Housing Standards 2007/2008:
The Factors behind the High Prices of Owner-Occupied Housing in Prague

2. An evaluation of the trend in residential real-estate prices in advanced countries

The second chapter contains an evaluation of the demand-side and the supply-side factors in the residential real-estate market. The chapter presents the main findings from selected empirical studies on price volatility in the housing market that tried to explain housing-price trends on the basis of economic principles and other factors. For example, OECD studies indicate that although 2000 many countries experienced weaker economic growth, residential real-estate prices continued to rise at a record rate – for the sum of OECD countries, the trend in residential real-estate prices ceased to reflect GDP development after 2000 (until 2000 these two factors were very closely related). The facts that there is a degree of similarity between price trends across numerous advanced countries and that prices ceased to correlate with overall economic development probably reflect the existence of global macroeconomic changes (a period of low inflation, low interest rates, and wide access to mortgage credit) and the much greater sensitivity of residential real estate prices to changing interest rates. However, the fact that the price trend ceased to reflect economic development may also signalise that prices have moved away from the fundaments (like for example disposable incomes, demographics factors etc.) that have long determined them and have begun ‘to live their own un-tethered life’; one cause of this could be the growing amount of speculative activity in the real estate market.

Findings from other studies presented in this second chapter indicate that the trend in residential prices is largely a self-determining process. In other words, it was found that alongside the fundamental factors that determine what prices will be like next year, those prices are also determined by what prices were like this year, last year, or even three years ago. If it were possible to predict future price trends from past price trends, then knowledge of price changes would make it possible to obtain abnormally high gains and the housing market would suffer from inefficiency – that is to say, among other things, it would cease to fulfil a basic precondition of neoliberal economic models, namely, that prices are not autocorrelated). One of the causes of this kind of inefficiency could be speculative buying, as it relates to short-term investment strategies.

All the OECD studies published up until 2007 were inclined towards the opinion that ‘in the majority of markets [of OECD countries] residential real-estate prices do not vary too much from the line determined by economic fundaments’, even though they added that ‘the degree to which actual real estate prices correspond to equilibrium depends crucially on interest rates remaining at today’s minimum lows or very close to them...’ However, it is possible that by omitting some factors or by taking into account other factors (which are explicitly listed in the book) the OECD findings were too optimistic. Just as many studies showed that housing prices did not stray significantly from their economic fundaments it was also possible to find many that claimed the very opposite and warned of a possible fall in residential real-estate prices. The main reason for the contradictory findings of these two ‘camps’ was evidently that no consensus or even any really strong professional evidence exists about what is and what is not an ‘economic fundament’, i.e. a factor that has a long-term influence on the trend in residential real-estate prices (or shapes so-called equilibrium prices) and thus explains or ‘justifies’ the price trend.

The second chapter also presents a comparison of the price-to-income ratio (P/I) for selected countries, which is an indicator that receives often attention in international studies. The reason is that, at least until recently, disposable (net) household income was the main determinant of the trend in residential real-estate prices (or the trend in equilibrium prices). One of the things that this comparison showed was that, with the exception of Japan and Germany, between 2000 and 2006 the P/I ratio rose in all the countries in the analysis (thus, the trends in prices and incomes were unequal, with prices rising faster); the rise in the P/I ratio was sharpest during the given period in Spain, France, Australia, Great Britain and Denmark; conversely, in Germany and Japan the indicator decreased in the period under observation (according to OECD data). A comparison was made not just of the pace of the rise in the P/I ratio but also its deviation from the ‘equilibrium’ level (the geometric mean for a relatively long period). In the majority of the countries in the analysis the P/I ratio was above the equilibrium level; Japan, Switzerland, and Germany were the only exceptions.

A comparison of the absolute values of the P/I ratios calculated from information on prices and household incomes obtained from national sources was used to determine how relatively costly housing is in individual countries compared to other countries. From this comparison it was found that the ‘most expensive’ countries from the selection of countries analysed in the book (measured with the P/I ratio) are Australia, the Netherlands, Switzerland, Great Britain, and Ireland; the ‘least expensive’ countries include Finland, Austria, and to some extent France. With the exception of Switzerland, Austria, Finland (and to some extent also Australia, where the level of P/I ratio is highly volatile), in most countries the P/I ratio followed a rising curve, especially in the second half of the 1990s and at the start of the new millennium.

Alongside comparing P/I ratios in different countries, a comparison was also made of the P/I ratios for the capital cities of selected countries for which it was possible to obtain the necessary data (i.e. information on the average prices of residential real estate and the average annual household incomes). Then a comparison was made of how much the P/I ratio in the capital city (or the metropolitan region) differs from the P/I ratio for the entire country in the given year. The biggest difference between the value of the indicator for the capital city and the entire country was found in Sweden (223%) and Norway (143%); the smallest difference was found in Austria and Finland, while in Australia, Canada, and the US the value of the P/I ratio in the capital city was even lower than the value for the entire country (in these countries, capital cities are not the most attractive locations for housing).