Inevitable slowdown in Finnish housing market

After continuous price increases since 2002, the Finnish housing market is cooling fast.

The average price of dwellings in Finland rose 4.5% to €2,052 per sq. m. in Q2 2008 from a year earlier. When adjusted for inflation, it rose by a mere 0.5% y-o-y, according to figures from Statistics Finland.

In Helsinki, the average price of dwellings was €3,110 per sq. m. in Q2 2008, up by 4.68% from a year earlier. Taking out inflation, the price was up by only 0.63% over the same period.

For the rest of Finland, the average price of dwellings was €1,449 per sq. m. in Q2 2008, up by a mere 0.76% from a year earlier but down 1.3% to from the previous quarter. When adjusted for inflation, prices fell 3.14% from the previous year and 2.65% from the previous quarter.

The slowdown in house price growth is therefore definitely established. In 2007, the average price of dwellings in Finland rose 6.4% (4.75% in real terms), in Helsinki by 7.9% (6.3%), and in the rest of Finland by 5.6% (3.9%).

As the full effect of the credit crunch manifests itself, the housing market will continue to slow down. There is a strong possibility of price falls within the next quarter because of high inflation and weaker economic growth.

House price cycles

From 1980 to the present, there have been at least four distinct house price boom-bust periods in Finland:

• 1983-1989: Real prices rose 55%
• 1989-1993: Real prices fell 51.8%
• 1993-1994: Real prices rose 11.2%
• 1994-1995: Real prices fell 7.6%
• 1995-1999: Real prices rose 52%
• 1999-2001: Real prices fell 10.5%
• 2001-2007 Real prices have risen 43%

The relative volatility of Finland’s housing market is due to:

• the export-oriented economy’s sensitivity to global shocks
• the housing market’s high interest rate sensitivity
• an insufficiently responsive supply side

On the surface, the housing market has recently become even more interest-rate sensitive. In 1994, about 70% of new mortgages were at variable rates. Since 2001, more than 90% of new mortgages have been at variable rates, mainly to take advantage of falling interest rates.

The most recent upsurge in house prices was mainly due to:

• Strong economic and wage growth
• The tax system. The 1980s reforms gradually liberalized the housing market, yet owner-occupied housing is still privileged by the tax system. A flat rate of 29% deduction on mortgage interest remains. Imputed rental income and capital gains on permanent homes are also untaxed.
• Changes in the mortgage market combined with low interest rates led to increased affordability of housing finance across income brackets. Outstanding housing loans to Finnish households grew 153% from €24.3billion in 2000 to €61.7 billion in 2007.

Housing loans and interest rates

Interest rate hikes have been primarily responsible for the housing market’s slowdown, given the market’s high sensitivity to interest rate changes.

From the record low rate of 2.0% (in effect from June 2003 to Nov 2005), the European Central Bank consecutively raised the repo rate to reach 3% in Aug 2006, 4% in Jun 2007 and 4.25% in July 2008 (its current level). Each time, the repo rate was raised by 25 basis points.

As a result, the average interest rate on new housing loans rose to 5.39% in July 2008 from below 4% from June 2003 to Sept. 2006. Despite the increases, current mortgage rates are still below the historic peak of 13.7% in September 1992.

Weaker economic growth

Finland has recently experienced very strong growth, much higher than the euro area average. However, the economy is rapidly cooling. Economic growth was 4.3% in 2007 down from 4.8% in 2006. In 2008, it is expected to slow further to around 2.8%. In Q2 2008, GDP fell 0.2% year-on year.

The major cause of the slowdown is weak export growth due to the global economic slowdown. Export growth was sluggish at 4.8% in 2007, down from 11.8% in 2006. In 2008, export growth is expected to slow further to 3.5%.

The economy is dependent on developments in the information and communications technology sector, a major driver of GDP growth since the mid-1990s. Nokia is generally regarded as the single most significant cause of Finland's success.

Because of successes in that sector, the economy has been strong for a decade now. Though the techno-bubble burst caused an economic slowdown in 2001. Unemployment, at 16.6% in 1994, has fallen to 6.9% in 2007. It is expected to ease further to 6.3% in 2008.

Yields and rents

Rental yields are relatively low in Finland at around 5% per annum. The private rental market is still relatively subdued with half of the country’s rental dwellings owned by social housing institutions. (About 800,000) Around 60% of dwellings are owner-occupied, 30% are for rental while other forms of tenure account for the remaining 10%.

Local governments are still building more social dwellings every year. About 70% of the 35,000 new dwellings produced annually are financed or subsidized by the government. So even with the complete deregulation of the private rental market in 1995, private rents are still distorted, due to the large social housing sector. Government subsidized rents are 25% lower than private rents in Helsinki and 15% cheaper for Finland as a whole.

After the initial rapid rent increases after rent liberalization, recent rental growth has been slow. From 2001 to 2007, house prices in Finland rose by around 50%, while private rents trailed with growth of only 17%. In Helsinki, house prices rose 55% while private rents rose by only 12% over the same period.

In 2007, private rents in Finland rose 4.7% while government-subsidized rents rose 3.65%. In Helsinki, private rents rose by only 1.5% while government-subsidized rents rose 3.62%.

Further slowdown likely

Rising global food and fuel prices have pushed inflation up. Consumer prices rose 2.5% in 2007, compared to 1.6% in 2006 and less than 1% from 2003 to 2005. In July 2008, inflation reached 4.4%, the highest in seven years. Overall inflation in 2008 is expected to be around 2.8%.

The growth of house prices is expected to slow further to around 2-3% in 2008 and 2009, according to the Bank of Finland. This means prices will fall by around 1% to 2% in real terms.