(renovation). This is a challenge in Norway, as no other nation in the world spends more money on house upgrading. Numbers from Prognoscentret shows that the Norwegian population refurbished for more than NOK 70 billion in 2015, which is the highest amount ever recorded in the country30. It is important to keep in mind that rental prices in Norway are partly regulated by law. This has probably impacted the development of the relationship between house- and rental prices, and likely been contributing to the indicator being at a high level. Historically, the average P/R ratio has been 11.1331, but is today as high as 31.61. Moreover, incentives for owner-occupied housing are greater than rental housing, making the rental market very small32.
Nevertheless, we believe the analysis to provide valuable feedback of the current situation. Based on historical developments in the P/R ratio and house prices, the simplified analysis may in several cases be helpful to identify possible bubble tendencies.
On the contrary, due to noticeably higher real P/R ratios compared to fundamental P/R ratios, the P/R analysis provided indications of a housing bubble in the Norwegian market. We find these divergent results interesting and will in the following final conclusion investigate the results in conjunction with the comparative fundamental analysis and the analysis of Case and Shiller’s seven criteria for a housing bubble.
8 FINAL CONCLUSION
This thesis started with the problem statement: “Are there indications pointing towards a housing bubble in the Norwegian housing market?”. A housing bubble exists if the current house price level cannot be defended by fundamental factors. It is difficult to prove a housing bubble before it eventually burst. However, using economic models, graphs and analyses in light of historical developments, we have managed to derive at a conclusion. We will first summarize all elements the thesis has undergone, and thereafter present our final conclusion.
Our thesis started by introducing characteristics of a housing bubble, in addition to the theoretical aspects of price dynamics in the housing market. This was in order to provide the reader with a solid knowledge regarding the underlying mechanics in the housing market. Further, we provided an overview of the historical developments in the housing market in both Norway and Denmark. This was to get an overview of previous crises and developments in the respective housing markets.
Hereafter, we went into detail on key fundamental variables with the purpose to investigate whether developments in house prices can be explained by fundamental factors or if the growth seems to be abnormal. The analysis was done in light of Jacobsen and Naug’s article “What drives house prices?”. The comparative fundamental analysis was followed by an analysis of Case and Shiller’s seven criteria for a housing bubble. Our last contribution to provide an adequate conclusion was an empirical analysis consisting of the HP-filter and the P/R method.
Can the high growth in house prices in Norway be seen as abnormal, or can it be explained by underlying fundamental factors?
The following factors suggest the high growth in house prices to be abnormal:
• Increase in the unemployment rate
• Increase in new constructions
• High pressure of being a home-owner
• Widespread comprehensions that it is profitable to own housing
• Widespread expectations of increase in house prices
• House prices receive much attention in the media and private conversations
• House prices increase more than private income
• Limited understanding of risk attached to the investment
• Simplified opinions regarding mechanics of the housing market dominates
• Historical high debt ratio in percent of disposable income
• Noticeably higher real P/R ratios compared to fundamental P/R ratios
The following fundamental factors support the high growth in house prices:
• Strong economic growth in terms of higher GDP
• Historical low key interest rate
• Low interest rate (lending rate)
• High growth in disposable income
• Historical high credit level
• Low levels of unsold homes
• Low deviations between real house price index and trend
By conducting several analyses, we found divergent results. After an overall assessment of the fundamental factors derived from Jacobsen and Naug’s article, we found that house prices cannot be supported solely by fundamental factors. Both unemployment and new constructions are increasing and do not support the high house price growth. Increased unemployment would in a perfect market lead to lower housing demand and simultaneously a smaller workforce, which in turn indicates less people being creditworthy. Hence, this would in principal cause lower house prices. An increase in new constructions would isolated lead to a larger housing supply, which in a perfect market would push prices down. Nevertheless, started constructions today might not turn out in lower house prices before the constructions are completed. However, we still see an overall increase in new constructions since the financial crisis, simultaneously with growth in house prices.
From the analysis of Case and Shiller’s seven criteria we found that every single criterion was fulfilled, and all criteria argue for a housing bubble in the Norwegian market. Furthermore, the analysis shows that Norwegian households have a historical high debt ratio in percent of disposable
income. This leads to an unbalanced economy, and provides indications of a housing bubble. This is additionally reinforced by the P/R analysis. Deviations between real- and fundamental values were significant, and suggest that house prices are overvalued. The analysis shows strong growth in house prices, whereas the rental prices do not follow an equal trend. Moreover, the real P/R ratio in 2015 was higher than during any previous housing bubble, which underlines the disequilibrium that was revealed in the analysis.
