Thursday, June 28, 2012

The strange case of real estate and banks

I must apologize from jumping out of the topic of IT and IT services with this post, but maybe there is something to learn from it for everybody. Including IT people. The topic I want to write about is the real estate market and ... how bubbled up it is. Especially the Swedish one.

To start up some facts, links and numbers:

- You can see the average apartment square meter price of different parts of Sweden at For Stor-Stockholm the average price is currently 34 826 kr/m2. That is approx. 3870 euros. The average means that it is something between 22 000 kr/m2 in the outer parts of Stockholm to 61 900 kr/m2 in Östermalm.
- The average netto salary in Sweden was 27 900 kr/m in 2010. It is a bit higher in Stockholm 31 700 kr/m. (But the SCB did not state if this is neto or bruto)
- The price of real estate in Sweden before the financial crisis (january 2008) was on average 18% lower than today. So there was just a slight glitch in the prices and then they continued to rise again.
- Every year about 30 000 new people move to Stockholm, but only about 5000 new apartments are built so there is a rather big gap between demand and supply.
- You can get a home loan in Sweden covering 80% of the real estate price. The strange case is that it is possible to get a loan that you do not pay back. Yes, you can get a loan where you pay only the interests or that has a 60 year amortization period (as paying back is called in Sweden). And 60 years in this case is infinity.
- ...and you can of course get a loan for the 20% down payment. With a higher interest-rate and this you actually have to pay 15 years.

How the market model actually works is:
- People who buy a home look at the monthly price they have to pay. It is not the price of the home, but the monthly payments that determine what a family can afford and will buy.
- The price of real estate is not something solid. For example you can produce an infinite number of luxury cars and therefore the price of the cars is tightly connected to the production and sales costs, but the number of apartments in Östermalm is fixed. Therefore the price has nothing to do with the production costs, but is an agreement between the players in the market. If the conditions change then the agreement changes. It is really mostly air. As we see in the case of Spain (2010-2012) and Estonia (2007-2009) the agreement between the market players can change also downwards ... a lot and fast.
- So the price of a square meter depends on two factors: buyers capability of monthly payments and the banks policy and ability on converting that monthly payment into a (virtual) value. Let me explain:
 Lets say that the average family is ready to pay about half of the average salary (13 161 kr/m) as a payment to the bank. Then if the interest rate would be 4% and the maximum payback time would be 10 years then the family would buy a home for 1,3 million crowns.
 If the maximum payback time however is closer to infinity (40 years for example) then the family would buy an apartment for 3,2 million crowns.
 The point is that it would be the same families buying and living in the same apartments, but in the latter case they would pay 40 years instead of 10 and the amount of air in the price would be bigger.

The interesting consequences and suggestions:
- In Sweden with the infinite payback times, it is almost like the banks own most of the real estate and rent it out to people. The only difference is that the people also carry the risk of price fall. Well at least that is what the banks assume, but in reality as we see in the Irish, Spanish and US case, if prices fall enough then it is the government and EU who have the risk.
- So as it is the tax payer who actually (and without its knowing) carries the risk of these 60 years to infinity loans, then it should also be the tax payer who creates the rules for risk management. So in essence the government should say what is the limit of the maximum loan period, the risk margin and minimum down payment.
- All tax levies on real estate are useless if the price is bigger than building costs. If through tax incentives a family can afford a bigger monthly payment then this will just increase the (virtual) price of real estate. It would be still the same families living in the same apartments, but the virtual value of the real estate would just be bigger. The tax bonuses would go straight away to banks and real estate owners.

So my suggestion to Swedish and Estonian governments is that introducing a maximum limit of maximum loan time would be an idea to consider. Perhaps 15 years would be appropriate. This should be introduced very calmly maybe in 10 to 20 years, but it would be sensible. It would minimize the unnecessary risks that the real estate bubble now holds for the economy and more importantly it would free people from lifelong debts.
 This would not bring horrible economical consequences and turn the world around would be ...well something like 2002. :-)


  1. A bit more on this (very relevant but far too often ignored) topic, the Swedish housing market:

  2. According to Statistiska centralbyrån the outstanding amount of Swedish houseloans was 2159 billion SEK at the end of April 2012, with the yearly increase of 4,9 billion SEK. (That is about 544 SEK per capita).

    It is a really good thing for all the markets where the Swedish banks are active that the price of real estate (in Stockholm) can never go down. It will not... It just is not possible....