The Housing Affordability Crisis in Europe in 7 Charts
Investing in a home has become a struggle in the EU
The last 16 years have seen so much turbulence in the European residential property market — a financial crisis, a sovereign debt crisis, a prolonged period of extremely low interest rates, a global pandemic, a war… Several construction booms, crashes, and shifts in mortgage lending resulted in significant swings in affordability for the general population. All these factors, combined with a major reduction in purchasing power in the post-pandemic world, have made housing unattainable for the average household in many European countries. This is a serious problem that requires strategic long-term solutions and policies that enable sufficient supply that can absorb the ever-rising demand.
The content of this post does not constitute financial or investment advice. It is intended for information and education purposes only. The author is not affiliated with any European institutions cited below.
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Since the global financial crisis, things changed in the European real estate markets. After the correction in housing prices and the contraction in construction activity, a major shift in monetary policy brought about a prolonged period of very low interest rates, while housing supply growth was less pronounced. As a result, over the last decade, demand grew and drove prices higher, in some countries to much higher levels than ever before. All of this was then amplified by the pandemic’s effects, which was accompanied by both an explosion of stimulus measures and structural shifts towards work-from-home. But these trends came to an end with the escalation of the Russia-Ukraine conflict, which led to another seismic policy shift and a completely new economic environment for mortgage borrowers and the European property market as a whole.
These developments have had a negative effect on housing investment as they have impacted the availability and affordability of homes. As financial conditions tightened and economic growth soured in the European Union, prices did start to come down across countries, but so did credit. The nature of the latest geopolitical inflationary shock meant that construction costs rose overall, while many households became unable to obtain financing at reasonable terms and invest in residential properties. This made a lot of projects unprofitable and has led to a spike in defaults of companies in the sector in many European countries.
Overall investment and affordability
Since 2022, European banks have been reporting a substantial tightening of credit standards on many types of loans, especially loans to households for house purchases. This had a major impact on sentiment (according to the consumer surveys) and household perceptions about the housing market — both for investment and for 12-month-ahead price growth — deteriorated quite materially. Looking at the market overall, the number of transactions and the construction of new housing have both plummeted since 2022 and are yet to recover meaningfully. Despite the fact that the ECB just kicked off with rate cuts in June 2024, most analysts point to a long period (likely several years) until the market is fully back to its pre-war condition, provided there are no further shocks.
Taking into account prices relative to incomes, as well as the impact of interest rates and composite indicators of housing costs, affordability has fallen drastically since 2022. However, the key driver so far was the increase in interest rates, which affected average mortgage rates (see next section), while prices were falling. As a result of the tightening in credit markets, household credit flows dropped rapidly from their peak in early 2022, and in 2023 they even turned negative in several EU member states when repayments exceeded new loans. More recent indicators show that this is changing, as credit flows have likely stabilized and price levels have probably bottomed out. Given rate cuts and overall growth expectations, prices are now expected to start gradually rising again.
Mortgage interest rates
After an unprecedented rapid hiking cycle, the ECB achieved a very effective and forceful transmission of higher rates to the economy via credit markets. There are multiple countries in the euro area where variable-rate mortgages dominate or the fixed-rate mortgages terms of fixation are rather short. Hence, the hikes have had a pronounced impact on the mortgage markets in the EU.
Interest rates and credit markets are the undisputed culprits for the price corrections across the EU, affecting household finances and the construction sector. What really exacerbated the situation was how rapidly the developments observed during the pandemic were disrupted and reversed by these changes: during COVID, mortgage credit flows in the euro area accelerated to levels unseen since the global financial crisis. And the sharp turn in 2022 effectively caused the share of overburdened households to rise materially, and household finances got so harmed that consumption and major purchases dropped, especially where floating-rate debt is prevalent. For new buyers, especially those with already constrained budgets and falling real incomes (due to the inflation impacts), financing real estate purchases became a major challenge.
ECB data show that some of the greatest increases in housing-related interest payments (relative share in household income) between 2022 and 2023 were observed in countries such as the Netherlands, Denmark, Sweden, Finland, Ireland, Belgium, France, Spain and Hungary.
