Do house prices need to fall?

Since the pandemic and subsequent sharp rise in inflation, and then interest rates, in the West, house prices have behaved very differently across different economies. After a short breather in 2022, house prices in the US have continued to surge higher, and are currently almost 50% higher in nominal terms (Figure 1). In contrast, prices in China have now been virtually flat since early 2021. After initially rising, prices in many European countries have been falling – most notably Germany.

Interest rates are a very important factor for house prices. They affect affordability for owner-occupiers, and the attractiveness of housing for investors. However, Figure 1 shows they are clearly not the only factor. Mortgage rates have increased on both sides of the Atlantic, yet US house prices have dramatically outperformed European ones. Mortgage rates have actually fallen in China, yet prices have stagnated.

It is likely that consumer confidence has played some part in house price divergence. The energy crisis in Europe and China’s long period of ‘zero-Covid’ restrictions probably depressed housing demand. And China has its own specific problems with an overhang of property development after years of over-investment. The peculiarities of the US market – where long fixed-rate mortgages create an incentive for existing homeowners to stay put, restricting secondary housing supply – have also played a role.

House prices matter for commodity markets because house prices tend to be correlated – although not perfectly - with the physical volume of residential construction. The construction sector is a major user of steel, aluminium, copper and other materials.

What will happen to house prices from here? Have they adjusted sufficiently to higher interest rates? To assess this, it helps to look at some metrics of affordability

(Figure 2). Nominal house prices only tell us so much – what matters in the long run is house prices in real terms, and relative to average income (as a measure of owner-occupier affordability) and rent (as a measure of investor return).

The high inflation rates in Europe and the US mean that real house prices have risen much less than nominal ones – and in Germany are actually lower than at the end of 2019. Relative to incomes, house prices in major European countries have risen little since the pandemic. However, they have still risen relative to rents. And on these affordability measures, the US market still looks stretched – as does, to a lesser extent, Japan. Of course, affordability is a moving target – further changes in interest rates could alter the ‘equilibrium’ price/income or price/rent ratio.

Affordability metrics therefore paint a somewhat brighter picture for Europe in relative terms. However, momentum is very important in property markets, and we expect the current slump in European residential construction to take time to bottom out. We forecast growth of just 0.2% in EU construction in 2024, with a stronger performance of 2.7% in the US, supported by strong growth in industrial construction. Although we expect construction value-added to grow 4.1% in China, this is below GDP (of 4.9%) and will be heavily supported by infrastructure and other non-residential spending.

These and other economic developments that impact commodity markets are discussed with CRU subscribers regularly. To enquire about CRU services or to discuss this topic in detail, get in touch with us.

CRU experts discussed the impact of the war in Ukraine on commodity markets in a recent webinar. Experts from all major commodity areas joined CRU’s Head of Economics and an energy specialist to discuss markets one month on from the invasion of Ukraine. The webinar is available to watch on-demand here.

About the Author

Alex Tuckett, Head of Economics

Alex Tuckett is Head of Economics at CRU. He has over 15 years experience in economic analysis. He has also published his analysis through a number of working papers, journal articles and blog posts on topics including productivity, exchange rates and modelling credit flows.