A fall in property prices could undermine economic growth

Greek economic growth has been out-performing average EU growth rates since 1996 and is forecast to do the same this year and the next. Although robust investment spending has been the main engine behind this, private consumption spending has also played an important role. Rising disposable income and double-digit growth in consumer credit are credited for fostering private real consumption spending growth rates of 2 to 4 percent per annum over the same period. But the importance of the Greek real-estate market in helping prop up private consumption growth rates and investment spending has largely gone unnoticed, which it should not. One of the reasons is that real estate, the largest component of household wealth in Greece, may turn out to be a source of weakness in the years ahead. After posting a remarkable 4.3-percent growth rate in the first quarter, the Greek GDP (Gross Domestic Product) is bound to surpass the official 3.8 percent forecast rate, reaching 4.0 percent or even higher in 2003, perhaps helping Greece retain the title of champion in economic growth rates in the eurozone. Still, the importance of the so-called wealth effect, that is, feeling good or bad depending on the value of one’s portfolio of financial and real-estate assets, has been largely ignored, although the wealth destruction caused by the multi-year stock market bear market has been frequently mentioned, along with calls for punishment for those responsible for alleged stock market manipulation schemes. Property offsets stocks Still, the considerable wealth destruction caused by tumbling stock prices has not been depicted in private consumption figures as much as one would imagine. Although cuts in personal tax rates, along with higher real wages, have helped boost real disposable income and, in association with lower interest rates, have helped support private consumption, sizable increases in property prices have more than offset the negative effect of the stock market decline on wealth. It is known that Greece has one of the highest home ownership rates, around 80 percent, in the eurozone. Consequently, buoyant high property prices have increased households’ net wealth, more than counterbalancing the adverse impact from equities. Thus, private consumption has risen unhindered by wealth-effect considerations, making a positive contribution to GDP growth. Moreover, the sustained increase in residential and commercial property prices from 1993 through 2001, coupled with the continuous readjustment of mortgage rates to lower levels since then (as the European Central Bank cut its key refinancing rates to help the area’s sluggish large economies), have also boosted private residential activity, helping the other major motor of economic growth. Residential construction spending roughly accounts for one-quarter of investment spending in Greece on average. Its importance is bound to increase if investment spending slows down after 2004. There is no doubt that real estate has been the main beneficiary of historically low returns offered by money-market and fixed-income investment instruments, as well as of the declining confidence in the more volatile equity market. Households and companies have sought refuge in the real-estate market despite the seeming stabilization of the prices of residential property in the last year and a half and the rather steep correction in commercial real-estate prices. Will the bubble burst? As in other countries, talk of a real-estate bubble has come up again and again but has not materialized so far. The economy is still cruising at high speed despite visible problems in certain sectors, mortgage rates are hitting fresh lows all the time and local banks are introducing new products linking variable mortgage rates to the ECB’s official rate. A correction in the order of 20 percent instead of a collapse seems more likely at present for the next couple of years in a worst-case scenario. Nevertheless, should the ECB start hiking up interest rates and housing prices correct, some of those who have borrowed a significant portion of the value of the house may be in trouble. It should be noted that most Greeks have taken out variable-rate mortgages exposing themselves to fluctuations in interest rates. This has worked so far, but few doubt that a good many people will start having problems if the ECB jacks up interest rates by two percentage points or more, property prices start falling and the economy slows down. This is not an unthinkable situation from 2005 onward, in which case real estate will stop contributing to economic growth and instead become a source of weakness. The role of real estate in shaping the so-called business cycle is well documented abroad and is more pronounced in countries with high levels of household leverage than countries with low degrees of leverage. Greece is still a country with low levels of household leverage in the eurozone but credit has been growing at a fast clip, driving household debt-to-GDP ratios closer and closer to average eurozone levels. In addition to the above, unfavorable developments in the real-estate market may have further negative consequences for the economy. A large number of unskilled immigrants are employed in the construction industry. Many of them will lose their jobs if this market takes a bad turn. This will have not just negative economic consequences but social ones as well, since it will be more difficult for all these people to find a new job which may lead to acts of desperation, such as theft, causing a backlash. There is little doubt that the importance of the real-estate market in the Greek economy has been underestimated. Through its wealth effect on private consumption and direct effect on residential investment spending, real estate plays an important role in the Greek economy. To this extent, the return of euro interest rates to more normal levels, coupled with an expected economic slowdown past 2004, threaten to make real estate a drag on the economy with potentially undesirable social consequences.