In the following section, we will investigate some of the price drivers on the demand side and to what extent they can explain the housing price increase. The demand side consists of many factors. Many of them are dependent on each other and can together greatly affect the housing market. All numbers will be analyzed on a national level as not all factors have area specific data.
8.1. Disposable income
A household’s disposable income sets the foundation of what financing possibilities they have, which ultimately affects the housing prices. In Case and Schiller’s article they conclude that in most states in the US, income almost completely explains housing price increases and decreases (Case & Schiller, 2004). The disposable income is a direct factor of the mortgage size one can receive from the bank at a given point in time. Therefore, if the costs related to the mortgage, such as interest and installments, increase relatively to the disposable income, many people will start struggling to fulfill their economic responsibilities.
By setting 2002 as the base year for the housing price index in Norway (“Boligprisene i Norge”) and the nominal income development (“Nominell lønnsutvikling”) we are able to see the development between the these two up until 2016. This is shown in figure 8.1 below.
Figure 8.1
From figure 8.1 and what is written above it is clear that housing prices cannot continue to deviate from disposable income over time, at least not at the rate shown in the graph. The reason is because most housing is financed by mortgages and they are serviced by paying interest and installments using the household’s disposable income. If interest and installments grow too high compared to the disposable income, there will ultimately be financial problems for the household. If this is the case then other spending must come down, or they must sell and buy something smaller. This relationship, mortgage divided by disposable income, is “mean-reverting”. Meaning, it will typically return back to its average (Larsen, 2005). However, it must be mentioned that if the key rate is maintained at a low level, as it currently is, there is room for movement and the gap between real housing prices and disposable income can stay wide without posing any immediate threat.
If one looks at the disposable income growth in a bigger picture, and not comparing it to real housing prices, one can see another side of the situation. When looking at the average Norwegian family owning a 90 square meter apartment, 18% of the disposable income is used on interest and installments (E24, 2017). This is actually below what was the case right before and during the Financial Crisis. We have to go back to the end of the 90’s to when we first had these levels. Also, the cost of living is lower compared to before. The cost of living took 60 percent of our disposable income in 1990, this number had gone down to 35% in 2015 (E24, 2017). From these numbers, the housing price increase seems more reasonable.
Conclusively, the disposable income is high, historically speaking. However, real housing prices have only continued to increase. Holding all else equal, if the disposable income increases in a country, people will afford higher mortgages and ultimately housing prices will go up. However, it is important to point out that although the real housing prices have gone up, the housing costs, i.e. interest and installments, are at a historical low in Norway, justifying in some sense the reason for high housing prices. This is no certainty though. The key rate is low now, but eventually it will start to increase. Closely connected with the disposable income is the unemployment rate. Therefore, it is natural for us to move to this factor in the next sub-section.
8.2. Unemployment
According to Jacobsen and Naug the demand for housing will depend on the household’s expectations for own and other’s disposable income. In other words, “increased unemployment will result in expectations of lower wage growth and increased uncertainty concerning future income and ability to repay debt. This reduces the willingness to pay for owner-occupied houses” (Jacobsen & Naug, p. 32-33, 2004). The unemployment rate is therefore usually seen as a good indicator for the current housing prices, future housing prices and ultimately the economy as a whole.
Figure 8.2 presents the relationship between the real housing prices and the unemployment rate. In a macroeconomic sense, as Jacobsen and Naug just stated, when the unemployment rate is low housing prices should in theory go up. However, by looking at the graph one can observe that the housing prices have continually increased throughout the time period, with an exception during the Financial Crises. At the same time the unemployment rate has been much more volatile. Following the oil price drop starting in mid-2014 the unemployment rate in Norway has increased. Where one would assume to see housing prices decrease as a response to this, the housing prices have continued to increase, even at a higher rate than before, as we can see from figure 8.2. Among others, chief economist in DNB Markets Øystein Dørum, stated that this can be explained by the fact that the key rate has been kept at a record low and more importantly the prognosis for the future is that it will stay at this rate for the short- to mid-horizon, as it has two and a half years later (Aftenposten, 2014). Although the unemployment rate is higher than a couple of years ago, it is still low relative to other Scandinavian countries such as Denmark (5.8%) and Sweden (7.1%) (EuroStat, 2016). Therefore, higher housing prices can be supported by a low key rate and higher disposable income, as previously written.
