The euro area housing market during the COVID-19 pandemic

Prepared by Niccolò Battistini, Matteo Falagiarda, Johannes Gareis, Angelina Hackmann and Moreno Roma

Published as part of the ECB Economic Bulletin, Issue 7/2021.

1 Introduction

The euro area housing market was in a relatively long expansionary cycle before it entered the coronavirus (COVID-19) crisis.^[1] On the eve of the COVID-19 crisis, the euro area housing market was on solid ground. In the last quarter of 2019, house prices, housing investment and housing loans were on an upward trend, supported by robust income developments and bank lending rates for house purchases at historical lows (Charts 1 and 2).^[2] Given the phase in which the housing cycle stood, an economic shock like the COVID-19 crisis might have been expected to turn the cycle.

However, the reaction of the euro area housing market to the COVID-19 crisis differed from that in previous crises owing to the different nature of the underlying shock.^[3] The global financial crisis of 2008 originated in the US housing market and the sovereign debt crisis that started in 2010 stemmed primarily from financial shocks. Initially, the shock caused by the COVID-19 pandemic was unrelated to economic fundamentals and – especially in its early phases – afflicted the economy mainly through mandatory and voluntary restrictions on mobility aimed at containing the spread of the virus. These restrictions induced peculiar features compared with the global financial crisis and the sovereign debt crisis, notably as a result of their diverse impact on real and nominal housing dynamics and differing housing developments across countries. The particular nature of the COVID-19 pandemic triggered vigorous monetary, fiscal and macroprudential policy responses.

This article explores the developments in the euro area housing market during the pandemic and compares them with those in previous crises, paying particular attention to the role of policy support measures. Throughout, the article takes a holistic approach that covers developments in and prospects for euro area housing investment, house prices and loans for house purchase. Section 2 focuses on the diverse impacts on the euro area housing market of the first wave of the COVID-19 pandemic from the first to the third quarter of 2020, when strict containment measures had the greatest effect on activity. Section 3 elaborates on the subsequent resilience of the housing sector through the second and the third waves of the pandemic up to the second quarter of 2021, amid more targeted containment measures and significant policy support measures. Section 4 provides a forward-looking perspective on the prospects and risks for the euro area housing market.

2 The first wave of the COVID-19 pandemic – the diverse impacts of containment measures on the euro area housing market

The containment measures in response to the first wave of the COVID-19 pandemic led to a divergence between real and nominal housing dynamics. The severe decline in mobility induced by containment measures and voluntary social distancing during the first wave of the pandemic had a negative impact on euro area housing investment, pushing it to 3.1% below its end-2019 level in the third quarter of 2020, broadly in line with the levels seen during the global financial crisis and the sovereign debt crisis (Chart 2). However, while in the previous crises deteriorating economic fundamentals hampered growth in house prices and housing loans, the COVID-19 shock did not weigh on the upward trajectory of prices and loans, which surpassed their levels in the fourth quarter of 2019 by 4.3% and 2.6% respectively in the third quarter of 2020, supported by resilient housing demand amid policy support measures (Box 1).^[4]

The different nature of the COVID-19 pandemic compared with previous crises is also visible in the larger degree of diversity in housing investment dynamics across countries. Losses in housing investment during the first three quarters of 2020 varied widely, with nine countries recording gains and two countries (Spain and Malta) incurring larger losses than during the global financial crisis (Chart 3). These heterogeneous dynamics can partly be explained by the timing and relative degree of restrictiveness of containment measures,^[5] with construction activity being temporarily halted in some countries.^[6] Other factors included the initial fiscal support measures, which varied considerably across countries in terms of scale and timing,^[7] as well as the different demographic structures of the national housing markets.

Demographic structures may also have induced diverse housing investment dynamics across countries, reflecting the differing impact of the first wave along the income distribution. Countries where a larger share of income is earned by poorer households experienced stronger declines in housing investment during the first wave of the pandemic.^[8] Euro area survey data corroborates this, as lower-income households remained significantly less willing to purchase a house compared with pre-crisis levels by the end of the first wave of the pandemic in contrast to developments during the global financial crisis and the sovereign debt crisis (Chart 4). Instead, the intentions of medium and higher-income households to purchase property increased. This most likely resulted from these income groups’ high levels of accumulated savings induced by restrictions on the consumption of high-contact services.^[9]

