European home prices fall but don't bet on a crash

Across a swathe of European countries, it's been a common complaint: people can't afford to buy their own home.

Rising inflation, a surge in interest rates and a cost-of-living crisis over the last two years have compounded the continent's long-established property problem.

European house prices have been on a seemingly relentless upward curve for close to a decade with  much of the surge driven by institutional investors. Since the first quarter of 2015, when prices rose rapidly, EU house prices have increased faster than rents in every quarter until the second half of 2022. In total, average EU house prices rose by 43% in that period.

The price surge was accelerated during the pandemic as people rushed to buy homes. In 2020 and 2021, the EU's house price index rose at a far faster rate than in the previous five years of growth.

However, in the final three months of 2022, the index finally fell back after 30 successive quarters of growth.  Figures released last week by the EU showed that for the second successive quarter, prices fell.

In total, the index has fallen by 2.9% over the space of six months. The figures have caused more than a few prospective house buyers, long priced out of the market, to wonder if the trend is likely to continue.

Higher borrowing costs put buyers off

The sudden halt to rising prices comes on the back of data showing that house prices fell in several European countries last year for the first time in more than a decade.

In Germany, prices for residential property fell by 6.8% in 2022, the biggest year-on-year drop since records began in 2000. The country's federal statistics agency attributed the fall to inflation and "higher financing costs".

The dwindling demand suggests many aspiring homeowners can no longer realistically afford to enter the market. There are also signs that supply is drying up. Almost one-third fewer apartments were approved for construction in Germany in April 2023 compared with April 2022.

"We have a real lack of housing in many places and at the same time we are canceling housing construction," said Ludwig Dorffmeister, expert for construction and real estate markets with the ifo Institute, a German economic research organization.

Another reason, according to Thomas Hein from Dutch bank ING's real estate financing division, is general uncertainty around the German market.

He says the forthcoming Building Energy Act in Germany means potential buyers are uncertain about what potential renovations will be needed to meet the energy efficiency requirements of the new law. This adds to "the current lack of cost certainty in construction or in modernization and renovation projects, the availability of materials and craftsmen and the further development of inflation," he told DW.

Across the Channel, the United Kingdom is seeing a similar fall in house prices. In June they fell at the fastest annual rate since 2011, with prices down 2.6% from the same month a year earlier.

Across many developed economies, including the UK, a sharp increase in mortgage interest rates are the main reason for this, experts say. 

"Based on mortgage affordability, we estimate that prices are currently around 30% overvalued," Andrew Goodwin, chief UK economist for the economic advisory firm Oxford Economics, told DW.

Oxford Economics arrived at the 30% figure by calculating what it determined 'fair value', measured as an affordable mortgage payment for a household with an average level of pre-tax income taking out a new mortgage with a 25% deposit. The group's benchmark of affordability was the average share of pre-tax income accounted for by mortgage payments since 2000.

Even if houses in the United Kingdom are at least 30% overvalued, as Goodwin estimates, he does not believe there will be a crash or anything like it.

"We don't think there will be a full correction," he said. "Because the high share of fixed-rate mortgages means the impact of higher mortgage rates feeds through gradually, and because we think unemployment will remain low

Over before it has begun?

Indeed, there are signs that the downturn may be slowing before it has really begun. In Germany, prices fell by 3.1% in the first three months of 2023, less than the 4.9% drop from the previous quarter.

While prices may continue to fall for a while longer, experts believe it won't be too long before the situation stabilizes.

"Whether the downturn is one, two, three or four years, there's no question that after this setback, all interested parties will again invest in the property market with confidence in the medium to long term," said real estate market expert Dorffmeister. "It is an asset."

Hein has a similar opinion. "We do not expect the real estate market for residential real estate to collapse," he told DW. "There is still demand in the market. We are currently seeing more willingness to negotiate among sellers, but without every price being accepted here. Many people still want their own property, so demand will stabilize again."

Given the link most experts have pointed to between price falls and high-interest rates, a fall in rates may spark demand again.

In April, the IMF said that "when inflation is brought back under control, advanced economies' central banks are likely to ease monetary policy and bring real interest rates back towards pre-pandemic levels".

Away from Europe, several rich economies which experienced a mild housing price slump in 2022 are already seeing a change. In both Australia and the USA, prices have risen in recent months. Even in South Korea, which has been hit by a particularly sharp fall in prices, there have been signs that they are stabilizing again.

Given how dramatically prices rose during the pandemic, many expected that the eventual fall in prices would be at least steep enough to offset what was gained in 2020 and 2021.

That does not look very likely now. Europe's house price index rose by more than 20% from the end of 2019 to the middle of 2022. So far, the overall fall in prices has been extremely modest in comparison.

Edited by: Kristie Pladson