OECD: Fundamentals of house price developments
In the vast majority of OECD economies, house prices in real terms (the ratio of actual house prices to the consumer price index) have been moving up strongly since the mid-1990s. Because of the important role housing wealth has been playing during the current upswing, this chapter will look more closely at what is underlying these developments, with a view to shedding some light on whether or not prices are in line with fundamentals.
The chapter begins by putting the most recent housing price run-ups in the con- text of the experiences of the past 35 years. It then examines current valuations against a range of benchmarks. It concludes with a review of the links between a pos- sible correction of housing prices and real activity. The highlights from this analysis are as follows:
- A number of elements in the current situation are unprecedented: the size and duration of the current real house price increases; the degree to which they have tended to move together across countries; and the extent to which they have disconnected from the business cycle.
- While concerns have been expressed in several quarters about high housing prices, the evidence examined here suggests that overvaluation may only apply to a relatively small number of countries. However, the extent to which these prices look to be fairly valued depends in good part on longer-term interest rates, which exert a dominant influence on mortgage interest rates, remaining at or close to their current low levels.
- If house prices were to adjust downward, possibly in response to an increase in interest rates or for other reasons, the historical record suggests that the drops (in real terms) might be large and that the process could be protracted, given the observed stickiness of nominal house prices and the current low rate of inflation. This would have implications for activity and monetary policy.
The magnitude and duration of house price cycles
Various statistical and other criteria will be used to put the current period of real house price increases into historical perspective. Based on a procedure to date house price cycles, it appears that, to the extent that there is an “average real-house-price cycle” over the period under consideration, it has lasted about ten years. During the expansion phase of about six years, real house prices have increased on average by around 45%. In the subsequent contraction phase, which lasts around five years, the mean fall in prices has been on the order of 25%. By implication, at least since 1970, real house prices have fluctuated around an upward trend, which is generally attributed to rising demand for housing space linked to increasing per capita income, growing populations, supply factors such as land scarcity and restrictiveness of zoning laws, quality improvement and comparatively low productivity growth in construction.
To put the current large run-ups in these prices in perspective, the characteristics of what are considered major real house price cycles are calculated. To qualify as a major cycle, the appreciation had to feature a cumulative real price increase equalling or exceeding 15%. In this context, the current housing price boom differs from the average of past experiences in two important respects.
Source: OECD Report 2005 “recent house price developments: the role of fundamentals”
- First, the size of the real price gains during the current upturn is striking. For Australia, Denmark, France, Ireland, the Netherlands, Norway, Sweden, the United Kingdom and the United States, the cumulative increases recorded in the recent episode have far exceeded those of previous upturns. With the exception of Finland, real house prices in the countries experiencing gains are above their previous peaks.
- Second, its duration has surpassed that of similar past episodes of large real price increases for almost all countries. It is at least twice as long in the Netherlands, Norway, Australia, Sweden and the United States.