3 The second and the third waves – housing market resilience amid policy support measures

The housing market proved resilient during the second and third waves of the COVID-19 pandemic. In spite of the deterioration in the epidemiological situation that led to a tightening of restrictions in the fourth quarter of 2020, the euro area housing market gained further momentum. House prices remained on an upward trend, increasing in annual terms by around 6% in both the fourth quarter of 2020 and the first quarter of 2021, a pace not seen since mid-2007. Housing investment recovered further in the same reference period, settling close to its pre-crisis levels. These signs of significant resilience stemmed from both the supply side, as indicated by the momentum in value added and employment in construction and real estate, and the demand side, as suggested by the return of the number of transactions to pre-crisis levels in many euro area countries and the increased demand for mortgage loans. The milder impact of restrictions compared with the first wave and the significant stepping-up of fiscal and monetary policy measures, continuous favourable financing conditions, the increased attractiveness of housing for investment purposes – in view of forced savings – helped to strengthen housing investment and exert upward pressure on house prices.^[15]

Fiscal policy measures were key in mitigating the negative effects of the second and the third waves of the pandemic on the housing market. These measures included short-time work schemes, targeted transfers to more vulnerable segments, cuts to personal income taxes, social contributions and indirect taxes. Policy interventions to support firms also contributed to mitigating the impact of the crisis on employment and income, and helped construction firms maintain housing supply.^[16] These measures included direct support schemes for firms and the self-employed, partial compensation of losses, subsidies, tax deferrals and public guarantees on bank loans.^[17] Other important policy tools were moratoria schemes, which provided households and firms with short-term relief through the suspension of principal and/or interest payments on loans, and very generous fiscal incentives for house renovation in some countries.

Monetary policy also provided key support to the euro area housing market by preserving favourable financing conditions for households and firms. First, the Pandemic Emergency Purchase Programme (PEPP) announced in March 2020, by impacting yields especially at the long end of the maturity spectrum, exerted significant downward pressure on lending rates. This was particularly pronounced for mortgage rates, as they are typically linked to longer-term interest rates. Second, the negative interest rate policy continued to contribute to historically low lending rates, thereby supporting bank lending. Third, the targeted longer-term refinancing operations (TLTRO III) offered attractive bank funding conditions, which banks passed on to firms and households, even for the non-targeted segment of the facility (i.e. housing loans).^[18] Overall, according to the ECB bank lending survey (BLS), the ECB’s monetary policy measures contributed to an increase in housing lending volumes and an easing of bank lending conditions on new mortgages during the COVID-19 period.^[19] As regards existing mortgages, households at the lower end of the income distribution seem to have benefited the most from the reduced interest rates via the so-called cash-flow effect of monetary policy, which increased their available resources for spending (Box 2).

Financing conditions remained favourable, especially for less risky households, supporting the robust demand for housing. Apart from the first two months of 2020, flows of housing loans remained robust, with the annual growth rate of the loan stock reaching 4.2% in the first quarter of 2021, a rate not observed since 2008, significantly moving in tandem with house prices. Households’ demand for mortgages was met by historically low bank lending rates, which remained immune to the tightening in credit standards reported by banks in 2020 and to the increase in market rates in the first months of 2021. This muted response reflected favourable bank funding costs (buttressed by the policy support), but concealed a widening of lending margins for riskier borrowers and higher collateral requirements in the context of deteriorated perceptions of households’ creditworthiness. In the first half of 2021, tightening pressures on bank lending policies for housing loans vanished, primarily reflecting lower risk perceptions related to the improved economic outlook (Chart 5). The favourable developments observed during the second and third waves of the pandemic allowed households to experience a significantly smaller tightening of bank lending conditions during the COVID-19 period as a whole compared with previous crisis episodes (Chart 6).^[20] The contribution of housing market prospects to loan demand was also strikingly different to that in previous crises in that it held up particularly well throughout the pandemic. Bank lending conditions for firms in the construction and the real estate sectors over the COVID-19 period were more favourable compared with those for firms in sectors that were hit harder by the containment measures.^[21]

In a context of low interest rates, high uncertainty and large savings, housing demand has also been supported by investment motives. The demand for housing for investment purposes has been a distinctive feature of the recovery in housing markets that started in 2013.^[22] This factor seems to have strengthened during the COVID-19 period, reflecting a further increase in the relative attractiveness of housing as an investment class and a further expansion of the availability of savings amid considerable economic uncertainty.^{[23] [24]} Moreover, flows into real estate funds, albeit declining slightly in 2020, remained at relatively high levels, also as a share of residential investment. Although some of these funds could also be directed to commercial real estate or outside the euro area, this evidence suggests that private and institutional investors searching for yield and safety may have contributed to additional housing demand during the COVID-19 period.

Supply-side constraints have also exerted upward pressures on house prices. Constraints on housing supply have been an important factor behind housing market dynamics over the 2013-19 period. Following the significant decline in building permits in the aftermath of the pandemic outbreak, supply bottlenecks were further aggravated during the different waves of the pandemic (Chart 7). While in the first wave financing conditions and other factors (notably, containment measures) particularly constrained production, in the second and third waves supply bottlenecks were mainly due to labour and material shortages. The lack of (especially high-skilled) workers was also a major factor limiting production before the COVID-19 crisis,^[25] but the shortage of materials reflected global supply-chain disruptions and a reallocation of resources induced by the outbreak of the pandemic, leading to increases in supplier delivery times and input costs. Overall, survey data suggest that, for construction firms, supply-side constraints increased relative to demand constraints during the COVID-19 period.

