In the past 25 years, house prices in Sweden have increased substantially more than in the neighbouring countries. Construction costs have increased by 50 per cent relative to consumer prices, while most similar countries have seen an increase of between 10 and 20 per cent. In NEPR 2021, economists Nyberg and Bergman examine the impact of land scarcity and weak competition in the Swedish construction sector on house prices.
House prices in Sweden have more than trebled since 1995
“The basic premise is that house prices have risen considerably from the 1960s and onward, and the question is: what are the main causes of that?”, says Sten Nyberg, Professor of Economics at Stockholm University.
Together with Mats Bergman, Professor of Economics at Södertörn University, Nyberg wrote the article Housing prices, construction costs and competition in the construction sector – a Swedish perspective. Since 1995, house prices have more than trebled in Sweden and Norway relative to consumer prices. The increase is more moderate in Denmark and Finland, although prices have approximately doubled in the two countries.
The fundamental economic reasons for the increase include higher income, population growth, lower interest rates and a favourable tax treatment. Not surprisingly, house prices have increased the most in central locations in metropolitan areas, where demand is high and supply is typically constrained by the availability of land for new development.
Land price accounts for less than one-third of the increase
To shed further light on the dynamics of the Swedish housing market, the economists developed a model comparing two different regions. One is more attractive than the other, land is scarce, incomes are higher, and people are prepared to pay more to live there. In the other, plenty of land is available, and salaries and land prices are lower.
This model allows for an analysis of the interaction between land prices and construction cost. If land prices go up due to increased demand, how does that affect construction cost, and vice versa? Bergman and Nyberg found that even though real land prices have quadrupled since the late 1990s, land price development is only part of the explanation.
“Land price development is usually considered to be the most important factor influencing house price growth,” says Bergman, adding that international studies have suggested that this is also the case in Sweden. “One of the most interesting findings is that we don’t really see that; less than 30 per cent of the increase is due to land prices. This is significantly less than we expected, and also less than what has been reported previously.”
Cost of building materials has skyrocketed
But what explains the remaining two-thirds? Some of the overall reasons mentioned in the article are capacity constraints, strict regulatory standards and municipal building codes that raise construction costs. The economists also point to weak competition in the Swedish construction sector as a contributing factor.
A quick look at the numbers reveals that construction costs have increased by 50 per cent relative to consumer prices, which is much more than in most similar Nordic and European countries. What is particularly striking is that the cost of building material has increased by 60 per cent more than the average consumer prices, compared to around 10 per cent elsewhere.
”Here, Sweden clearly deviates from the other countries,” says Nyberg. ”From what we can see from the construction cost development, there are clear indications that we may have a competition problem in the sector.”
Bergman and Nyberg take the highly consolidated wholesale market for professional builders as an example. The wholesale market has long been characterized by inflated list prices and substantial volume-related rebates, which are likely to mainly benefit larger companies. This distorts competition and also creates a lack of transparency, says Nyberg.
“It’s quite possible that the cost increase is overstated, as the discounts do not appear in the official statistics. Even if that’s the case, however, these conditional rebates can substantially lessen competition in the market and create entry barriers for smaller firms.”
Rent control contributes to higher construction cost
The Swedish housing market stands out in a Nordic comparison in a number of ways. Sweden has the least new housing per capita, the lowest ratio of new housing to population growth, and the lowest investment in housing relative to GDP since 2000.
One important difference is that approximately one-third of all housing in Sweden is rental housing, which is subject to what the economists refer to as a de facto rent control. In Sweden, a benchmark rent is set through negotiations between property owners and the tenants’ union.
In 2006, a reform was implemented to stimulate construction of new rental housing. The idea was to ensure investors a reasonable return on their investment by exempting new rental housing from the general rent-setting principles for the first fifteen years. Bergman and Nyberg argue that the regulation creates incentives for rent increases.
“One way of stimulating construction is to give subsidies, but you can also compensate for cost, which is the current approach in Sweden,” says Nyberg. “As soon as you start compensating for cost, however, you reduce the incentives to cut costs. This will most probably result in higher construction cost and therefore also higher rent.”
Another concern raised in the article is the apparent lack of competition in public procurement of municipal housing. Between 2015 and 2018, the average number of bids in such procurement processes in Sweden was just below 3.5.
“In four out of ten procurements, only one or two bids were submitted,” says Bergman. “If the construction companies anticipate that there’s not going to be much competition, they can adjust their bids accordingly. We see clear signs of weak competition in procurement, which tends to inflate building costs.”
