The capital area house price index, published by Registers Iceland (RI) last Tuesday, rose by 2.7% month-on-month in April, bringing the rise in greater Reykjavík house prices as measured by the RI index to roughly 10% for the first four months of the year. The RI index gives a solid indication of developments in housing market prices, which are also measured by Statistics Iceland (SI), but the two measurements differ from one another. RI’s measurements apply to the capital area only, while SI calculates a three-month moving average of house prices for the entire country. In our recent inflation forecast, we project a 2.2% MoM increase in imputed rent (which is by and large a reflection of house prices). In recent months, imputed rent has generally risen slightly more slowly than the RI house price index.
House prices to keep rising in the near term
House prices have surged in 2022 to date, and we expect them to keep climbing over the next several months – or until supply catches up with demand. The market looks set to calm down by mid-2023.
There are still strong demand pressures in the market and clear signs of severe supply-demand mismatches at present. Actually, it can be said that the market has been emptied of available homes: the number of advertised properties has fallen by nearly 70% since the onset of the pandemic and is now at an all-time low.
Record-breaking surge in housing supply has not satisfied demand
Clearly, not enough homes have been built to satisfy the keen demand currently in evidence, but it takes time to respond to changes in expected demand and build more new properties. Even though supply has not kept pace with demand, a large number of properties have been built in the past two years, according to data from SI. A record 3,800 new properties were put on the market in 2020, followed by another 3,200 in 2021, and while the latter figure represents a year-on-year drop, it is still well above the recent average.
House prices are now very high in historical terms and have deviated sharply from fundamentals. This gives cause for genuine concern, and the Central Bank (CBI) has adopted measures to contain the price hikes and ensure that borrowers do not become overleveraged, raising the key interest rate and tightening rules capping loan-to-value (LTV) ratios and debt service-to-income (DSTI) ratios on new mortgages.
Thus far, these measures have not cooled down the market as intended, as demand shows no sign of easing. The average time-to-sale is at an all-time low, and in March, more than half of properties that changed hands sold at a premium on the asking price – the first time this ratio has ever risen above 50%. We are convinced that the shortage of supply must be rectified in order for CBI measures to make any real dent in house price inflation.
House price inflation set to ease later in 2022
According to a recent tally carried out by the Federation of Icelandic Industries and the Housing and Construction Authority, over 7,000 new homes are under construction nationwide, some 5,000 of them in greater Reykjavík. It is expected that a large number of them will be put on the market later this year – hopefully enough to satisfy both pent-up demand and increased need due to population growth.
Nominal house prices have already risen by 8% in the first four months of 2022 and appear set to increase by another 2% or more in May. We believe the conditions are in place for prices to keep rising briskly in coming months, but as supply grows and demand is satisfied we expect house price inflation to ease as the year progresses.
In our most recent macroeconomic forecast, we projected that real house prices will rise by 13% in 2022. It should be borne in mind that inflation is expected to be high throughout the forecast horizon and that nominal house prices will probably rise by more than 22% this year. For 2023, we assume that real prices will rise by 1%, although house price inflation should slow significantly and the market should rebalance by mid-year. There is precedent for an abrupt slowdown in house price inflation following a surge – most recently in 2018, after the housing boom in the two years beforehand. We project that real house prices will remain flat in 2024, reflecting the newly re-established equilibrium in the market.