Iceland’s housing market is now losing steam

After a decade-long house price boom, Iceland’s housing market is now noticeably slowing, as rising interest rates and tighter lending conditions are adversely impacting demand.

During the year to Q3 2023, the nationwide residential property price index rose by a modest 2.26%, sharply down from increases of 7.88% in the previous quarter and 22.63% in the same period last year, according to Statistics Iceland. It was its weakest performance registered since Q4 2010 when house prices declined by 1.39%. In fact, when adjusted for inflation, prices actually declined 5.26% y-o-y in Q3 2023.

On a quarterly basis, nationwide house prices fell by 1.86% (-2.52% inflation-adjusted) during the latest quarter.

During the year to Q3 2023:

  • In Reykjavik, prices of single-flat houses fell slightly by 0.73% (-8.02% inflation-adjusted) – in stark contrast with the y-o-y increase of 8.39% in Q2 2023 and 20.75% in Q3 2022. Likewise, prices of multi-flat houses increased slightly by 1.76% (-5.72% inflation-adjusted) y-o-y in Q3 2023, its weakest showing in nearly 13 years.
  • Outside the capital, residential property prices increased by 5.42% (-2.32% inflation-adjusted), a sharp deceleration from the spectacular growth of 23.6% seen in the previous year.

 Iceland’s house price annual change

Demand is now plummeting. During 2022, the total number of purchase agreements in Iceland fell sharply by nearly 30% y-o-y to just 6,296 units, according to figures from the country’s Housing and Construction Authority. Then in the first seven months of 2023, purchase agreements plunged further by 22.2% to 2,940 units as compared to the same period last year.

“The average time-to-sale in the capital area was 6.3 months in July 2023, considerably more than the July 2022 figure of 1.5 months, and the number of homes for sale has increased markedly in recent months,” said the Central Bank of Iceland in its Monetary Policy report published in September 2023.

With weakening demand, unsold properties in the market are increasing. The total number of used flats listed for sale in Greater Reykjavik stood at 1,605 units in August 2023, almost twice as much as the 842 units listed a year ago. Likewise, the number of newly constructed houses listed for sale in the capital surged to 1,048 units, almost seven times as much as the 157 units from the same period last year.

“Housing market activity has eased considerably. The supply of available homes has risen, the time-to-sale has grown longer, and turnover has shrunk,” said the Central Bank of Iceland in its Financial Stability Q2 2023 report.

“Financing is more difficult to obtain than before, as interest rates are higher and borrower-based measures tighter. Market prices are still high by most measures, even though imbalances have receded. The deviation of house prices from long-term trend has also narrowed somewhat, as nominal prices have held virtually flat and real prices have therefore fallen,” added the central bank.

The housing market is expected to remain muted during the remainder of the year. “Arion Research expects housing prices to decrease slightly until the end of this year before recovering in 2024,” said Arion Bank in its Q2 2023 report.

Iceland experienced strong house price rises in recent years, mainly driven by booming tourism, robust economic growth, and limited housing supply. From 2010 to 2019, residential property prices surged 109% (62% inflation-adjusted), including a growth of 15% per year in 2016 and 2017. Despite the health crisis, prices continued to rise by 7.8% (4.1% inflation-adjusted) in 2020 and by another 15.9% (10.2% inflation-adjusted) in 2021. During 2022, house price growth accelerated further to 20.3% (9.8% inflation-adjusted).

During 2022, Iceland’s economy grew strongly by 6.4% from a year earlier, following a 4.5% growth in 2021 and a 7.2% contraction in 2020, buoyed by robust domestic demand, recovering tourism, and favorable terms of trade. The economy is expected to continue growing in the next two years, albeit at a much slower pace of 3.3% this year and 1.7% in 2024, based on projections released by the International Monetary Fund (IMF).

With a population of only 376,000 in 2022, Iceland is one of the wealthiest and most developed countries in the world. GDP per capita is currently at US$74,600. This small country also has low taxes compared to other OECD countries. The economy is heavily dependent on fishing, which provides 40% of export revenues and employs 7% of the workforce. However, in recent years, the country diversified into manufacturing and service industries - most notably, tourism.

Iceland GDP Per Capita graph

Iceland’s great house price boom

Iceland experienced an unprecedented housing boom from Q1 2000 to Q1 2008, with property prices surging 152.9% (71% inflation-adjusted), fuelled by rapid economic growth from 2000 to 2007, when the economy expanded by an average of 5.1% annually.

After the financial crisis and the collapse of Iceland’s banks in 2008, GDP shrank by 7.7% in 2009 and by another 2.8% in 2010. From Q1 2008 to Q1 2010, house prices fell by 15.1% (-32% inflation-adjusted).

Iceland House Price Annual Change per Region graph

To save the economy and to help homeowners, Iceland’s state-controlled banks have forgiven mortgage loans for more than 25% of the population since end-2008, equivalent to about 13% of the country’s annual GDP.

