The rent price index was up 1.8% in October, according to newly published figures from the Housing and Construction Authority (HMS). The rise comes on the heels of monthly drops of 0.6% in September and 1.1% in August. The October rise has all but erased the August-September decline, bringing the index back to its July value. The house price index rose 0.18% in October, after falling 0.28% in September. The housing market appears to be settling down now that most of the Grindavík Effect has come to the fore, and there are signs that the market is turning a corner. Falling interest rates will surely liven it up, although it is uncertain how much and how quickly they will do so, as there are braking mechanisms in place that have proven anything but toothless. We expect modest real price hikes in the housing market over the coming two years.
Autumn slowdown in the housing and rental markets
The housing and rental markets have slowed down markedly this autumn, after brisk activity early in the year. The rent price index rose in October, after two consecutive monthly declines, and the house price index increased as well, albeit less, after falling in September.
Determinants of rent prices
According to the HMS monthly report, the increased weight of Airbnb flats pushes rent prices upwards, as it absorbs some of the supply of long-term rentals. At mid-year, 9,388 rental units were listed with Airbnb, although the total is still below the pre-pandemic level. Because the market is also affected by seasonal swings in tourist arrivals, there are far more properties available for short-term rental during the summer season, when demand is stronger.
The HMS report states as well that mortgage debt service and rent prices have correlated quite strongly over the past thirteen years. Higher interest rates push landlords’ expenses higher, and many of them pass a portion of the cost hike on to their tenants. When interest expense rises sharply, however, rent prices tend to increase far less than debt service does. Since 2021, for example, debt service on indexed loans has risen faster than rent prices, according to the HMS report, and as is well known, the policy interest rate has surged since then, pulling debt service along with it. Over time, with declining interest rates and inflation, debt service burdens should ease and the rental market should become better balanced.
In our most recent inflation forecast, we projected that imputed rent would fall by 0.2% in November. The new imputed rent calculation method adopted in June by Statistics Iceland (SI) is based on estimating the rent price “for every residential property not being rented out, based on all rental market leases in effect at the time in question and for which information is available”, and then estimating the equivalent rent for each property by using data from the 30 leases that most closely resemble the property concerned. As a result, changes in imputed rent will not fully reflect changes in the HMS rent price index. Actually, changes in imputed rent have fluctuated much less than the rent price index has. For instance, imputed rent rose 0.1% in October, while the rent price index rose 1.8%. We expect the slower pace in the rental market to cause imputed rent to rise less – and perhaps even fall – in coming months, thereby supporting continued disinflation.
Calm housing market
After falling 0.28% in September, the house price index rose by 0.18% in October. The biggest increase was a 0.28% rise in the price of condominium housing in greater Reykjavík, while condominium prices in regional Iceland fell 0.09%. Detached home prices rose 0.09% in greater Reykjavík and 0.18% in regional Iceland.
In the past twelve months, the house price index has jumped by 8.71%, but the lion’s share of that increase stems from the impact of the volcanic eruptions in Grindavík. Over the first eight months of the year, the index rose 8.7%, the same as the current twelve-month increase. Since August, the index has not risen at all, which indicates strongly to us that the impact of the seismic activity has largely come to the fore. Further ahead, we expect prices to rise at a more moderate pace, and we do not rule out the occasional month-on-month decline. Nevertheless, we project that real prices will rise modestly over the next two years.
According to the Central Bank’s (CBI) most recent Monetary Bulletin, households’ financial conditions have grown tighter, but their overall financial position remains good. In the recent term, however, indexed mortgage interest rates have risen in line with other real rates, and borrowing requirements for mortgage loans have been tightened. In the CBI’s opinion, tighter borrowing requirements amplify the effects of higher indexed interest rates on the debt service burden for new mortgages.
It is also noted in Monetary Bulletin that the supply of homes for sale has increased in recent months, and around 4,000 homes are currently listed on the market. At the same time, the ratio of new construction to the total residential housing supply is up to an all-time high of 38%. Furthermore, the average time-to-sale has grown longer again. It was nearly four months this September, up from slightly more than two months this past spring.
As inflation and interest rates taper off further ahead, we expect supply and demand in the housing market to rebalance, with prices rising far more modestly than in the recent term. In our macroeconomic forecast from September, we projected that house prices would rise by 10.7% this year, 7.0% in 2025, and 6.1% in 2026. The outlook is for this year’s price increase to be slightly smaller than we projected in September, as we had assumed that the market would cool gradually as the Grindavík Effect subsided, instead of turning around as sharply as it appears to be doing. On the other hand, the effects of an increase in the supply of HMS equity loans could sustain higher prices in the final two months of the year. If so, our forecast for 2024 will materialise.
Analyst
