Could rising interest rates lower real estate prices?

What if what prevents some people from borrowing today could allow them to buy cheaper tomorrow? Anne-Sophie Alcif, chief economist at BDO France, and Roche-Elois Grieve, consultant at BDO Advisory, contribute to this question.

Since 2000, house prices have increased significantly. This increase is to some extent due to the low interest rate policy implemented by the European Central Bank (ECB) following the economic and currency crisis in 2008. In fact, the ability of families to borrow was eased at this time. With inflation linked to Russian intervention in Ukraine, the ECB's mandate requires it to keep inflation at around 2%. Raising interest rates is the main tool to fight inflation. Since the beginning of 2022, the ECB has made 10 consecutive rate hikes. As a result, families' borrowing capacity has shrunk. The number of real estate transactions has also declined over this period, putting downward pressure on house prices.

Could this new monetary situation reduce real estate prices? If real estate prices have tended to rise when interest rates have fallen, a reverse decline in prices when rates rise seems unlikely in the near future. However, keeping the number of transactions low seems more likely. Over the past twenty years, mortgage interest rates have trended downward in several euro area countries. Between 2000 and 2023, the decline was greater in France than in other countries. This difference becomes particularly evident between 2013 and 2023, when interest rates began to fall in France by an average of 1.9% annually during this period, while rates in Germany (3.4%), Spain (1.5%) and Italy (0.9%) began to rise. During the same period, prices for new and old housing tended to rise. Overall, the real estate price index increased by an average of 4% per year between 2000 and 2023. While this trend weakened slightly, it remained the same from 2013 through 2023 with an average annual increase of 3%.

Downward trend The situation of rising interest rates does not really seem favorable for a decline in house prices in the coming timeframe, but rather contributes to a decrease in the number of transactions. In the last period (Q1 2021, Q1 2023), interest rates in the countries under consideration increased on average by 10% per quarter in France and Spain and by 14% on average per quarter in Germany and Italy.

Real estate price declines may come later, but financial interests, especially of sellers, are likely an impediment to a rapid decline in real estate prices - matched by the pace of rate increases. Sales and supply data for detached and multifamily housing show a decline in transactions and offers. From Q1 2021 through Q3 2023, sales of new individual residential units declined by an average of 8 percent per quarter, as did offers. During the same period, new multifamily residential sales declined an average of 7% per quarter (4% for offers). In the 3rd quarter of 2023, sales of detached homes and new multifamily units declined 35% and 31%, respectively, compared to the 3rd quarter of 2022. The dynamics are similar for sales of older housing. From Q1 2021 through Q3 2023, sales of older housing declined an average of 5% per quarter. In the 3rd quarter of 2023, old home sales declined 42% compared to the 3rd quarter of 2022.

This information demonstrates well the economic actors' expectation of higher interest rates for buyers and relative price declines for sellers. Since the beginning of the inflationary period, mortgage interest rates have risen at a faster rate than the decline in real estate prices. Since late summer 2023, the ECB has announced that it is suspending its policy of raising rates. This policy seems ill-suited to reduce real estate prices in the near term. Instead of price reductions, we have seen a decline in transactions and offers, indicating the difficulty that sellers and buyers have in protecting their interests in the current situation. In the longer term, however, the lack of demand may put more pressure on price reductions than today.