Fears of Frothy House Markets?

As the housing correction in the US subprime mortgage market and perhaps beyond continues at a hefty pace the sentiment in other countries with frothy house markets is beginning to become chilly as well. A notale example here is for example Spain which have enjoyed an asset price boom in the housing sector the recent years. As such, the looming crisis in the US has prompted the Bank of Spain to go out in the national newspaper El Pais (in Spanish) (hat tip Eurointelligence) to quell worries of an impending correction in Spain's housing markets. Among the points noted were first and foremost the Bank of Spain's expectations of a gradual normalization process in a housing market which after all features a hefty overvaluation of between 24% to 32% according to national estimates. Another point emphasized by the Bank of Spain was that default rates in Spain are not very high (0.4%) compared to the current default rate in the US (4.6%). Finally, In terms of the transmission mechanisms between the US housing correction and the European economies, Wolfgang Munchau from Eurointelligence has an interesting note up.

What about Denmark then?

However, what about my own country then? Well, first of all it is pretty obvious that Denmark qualifies quite nicely for slot in the group of nations which have enjoyed a more than impressive run recently in terms of its housing market. The most notable evidence of this is that Denmark for (I think) the fourth consecutive time claims first place in the Economist's house price index which reports that house prices climbed 23.3% y-o-y in Q4 2006 relative to Q4 2005. In essence, the rising house prices in Denmark and the risk that they might fall at some point should not surprise anyone but since prices recently, especially in Copenhagen which after all inhabits about two fifths of the Danish population, have been falling or stagnating Danish economic analysts are begging to voice concerns over the potential for a collapse in the Danish house market, especially in Copenhagen (Danish content!). I won't quote Danish content here but one of Denmark's leading researchers on house markets Jens Lunde from the Copenhagen Business School notes the risk of a general depreciation of up to 25% in his analysis in which he also describes the Danish house markets as balancing on a knife's edge. Also chief analyst of Danske Bank Steen Bocian chimes in and joins the worrying crowd. Of course, these worries do not fall from the sky as jolts of lightening at least not if you have been reading the latest economic survey from the OECD on Denmark where the following quote nicely sums up the view on the Danish house market ...

Since 1995, house prices have increased substantially with an average yearly growth rate of 8% (6% real).8 The ratio of house prices to disposable income has risen over the same period by 70%. This has supported consumption growth, not least because the increased flexibility of the mortgage market made it easier to borrow against higher house price values.

Over the last year, the speed of price increases has been particularly strong: During 2005, house prices rose at double-digit annual rates, reaching 21% in the fourth quarter – the largest increase in nearly 20 years – and this trend continued at the beginning of 2006. While there are good fundamental reasons to believe that house prices should be higher today than in 1995, recent growth rates look increasingly exaggerated and it seems likely that further price increases would bring valuations significantly out of line with fundamentals.

Also the Economist Intelligence Unit's annual report (2007 (sorry no link available) notes how the Danish economy might be slowing down going into 2007. A notable sign is private consumption which has slowed down considerably on a y-o-y quarterly basis in 2006 with a 4.9% annual growth rate in Q1 2006 to 1.8% in Q3 2006. Especially the purchase of vehicles contracted considerably from Q3 (12.1%) to Q4 2006 (-1.2%). On house prices per se the EIU also notes the risk of a sharp correction which naturally would dampen private consumption even further.

Some Stylised Facts on Denmark then ...

Since I have just recently really learned how to master the stats creating engine of the Danish statistical office I thought I would end this one with some graphs of the developments in the Danish house markets in the recent years. Let us begin with sales of one family houses which give a pretty impression of the general and also of how the market might be slowing down going into 2007. The first graph shows the development from 2002 to 2005.

 

And now turning to a quarterly breakup of 2006 which shows a decline from Q3 and onwards ...

 

Turning towards the price development the situation mirrors that of sales depicted above. Firstly let us take a look at development in prices from 2002 to 2005 (1995=100) once again in one family houses. As we can see the appreciation has climbing at a pretty hefty clip.

 

However, if we look once again at a break up quarters of 2006 we get an indication that the appreciation might be levelling off. 

 

In fact, the graphs above probably don't tell the entire story and as such the appreciation of Danish house prices have concentrated regionally and especially Copenhagen as a region here tells a very important story. As such, we first take a look at price development since 1995 in Copemhagen county we see evidence of a quite remarkable appreciation.

 

Finally, in terms of sales we see the same development in Copenhagen as in Denmark on a general basis with sales of real property (one family houses) dropping rather sharply going out of 2006.

 

 So, there you have it. Not quite the worrying tendencies we see in the graphs from the US but a correction is definitely coming (and indeed overdue) in Denmark but it remains to be seen how severe its impact will be on the general macroeconomic environment. I think that especially the correction in Copenhagen and its anatomy will be a telling sign, so my advice; watch Copenhagen!