenager.”
A delayed response
The OECD published the Price Responsiveness of Housing Supply two years ago in which research proved the new housing supply is more flexible in North America and some Nordic countries than in some continental European countries and the UK, where the market is relatively unresponsive. According to authors Aida Caldera Sánchez and Asa Johansson, in the US a one percent price increase will cause a two percent rise in supply; in Sweden, Denmark and Finland supply increases proportionally more than housing prices, ensuring long-term affordability. “In the short to medium term, an increase in housing demand would translate into smaller increases in real house prices if housing supply is more responsive,” say Caldera Sánchez and Johansson in their report.
“Responsive housing supply is especially important to avoid bottlenecks in different segments of the market. However, the flipside is that in flexible-supple countries, housing investment adjusts more rapidly to large changes in demand.”
The same cannot be said for the UK, France, Spain, Germany and other European countries, where a one percent price increase only triggers a 0.4 percent increase of supply. “During recent decades very large price increases were observed in the UK and the Netherlands – in these two countries, the responsiveness of new housing prices is noticeably low.”
In the UK, at least, the economy has somewhat returned, but in Spain and Greece, which remain in deep recessions, the property price and house building slump is deeply worrying. Research by estate agent Knight Frank shows that property prices in Greece fell by 11.8 percent in the year to March 2013, the rate of decline worse than the year before when the slump had already been an eye-watering 9.8 percent. In Spain, prices dropped 7.9 percent in the year to March, the result marginally worse than the year before when house prices dropped 7.3 percent.
The Spanish economy was growing at a healthy average of 3.7 percent a year between 1999 and 2007, with house building an important part of that sustained period of growth. This boom, however, was underpinned by a massive housing bubble fuelled by cheap loans to builders, developers and buyers. Between 2004 and 2008, house prices increased by a massive 44 percent. Since the bubble burst, prices have dropped again by a third. Spain’s property collapse went hand-in-hand with the collapse of the local banking industry, which had for years indulged in risky practices.
In many ways, Spain’s situation is the polar opposite of the UK’s where there is a housing shortage; across the Iberian Peninsula and much of Spain there is a surplus. It is not a surprise that UK buyers have been put off by the astronomical prices at home, and turned to options abroad instead.
France, in particular, has been a popular destination, as prices remain low. According to FNAIM, the real estate federation of France, property prices dropped 3.5 percent in the first six months of 2013, compared to the same period the year before. There are signs that the local market is beginning to rally. In the Ile-de-France, prices have increased around 2.7 percent over the same period, and experts are starting to suggest the growth of a buyer’s market, where borrowing conditions are improving but prices remain low. In a recent poll FNAIM found that 58 percent of respondents thought that profitable real estate transactions could be carried out in France in the current climate.
Real estate recovery
Though the situation is far from back to normal – and it will be a good few years before conditions return to pre-crisis levels – a recent paper by CBRE revealed improving economic sentiment across Europe in 2013 will set the stage for a real estate recovery by next year. “Economic forecasts still point to a difficult year ahead, but much of the downside, principally fears around a eurozone break-up, has diminished,” says Neil Blake, head of UK, and EMEA research at CBRE. “Market confidence is all important. If the trend of positive indicators persists, we expect to see improved economic growth and property market conditions, but we may have to wait until 2014 for signs of significant progress.”
As things continue to improve slowly across Europe, it is vital that the construction and real estate markets don’t fall back into old habits. Consumer confidence is key, as buyers need to feel safe investing in the housing market, but countries across Europe must rethink their incentives in order to provide a healthy setting for investment. Spain has learned the hard way that a housing boom might feel great at the time, but is extremely damaging in the long run – a lesson Britain would do well to learn as it continues to invest in misguided stimulus and schemes.
It has been over five years since the start of the crisis that ravaged Europe’s economies and it is understandable that buyers and investors remain cautious, particularly when it comes to the housing market and taking on new debt. The only way the housing industry will be restored to full health is if European decision-makers create a solid and stable foundation for it to grow, and not hurry back to rampant expansion. We all know where that leads, and it is not a place Europe should ever want to go back to.