Figure 8.2
Source: NCB, 2017; SSB, 2017
8.3. Interest Rate
The key rate and ultimately the lending rate from banks is said to be one of the biggest factors affecting housing prices. This is at least stated and concluded in many articles, there among in Jacobsen and Naug’s article (Jacobsen & Naug, 2004). The key rate has a large effect on the decision to purchase a dwelling because of how it will affect a household’s disposable income. A high key rate will weaken the willingness to buy housing. On the other hand, a low key rate will ultimately make it more affordable to loan money and this will consequently push housing prices up. This is the current situation in Norway, where the key rate is at a historic low of 0.50% (NCBa, 2017). If we look at figure 8.3 we can see that the national bank in Norway predicts that this low rate will most likely continue for four-five years to come. This further lifts people’s expectations of continued low interest rates and again makes it even more attractive for people to invest in housing. Expectations is another fundamental factor we will address later in this section.
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Figure 8.3
Source: NCB, 2017
The reason for why we keep on referring to the key rate and not directly to the banks’ lending rate is because they are extremely correlated. For the banks, a low key rate means a low money market rate and capital costs. Therefore, the banks have the ability to lower the lending rate to customers and remain competitive compared to other banks. Hence, we will continue to only refer to the key rate, unless stated otherwise.
By looking at figure 8.4 one can see the relationship between the real housing price index and the key rate development. The housing price index has continuously increased since 1982 until the present day, with exceptions of the Norwegian banking crisis and the Financial Crisis. Simultaneously, the key rate has steadily decreased until today, yet at a much more volatile rate. Today’s record low interest rates, and forecasts will directly stimulate the housing market, especially in Oslo and the larger cities where there is an extreme pressure from the demand side of the market. This in turn will increase the amount of mortgage people will apply for, hence pushing for an even higher price increase in the housing market.
Figure 8.4
Source: NCB, 2017; SSB, 2017
It is important to remember that the current situation with regards to the key rate in Norway, or any other country with low interest rates for that matter, is due to the fact that the economy in the country as a whole is struggling. Therefore, in an economic sense, it is not desirable for this situation to continue in the long run. Professor at BI Norwegian Business School in Oslo, Erling Steigum explains the current situation in Norway as such, “The Norwegian Central Bank has chosen to keep the key rate in Norway low to avoid lower economic growth. Also, the key rate has been lowered internationally. If Norway has a high key rate compared to other countries, the Norwegian Krone will be very strong. Currently we have a weak Norwegian Krone, which is an advantage given the recent oil price drop, and because we need to be competitive in other sectors right now” (E24a, 2016). Although NCB currently predicts a minimal increase of the key rate, one must assume that the economy will begin to rise again in the future.
When this happens, the NCB will increase the key rate to maintain a stable growth and keep the inflation rate near the long-term goal of 2.5% (NCBb, 2017). It is difficult to precisely predict the outcome in the housing market of such an increase of the key rate.
8.4. Population growth
With more citizens, there is naturally a larger need for housing. In Norway, net-immigration is more important than birth surplus, as it contributes to a higher growth rate (SSB 2017e). By net-immigration
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we mean that more people are moving into the country than out. The death rate has been declining the last century, which is also reflected in the higher life expectancy and increased population.
Keeping in mind figure 7.3 from the section above, we can observe the relationship between new builds and the population growth rate. As stated above, the growth rate of the population is important for the house price development. This is also supported by chief economist at “Prognosesenteret” Kjell Senneset, “The relationship between population growth rate and new builds are important for the price development. For 20 years now there has been built too few dwellings relative to the population growth rate, and this will most likely continue. In other words, the price driving factor of this will continue.”
(Aftenposten, 2014). Throughout the period the population has experienced a positive growth rate. In these same years, the population in Norway has grown with just below one million people. Which is a significant number, as we only have 5.2 million inhabitants currently (SSB, 2017e). From this we can conclude that the market consists of many more people.
Another aspect worth looking at is the fact that urban areas are experiencing a higher growth rate than rural areas. An example of this is Oslo, which has in this same time period experienced a growth rate of 40% (SSB, 2017e). The larger cities have for some time now experienced a higher demand than supply.
However, we think that the total population growth in itself has limited effect on housing prices.
