Czech residential real estate market, a reason for concern.
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Loading... - Veronica Cerny
- 14 Jul 2022
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In 2021, house prices rose strongly in most European countries, but in the Czech Republic the increase was remarkably high (see figure 1). In the third quarter of last year, Czech house prices were 22% higher compared to the third quarter of 2020. Such price increases suggest some exuberance. The outcome of several valuation models is quite clear, the overvaluation of Czech residential real estate has increased significantly over the last year. The ECB reported a model-based overvaluation of 34% for the third quarter of 2021, compared to 5% before the outbreak of the pandemic. The KBC economics valuation model, based on fundamental drivers of the housing market such as population growth, economic growth and the current interest rate environment, estimates an overvaluation of 25% in the third quarter of last year (see figure 2), a number that requires an in-depth analysis.
Rising construction costs
We cannot view the current price trends in European housing markets in isolation from supply-side issues caused by the covid pandemic. First, there are mobility constraints, due to lockdowns, which affected the construction sector mainly in the second quarter of 2020. Second, problems in global supply chains have made the supply of construction materials tighter and consequently increased their price. These ‘housing market’ supply shocks have played an important role in the recent increase of house prices. Such shocks cause negative effects on real investments combined with increasing house prices. This contrasts with the demand shock, which has a contemporaneous positive effect on both house prices and residential investment. Unlike more general demand supply shocks, we assume that such real estate shocks would not have an (important) immediate effect on overall economic activity and would only start affecting the economy with some delay. These real estate demand and supply shocks can be identified and estimated using standard BVAR models. Looking at Figure 3b, we indeed observe negative supply shocks in the housing market, both in the second and third quarter of 2020 and in the first and third quarter of last year. The cumulative effect on real house price growth of these shocks in 2020 and 2021 is 5.7% (median). Thus, house market specific supply shocks contributed to the rise in real house prices, but they are certainly not enough to fully account for the recent price surges in the Czech residential real estate market. Given the sharp increase in construction costs in the past year, the contribution of these supply shocks may seem limited. But as seen in Figure 4b, these construction costs are also driven by demand shocks in the housing market, among others. Thus, a rise in construction costs themselves is rather symptomatic of supply problems in the construction sector, while other factors (demand shocks specific to the housing sector in addition to general demand shocks in the economy) of course also contribute to a rise in construction costs. Read More...
