Property markets may be at turning point, ECB warns

After a long period of expansion, EU property markets may be “at a turning point” as the rise in borrowing costs dents demand for new loans, the European Central Bank (ECB) has warned.

A reversal in the region’s real estate markets was one of the risks identified in the ECB’s twice-yearly financial stability review, published on Wednesday, which also warned that a combination of high inflation, low growth and tighter financial conditions posed a serious risk for indebted households and firms.

“All of these vulnerabilities could unfold simultaneously, potentially reinforcing one another,” it said, noting that surging energy costs had increased the probability of a recession in the euro area to 80 per cent. These factors also increased the risk of a disorderly adjustment in financial markets, one that could spill over into the real economy, it said.

Adding to the list of worries was a deterioration in real estate markets.

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“There are signs that the real-estate expansion of recent years could come to an end, with overvaluation estimates and mortgage rates now standing at their highest levels in more than five years,” the ECB said.

Pronounced correction

“Similarly, financing conditions in commercial real-estate markets have tightened, potentially reversing the post-pandemic recovery,” it said, noting that a pronounced correction in commercial markets could prompt investor losses and a decline in collateral values.

The warning came as Central Statistics Office (CSO) figures here showed a further deceleration in house price inflation as higher borrowing costs and cost-of-living pressures dampened demand.

The ECB said households’ reported intentions to buy or build a home pointed to a turn in the real estate cycle, “mirroring the sharp increase in interest rates on new mortgage loans since the start of 2022″.

“Also, providers of finance have become more cautious, as residential real estate investment trusts (REITs) have significantly underperformed the broader stock market and euro area banks have tightened their credit standards for mortgage loans,” it said.

Mortgage type

The ECB also warned that higher interest rates would increase households’ debt-servicing costs, with the speed of impact differing according to mortgage type.

Mortgage lenders here have begun to raise the rates attached to certain products in response to ECB moves, increasing the financial squeeze on households.

More generally, the ECB warned that the risk of disorderly market adjustments had risen amid higher volatility and potential for further asset repricing.

“Despite large corrections in 2022, risky-asset valuations remain sensitive to the uncertain path of inflation, monetary policy normalisation and economic activity,” it said.

ECB vice-president Luis de Guindos said risks to financial stability in the euro area had increased amid soaring energy prices, elevated inflation and low economic growth. He also urged banks to put in place provision for bad loans.

A potential stress for markets will be a reduction in the ECB’s €3.3 billion asset purchase programme next year but Mr de Guindos said that any cut in the bank’s pile of mostly government debt is likely to be gradual and “passive,” meaning some bonds will be allowed to expire but none will be sold.