Strong real estate price corrections - on the way?

Opinion | At the beginning of 2022, it seemed that all the conditions for further house price growth in France were in place: the development of work at home, the increase in single parent families, the desire of households to own their homes, low yields on low-risk bond investments and the rate on Livre A set at 1%.

However, the emergence of inflationary pressures and the end of the Fed's quantitative easing policy and rate hike plans in the US have changed the situation. Are inflation and rate hikes in Europe affecting asset price declines? In particular, can we expect a significant correction in house prices in France?

The impact of inflation and rising asset market rates

In light of rising inflationary pressures in the U.S., Fed Chairman Jerome Powell paved the way for a rate hike by announcing a reduction in monthly purchases of financial assets designed to inject money supply into the economy to stimulate growth. The timetable had envisioned the end of quantitative easing policy in June 2022 and the start of rate hikes over the summer.

The European Central Bank (ECB) then, according to its president Christine Lagarde, considered inflationary pressures to be temporary; in such a context and to prevent the suppression of economies still recovering from the COVID-19 crisis, an intensification of fiscal policy was inappropriate, and even less possible.

Trends affecting inflation and rates

The resurgence of inflation did not start with the outbreak of war in Ukraine: the recovery in investment and consumption due to the easing of restrictive measures, enabled by mass vaccination, led to strong demand growth that industry could not always meet. China's COVID-19 zero-risk policy led to supply chain disruptions; semiconductor suppliers no longer gave priority to their historical customers, leading to significant delays in the production of finished goods, especially in the automotive industry. In addition, the strong recovery in activity led to increased demand and prices for certain raw materials, primarily oil.

Rate forecasts and their impact on the housing market in France

Bond markets quickly aligned with the Fed's stance, betting that rates will rise in the eurozone. The value of an asset is equal to the sum of the discounted future cash flows that the asset will bring to its owner. Thus, applying this principle to any fixed-rate mandatory bond allowed us to estimate the expected market rate and conclude that rising rates were already a reality.

Russia's invasion of Ukraine increased the inflation trend and accelerated the Fed chief's rate hike schedule.

In Europe, inflation compared to April 2022 was 8.1% in May 2022, allowing Christine Lagarde to sound the end of negative interest rates and open the door for the first ECB rate hike in 11 years.

Impact of rate hikes on mortgage loans

Mortgage rates are tied to the yield of 10-year government bonds. As the yield on 10-year government bonds rises, the mortgage rates offered to individuals increase as well. The maximum interest rate is the limit that the annual effective interest rate on a 20-year mortgage can reach to prevent borrowers from incurring excessively high debt costs.

It is forecasted that rising interest rates and restrictions on credit supply will lead to a decrease in real estate prices in France.

Forecasts for the housing market in France

The increase in interest rates and restrictions on available liquidity for real estate investments will lead to a decrease in housing prices in France. It is expected that prices could drop by 21% as a result of this correction.

All of this will be more of a correction in real estate prices than a complete market crash. A sharp decline in credit availability in the market will have a greater impact.

Professor of Finance at ISC Paris, Olivier Levin, believes that the reduction in available liquidity for real estate investments and the resulting decline in housing prices are the most likely scenarios.