On the contrary, there are several indications pointing towards a housing market that can be explained by fundamental factors. First of all, Norway is experiencing strong economic growth, measured by GDP. When developments in fundamental factors, such as a low key interest rate, a low interest rate (lending rate), and high growth in disposable income, is seen in relation to house price developments and the corresponding HP analysis, the house price growth can to a large extent be claimed to root in reality. The empirical presentation of the HP-filter showed a low deviation between the real house price index and the trend. From 2014 until today, the deviation was approximately zero, which evidently does not provide indications of a housing bubble in the Norwegian market. Moreover, other factors such as a high credit level and a low level of unsold homes support the high growth in house prices. People are able to serve a higher total debt level due to growth in disposable income, combined with lower interest rates the past years. Consequently, we get a higher housing demand. If housing demand is high, people would sacrifice more to win the bidding round and thus push the willingness to pay towards the payment capacity. This may further result in strong growth in housing prices.
Can we prove the Danish housing bubble prior to the financial crisis?
Our conducted analyses show that the following factors prove the housing bubble:
• Low economic growth in terms of GDP
• A high key interest rate
• Increase in new constructions
• High pressure of being a home-owner
• Widespread comprehensions that it is profitable to own housing
• Widespread expectations of increase in house prices
• House prices receive much attention in the media and private conversations
• House prices increase more than private income
• Limited understanding of risk attached to the investment
• Simplified opinions regarding mechanics of the housing market dominates
• Significant deviations between the real house price index and trend
Two of the four fundamental factors from Jacobsen and Naug’s study showed bubble tendencies in the Danish housing market, namely increase in new constructions and rise in the interest rate. This shows that a housing bubble may exist although the growth in house prices can be supported by some fundamental factors. Consequently, we can argue that Jacobsen and Naug’s study may not be an appropriate measure when analyzing abnormal markets. However, both the GDP and the key interest verified the housing bubble. From the analysis of Case and Shiller’s seven criteria, we found that every single criterion was fulfilled during the house bubble, and all criteria argued for a housing bubble in the Danish market. This indicates that Case and Shiller’s model may be suitable when analyzing the Danish house market. Hence, we can argue that this model is reliable for the Norwegian house market as well. Furthermore, the empirical presentation of the HP-filter undoubtedly proves the housing bubble, due to significant deviations between the real house price index and trend. For every implemented lambda value, the model shows clear signs of a housing bubble. The model shows vital signs even with the lowest lambda value. Accordingly, we can argue that this model is valid for the Norwegian market as well.
Are there indications pointing towards a housing bubble in the Norwegian market today?
By looking at the totality and an overall picture of the analyses in conjunction with each other, we can argue that there are indications pointing towards a housing bubble in the Norwegian market today. Case and Shiller’s model and the P/R analysis show clear indications of a housing bubble. In addition, a historical high debt ratio in percent of disposable income, an increase in the unemployment rate, and a high level of new constructions do also provide indications of a housing bubble. Case and Shiller’s model confirmed the housing bubble in Denmark, and we therefore consider this model as highly valid and reliable. Moreover, if we look at the current Norwegian
policy prevails. This phase is characterized by low interest rates, an optimistic market outlook, increased unemployment and high levels of disposable income, which all indicate the presence of a housing bubble.
The HP-analysis showed no indications pointing towards a housing bubble in the Norwegian market. Even though this analysis under no doubt underlined the housing bubble in Denmark, it is important to emphasize that this bubble happened in a period back in time, which minimizes the endpoint problems that exists in the Norwegian analysis. Hence, we choose to place less emphasis on the results from this analysis. It is also important to remember that the Case and Shiller’s analysis were based on subjective and discretionary assessments, and may consequently lack some substance in the argumentation. Additionally, it is important to bear the P/R model assumptions in mind, as well as the fact that rental prices were calculated based on historical CPI figures, which may provide unrealistic development in rental prices.
We will once again emphasize that our study is an interpretation of the current housing market, and our conclusion is to some extent based on our expectations as well as different surroundings under the thesis process. The housing market is also characterized by psychological behavior, which has a great impact on house prices. It is not easy to get an appropriate measure of the psychological aspect. Consequently, the price formation in the housing market is complex and affected by numerous factors, which are hard to measure.
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APPENDIX Table of Content
Appendix 1: Mail correspondence from Karen Larsen, Statistics Denmark ... 2
Appendix 2: Nominal- and real house prices in Norway ... 3
Appendix 3: Nominal- and real house prices in Denmark ... 8
Appendix 4: House prices with HP-filter in Norway ... 9
Appendix 5: House prices with HP-filter in Denmark ... 14
Appendix 6: Real P/R calculations ... 15