A full scale housing crisis is raging in Iceland. Housing prices are at an all-time high and no signs of relief can be seen for home buyers in near future. As usual, low wage workers are the hardest-hit and it’s now pretty well impossible for first-time buyers to enter the market without considerable financial aid. An uncontrolled rise in housing prices therefore further exacerbates social inequality. Vinnan asked ASÍ economists Róbert Farestveit and Arnaldur Sölvi Kristjánsson, to explain the reasons for this dire housing market and whether changes for the better can be expected in the near future. 

Although many factors always affect housing price formation, the increase we saw at the end of the COVID pandemic is largely due to lower interest rates. Quite suddenly, the interest rate cut made it possible for a larger group to enter the housing market as first-time buyers while those already in the market used the opportunity to buy more expensive real estate. In general, lower interest rates push up asset prices, and this is in fact a normal transmission of monetary policy. 
 
The Central Bank key interest rate cut significantly affected mortgage rates. It was common for variable interest rates to be around 5-5.5% on non-indexed loans at the end of 2019. A year later, they were around 3.3-3.4%. The debt service burden on the purchase of a new 90 sqm apartment thus decreased by ISK 38,000 per month in a short period of time, a decrease of one-fifth. For those who owned a 90 sqm apartment with 80% debt, it was possible to increase the debt by 10 million while keeping the payment burden unchanged.

The development is by no means limited to Iceland. Housing prices have risen in many countries following the COVID pandemic. Iceland stands out, however, in that there have been two periods in which housing prices have risen rapidly in a relatively short period of time. The last round of increases was in 2017 when house prices rose by 24% between years. The increase in Iceland has been one of the steepest we have seen in OECD countries since 2015.

Icelanders have a long history of choosing to invest in housing. So, landlords in this country tended to be individuals rather than rental companies. The government's housing policy has long been focused on ownership, making the rental market small and the scope of rental companies quite limited. 
 
Recent data from Registers Iceland show in part the extent of such investment. After the pandemic, first-time buyers and people exchanging property have made up the bulk of demand with regard to housing. The proportion of first-time buyers rose after the interest rates were cut and subsequently the average age of first-time buyers fell. 
 
Since the turn of the century, the number of apartments owned by legal entities and individuals who own more than one property has increased. This development is not entirely negative, it goes hand in hand with increased demand and the need for rental housing. However, it indicates that the Icelandic rental market is unorganized; a large part of the landlords are individuals and the government has reacted too late with regard to construction of non-profit housing to meet demand. 
 
The scope of such investments increased in the run-up to and after the collapse of the financial system in the autumn of 2008. Since the turn of the century, apartments owned by investors, i.e. so-called legal entities and those who own more than one property increased from 27 thousand units to 55 thousand. Proportionally, they have gone from 26% of all properties to 37% of the total number of apartments.

As we said earlier, Iceland is not the only country that has had difficulty controlling the housing market. Iceland is a small and open economy and fluctuations in the economy are often exaggerated.  This affects the housing market. In addition, government actions tend to be on the demand side, e.g. by facilitating access to credit or expanding mortgage lending. Such measures have boosted housing demand and pushed up house prices. 
 
In recent years, several new influencing factors have emerged. One is the rapid growth of tourism and its consequent effects. This development boosted housing demand with regard to both short-term tourist rentals and long-term leases for people who moved to Iceland in order to work in tourism and related industries. For example, immigration to Iceland exceeded emigration by about 23 thousand individuals in 2016-2019. The housing market finds it difficult to meet rapid fluctuations on the demand side due to short-term supply.

In recent years, considerable construction has taken place. Since 2017, the number of apartments has increased by an average of 3,200 each year. Forecasts for housing construction in the coming years assume a similar development. It’s common for the number of apartments to increase by 2,000 per year, meaning that housing construction in recent years is quite beyond the average in historical context. The reason for this is a considerable need for housing, partly because increase in housing was very limited in 2009-2014 and partly because of high demand for housing related to developments in the tourism sector. In the last two years, demand for housing has increased again following the interest rate cut. It’s not realistic to expect that it will be possible to build enough to meet such an increase in demand in such a short space of time.

In the short term, interest rates and access to loans can have a considerable effect on house prices. In the long run, housing prices are determined by income, population and the supply of housing. If house prices continue to rise in excess of income, demand is likely to give in as people can’t afford to buy a home. Price increases in excess of construction costs would also lead to an increase in supply, as contractor profitability would then increase. Recently, prices have risen in excess of income and the cost of capital is now increasing due to rising interest rates. As a result, house prices are unlikely to continue to rise as much in coming years as in recent quarters.