Italy - house price declines expected soon!
September 15, 2009
Italy’s housing market has remained resilient, despite falling markets in most other developed countries. House prices in H1 2009 rose by 3% from a year earlier, according to the index published jointly by the Bank of Italy (BoI) and the National Statistical Institute (Istat). When adjusted for inflation, house prices rose by 1.9%.
Italian house price rises peaked in 2002, rising 12% (9.2% in real terms) from a year earlier. House prices rose by an average of 6.5% p.a. (4.1% in real terms) from 2003 to 2006, then by an average 4.6% p.a. (2% in real terms) from 2007 to 2008.
The resilience of Italy’s housing market is attributable to what was formerly considered a weakness, its underdeveloped mortgage market. Despite having the fourth largest economy in the EU, Italy’s mortgage market is around 20% of GDP, significantly below the EU average of 50% of GDP.
Italy’s housing market has been shielded from the global credit crunch afflicting most countries. Prudent loan practices prevented the development of housing bubbles similar to Spain, Ireland or the UK.
Trouble on the horizon
However, Italy’s resilience may not last for long. Italy’s GDP is expected to contract by as much as 5.5% in 2009, its worst recession since World War II, after shrinking 1% in 2008. Unemployment is anticipated to rise to 10.7% by the end of 2010, from 6.8% in 2008.
Property prices are expected to drop by 7% to 8% starting the second half of 2009, says Nomisma, an economic think-tank, noting that residential sales dropped by 15% in 2008. Housing sales are also expected to contract a further 8% to 10%. Nomisma expects the property market to stabilize in 2010.
Low rates aren’t helping much, because the mortgage market is small
Italy’s mortgage markets are smaller than those in other European countries, at below 20% of GDP in 2008, significantly lower than the EU’s average of 50% of GDP (though strongly up from 10% of GDP in 2000).
That’s why though average housing mortgage loan rates in Italy fell to 3.64% in June 2009, after the ECB eased monetary conditions, the effect of interest rate reductions is likely to be small, since most households rely on personal savings for home purchases.
One of the main reasons for the underdevelopment of the mortgage market is the length and cost of the loan recovery process. From the time a borrower has defaulted, it takes around five to seven years until final settlement of the legal proceedings. This makes Italian banks cautious about extending mortgage loans.
From a low 3.6% for most of 2004 and 2005, average interest rates on new house purchases rose to 5.95% in August 2008. Partly as a result, in 2008 lending growth slowed to 2.5%.
Most Italian housing loans are now variable rate, making those households with mortgages relatively sensitive to interest rate changes (at the end of 2008, only 36% of outstanding housing loans were fixed rate loans, though this was more than double the level of 2005, largely because of interest rate rises between 2006 and 2008).
The sick man of Europe
Italy’s GDP is expected to contract by 5.5% in 2009. In 2008, Italy’s economy shrank by “only” 1%, outperforming other major European countries such as UK, Germany, France and Spain.
From 2001 to 2007, the Italian economy grew by an average 1.1% per annum, one of the EU’s lowest growth rates. It was dubbed the “sick man of Europe” (tugging away the title from Portugal).
Italy’s unemployment rate was relatively high in 2008 at 6.8%, and is expected to rise to 8.4% in end-2009 and 10.7% in 2010.
Italy’s relatively underdeveloped financial sector, combined with falling productivity, may hamper its recovery from the recession. The government’s ability to pump-prime the economy is also extremely limited. There is huge public debt, at 106% of GDP in 2008. Italy’s ratio of public debt to GDP, already the highest in Europe, is projected to rise to 117% by end-2010.
The budget deficit is also expected to rise to 4.7% of GDP in 2009 and 5.9% of GDP in 2010, from 2.5% in 2008. The EU mandates a 3% of GDP cap on the budget deficit.
Over-regulated private rental market
Private renting remains unattractive in Italy. Because of rent controls and other restrictions, rental properties have long yielded poor returns. When a law was passed in 1978 encouraging landlords to sell, a lot of landlords grabbed the chance.
The standard contract allows free negotiation of the initial rent, but commits the landlord to a four-year contract and gives the tenant the option of extending for another four-years. Rents can only be increased annually by 75% of the cost of living index; i.e. if the inflation is 2% then you can only increase your rent by 1.5%.
Because of the restrictions on rent increases, most landlords prefer to ‘frontload’ long rental contracts to take account anticipated future rent increases, and inflation and capital value appreciation. Frontloading, in turn, artificially raises rents for new contracts. Despite this, average rents have failed to keep up with inflation since the mid-1990s.
While house prices rose by an average of 6.3% from 2000 to 2008, rents rose by an average of only 2.5% over the same period. In 2007 and 2008, rents rose by only 2.55%, while residential property prices rose by an average of 4.6%.
Rental yields in Italy are generally low at 3% to 5%, based on Global Property Guide figures. In June 2009, apartments in the historical centre of Rome had gross rental yields of 4.3% - 5%, while apartments in Rome’s suburbs had yields ranging from 3.2% to 4.2%. Similar apartments in Milan had yields ranging from 3.3% to 4.9%.
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