8.5. Demographics
Urbanization is a trend that is only becoming stronger in Norway. People are moving from the rural areas to the cities. As a result, there is an extremely high demand for housing in the city centers. The five largest cities in Norway; Oslo, Bergen, Stavanger/Sandnes, Trondheim, and Drammen inhabit around one third of the total population of Norway, and this fraction is continuing to increase. As of December 6th, 2016, the amount of people in Norway living in urban areas has reached 81% (SSB, 2016d).
Currently the age group between 16-44 accounts for about 39% of the population, and it is this age group that is most likely to move around for work and education. When doing so they tend to draw to the larger cities as mentioned above (SSB, 2017e). The social aspect is equally important as work and education
for this age group as well, and even more so more recently. This trend has actually been termed the
“caffé latte factor” by scientist Erling Røed Larsen. In other words, people are more likely to gather around urban hot-spots with a close proximity to school, work, and other social possibilities, than to care about size and design of a household (Larsen, 2005).
This can be tied into the fact that the size of households has become smaller and smaller throughout the years, in other words, fewer and fewer people are living together. Reasons for this is that family sizes are generally becoming smaller, and there is a higher debut-age for cohabitation. Also, people are single longer and more often become single at an adult age. Interestingly enough the amount of divorces has not been as low as it was in 2016 since 1990 (SSB, 2017h). This is a positive factor in terms of housing prices, as two incomes is better than one when servicing a home mortgage. Oslo actually has the largest portion of single habitants in Norway with close to 60% of the citizens living alone in the inner-city limits (Ensliges Landsforbund, 2013). From figure 8.5 we can see the development of household sizes.
As we can see, households of one or two people are the most common. The trend is clear; fewer and people are living together, hence a high demand for small households.
Figure 8.5
Source: SSB, 2011; Own calculations
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This trend is clearly visible in Oslo, especially where apartments below 30 square meters are going for prices far above 100,000 NOK per square meter. In May 2016, a 19 square meter apartment went for 132,000 NOK per square meter (E24b, 2016). Whereas before it was an exception that households under 30 square meters would go for over 100,000 NOK per square meter it has now become more of a rule in Oslo. This is a direct result of the increased urbanization and demand for small households in the large cities.
8.6. Housing Taxation
The taxation system in Norway today with regards to housing can be considered low, compared to other capital. In Norway housing is taxed with regards to the housing capital, property taxes, and the potential gain of a sale. Also, there are tax deductions to interest expenses as well as tax-free rental income in certain situations. In this sub-section we will go through how the housing taxation works in Norway and how this can possibly affect housing prices.
8.6.1. Tax on Housing Capital
As we have previously stated, a large portion of the population in Norway have most of their capital tied up in housing. The Norwegian government has always supported this. One way of doing so is to have favorable measures when accessing the taxable value of housing. In 2010, the Norwegian government determined a new way of determining the dwellings taxable value (Skatteetaten, 2017a). The new method was developed by SSB such that it is able to move with the market value. The equation includes factors such as the dwellings’ age, location, size and type (Skatteetaten, 2017c). For primary dwellings, the maximum taxable value should not surpass 30% of market value. For secondary dwellings, the maximum taxable value should not surpass 90%. If the assessed value does in fact surpass these two thresholds, you have the right to have the value reduced.
Once you have found the taxable value of your dwelling you can use this value to find your net wealth.
Your net wealth is the remainder when subtracting all debt from your total fortune. Currently, if you have a net wealth below 1,480,000 NOK you are exempt from paying a wealth tax, anything over this you would have to tax 0.85%. In other words, you can have a dwelling with a market value up to 4.9
million NOK which is self-financed and you still do not need to pay a wealth tax1. On the other hand, having 4.9 million NOK in a bank account, would result in you having to pay 29,359 NOK in taxes2. Having these conditions clearly makes it more favorable to have your money in housing rather than in a bank account.
8.6.2. Property Taxes
The property tax is a voluntary tax form decided by each municipal. In 2016, 365 of 428 municipalities in Norway had applied the property tax. Although it varies from municipality to municipality, the taxable value used to calculate the property tax is usually SSB’s equation. Using the equation from SSB, the taxable value is set to maximum 30% of the market value of the dwelling. Each municipality can choose to have a property tax rate of between 0.2% to 0.7% (Huseiernes Landsforbund, 2015). The inception of a property tax will not lead to an immediate drop in house prices as the tax rate is so small, as well as the fact that most municipalities has this tax, therefore it is almost inevitable that one has to pay it.