Borrowing capacity and market activity
The relative constraining effect of higher mortgage rates since 2022 has outweighed the development of nominal income, which has led to a drop in the borrowing capacity of new home buyers. The implied price growth presented on the chart above is the real estate price growth a buyer can accommodate when devoting a fixed share of their income to mortgage payments (using an asset pricing model that factors in mortgage rates, income data and structural factors of mortgage markets). And thus, the falling interest rates and rising incomes of the 2010s enabled euro-area borrowers to pay more for a dwelling every year. Until 2022 and 2023, when the rate increases overtook income growth as a dominant factor, leading to a decline in the borrowing capacity of households.
As the European Commission analysis shows, in most EU Member States except for Bulgaria and Croatia, new borrowers are unable to afford as many residential square meters as they could in 2019. In some (e.g., Belgium, Germany, Luxembourg, Austria, Portugal, Sweden) the ability of new borrowers to fund new residential space is even worse than in the year 2000. A similar dynamic is observed in rental markets.
Issuance of building permits and real estate market transactions have essentially collapsed. This is because the reversal in prices and the considerable deterioration in economic sentiment have affected demand to a significant extent. At the same time, supply has also been affected — let us look at some of the factors.
Construction and supply shortage
ING Research have compiled an analysis of several indicators with a considerable impact on the housing markets of some of the largest EU member states. For three of these countries — namely, Germany, the Netherlands and Italy — the scarcity of housing supply is becoming a particularly severe problem. In Germany, Italy and Spain, the average annual completions of new dwelling is too low — meaning, there are not enough new homes coming to the market relative to the existing housing stock. In the Netherlands and Germany, the affordability of living is problematic and the population density is high, which makes further expansion of the housing stock more challenging. In Sweden, both the high share of housing costs combined with the baseline population growth projection make for a challenging case but are somewhat offset by the relatively higher completions rate and very low population density.
One of the major deterrents to supplying more housing is construction costs. Their increases have been driven by rising prices of materials and labor (both during and after the pandemic), persistent disruptions of supply chains and increases in commodity prices, as well as spikes in energy prices. In multiple surveys on national and European level, construction companies have reported that they have been forced to scrap projects because the increase in costs was a significant factor that turned them into unprofitable undertakings. Some even indicated that the growth in costs alongside the drop in new orders and cancellations of projects meant that they were now facing significant financial difficulties and even bankruptcy.
User costs of housing
Housing costs as a share of disposable income have risen over the last couple of years, mainly due to the rise of mortgage costs and inflation. This has disproportionately affected those with lower incomes and/or a higher proportion of housing debts. For instance, the data in the chart above from 2023 show that for those whose income is below 60% of the median in each country, the share of housing costs reached between 30–60% overall out of their disposable income, compared to just 10–15% for those in the upper-income brackets.
The ECB has developed an indicator of the user cost of housing (UCH) which measures the cost of the capital investment of a household into a dwelling. It is intended to provide a metric for affordability, capturing the homeowners’ opportunity cost of living in their dwelling compared to the utility of consuming other (current or future) goods and services, and includes:
– debt service costs (mortgage interest expense);
– unrealized alternative income from investing in assets other than the home;
– offsetting potential benefits from rises in housing prices (i.e., expected capital gains);
– taxes & other effects.
The latest ECB publication of the UCH showed that over the last 2 years, this metric has risen quite materially across the euro area — with the main driver being — you guessed it — debt service costs. Germany has been particularly strongly impacted because there, unlike in other major EU economies, debt service costs are not the most important driver — but rather the second most important after house prices. Since Germany experienced one of the most rapid drops in house prices in the EU, capital losses were the primary factor for this development.
Even if debt service costs start to decline now that the ECB is cutting rates again, the bank does point out that expected capital gains could still fall further due to their delayed adjustment to past changes. Therefore, it is likely that housing investment could still contract further going forward, at least in the near term, before it starts to recover.
Conclusion
Housing investment in the euro area fell by about 4% between Q4 2022 and Q4 2023 (with Germany and France being two examples of particularly sharp declines). The most important causes for this have been the considerable rise in long-term financing costs due to interest rate hikes, alongside the tightening of financial conditions which led to a major decline of credit flows to households, and the rise in construction costs. This has constrained the growth of the housing supply and led to a decline in household borrowing capacity, which affected negatively housing affordability — despite a correction in residential property prices. How the user cost of housing and the attractiveness of residential real estate as an investment will develop going forward will depend on the shifts in policies, the dynamic of financial conditions and the effect of economic shocks and macro factors such as output growth, unemployment and income growth.
Author: Nikolay
Founder of MoneyCraft