4 Prospects and risks for the euro area housing market

Several factors are likely to support housing market prospects in the near term. The expected recovery in economic activity – sustained by a successful vaccination campaign in the euro area – should hold up households’ income and employment prospects, including when fiscal support gradually recedes. Financing conditions are likely to remain favourable, reflecting the policy support and the expected improvements in borrowers’ creditworthiness. Recent lending dynamics and indications from the BLS, which tend to display good leading properties in around two to three quarters in terms of house prices and housing investment, point to continued dynamism in the housing market in the coming quarters. Housing investment is likely to continue its positive trend observed since the third quarter of 2020, reinforced by resilient house prices relative to construction costs, improving real disposable incomes and buoyant intentions to buy and renovate properties (Chart 7). In addition, a part of the savings accumulated during the pandemic could be redirected into the housing market amid a low-yield environment and the increased relative attractiveness of housing for investment purposes. The share of residential property in real estate portfolios is likely to increase since it is perceived as a safer asset in times of uncertainty (housing is a primary need) entailing stable income streams (rents).

Nevertheless, the outlook for the housing market remains highly dependent on uncertainties related to the pandemic. Adverse developments related to the COVID-19 pandemic, such as the possible spread of new variants, might weigh on housing market prospects, and particularly on housing demand, as observed at the beginning of the pandemic. Amid high uncertainty, the withdrawal of policy support measures is an additional factor that could possibly limit prospects for the housing market if such policies were to be phased out before the recovery is on track. In addition, the overall increase in risk-free interest rates observed since the beginning of 2021 may exert upward pressure on mortgage rates. Moreover, the developments in shortages of raw materials and the associated increases in supplier delivery times and input costs could negatively affect construction activity and exert strong upward pressure on prices in the near term (Chart 7). This would contribute to keeping house prices in the euro area at an elevated level,^[32] thus possibly increasing the importance of and need for macroprudential measures (Box 3).

Changes in housing preferences may also affect the housing market going forward. The COVID-19 pandemic may bring changes in preferences and behaviour that could influence housing demand over the medium-to-long term. Should work-from-home arrangements become more prevalent, housing demand may partly shift away from city centres towards suburban and rural areas, as the opportunity costs associated with peripheral working places would decrease in tandem with commuting time.^[33] This could contribute to limiting upward pressure on rent and house prices in large cities characterised by limited housing supply. As observed in other advanced economies,^[34] preliminary evidence for some euro area countries tends to corroborate this narrative, hinting, for example, at buoyant house prices in rural areas in Germany and softening house price increases in capital cities in the euro area compared with the pre-pandemic period (Chart 8).^{[35] [36]} The accelerated introduction of remote working arrangements slowed down the demand for commercial office and retail spaces, potentially opening up the possibility to convert some of these properties into residential housing in areas where supply is limited.^[37] Both climate change and climate policies could also affect the housing market going forward. Investment in the energy efficiency of buildings could boost housing investment – also helped by fiscal incentives in some countries – thus lowering household spending on energy. In addition, properties meeting enhanced energy credentials could command higher prices, thus posing additional challenges for housing affordability.

5 Conclusion

This article discussed developments in the euro area housing market since the outbreak of the COVID-19 pandemic. The mandatory and voluntary restrictions on economic agents’ mobility in response to the first wave of the COVID-19 pandemic had a strong impact on activity without significantly impairing the upward trend in prices and loans, in contrast to the global financial crisis and the sovereign debt crisis. Moreover, the first wave of the pandemic induced greater diversity in housing investment across countries compared with previous crises, which is partly explained by the varying impact of restrictions along the income distribution.

Several factors supported the housing sector throughout the pandemic. The resilience of the housing market originated in part from the declining impact of restrictions after the first wave. Other factors included fiscal, monetary and macroprudential policy measures, continuously favourable financing conditions, the increased attractiveness of housing for investment purposes, as well as supply-side bottlenecks exerting upward pressure on house prices without significantly weighing on activity.

Overall, pandemic-related uncertainties and associated structural changes will continue to influence the prospects for the housing market. The broad-based economic recovery and the use of the large stock of accumulated savings are likely to support housing market prospects going forward. However, the outlook remains uncertain and depends on how the pandemic develops and the timing of the withdrawal of policy support. Changes in housing preferences may also lead to a reallocation within the housing market, away from commercial and urban residential properties and towards suburban and rural residential real estate. Heterogeneous developments across households are likely to persist and possibly intensify.