8.6.3. Tax Deductions on Interest Expenses
The tax deduction on interest expenses is not directly aimed towards households who own a dwelling.
However as previously stated, since such a large portion of the Norwegian population own their own dwelling, the tax policy is very favorable for a large portion of Norwegians. The tax is only an act of tax symmetry. As interest income is taxed at a 24% level, all interest expenses must be deducted at a 24%
level (Regjeringen, 2017). Both these levels have gone down from 27% only two years ago, giving a tax break for income, but at the same time making it relatively more expensive to service your mortgage.
From this one would expect to see the demand go down, however this has not been the case and the demand has only gone up.
8.6.4. Tax on Sale Profit
Any sale of a dwelling in which results in a profit the owner or owners must pay a tax of 24%. However, the tax is voided if both these two statements are fulfilled.
1 (1,480,000/0.30) = 4,933,333
2 4,933,333 * 0.85% = 29,353
1. “The sale must take place or be agreed upon more than one year after the property was acquired, and
2. The owner must have used the property as his own home for at least one of the past two years before the sale takes place” (Skatteetaten, 2017a).
Also, one will receive a tax deduction at the same rate if the sale results in a loss. The tax in itself does not primarily effect the average household, as they usually live longer than two years in the same dwelling. One can say that this tax helps keep many speculators out of the market as it lowers the profitability for short-term investments.
8.6.5. Tax on Rental Income
Rental income for a dwelling owner is rent free if less than 50% of the dwelling, measured by rental value, is rented out. Also, the rental income is tax free if a larger portion or the entire dwelling is rented out and the rental income does not surpass 20,000 NOK (Skatteetaten, 2017b). These favorable tax policies give incentives for people to buy dwellings with the possibility to rent out a section. From this, these policies could lead to a higher demand for larger dwellings, which in turn would lead to a higher debt burden.
All these favorable tax policies for dwelling owners allows the potential returns after tax to be higher than the alternative cost of placing their money in other assets. This ultimately leads to a larger portion of the Norwegian population who invest their money in housing. This will again lead to higher housing prices. We think that the tax deduction for interest expenses have the largest effect on each household’s behavior towards investing in housing. Conclusively, housing taxation in Norway is clearly a large factor in the housing price development.
8.7. Expectations
The housing market is largely driven by the consumer’s expectations. Expectations of future increases in housing prices provides an incentive to buy today. This will in turn lead to an increased demand. On the other hand, expectations of higher prices will also lead to people holding on to their dwelling longer to be able to benefit from potential price increases. This is something we are currently experiencing in
Oslo as people are waiting to sell their own dwelling before they have purchased something new. This is in fear that they will not be able to buy something new for the same sell price. This is solely made from the situation that people expect the prices to go further up. Ultimately this leads to less houses available and a higher demand for housing, hence higher prices. Daniel Kjørbeg Siraj, CEO for OBOS in Norway explains the situation like this, “clients are telling us that they are scared to sell their house before they buy something new. Simply because of the fact they do not know if they will find a new house they can afford. People have a tendency to buy themselves upward in the housing market. However, right now there are so few objects available, and because of the high price increase they risk not being able to keep up when the bidding rounds go. Also, people would rather not be back in the renting market”
(Dagens Næringsliv, 2016a).
Increased expectations lead to increased activity in the market. This results in increased demand for mortgages. In a rising market the banks will also be optimistic. The effect is self-reinforcing. The banks will lighten their conditions and more people will get their mortgage approved. The banks believe that their clients will meet their payment obligations and as a result they will require a smaller risk premium.
This will lead to a reduced real interest rate. The amount of money in the market will therefore increase.
Conclusively this means that dwelling buyers can more easily finance the housing price increase from what the expectations of higher prices creates.
However, much of this is not true anymore in Norway, at least in terms of the banks. Because of the situation, regulations regarding approval of mortgages have increased. Now everyone must have at least 15% equity when purchasing a house in Norway, up from 10%. Also, a client cannot receive a mortgage of more than five times their gross income. More recently the Norwegian government has introduced specific regulations for the market in Oslo. The most significant is the requirement of 40% equity for the purchase of a secondary dwelling in Oslo. This is strictly to make it more difficult for speculators to buy dwelling in Oslo.