As the economy recovered, house prices rose by 13.3% between Q2 2010 to Q4 2012. But this rise was partly illusory since when adjusted for inflation, house prices rose by just 2.6% over the same period.

The economy expanded by an average of 4.1% per year from 2013 to 2019. Over the same period, house prices rose by 70.1% (50.5% inflation-adjusted).

During the boom years, property owners often received multiple offers as soon as their properties were listed for sale and sales prices were usually 4% to 8% above asking prices, particularly in the popular neighborhoods in downtown and western Reykjavik. Residential sales have risen by about 20% per year for four years, according to local real estate experts.

Despite the COVID-19 pandemic, nationwide house prices still managed to rise by 7.8% (4.1% inflation-adjusted) in 2020 and even accelerated in 2021 to reach a double-digit growth of 15.9% (10.2% inflation-adjusted). With strong economic growth in 2022 and as pandemic-related restrictions were finally lifted, house prices also surged by 20.3% (9.8% inflation-adjusted).

Year Nominal Inflation-adjusted
2009 -8.32 -14.70
2010 -1.39 -3.78
2011 8.07 2.68
2012 4.57 0.35
2013 8.66 4.34
2014 6.09 5.22
2015 9.05 6.89
2016 14.68 12.55
2017 15.00 12.89
2018 6.90 3.04
2019 4.28 2.20
2020 7.77 4.05
2021 15.85 10.22
2022 20.27 9.78
Sources: Statistics Iceland, Global Property Guide

IMF urges Iceland to cool the housing market

Last year, the IMF in its 2022 Article IV Mission Concluding Statement urged Iceland to implement macroprudential measures, in addition to the ongoing monetary tightening, to cool the heating housing market and avoid a disastrous crash. Risks in the banking system have risen in recent years due to surging house prices.

“A sharp correction in house prices could weaken the balance sheets of households and the financial sector. The house price surge has also worsened housing affordability, particularly for young and lower-income households. Well-calibrated and coordinated policies are crucial to navigating the house price cycle,” said the IMF.

“Further macroprudential tightening through binding and effective debt service-to-income caps is needed to contain growing housing risks,” the IMF added.

Some of the measures recommended by the IMF include:

  • Requiring mortgage lenders to apply a premium over the contractual rate in the analysis of borrowers’ debt-service capacity;
  • Introducing a cap on the debt-to-income ratio;
  • Reducing administrative burdens in the construction sector and increasing housing supply to address housing affordability;
  • Simplifying planning regulations, easing the process of obtaining building permits, introducing a one-stop shop for permits and inspections, and;
  • More targeted rental housing assistance and continued investment in social housing to promote rent affordability.

In 2021, Iceland’s central bank cut the maximum loan-to-value ratio to 80% from 85%, in an effort to rein in one of Europe’s fastest house-price rallies. Coupled with rapidly rising interest rates, as well as declining purchasing power caused by high inflation, house price growth is now decelerating sharply, amidst falling property demand.

In its recent statement released in May 2023, the IMF noted that “the macroprudential stance taken by the Central Bank of Iceland (CBI) is broadly appropriate” but warned that the central bank “should remain attentive to the materialization of systemic risk”.

“The tightening of borrower-based measures on households and the increase in the counter-cyclical capital buffer has bolstered resilience to a disorderly correction in the housing market and tighter financial conditions,” said the IMF.

Available supply is increasing

The total number of used flats listed for sale in Greater Reykjavik stood at 1,605 units in August 2023, almost twice as much as the 842 units listed a year ago. Likewise, the number of newly constructed houses listed for sale in the capital surged to 1,048 units, almost seven times as much as the 157 units from the same period last year.

Residential construction activity has sent mixed signals in recent years. Permits and under construction have been increasing, while completions continued to fall.

Countrywide (in 2021 – the latest figures available from Statistics Iceland):

  • Dwelling starts rose by 80.3% to 4,338 units in 2021 from a year earlier, in sharp contrast to a decline of 36.6% in 2020 and the highest level since 2007.
  • Dwellings under construction surged by 29.5% y-o-y to 5,042 units in 2021, following a fall of 26.6% in 2020.
  • Dwelling completions fell by 16.4% y-o-y to 3,190 units in 2021, after increasing by 25.8% in 2020.

In the capital, Reykjavik:

  • Dwelling starts more than doubled to 2,760 units in 2021 from a year earlier, in sharp contrast to the 50.3% growth in 2020 and the highest level in recent history.
  • Dwellings under construction increased 23.2% y-o-y to 2,892 units in 2021, following an annual decline of 33.3% in 2020.
  • Dwelling completions fell by 12.3% y-o-y to 2,215 units in 2021, following an annual increase of 23.5% in the prior year.

Iceland’s residential market consists of around 145,000 apartments and houses, according to Arion Bank.  About 85% of the population are owner-occupiers while the remaining 15% are renters.

