House prices rise as the Netherlands’ economy strengthens

The Netherlands is experiencing one of Europe’s longest house price booms. In the year to March 2007, prices rose 5.15% - not spectacular, but the kind of gentle upwards motion which has been in progress for a long time.

Since the mid 1980s, house prices have been rising continuously in the Netherlands. There was a period of very rapid appreciation during the six years 1995-2001, peaking at 20% y-o-y in 1999, reflecting strong GDP growth and dramatic cuts in interest rates. Nominal disposable income rose by an average of 6% annually between 1990 and 2000; while average inflation was only 2%. This led to a tremendous increase in purchasing power.

Since then, things have calmed down, largely because the period 2001-2005 saw a considerable slowdown in GDP growth. It was only in 2006 that the country returned to form with 2.9% GDP growth.

The strength of house prices in recent years has been something of a surprise. One explanation may be that in the 4 years 2001-2004 real wage growth was strong, despite the economy’s weak performance. The reverse has been true more recently – real wage growth in 2005 and 2006 was only 0.7% p.a.

The Netherlands’ mortgage market

In the Netherlands, 85% of all mortgages are fixed rate, according to one definition. However, in fact households have been becoming more sensitive to interest rate changes; about 50% of all mortgage loans released in 2005 were either floating rate loans or fixed for only five years. Only 10% of all loans were fixed for more than 10 years.

Despite recent rises in Eurozone rates, interest rates on mortgages with a term of 5 years or more have actually fallen from 5.23% in March 2003, to 4.77% in March 2007. However, interest rates on loans of between 1-5 years have risen from 3.88% in March last year to 4.74% this March (2007). Floating rate loan interest rates have risen even more.

Demographics

Every year the number of single-person households has increased, growing faster than the over-all population and the rate by dwellings are constructed. About 100,000 immigrants also arrive each year, stretching the housing supply.

The housing supply has simply been insufficient, in the opinion of analysts, with 80,000 to 100,000 new houses each year necessary to meet demand. Dwellings completed have been below 80,000 units since 1999. The construction outlook for 2005-2008 is an average of 54,200 houses per year; actual dwellings completed in 2006 were 72,383. At the same time, 20,000 to 30,000 houses (net) are taken off the market each year.

Huge social housing sector

The Netherlands’ housing market is traditionally characterized by low owner-occupancy and a large social rental housing sector. In the 1950s, owner occupancy was at 29% only, but this had increased to 42% by 1980. In recent years the government has been promoting home ownership with remarkable results. Owner-occupancy rose to 52% in 2002 and to 55% in 2005.

Homeownership receives favorable tax treatment. There is full income tax deductibility of mortgage interest; this is significant in view of the high marginal income tax rates. The capital gains from rising house prices are also not taxed. However, this is partly offset by an annual imputed rental income tax based on the property’s assessed value. The government also provides home-ownership grants to low-income households.

Shrinking private rental market

The rise in owner-occupancy has taken its toll on the private rental sector. In 1980, about 24% of dwellings belonged to the private rental sector. This had fallen to just 11% by 2005. In contrast the Netherlands’ social housing sector is the largest in EU region in terms of proportion to the housing stock. Its size peaked in 1998 at 34% of all dwellings, before falling back to 34% in 2005.

In Amsterdam the relative size of private rented sector has shrunk rapidly from 52% in 1990 to just 29% in 1998. Most of the renters switched to social housing, whose share rose from 41% to 57% over the same period. Owner occupancy doubled from 7% in 1990 to 14% in 1998.

The private rental sector is further handicapped by extremely tough rent controls and regulations. Rents can only be adjusted once a year within the government-mandated limit. In 2005, the permitted increases in the regulated sector were fixed at 1.5% above the inflation in 2005 and 2006, 2.5% in 2007-8 and 3% in 2009.

Insignificant rent growth

Even if the allowable rent increase for 2005 was 2.7%, nominal rents rose by only 2% (virtually zero in real terms); the lowest increase in almost 50 years. Security of tenure is also guaranteed (it can be passed to spouses, children, and others) and temporary contracts are forbidden.

Units with monthly rents above €604.72 per month are exempted from rent control but their share of the market is very small (5% of the total rented sector or 2.25% of the almost 7 million housing stock). Most of these units are owned by institutions.

In response to the need for more rental housing, the government is introducing intermediate “transitional” category of rental property from July 2006. About 20% of the rental stock will be categorized this way. Rents will be allowed to rise by 2% in 2006, 3% in 2007, 3.5% in 2008 and 4% in 2009. However, the system will be evaluated in 2008. Despite the higher provisions, the increases are still insufficient to cope with the impact on yields of the rise in property prices.

Due to the rent control, rental yields are quite low at 4.2%. However, for properties that are not covered by the rent control law, gross yields are can be as high as 8.25% in Central Amsterdam and 5.5% in the suburbs. In Den Haag and Utrecht, apartment gross yields are at around 7%-7.5%.

What lies ahead?

The economy is finally recovering, but real wages are hardly rising. Dutch households are already heavily indebted, an average of debt-to-income ratio of 225%, one of the highest in the world. Households (as we have seen) are now more sensitive now to interest rate changes.

Nevertheless, the relative insulation of the mortgage market from interest rate fluctuations, combined with healthy GDP growth, should continue to push house prices up.