House price inflation at its highest since 2006

According to figures from Registers Iceland (RI), capital area house prices jumped about 3% month-on-month in May.

According to figures from Registers Iceland (RI), capital area house prices jumped about 3% month-on-month in May, bringing the rise in greater Reykjavík house prices as measured by the RI index to roughly 13% year-to-date. Twelve-month house price inflation currently measures 24%, overtaking the peak from 2017 and reaching its highest since the beginning of 2006, some 16 years ago. Single-family home prices have risen most in the past year, or 25.5%, while multi-family home prices are up 23.7%.

This episode of house price inflation, which began in mid-2020, shows no signs of abating – in fact, it has gained momentum. The housing market is still buoyant, as can be seen in turnover and purchase agreement numbers. Both of these variables have been fluctuating in recent months, however, possibly due to the limited supply in the market.

Data from the Housing and Construction Authority show that demand pressures are still strong. It seems that each month breaks the previous month’s records in terms of average time-to-date and the share of homes that sell at a premium on the asking price. In April, 65% of apartments and 53% of single-family homes in greater Reykjavík fetched more than the asking price. Furthermore, the average time-to-sale is at its shortest ever, measuring 35 days in greater Reykjavík in April.

The Central Bank first intervened in the market a year ago

House prices are now very high in historical terms and have deviated sharply from fundamentals. This has been a cause for major concern at the Central Bank (CBI), which has taken various measures designed to contain the price hikes and protect buyers from becoming overleveraged.

The CBI began raising the policy rate a year ago and, as of this writing, has increased it by 3% from its trough. This has passed through to mortgage lending rates, which have risen more or less commensurably. Fixed non-indexed rates, which are quite popular at the moment, are now about where they were in mid-2020. The CBI is likely to keep raising the policy rate in coming months. The Monetary Policy Committee’s (MPC) next interest rate decision will be announced tomorrow morning, and we expect a rate hike of 0.75 percentage points.

The CBI’s Financial Stability Committee (FSN) has also intervened in the market, either directly or indirectly. It intervened for the first time in June 2021, lowering the maximum loan-to-value (LTV) ratio on consumer mortgages from 85% to 80%. That autumn, the FSN adopted rules capping the debt service-to-income (DSTI) ratio on consumer mortgages at 35% (40% for first-time buyers). Last week the committee tightened these rules even further. It lowered the LTV ratio for first-time buyers from 90% to 85% and tightened the DSTI rules, so that the DSTI ratio is calculated based on a minimum interest rate of 5.5% for non-indexed loans and 3% for indexed loans. A change was also made to the maximum loan maturity used to calculate debt service on indexed loans.

What impact will this have?

It will be interesting to see how much these measures affect the market in coming months. The new CBI rules took effect the day after the changes were announced. Clearly, it will be harder in some cases for first-time buyers – who accounted for 30% of all buyers in Q1/2022 – to enter the market. With higher house prices and higher interest rates, it will also be more difficult for consumers to get through the credit assessment phase. Presumably, this will dampen demand, but the big question is how much.

We believe the conditions are in place for a continued rise in house prices in the next few months. Hopefully, increased supply of new properties and a downturn in demand will be enough to cool the market a bit later this year. In our last macroeconomic forecast, published in May, we projected that home prices would rise by just over 22% in 2022, but at a considerably reduced pace later in the year, and that the market would settle down around mid-year. We are still optimistic that this forecast will be borne out.


Bergthora Baldursdottir