The Czech National Bank warned last month that the residential market is overheating, claiming that on average, prices are 17% above where they should be. It’s these types of fears that have led banks to begin reducing the amount they’ll lend against the average home by cutting valuations. With commercial buildings, where there are far fewer deals to base valuations on, valuers give their estimate on what a given asset will sell for. In their valuations of residential properties, bankers tend affix values based on what they’re afraid they might sell for in a pinch.
Are banks over-reacting? Inevitably, the massive spike in residential prices will come to an end. And something does now seem to be happening to the pace of price rises and the wider market. The economist and Investment Consultant Mark Robinson warns that the falling affordability of residential assets could be a harbinger of falling liquidity levels. Added to the risk of inflation and a hike in interest rates once the pandemic passes, there could be more danger in the tail of this crisis then we realize.
Why does affordability matter? And why is the Central Bank getting involved?
Robinson: We’ve reached very, very high levels of valuation relative to income for house valuations. At the end of Q3 we were up 10% in the Czech Republic for 2020. So there are valid concerns because the economy is contracting by let’s call it 6% in 2020. It might be 7% with the latest lockdowns while housing prices go up by 10% or more. Therefore the differential is 16% or more. That is quite an extraordinary performance and is one which pushes the affordability analysis off the screen. That’s what they mean by overvaluation. It’s simply gone out of control. The [central bankers] have made similar noises in previous years. But there was wage growth, so you had the ability for some participants in the residential real estate market to continue to trade upwards — to sell houses where they’ve generated equity, use the equity to buy something slightly larger and take out a slightly larger loan because they’ve had wage growth. That’s the escalator that happen in residential real estate markets and has happened over the last 30 or 40 years in developed countries. And it happened in the Czech Republic as well.
But this year let’s assume there’s zero wage growth for 2020. Even if it’s slightly positive — 1% maybe 2% — it won’t be very much like even the rate of inflation in the Czech Republic which was 3%. So real wage wages are probably going down in real terms in 2020 which is nowhere near the house price rise of 10%. That wage engine is missing from this house house price rise in 2020 and this is where the central bank is coming from. The market has become a lot more stretched and less affordable and they’re beginning to get worried about it.
If developers are selling flats successfully, doesn’t that mean they’ve set the price correctly? Why the concern over affordability if people are affording them?
You’ve got to judge liquidity. You’ve got to ask how many transactions are happening because a price is just a price. But if 10 people buy apartments in the given year rather than 100 in a given year, then yes, you have a new reference price but the market is a lot less liquid. We’ve got to be very careful about volume of activity.
Having said that, what is the case is that in 2020 obviously what we saw was a collapse in interest rates and mortgage rates were also falling. So that affordability gap that I just described was actually mitigated to a large extent by the fact that the banks dropped their funding costs. So people who had existing mortgages took the opportunity to remortgage and those that are the marginal buyers of flats and houses actually think to themselves “I can just about stretch to this because the mortgage rate is lower.” Now again, that starts to ring alarm bells in the central bank. Particularly since it has a single mandate, which is fighting inflation. Because one day, inflation might come back and they might have to raise interest rates again, so suddenly mortgage rates would go back up again. They’re worried about those that have just managed to afford flats or houses this year getting into trouble.
The country is in the middle of a second lockdown and GDP will fall at least 6% this year. Where’s inflation going to come from?
Imagine when we don’t have a lockdown situation. The economy is just going to explode — very quickly it will regain traction like like a Formula One car getting out of the pit after a tire change. It suddenly hits the road and goes goes off at 200 miles an hour which likely happens with inflation. If the central bank has to act and it starts raising interest rates, then mortgage rates go up again. The affordability equation that we just talked about starts to get messy again. You might see wage growth come back if unemployment stays low, so that might mitigate it. But you may get a housing crunch.
Also in thePrime:
3things: Komerční banka lay offs, an investor for Rohlik.cz and Vafo
Mint jumps at chance to build for less in Prague, Bratislava
