Credit crunch grounds Sweden’s housing market

Sweden’s decade long house price boom is officially over with house price falls observed all-over the country.

The average price of houses in Sweden were SEK1,885,000 (€194,790) in Q2 2008, down 3.3% from the previous quarter.

In Stockholm, the average price of houses fell 2.55% to SEK3,407,000 (€364,242) in Q2 2008 from SEK3,496,000 (€373,757) in Q1 2008. Other regions in Sweden registered price falls ranging from 0.87% for South Sweden to 7.7% for Central Norrland.

After recovering from the early-1990s economic crisis, Sweden’s house price boom saw property prices rising 141% to Q1 2008 from a decade earlier (109% price rise when adjusted for inflation). Over the same period, the average price of houses in Stockholm rose 159% (125% in real terms).

Property prices in major cities rose by around 120% from Q1 1998 to Q1 2008, while five of the eight regions saw prices doubling over the same period. The remaining three regions registered price increases ranging from 81% to 90%.

The housing market crash is primarily due to higher interest rates caused by the global credit crunch. The problem is exacerbated by higher inflation rates and lower economic growth.

House price boom

There were several reasons cited for the high house price increase in the past decade including low interest rates, rapid economic development and a drop in construction activity.

1. Low interest rates and mortgage market developments increased households’ access to housing loans. With inflation stabilized after 1995, interest rates offered by housing credit institutions dropped from more than 10% in the first half of 1996 to less than 5% from 2004 to the first half of 2008. Adjusted for inflation, real interest rates dropped from 7% to 2% over the same period.
   
   
   Lending to households by housing credit institutions soared from SEK490 (€58.3) billion in 1996 to SEK1.24 trillion (€134 billion); an impressive 153% increase. As a percentage of GDP, it rose from 26% of GDP in 1996 to 43% in 2006.
   
   
2. The country recovered gradually after an economic crisis hit the country in the early 1990s with the economy contracting by an average of 1.2% from 1991 to 1993. The economy then grew by around 3.9% in 1994 and 1995 and by an average of 3% from 1996 to 2006. GDW growth rate in 2007 was 2.6%.
   
   
   Real private sector wages rose by an average of 4% from 1996 to 2007. Unemployment dropped from 8% in 1996-97 to 4% in 2000-01 before rising to 5.8% in 2005. In 2007, it was down to 5.3%.
3. While demand was constantly increasing, housing construction declined from mid-1990s to early-2000s. From 1995 to 2001, less than 10,000 dwelling units were completed annually. This was significantly lower compared to previous decades; around 42,000 dwellings were completed annually from 1980 to 1990.

There is a notable drop in the number of dwellings constructed for social renting, both in absolute numbers and as a share of total completions. In 1991, around 36,000 social dwellings were completed, representing 54% of all completions (28% tenant-owned and 19% owner-occupied). In 1999, only 4,000 rental dwellings were completed which accounts for around 35% of all completions (32% tenant-owned and 33% owner-occupied).

It was only in 2004 that dwelling completion exceeded 20,000 units. From 2004 to 2006, around 26,000 dwellings were completed yearly. In 2007, completions reached 30,527 dwellings; 36% intended for owner-occupancy, 34% for tenant-ownership, and 30% for rental.

Tax reforms

Radical reforms in property taxation and subsidization significantly reduced the costs of ownership giving the market a further boost.

In 2006, taxes for owner-occupied housing and tenant-ownership associations and their members were reduced by about half of what would be required for neutrality vis-à-vis other capital taxes and interest deductibility.

In 2007, tax on imputed housing rent was abolished. Imputed rent is assessed on a rent that is deemed. Also, on whether the party actually rented the unit out or not.

In 2008, real estate tax was replaced by a municipal fee with SEK4,500 (€481). On the other hand, capital gains tax was raised from 20% to 30%.

Distorted rental market

In 2002, 46% of dwelling stock was rented (24% social rental and 22% private rental), 38% owner occupied and 16% tenant-owned (housing cooperatives). The Swedish rental market is strictly regulated. Rent controls and high tax rates mean it is unprofitable for individuals to buy to rent.

A large part of the rental sector is publicly-owned through property companies controlled at the municipal level. However, the number of municipal dwellings is being reduced at a faster rate than new units are established. Eight percent of the Swedish population is queuing for a new apartment, with an average waiting time of 10 years.

Lately, there has been a trend to convert public housing into private property. Nevertheless, quasi-ownership rights for tenants coupled with the legal design of lease contracts have barred the emergence of a proper rental market. Consequently, housing is bought for occupation, not for renting.

Rents in Sweden are largely historic cost-based, and reflect the age composition of the social housing stock. Swedish law requires that rent-setting be negotiated between tenant organizations and municipal housing companies (MHCs) or private landlord organizations.

Private rents in the negotiation process are compared to social housing rents, which lead to rent conformity across tenures. This rent-setting structure means that in attractive central urban locations, rents are often well below market levels. This limits the profitability of private rental markets. Thus the private rental sector has declined significantly over the past two decades.

Interest rates hikes

Swedish interest rates have followed the European Central Bank’s key interest rates upward. From the record low rate of 1.5% (in effect from July to December 2005), the Riksbank successively raised the repo rate to reach 3% in Dec 2006, 4% in Oct 2007 and 4.5% in July 2008. Each time the repo rate was raised by 25 basis points.

Housing credit institutions’ interest rates for house purchase rose steadily from 2.8% in Sept 2005 to 5.66% in June 2008 (due to a major change in the structure of interest rates in Sept 2005, earlier figures are not available).

Swedish households are particularly sensitive to interest rate hikes because majority of the loans are either a variable rate or fixed for less than 5 years. Generally, less than 20% of new housing loans approved since Aug 1999 have interests fixed for more than 5 years.

With the interest rate hikes, lending to households by housing credit institutions fell 4.5% to SEK1.19 trillion (€128 billion) to end-2007 from a year earlier. There was also a notable drop in the amount of new loans granted each month.

Economic slowdown

Aside from its direct effect on interest rates, the credit crunch took its toll on the Swedish economy. The country’s gross domestic product (GDP) was unchanged in Q2 2008 from the previous quarter, although still up 1% from the same quarter in 2007. The economy is expected to grow by around 2% in 2008, down from 2.8% in 2007.

Inflation in Sweden has been one of the lowest among European countries since the mid-1990s. With rising global fuel and food prices, inflation was 4.36% In July 2008. This was the highest rate since 1993 and way beyond the Riksbank’s 2% inflation target.

With lower economic growth and softening of house prices, inflation is expected to ease to an average of 3.0% for 2008.