The impact of the rise in mortgage rates on the euro area housing market

Curated by Niccolò Battistini, Johannes Gareis and Moreno Roma

Mortgage rates in the euro area have risen significantly since the beginning of 2022, after an all-time low in 2021. The euro area housing market has been buoyant over the past two years and has been supported by favorable mortgage rates (Graph A).[1] Aggregate house price growth in the euro area accelerated from an annual increase of around 4% at the end of 2019 to nearly 10% in the first quarter of 2022, the highest rate since the beginning of 1991. At the At the same time, real estate investments recovered quickly after the pandemic slump in 2020 is around 6% above pre-crisis levels in the first quarter of this year. The composite cost of home loan cost indicator for households fell to an all-time low of 1.3% in September 2021 and remained broadly unchanged until December 2021.[2] However, mortgage rates increased significantly (by 63 basis points) in the first half of this year, the largest half-yearly increase on record.

Graph A

Real estate investments, house prices and mortgage interest rates

(left scale: annual percentage changes; right scale: percentages)

Sources: Eurostat, ECB and ECB staff calculations.
Note: Mortgage rates refer to the composite indicator of the cost of household debt for the purchase of a home and are expressed in quarterly averages.

Empirical evidence suggests that the dynamics of the real estate market are very sensitive to mortgage rates. A linear local projection framework is used to shed light on the impact that rising mortgage rates have on house prices and property investment in the euro area.[3] According to the estimation model, a 1 percentage point increase in the mortgage rate leads, all things being equal, to a drop in house prices of about 5% after about two years (Graph B).[4] However, the same percentage point increase in the mortgage rate has a greater impact on real estate investments, leading to an 8% decline after about two years.

Graph B

Estimation of the semi-elasticity of house prices and real estate investments at a 1 percentage point increase in the mortgage rate

(percentages)

Sources: Eurostat, ECB and ECB staff calculations.
Notes: The graphs show the “smoothed” estimated semielasticity of home and investment property prices at a 1 percentage point increase in the mortgage rate, using linear local projections. The projections include real GDP, the HICP, a short-term interest rate and real estate loans as control variables and are estimated for the period from the first quarter of 1995 to the last quarter of 2019 (i.e. excluding the period of COVID-19 emergency). crisis). “Smoothed” refers to three-period centered moving averages of the estimated semielasticities, excluding the start and end points. The dotted lines refer to the 90% confidence bands.

The impact of rising mortgage rates on home prices and real estate investments is greatest in a low interest rate environment. Asset price theory suggests that the lower the level of mortgage rates, the more sensitive home prices are to changes in mortgage rates, because lower mortgage rates lead to greater discounting effects on future rents and prices.[5] This increased housing price sensitivity may, in turn, also imply greater property investment sensitivity through housing profitability and side effects on value, as both are important factors in real estate investing and are influenced by movements in house prices. housing.[6] To capture this non-linearity, the model is adjusted to include an indicator that monitors the level of mortgage rates.[7] The results of this non-linear model show that, in an environment of low interest rates, the estimated decline in house prices and investment property in response to a 1 percentage point rate increase in mortgages is approximately 9%, respectively. and 15% after about two years. This is about double what linear results suggest (Graph C).[8]

Chart C

Estimated semielasticity of house prices and real estate investments at a 1 percentage point increase in the mortgage rate in a low interest rate environment

(percentages)

Sources: Eurostat, ECB and ECB staff calculations.
Notes: The graphs show the “smoothed” estimated semielasticity of home and investment property prices at a 1 percentage point increase in the mortgage rate in a low interest rate environment, using local non-linear projections. The projections include real GDP, the HICP, a short-term interest rate and real estate loans as additional variables and are estimated for the period from the first quarter of 1995 to the last quarter of 2019 (i.e. excluding the period of COVID-19 emergency). crisis). “Smoothed” refers to three-period centered moving averages of the estimated semielasticities, excluding the start and end points. The dotted lines refer to the 90% confidence bands.

However, the trend in the real estate market is affected by other factors, including structural ones, in addition to mortgage rates. While the empirical evidence from local projections points to potentially large downward corrections for the euro area housing market, other factors, not captured by the models, should also be considered. Such factors could increase uncertainty about housing prospects.[9] Following the COVID-19 pandemic, families now seem to place greater value on more spacious properties that allow people to work from home and are finding more attractive locations than the office.[10] Preliminary evidence points to a higher price increase since the COVID-19 pandemic for single-family homes in some euro area countries for which data is available (Graph D, box a). Furthermore, euro area prices increased the most for properties outside euro area capitals following the COVID-19 pandemic and the share of the euro area population living in single-family homes. increased in 2020 (Graph D, box b).[11] The preference for more space could also favor real estate investments. The pandemic-induced shifts in housing preferences could counter the rise in mortgage rates and could explain some of the resilience observed in the euro area housing market.

Graph D

Price increases for single-family homes relative to price increases for semi-detached houses, aggregate euro area house prices and house prices in euro area capitals and share / change in the share of the population living in single-family homes

a) Increase in single-family house prices compared to price increases in two-family houses

(percentage point differences from the first quarter of 2020)

b) House prices in the euro area and share / change in the share of the population living in single-family houses

(percentage changes in prices from the first quarter of 2021; population share as a percentage of the total population, percentage point change in the population share)

Sources: OECD, BIS, Eurostat, ECB and ECB staffing calculations.
Notes: Panel a: For Germany and Belgium the data refer to the difference between the prices of houses and apartments. Data for Germany, Estonia, Ireland and Lithuania refer to all homes (new and existing), while for the other countries they refer to existing homes. The last observation refers to the first quarter of 2022, with the exception of Luxembourg, Austria and Finland, for which it is the last quarter of 2021. Panel b: The euro area aggregate series for house prices is a weighted average based on the weights of GDP and includes Belgium, Germany, Estonia, Ireland, Spain, France, Italy, the Netherlands, Austria, Slovenia and Finland.

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