The large movements in residential property prices in emerging markets observed over the past decade have raised interest in housing market developments. Within a cointegration framework applied to an unbalanced panel, we assess the relationship between residential property price developments, economic fundamentals and transition-specific factors in Central, Eastern and Southeastern European (CESEE) EU countries from 1999 to 2011. Our results show that demand-side fundamentals (disposable income, population, interest rates) and transition-specific factors related to housing demand (such as funding through remittances and credit growth) as well as construction costs on the supply side have been particularly important in residential property price movements. Nevertheless, these factors cannot fully explain residential property price movements, i.e. we find evidence that house prices moved above the level indicated by those factors in the years preceding the crisis. The sharp correction of residential property prices that took place following the outbreak of the financial crisis reversed these overshoots and brought house prices back to – and in some countries even below – the level indicated by the explanatory factors. This suggests that residential property prices are likely to rebound somewhat when economic conditions improve. Since 1999, residential property prices (henceforth simply referred to as house prices) in many Central, Eastern and Southeastern European (CESEE) EU countries have gone through a dramatic rise and a slump, often causing devastating effects on the real side as well as on the financial side of many economies in the region.

A feature of many housing booms is the emergence of seemingly plausible fundamental explanations to describe the upward movement in house prices. Looking back, the appreciation of house prices in many CESEE countries was to some extent driven by fundamentals, such as rising disposable income and better access to credit, but in light of the sharp declines in some countries, it is evident that these house price increases were not sustainable, which raises several questions. What are the factors underlying the observed developments and can they be explained by transition-specific factors, such as pronounced credit growth? To what extent have house prices decoupled from economic fundamentals?