continue until the level where housing costs are equal to the previous level for the marginal home buyer. If housing prices are pushed up, the decrease in interest rates will only have a small effect for first-time buyers, and the willingness to pay will only be higher for those already having debts (Kommunal og Regionaldepartementet, 2002).
Actual- or expected increase in construction costs may affect expectations regarding an increase in the property value, since increase construction costs are expected to result in lower supply. This will in turn lead to increased house prices. On the other hand, if several people are expecting higher house prices not supported by developments in fundamental conditions, it may lead to an unbalanced market. Such a self-reinforcing mechanism creates a momentary and potential significant growth in prices7. It may also result in a negative spiral with market pessimism, which we have discussed in section 3.1 about housing bubbles.
Furthermore, it is important to take risk into account when buying a home. People with low wealth will normally have lower willingness to pay than people with high wealth. They will have to issue a higher loan to finance the house purchase, which involves a greater risk and uncertainty regarding both future interest rates and future income development. This could in turn affect the demand, and particularly young adults and immigrants, as they often have uncertain future income and normally less savings (Kommunal og Regionaldepartementet, 2002). Unemployment also affects prices through the expectation channel. When unemployment decreases more certainty regarding future income is creates, which may further result in increased housing demand. Accordingly, house prices will increase.
had experienced significant growth during the period between 1992 and 2004 - when the prices more than tripled.
Jacobsen and Naug’s model presents four central and crucial key factors that are decisive for a property’s value in the longer run. Hence, we will look at the changes and movements in each of these factors for both Denmark and Norway. These factors are: interest rates, unemployment, level of income, and housing construction. Jacobsen and Naug states that the fundamental factors cited in the analysis as the key drivers of housing prices are good arguments to provide an explanation of the intense rise in housing prices we have seen the recent years.
The authors tested a number of variables to determine which factors that are influencing house prices. More concrete, they tested 12 different variables, before taking lagged values into account.
They used short time series for housing prices with the price index for pre-owned housing as a whole. This index has quarterly data going back to Q1 1990. The authors solved the problem by estimating a number of models, which only contained a subset of variables. Further, they simplified the models by imposing restrictions that were not rejected by the data and that simplified the interpretation of the dynamics.
The variables that Jacobsen and Naug tested in their model were income, indices of paid rent and total house rent in the consumer price index (CPI), other parts of the CPI adjusted for tax changes and excluding energy products (CPI-ATE), various measures of the real after-tax interest rate, the housing stock, the unemployment rate, backdated rise in house prices, household debt, total population, the percentage of the population being in the establishment phase (i.e. aged 20-24 and 25-39), various measures of relocation/centralization and TNS Gallup’s indicator of household expectations concerning their own and the country’s economy. We will not go further in to the mechanisms behind their model, but only focus on the four most important fundamental factors. The next section will explain the four different fundamental factors included in Jacobsen and Naug’s final model.
3.5.1 Interest rate
Jacobsen and Naug (2004) point out that the interest rate largely affects house prices. The factor that probably has the greatest impact on demand for credit is developments in the interest rate. Hence, interest rate indirectly affects the demand for housing. A reduction in the interest rate will result in expectations about a further increase in house prices, and a rise in the interest rate results in expectations about a decrease in house prices.
3.5.2 Unemployment
Unemployment is another important factor that is being brought up. The unemployment is a variable that will impact house prices directly. If the level of unemployment rises, several people will have difficulty serving their loans, which further may lead to forced housing sales. Increased unemployment will have a clear negative impact on house prices. The rationale for including unemployment as an explanatory factor is that increased unemployment leads to expectations of lower wage growth and higher uncertainty about future income and ability to pay for themselves and others. This will in turn result in reduced willingness to pay for housing.
3.5.3 Real income
As mentioned earlier, income is one of the most central drivers for housing demand. Jacobsen and Naug (2004) argue that housing prices must rise in line with income in the long run, because variables such as interest rates, unemployment and expectations are stationary. Hence, they fluctuate around an average that is constant over time. Real income directly affects the ability to pay, and an increase in income may therefore result in increased willingness to pay. If housing demand is high, several 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.
Growth in income is in isolation a factor that forms the basis for fundamental price growth in the housing market. Even though an increase in income level provides a fundamental argument and vindication of the rise in housing prices, it will not be possible, or sustainable, if housing prices increase more than the income level.
3.5.4 New constructions
Jacobsen and Naug (2004) argue that house prices affect the activity in the construction industry.
New constructions will be profitable if house prices increase relative to the construction cost. In the short-term it is difficult to determine whether new constructions are affecting house prices, as the housing supply is fairly stable. It takes time to build new homes, and new construction each year is relatively low compared to the total housing stock.
In the long-term, new constructions should be adapted to the demand for housing. An increase in new constructions will result in reduced house prices, and a reduction in new construction will result in increased house prices. In other words, long-term fundamental increase in house prices might be explained by low construction activity.
4 HISTORICAL DEVELOPMENT