NORDIC REAL ESTATE MARKETS SCREEN AS MOST VULNERABLE TO DOWNTURN!

Following a true real estate frenzy in most developed economies during the pandemic, rapidly rising interest rates through 2022 effectively stopped the party and caused most real estate markets to ‘roll over’. Looking at various statistics on debt levels and interest rate sensitivity, Nordic countries screen as particularly vulnerable to rapidly rising financing costs.

The first chart from Deutsche Bank shows the household debt-to-income ratio in selected developed economies. The most indebted country on the list is Norway followed by Australia and Sweden. As interest rates rise, highly indebted households will feel the most pain. Interestingly, the household debt-to-income ratios in the US and the UK have dropped since the Global Financial Crisis in 2008-2009, while it has been on the rise in the Nordics, Australia, and Canada. Households in the Eurozone do not screen as particularly vulnerable on this metric.

The second chart from Bank Credit Analyst plots various developed markets according to household debt-to-income ratios on the y-axis and the share of adjustable-rate mortgages on the x-axis. With an adjustable-rate mortgage, the monthly or quarterly mortgage payment gets adjusted up or down with changes in short-term interest rates, exposing the mortgagor to interest rate risks. The countries with most widespread adoption of adjustable-rate mortgages are Finland, Norway, and Australia, while Sweden is also near the top. In Denmark, adjustable-rate mortgages account for around 40% of new mortgage issuance. This figure is lower than in other Nordic countries, but it should be noted that the household debt-to-income ratio in Denmark is the highest among the countries analyzed by Bank Credit Analyst! At the other end of the spectrum is – again – the US and the UK plus most large Eurozone economies.

The high household debt-to-income ratios in the Nordics are partly explained by relatively high homeownership rates and most importantly by the fact that most homeowners own their home with a mortgage and not outright. The third chart from J.P. Morgan shows that Norway and Sweden screen at the top of the list of households having a mortgage. While approximately 50% of all households (homeowners and renters combined) in the two Nordic nations have a mortgage, the share in Italy is only 15%!

The fourth chart from J.P. Morgan shows that the supply of housing for sale in the US and the UK is less than half of what it was at the height of the housing bubble leading up to the Global Financial Crisis. The low inventory level indicates that there has not been overbuilding in the US and the UK in recent years – in contrast to the situation in the 2000’s. This should limit the scope of price declines in those markets compared to the last housing market crash. Having said that, real estate markets in the US and the UK are not insulated from the impact of higher interest rates as new buyers’ budgets are stretched by higher mortgage payments, not to mention the broader cost of living crisis. However, the low inventory level, the strength of US and UK homeowners’ balance sheets, and the limited exposure to adjustable-rate mortgages should prevent an avalanche of defaults, foreclosures, and a negative price spiral from developing.

Without getting too gloomy, the picture looks less encouraging in Norway and Sweden. In the Nordic nations, price declines of 20% or more would not surprise us, and consumer spending is likely to be hit hard as mortgage payments will ‘eat’ a larger share of household income and as a negative wealth effects from lower real estate prices will weigh on consumers' propensity to spend.