The Swedish housing market: Trends and risks
Introduction and outline of the report:
Since the mid-1990s real house prices in Sweden have more than doubled and they are now at a historically high level. This has raised concerns that the market for owner-occupied housing may be overvalued and that Sweden may be headed for a significant drop in house prices.
Against this background, Sverige’s Riksbank (2011) recently published an extensive report analyzing trends in the Swedish housing market and discussing the resulting risks to economic and financial stability. The present report supplements the Riksbank report by offering some further perspectives on the Swedish housing market. The basic issue is whether Swedish house prices are currently seriously overvalued. If that is the case, what are the future implications for the Swedish economy? In addressing these difficult questions, the report draws on the international literature on the economics of housing markets and presents some new estimates of long-run equilibrium house prices in Sweden.
The report is structured as follows: Section 2 reviews the long-term and recent trends in Swedish house prices and compares them to house price developments in other countries. The section also discusses whether real house prices can be expected to remain constant or to trend upwards in the long run. Section 3 discusses how we can measure whether house prices are in some sense overvalued so that we may speak of a “housing bubble”. The section reviews alternative theories of how housing bubbles may arise, and it offers an illustrative case study by describing the recent bubble and subsequent downturn in the Danish housing market. The last part of the section considers whether there are signs of a genuine housing bubble in Sweden. Section 4 explains the concept of the user cost of owner-occupied housing and illustrates how estimates of the user cost may be used to evaluate whether house prices are out of line with the cost of rental housing and with disposable incomes.
Is there a bubble in the Swedish housing market?
Although theoretical and empirical studies of housing bubbles abound, it remains very difficult to judge whether a housing bubble exists in a particular country at a particular time. In the beginning of this section we considered three alternative ways of evaluating whether the housing market is overvalued: we may ask if current real house prices are significantly above their long-run trend; whether current prices are substantially above the level predicted by existing econometric house price models, or whether such models predict a significant drop in future house prices. As we saw, it is not very satisfactory to rely on the first method. When evaluating whether the Swedish housing market is currently overpriced, we will therefore focus on the latter two criteria.
Conclusion:
Weighting all the evidence summarized above in an overall judgement of the current state of the Swedish housing market is difficult. The empirical house price model discussed in Section 3 and the estimates of the ratios of imputed rents to rents and incomes presented in Section 4 do not indicate that Swedish house prices were overvalued to any significant degree in 2012. However, the analysis of fundamental house prices in Section 5 has a stronger theoretical foundation, and the empirical analysis in that section indicated that actual house prices do in fact move towards the fundamental price level, albeit slowly and gradually. According to the estimates in Section 5, house prices in 2012 were about 15 per cent above their fundamental level, and possibly more. Although this estimate is rather uncertain, and even though the analysis of Section 6 pointed to several neglected factors that could have raised fundamental house prices in recent years, a cautious reading of the evidence gives reason to expect downward pressure on Swedish real house prices in the years to come.
And if the Swedish economy were to be hit by a large negative shock, the downward adjustment of house prices could become more rapid than the analysis of Section 5 would suggest.
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