The Athens stock market has been gaining more than 15 percent since the beginning of the year, making it one of the top performers among European Union (EU) bourses again this year. However, its significant gains for the third consecutive year since 2002 has failed to impress retail investors who continue to liquidate their holdings. Nevertheless, the same investors who continue to shun the stock market have turned again to a familiar place to invest their money. It is the real estate market. In so doing, they have driven already high property prices even higher, boosting wealth, a significant determinant of private consumption. This will most likely have a greater (than initially forecast) beneficial effect on GDP growth this year but may turn out to be a source of weakness from next year on. There is no doubt the majority of retail investors continue to abstain from the Athens bourse because they continue to nurture big losses in the portfolios made up mostly of small cap companies, the darlings of the stock market hype era. Even though the main stock market indexes trade at a four-year high, this is more due to the comeback of a limited number of large and small caps making up the indexes rather than the broader market. So, retail investors sell their stocks or equity mutual fund shares whenever the market rises. But they are usually unable to get satisfactory after-tax returns from their traditional low-risk investments, such as bank deposits and government bonds, and being less sophisticated, they turn to investing in land and houses. Property not tradeable However, unlike the US or the UK, the Greek average investor does not consider his or her real estate holdings tradeable. In other words, he buys for the long haul even though Greece has one of the highest home ownership rates in Europe, estimated between 70 and 85 percent. This makes the Greek real estate market, especially its residential segment, more rigid and less vulnerable to severe price falls. Real estate agents say the value of commercial property has fallen between 20 and 30 percent on average in the last few years or so but residential prices have shown much greater resilience, easing by an estimated 5 percent on average in the same period. This is no longer the case. By speaking to contractors, civil engineers and others in the construction industry one becomes aware of a surge in activity in the real estate market in the last few months, at least in the large urban centers like the Athens region. They all attribute it to press reports pointing to the government’s intention to increase the so-called «objective prices» for property on which the tax is calculated and for the first time impose a value added tax (VAT) on new houses with building permits issued after January 1, 2006. Although their estimates range, they say prices have gone up by as much as 15 percent in some cases with most being in the 5 to 10 percent ballpark. This event should not be underestimated, since real estate holdings constitute the greater portion of the personal wealth of Greek households, much more than bonds and stocks combined. This partially explains why the piercing of the stock market bubble did not have a material impact on private consumption and economic growth since 2000. The significant (well above inflation) increase in residential property prices more than offsets the negative wealth effect of the stock market collapse on private consumption in the 2000-2002 period. The wealth effect relates to how one feels about his economic situation and well-being. The better he feels the more he is likely to spend according to the theory. Consumption-driven growth Of course, the lowest borrowing rates in generations and a healthy increase in disposable income – that is income received after taxes are subtracted – during the same period also helped propel private consumption spending. The double-digit rise in consumer credit each of the last seven years or so, a byproduct of lower interest rates, is generally accepted to have maintained satisfactory private consumption spending rates in the order of 2.3 to 3.8 percent annually. This, along with partially EU-funded investment spending, underpinned strong Greek economic growth averaging more than 3 percent since 1996. Still, the pick-up in residential prices in the last few months has raised concerns about a potential slump in demand in 2006 which may depress prices. Similar concerns were voiced a couple of years ago, but it turned out the ensuing price adjustment was limited to have an effect on wealth, private investment and economic growth. Of course, things may be different this time around although the stock market rise, if sustained, should have a positive effect on household wealth overall. In addition to contributing to GDP growth through the wealth effect on private consumption, the increased construction activity to be brought about by the buoyant demand is bound to have a positive effect on private investment spending. This lagged effect should also contribute to economic growth since construction spending is estimated to account for more than 20 percent of total private investment spending in Greece. Higher rates ahead? Nevertheless, the high-flying residential market should be a source of concern to the Greek authorities, like their counterparts in other eurozone countries. This will become more so if economic activity does slow down in the second half of 2005 and 2006 and the European Central Bank (ECB) starts nudging up its interest rates. The prospect of much higher borrowing rates is worrisome since more than 90 percent of mortgages taken out in Greece feature adjustable rates. But GDP growth surprised on the upside in the first half, and key eurozone countries, mainly Germany and Italy, experienced slow economic growth and even a recession, leaving little room to the ECB for significant rate hikes in the next nine months or so. This means the Greek residential market can hold on to its gains and even add more by end-2005 before a likely decline in demand sets in. Even so, prices may go up again next year on purely tax reasons if contractors decide to keep their fat profit margins, usually around 30 percent, intact. If this turns out to be the case, then the government should become more concerned about a more protracted and deeply felt slump in the residential market later down the road – even more so if it coincides with a cycle of interest rate hikes.