Current issues related to economics, (responsible) investment, pensions and income: every week, an APG expert gives a clear answer to the question of the week. This time: Vincent Fokke, Head of Listed Real Estate Europe, on whether the European Central Bank’s (ECB) recent interest rate move will lead to a cooling of the Dutch housing market. “The housing market is not purely driven by rational investment decisions. Often, emotional considerations play a bigger role.”
In an attempt to suppress high inflation, on July 21, 2022, the European Central Bank raised the deposit rate - the interest rate banks receive when they deposit excess money with the ECB - from -0.5 percent to 0 percent. A significant step - in a historical sense, since the ECB had not raised interest rates for over a decade, but also because such an adjustment of 0.5 percentage point does not normally happen in one go. And, the ECB’s expectations for the coming months showed that the end of the rise does not seem to be in sight.
Will those rising ECB interest rates also lead to higher mortgage rates, so that the Dutch housing market can finally cool down a bit after years of big price increases? According to Fokke, the people who are looking forward to this should not rejoice too soon. If only because the ECB interest rate is not the most decisive factor for the level of mortgage rates.
“With negative deposit rates, banks have a strong incentive to put out ‘excess’ money. That may contribute somewhat to a higher supply of mortgage loans, resulting in a depressing effect on mortgage rates. However, ultimately, mortgage rates are not so much related to the ECB rate, but to a greater extent to long-term capital market rates. The interest rate on government bonds - for example on Dutch government bonds with a maturity of ten or thirty years - is therefore a much more important reference point for the mortgage market than the ECB interest rate. That also explains why we have seen a strong upward movement in mortgage rates over the past seven months. Because from January to mid-June, capital market rates rose sharply, while the ECB rate hike had yet to take place at that time.”
After mid-June, however, capital market rates dropped significantly again. So, can we now expect lower mortgage rates again? That seems a bit premature.
“Due to the current geopolitical situation and the reversal of monetary policy - the ECB has raised interest rates, but since July has also stopped net bond purchases to stimulate the economy - those capital market rates are currently quite dynamic. For example, the interest rate on a ten-year Dutch government bond had risen to 2.1 percent in mid-June, while now - at the end of July - it is only 1.3 percent. Because of this high volatility of capital market interest rates, banks are still somewhat reluctant to adjust their mortgage rates. After all, things can quickly go the other way again.”
Despite the recent volatility, however, we can see that capital market rates have started an upward trend, driven in part by the sharp rise in inflation, Fokke emphasizes.
“Of course, it’s not out of the question that in the shorter term mortgage rates will also come back down. But if you compare the capital market rates of today with those of five or seven years ago, you can see that the trajectory of those rates is up, even though they have fallen sharply in recent weeks. In the recent six months, mortgage rates have risen along with this market movement.”
And this brings us to the key question: can a possible continuation of this rise in capital market interest rates that has been going on for years cause the air to be let out of the Dutch housing market bubble? After all, based on economic theory, you would expect that when financing becomes more expensive, the demand for houses falls - and so does the price. But with the housing market, it’s all just a bit more nuanced, says Fokke.
“The housing market is not driven purely by rational investment decisions. People who are looking for a house do not see it only as an investment object. In fact, emotional considerations often play a bigger role. This makes it relatively difficult to predict how such a market will develop. For example, I think many an analyst would have expected house prices to fall during Covid times because of the increased economic uncertainty - after all, they had already risen considerably. But the opposite turned out to be the case, and that illustrates the different character of this market. On top of that, although mortgage rates have risen, they are still not at a shockingly high level.”
Moreover, you can’t really speak of “the housing market”, and that too complicates the relationship between mortgage rates and the housing market.
“The housing market is not only fragmented regionally, but also in terms of housing type. All those different markets have their own dynamics of supply and demand. And of all the factors that determine the direction of the market, that dynamic is the most important factor. Many sub-markets show tightness, but the extent varies. For example, in the case of detached houses in the higher segment, supply and demand are reasonably in line. In contrast, the tension between supply and demand is much greater in cities, due to urbanization.”
Another reason why higher mortgage rates do not necessarily lead to falling house prices, according to Fokke, is several developments on the supply side of the housing market.
Rent increases curbed
“I am seeing at least two developments that are having a major impact on housing supply. The first development is that many investors are withdrawing from the housing market as a result of the increasingly strict regulation of the free sector. For example, initiatives have been taken to limit rent increases or to require that a buyer of a house first occupy it himself for a number of years before it can be rented out. The second development is the enormous increase in construction costs. Many materials - wood, steel and cement, for example - have become considerably more expensive, resulting in fewer building projects.”
The ECB can exert limited influence on mortgage rates through adjusting deposit rates. But the effect of that is dwarfed by the effect that changes in capital market rates have on mortgage rates. Capital market rates have risen since seven years ago and, more recently, so have mortgage rates. But even rising mortgage rates do not necessarily lead to lower house prices. So now that the ECB is raising interest rates, this will not automatically lead to a cooling of the Dutch housing market.