Iceland Residential Construction graph

Shortage of affordable housing

There is a shortage of affordable housing in all regions of Iceland, according to a report released by the Ministry of Social Affairs and the Housing Financing Fund. In the past decade, dwelling completions in the country have been averaging less than 1,900 units - lower than the required construction of 3,900 to 6,600 new units to stabilize the market.

According to Asgeir Jonsson, an economist at the University of Iceland, property developers, and contractors have been catering to the luxury market, leaving the demand for affordable housing largely unmet.

“They shouldn’t have stopped building in the suburbs, which are cheaper,” said one builder. “Apartments downtown are more expensive and less practical for families.”

To address the problem, a working group established by Prime Minister Katrin Jakobsdóttir has recently proposed to build about 35,000 apartments over the next ten years. More specifically, the group recommends building at least 4,000 units annually in the next five years and 3,000 units annually for years thereafter.

Earlier, the government announced that it would increase housing subsidies and the availability of land in the market. The measure includes:

  • Selling of a considerable area of government-owned land to Reykjavik City Council for construction;
  • Deregulation of housing and planning standards to speed up new residential construction;
  • Introduction of incentives to increase long-term rental housing;
  • Increase in rental benefits and special efforts to build low-cost housing for students and disabled individuals; and
  • Offering special support to families purchasing their first residential house.

Interest rates rising sharply to curb soaring inflation

The Central Bank of Iceland kept its key interest rate unchanged at 9.25% during its October 2023 meeting, as policymakers adopted a wait-and-see approach to the country’s macroeconomic conditions. The central bank raised the key rate fourteen times since May 2021, with a cumulative rate hike of 850 basis points, in an effort to curb surging consumer prices.

Inflation climbed again to 8% in September 2023, up from 7.7% in the previous month and significantly above the central bank’s inflation target of 2.5%, driven by a surge in the cost of transport, housing and utilities, and the prices of food and non-alcoholic beverages.

“On the whole, economic developments have been consistent with the assessment made by the MPC at its last meeting. Inflation has risen again, measuring 8% in September. Inflation excluding housing has risen as well, but underlying inflation has tapered off slightly. There are signs that price increases are somewhat less frequent than before and less widespread. Inflation expectations are still too high but have fallen by some measures,” said the central bank.

As a result, mortgage interest rates are now rising rapidly. In September 2023, the average interest rate on mortgages increased to 10%, from 9.5% in the previous month and 6.25% a year earlier. In fact, mortgage interest rates averaged only 1.87% in 2021 and 2.24% in 2020.

Iceland Interest Rates Annual Averages graph

Mortgage loans continue to rise, albeit at a much slower pace

The country’s mortgage market growth is now slowing, amidst soaring interest rates. In August 2023, the total amount of residential mortgage loans outstanding rose by 5.2% to ISK 1.78 trillion (US$12.93 billion) from a year earlier, a sharp slowdown from increases of 13.5% in the previous year and 33.4% two years ago, based on figures from the Central Bank of Iceland.

In August 2023:

  • Indexed loans: ISK 704.68 billion (US$5.11 billion), up nearly 25% from a year earlier
  • Unindexed loans, in domestic currency: ISK 1.08 trillion (US$7.82 billion), down 4.6% from the previous year
  • Unindexed loans, in foreign currency: ISK 93 million (US$0.67 million), down 8.7% from a year earlier

As a percent of GDP, the size of the mortgage market stood at 45.5% in 2022, down from 48.3% in 2021 but still up from 43.6% in 2020.

About 40% of household mortgages are indexed while the remaining 60% are non-indexed. CPI-linked mortgages are typically annuities, where the monthly payment, as well as the remaining principal, is indexed to the CPI.

Iceland Residential Mortgage Loans graph

Krona strengthens against the US dollar but weakens further against the euro

In September 2023, the Icelandic krona appreciated against the US dollar by 4.6% from a year earlier, reaching a monthly average exchange rate of ISK 135.42 = USD 1. This was after krona lost 13.3% of its value against the US dollar in the past three years from January 2020 to December 2022.

In contrast, the krona depreciated modestly by about 3% y-o-y against the euro, with the exchange rate at ISK 144.49 = EUR 1 in September 2023. This followed a more than 9% decrease in the value of the krona against the euro in the past three years.

During the global financial crisis, the value of the krona plunged from ISK62.33 = US$1 in December 2007 to about ISK123.73 = US$1 in December 2008. To stabilize the krona, US$2.1 billion was borrowed from the IMF, and exchange controls were imposed that were still in place in 2015.

As a result, the krona gained about 38% against the US dollar and 21% against the euro from March 2015 to March 2018. However, these gains were partly reversed again from April 2018 to December 2019, when the value of the krona depreciated by 18.3% against the US dollar and by 9.8% against the euro.