Rising interest rates slow Norway’s housing market

Last Updated: Jul 16, 2008

Rising interest rates slow Norway’s housing market

Norway’s hot housing market is rapidly cooling. The rapid increase in oil prices in recent years, and strong economic growth, had helped fuel house price booms in several key cities in Norway. But in Q1 2008, the overall house price index rose by a mere 2.9% from a year earlier. When adjusted for inflation, house prices actually dropped marginally (-0.28%) over the same period.

The price rise in Q1 2008 was a far cry from the 16.7% (15.4% in real terms) y-o-y rise to Q1 2007. House prices had risen strongly from 2004 to 2007; the over-all house price index rose 10% (9.7% in real terms) in 2004, 8.3% (6.6%) in 2005, 13.3% (11%) in 2006 and 12.3% (11.2%) in 2007.

Multi-dwelling units were affected the most by the housing slowdown, their section of the index fell 4.2% to Q1 2008 from a year earlier. On the other hand, the price index for detached dwellings rose by 5.1%, while the small house price index increased 4% over the same period. In the previous year to Q1 2007, the price index for all types of housing units had risen by double digits.

Rising interest rates and inflation led to the cooling of the housing market. Norway’s mortgage market is largely dominated by floating rate loans, so is highly impacted by interest rate changes. Since mid-2006, interest rates on mortgages have inched up from below 4%, to more than 6.5% in Q1 2008.

Oil fuelled house price growth

The average price of second-hand detached houses in Norway was NOK16,643 (€2,066) per sq. m. at the end of 2007, 11.6% up on the year. House prices are highest in Oslo, the capital and largest city, at NOK 31,046 (€3,854) per sq. m.

For new detached houses, the average price was NOK19,434 (€2,413) per sq. m., 16% up on a year earlier. The average price of new houses in Oslo rose 10.5% to NOK27,468 (€4,652) per sq. m.

Strong house price increases were also observed in Norway’s next three largest cities.

• In Stavanger, the average price of second hand detached houses rose 17.6% in 2007, to NOK 25,199 (€3,128) per sq. m.
• In Bergen, prices rose 21.4% to NOK 22,832 (€2,835) per sq. m.
• In Trondheim, prices rose 8.1% to NOK 22,153 (€2,750) per sq. m.

Stavanger and Bergen are centres of Norway’s oil and shipping industries, while Trondheim is the academic and technological centre of Norway.

Norway is the third largest exporter and eighth biggest producer of oil in the world. It is a major producer and exporter of natural gas. Exports of oil and other petroleum related products account for about 65% of its exports.

The rapid increase in oil prices in recent years has fuelled house price booms in several key cities in Norway. The house price index for Stavanger, Bergen and Trondheim rose 111% from 2000 to 2007, the index for Oslo (and its suburb Baerum) rose by only 71% and for Norway by 73%.

Strong growth, low interest

Strong house price rises between 2004 and 2007 were mainly due to strong economic growth and relatively low interest rates.

Despite fluctuations in GDP growth, Norway has not experienced a recession since 1990. The economy expanded by more than 5% annually between 1994 and 1997. Even during the economic slowdown in 2002 and 2003, the annual GDP growth rate did not fall below 1%. From 2004 to 2006, the economy expanded by an average of 3% annually. In 2007, GDP growth was 3.5%

Developments in the mortgage market have provided an additional push to the housing market. The mortgage market expanded from NOK589 (€73) billion in 2000 to NOK1.187 trillion (€147 billion) in 2007. As a proportion of Norway’s GDP, the mortgage market rose from 40% in 2000 to 54.3% in 2005, before settling at 52% of GDP in 2007.

Competition between mortgage providers has pushed down interest rates on housing loans. Mortgage rates offered by banks were at 4% and below from Q1 2004 to Q2 2006; significantly lower than the rates in late-2002 (above 8%). Banks hold about 85% to 90% of outstanding mortgage debt in the market.

With falling interest rates, share of fixed-rate mortgages (FRM) dropped from 17.6% of total loans in Q1 2004 to 11.6% in Q1 2006. Despite recent interest rate hikes, the share of FRMs has continued to drop, to 7.6% in Q1 2008.

Owner occupancy

Other factors have contributed to strong housing demand. Aside from preferential interest rates offered to households through the State Housing Bank, buyers can also purchase municipal land at subsidized prices. Owner-occupiers also get tax relief for mortgage interest payments. The return for owner-occupied housing is, in addition, taxed at a lower effective rate than the return on rental housing capital. Owner occupied dwellings are also exempted from capital gains tax.

Owner occupancy has always been popular in Norway, even before the housing policy favorable to owner occupancy was established.

Nevertheless state policy has had a strong impact. In 1920, about 47% of households were renters. The figure was much higher in the capital Oslo, at 95% of households. In 1960, the share of renters declined to about 40%. This fell further to about 23% in 2001 and 18% in 2004. Owner-occupancy was around 77% of households (63% freeholders and 14% coop-owners) in 2001 and 82% in 2004. In Oslo, the share of renters was a bit higher, at 29% of households.

At the same time, there is an emerging consensus that the free market does not provide sufficient housing for the poor. In 1998, the Government agreed that the state should finance a new non-commercial rental housing sector, with the aim of building 50,000 new non-commercial rental dwellings over the next 10-15 years, located in the biggest towns, with low and regulated rents. Social rental housing made up around 15% of the 800,785 rental stock in 2001.

Second homes

Only about 21% of rental units are owned by professional landlords, i.e. owned by a real estate rental company or privately owned and situated in a multi-unit building. About 60% of rental units are either a) units inside or attached to the landlord’s primary dwelling or b) secondary dwellings let by owners in a temporary basis.

Probably due to low transaction cost in buying and strong government support for house purchase, about 10% of households in Norway own an additional housing unit. This is relatively high compared to just 2% in the UK and 6.5% in the US and Canada. About 50% of the secondary houses have been acquired through inheritance. Interestingly, about 50% of these households do not rent out these second flats or houses. This is probably due to the low yields prevailing in Norway.

Monetary tightening

With the oil windfall, the government adopted expansionary fiscal policies that boosted economic growth. Unemployment dropped to 2.5% in 2007, the lowest rate in almost two decades, and much lower that of the European average. Fearing that the economy might overheat, the Norges Bank (the central bank) initiated gradual interest rate hikes since late-2005.

The Norges Bank’s key rate, the official sight deposit, rate rose from 2.25% in Oct 2005 to 3.38% in Dec 2006. More aggressive interest rate hikes were implemented in 2007, with the key rate at 5.14% Dec 2007.

Through a steady appreciation of the Danish kronor against the US dollar (to a certain extent the euro), inflationary pressures were kept at bay. Inflation in 2007 was only 0.8%, down from 2.26% in 2006.

With global commodity prices surging, inflation in the first half of 2008 crept up to above 3%. This prompted the central bank to hike interest rates further. In June 2008, the oversight deposit rate was at 5.54%. Mortgage rates offered by the central bank likewise rose from 6.35% in Q4 2007 to 6.72% in Q1 2008. This is expected to dampen more the real estate market.