Few examples of house price bubbles in the Nordic countries

Contrary to what many might think, house price bubbles have been a rare phenomenon in the Nordic countries in the last couple of decades. While house prices have risen to historically high levels, the only indications of a price bubble were found in Denmark in the period before the global financial crisis in 2008. Research Professor André Kallåk Anundsen has looked into price developments of owner-occupied dwellings in the Nordic Region.

Are house prices in the Nordic region overvalued?

In his NEPR 2021 article, House price bubbles in the Nordic countries?, Anundsen studies if house price developments in Denmark, Finland, Norway and Sweden can be explained by underlying economic fundamentals or if there is an element of speculation that would indicate a house price bubble.

The paper looks at price developments between 2000 and 2019. During this period, real house prices in Norway and Sweden have increased by 109 and 147 per cent, respectively, while prices are up by 49 per cent in Denmark and 27 per cent in Finland.

Anundsen compares actual house price development to fundamental house prices, which is the price level that could be expected in view of developments in household disposable income per capita, the housing stock per capita, and real after-tax interest rates. This provides an indication of whether house prices are under- or overvalued relative to the fundamentals.

“The main conclusion is that we can explain house price developments over most of the period for most of the countries,” says Anundsen, who is Deputy Head of the Housing Lab at Oslo Metropolitan University. “The only exception is Denmark in the period just before the financial crisis, where we’re not able to explain the price development by economic fundamentals. That’s the only example of a house price bubble at the national level over the period I’ve considered.”

Anundsen’s analysis indicates that in 2007, real house prices in Denmark were overvalued by 57 per cent. Prices in the remaining three countries were also slightly overvalued, or by 17 per cent in Norway, 13 percent in Finland, and 4 per cent in Sweden.  

By the end of 2019, the analysis suggests that house prices were overvalued by 9 per cent in Norway and by 7 per cent in Sweden, which is the only country where house prices have been systematically overvalued since 2014. In Denmark and Finland, prices were slightly undervalued, or by 9 and 3 per cent, respectively.

Signs of explosive development in Stockholm, Copenhagen and Oslo

In addition to this comparison, Anundsen applies a statistical test to identify signs of explosive growth in house prices. This alternative method provides similar results for the countries, and also allows for a comparison of the housing markets in the four capitals: Copenhagen, Helsinki, Stockholm and Oslo.

House prices have grown substantially more in the capital cities than the national average. In Oslo and Stockholm, prices have increased twice as much, or by around 60 per cent, and in Helsinki, prices grew by 16 per cent while national house prices dropped by 5 per cent. In Copenhagen, the increase was 56 per cent, while the national average was just below 10 percent. Anundsen finds some signs of explosiveness in Oslo, Stockholm and Copenhagen, but these are only short-lived and can therefore not be categorised as house price bubbles.

Income and interest rates are the most important factors

Anundsen also dives into some of the most important factors that contribute to developments in fundamental house prices in the Nordic countries.

“Income is the most important factor in explaining house price developments – when income goes up, people have more money to spend on housing, which causes prices to go up,” says Anundsen. “However, that’s not the full story. We also need to look at interest rate developments and the high semi-elasticity with respect to interest rate changes.”

The semi-elasticity indicates by how much house prices increase if the interest rate is lowered by one percentage point. According to Anundsen, the housing market in all four countries is highly sensitive to interest rate changes, in particular Norway and Denmark. Here, house prices increase by between 11 and 12.5 per cent for each percentage point of lower interest rates.

“The global secular decline in interest rates over the past 20 years has been an important contributor to developments in real house prices,” Anundsen explains. “The lower interest rates make it cheaper to borrow, which increases demand and leads to higher prices. This does not come without challenges, as house prices are also highly sensitive to interest rate increases. The central bank of Norway has signalled that interest rates will increase in the autumn, and we expect that to lead to downward pressure on house prices.”

A question of affordability and social balance

Another important factor discussed in the paper is the role of housing supply in house price development. Here, supply elasticity is a central term, describing the increase in construction when house prices go up one per cent. These elasticities are rather low in the Nordic countries but differ significantly between areas.

“When demand shifts in a city like Oslo, due to lower interest rates for instance, you will see a tremendous increase in prices. In Kristiansand, however, you can just react to the increased demand by building more, which means that prices remain stable. If we want to secure more affordable homes and lower house price growth, one solution is to increase the supply elasticity by simplifying building requirements and making it easier to build.”

In the long-term, says Anundsen, the rising house prices are a question of affordability and social balance. At some point, price levels will become so high that ordinary people will have trouble moving to the cities. What is interesting now, he adds, is how the pandemic will change the way in which we think about housing and labour markets.

“For many years, the tendency has been that people move into the cities, but that might change with the increased possibilities of working from home. To address the issue of rising house prices, we can therefore either build more in the cities or expand their borders by improving connectivity and commuting access into the city centres.”

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