Clearly, supply is nowhere near on a par with demand at present, and very few flats are listed for sale at the moment. According to Vísir’s real estate listings, around 450 properties in the greater Reykjavík area, and about 1,050 nationwide, are up for sale as of this writing. But it cannot therefore be said that construction activity has lain dormant in the recent term. A record number of new properties were put on the market in 2020 – around 3,800, according to data from SI. In 2021, however, the number declined to about 3,200, which is nevertheless well above the recent average.

Obviously, not enough homes have been built to satisfy the current level of demand. By its very nature, the housing market is subject to supply constraints that make it impossible to respond immediately to increased demand. Supply takes quite a while to catch up with rising demand in the housing market, as it generally takes two years from the time ground is broken until the flat is finished.

But the bright spot on the horizon is that the construction market appears to be picking up already. According to SI data, the number of flats in the first stage of construction has risen somewhat, from around 1,400 at the end of 2020 to 3,000 by the end of 2021. This suggests that the supply side of the market is rebounding, giving rise to the hope that more new homes will be put on the market as 2022 advances.

Demand pressures a sign of households’ strong position

This strong demand for housing can be construed as a sign of households’ financial strength. In spite of the pandemic, real wages have continued to rise, growing by nearly 4% in 2021. Furthermore, private consumption has been brisk in the recent past, growing in 2021 by 7.6% in real terms relative to 2020 and by 4.4% relative to 2019. It is therefore clear that most Icelandic households are fairly comfortable financially at present.

But there is cause for concern, as house price inflation far outpaces the rise in wages and the general price level, which is not sustainable in the long run. The CBI has responded to this situation by raising the key interest rate and tightening rules capping loan-to-value (LTV) ratios and debt service-to-income (DSTI) ratios on new mortgages. The bank did this in a bid to contain rising house prices and ensure that buyers do not become overleveraged. As yet, the CBI’s measures have not had the intended effect on the property market, which is still in high gear. We think it highly likely that the CBI will intervene further in the market in order to control house price inflation. Indeed, policy actions designed to do this may well see the light of day when the Financial Stability Committee meets on 16 March.

In our macroeconomic forecast from January, we projected that house prices would rise by 8% in 2022. Given the market’s behaviour since then, that figure is surely on the low side, and we now expect prices to rise slightly more than this. We are still convinced, however, that the market will rebalance sometime next year, as demand subsides and supply gradually increases. There is a precedent for spiking prices to be followed by a relatively abrupt slowdown in house price inflation. To see an example of this pattern, one need look no further than back to 2017, when the market was subject to strong demand pressures and real prices rose by 13%. Then, in 2018, the rate of increase started to slow, and real house prices rose by only 3% that year. We hope this sequence repeats itself in the coming term.