Less exuberant housing market after peak year 2021
The Belgian housing market continued to perform strongly during the pandemic, with particularly steep price increases in 2021. According to STATBEL's residential property price index, the prices of (existing and new) homes in 2021 were on average no less than 7.1% higher than a year earlier. That is the highest annual price increase in the period since the financial crisis broke out in 2009. The strong annual figure does, however, conceal a cooling in the rise dynamics at the end of the year. Indeed, in the last quarter of 2021, the year-on-year rise in prices weakened to 6.1%, coming from 6.9%, 7.4% and 8.2% in the first, second and third quarters. Compared to the previous quarter, house prices stabilised. There is no STATBEL figure for the first quarter of 2022 yet, but early figures from the Federation of Belgian Notaries already point to a further cooling.
That the housing market is cooling is a good thing. After all, the strong price dynamic that has persisted for more than two decades raises the question of whether the market is overheating. To what extent this is the case, we can examine it using an econometric model. In this model, the price development of houses over a longer period is statistically explained on the basis of a series of fundamental determinants. In addition to disposable income of households and mortgage interest rates, these include other factors, such as demographics (i.e. the number of households) or changes in property taxation. The aim is to find a long-term equilibrium relationship between the house price and these determinants. The extent to which the actual price at any given time deviates from the estimated equilibrium price can then be seen as a measure of over- or undervaluation.1
The calculated overvaluation depends heavily on the specifications of the model used, such as the choice of the demand determinants included and the period over which the model is estimated. This explains why the available estimates of overvaluation may differ and also illustrates that it is not an 'exact' figure. For example, in its Annual Report 2021, the National Bank of Belgium (NBB) reported an overvaluation of Belgian real estate of 20.8% on average in the first three quarters of 2021. The European Central Bank (ECB), also using a model approach, arrives at only 8.7% on average in the same period. KBC Economics also has such a model, which points to an overvaluation of 13.1% on average in the first three quarters of 2021 (see figure 1).
The NBB and ECB have not yet published a fourth-quarter figure for the overvaluation. However, this is now possible, following the publication of new data for household disposable income by the National Accounts Institute (NAI) last week. According to KBC Economics' model, the overvaluation fell to 10.4% in the fourth quarter of 2021 from 12.9% in the third, against the backdrop of cooling price dynamics at the end of the year. The fundamental price determinants, as included in the model, point towards a further cooling of the market. Specifically, these are: (1) further rising interest rates, (2) weaker income dynamics in light of the expected cyclical slowdown caused by the Ukraine war, and (3) a weaker increase in the number of households according to the Planning Bureau's forecasts. If house prices actually follow the direction indicated by the model this year and next, then the overvaluation will not increase and (depending on how much the price dynamics weaken) may even decrease a little further.
KBC Economics assumes such a scenario. Specifically, we expect Belgian house prices to rise 4.5% in 2022 and 2.5% in 2023, a weakening from 7.1% in 2021. Combined with the high inflation forecast (8.3% in 2022 and 3.0% in 2023), this does imply a decline in house prices in real terms by 3.8% in 2022 and 0.5% in 2023. This scenario is surrounded by many risks, mainly due to the uncertainty about the further course of the war in Ukraine. If it drags on or spreads further, it could weigh more than expected on activity, and thus prices, in the housing market, especially given the persistent overvaluation. The main risks are a sharper-than-expected rise in interest rates, a significant deterioration in the labour market and continued sharp increases in the price of building materials. Apart from these factors that directly impact the affordability of real estate, the crisis may also cause households to adopt a more general wait-and-see attitude in their decision to buy or build a home.
1 In econometric terms, this is a co-integration relationship. The deviation between the actual house price and the estimated equilibrium value corresponds econometrically to the residual of the regression equation.