Greek realty bubble?

The strong rise in the property market partly fueled by the low interest rate policy advocated by the US Federal Reserve and the European Central Bank (ECB) helped soothe the negative impact of the stock market collapse earlier this decade on the real economy. Greece, a country featuring one of the highest home-ownership rates in the world, was not an exception since it posted one of the highest levels of price appreciation during this period. However, unlike other countries, where the specter of a real estate bubble has arisen, there are good reasons to believe Greece will not be part of it even if one assumes the presumptive bubble bursts in the next couple of years. According to different estimates, the share of real estate in Greek household wealth appears to exceed 80 percent on average and perhaps 90 percent, as opposed to 40-50 percent in most other eurozone countries. The steep rise in residential property prices since the mid-1990s, projected at more than 150 percent, has boosted household wealth and had a positive contribution on consumption, the biggest component of aggregate demand and GDP driver. National Bank of Greece estimates that the real estate boom increased private consumption by about 0.4 percentage points per year on average during the 1995-2004 period. It also had a positive impact on fixed-capital formation since residential investment accounts for a large chunk of total investment spending, which in turn is one of the highest in the eurozone at about 26.5 percent of GDP. Following a surge in demand in the first quarter of 2005, which continues to go strongly on the back of announced tax reform, making the building of new houses more expensive, property prices in the Attica region are estimated to have gone up by some 10 to 20 percent so far. This comes after two years of relative calm which saw prices of large dwellings decline by up to 10 percent and small buildings by some 5 percent on average. But the sharp rise in property prices, especially in the residential segment, has raised eyebrows among bankers, civil engineers and others who consider it unsustainable in the medium to long term. They appear to be less concerned about commercial property, since this segment went through a sharp correction in the last two years or so. They believe that most of the favorable impact of low real interest rates – that is, nominal interest rates minus expected inflation – on mortgage demand has already been seen in the real estate market. This, along with a forecast economic slowdown, makes them believe the residential market will go through a similar correction experienced by the commercial property market. Positive views On the other hand, there are analysts who take a more positive view of the situation. Last week, Citigroup issued a report on the European mortgage market, predicting a cumulative average growth rate of 11 percent in property prices by 2009, fueling mortgage growth further. A rapid increase in Greek personal incomes, estimated at 6.5 percent on average, and a low price-to-income ratio are the two drivers behind the forecast by the Citigroup team. Some of the optimists also cite the Greek households’ relatively low leverage compared to their eurozone peers, which is mainly the result of the late liberalization of the Greek banking market. Mortgages accounted for some 17.5 percent of GDP in 2004 compared to an average 44 percent in the eurozone. They think low real lending rates in Greece, the country with one of the eurozone’s highest inflation rates, will continue to drive demand for mortgages higher. The strong performance of the Greek economy so far this year, an expected down year following the 2004 Olympics, has boosted their confidence that the economy will continue to outperform most of its eurozone peers in the next two to three years. They see economic growth and per-capita income convergence with the rest of the eurozone being underpinned by a pickup in EU inflows and investment spending as new projects are admitted in the new development law. At the same time, they point out to changing consumer behavior by the average Greek and attribute it to the mortgage culture. «Few people realize that mortgages have done some good for the average Greek that no other [change] has done before. They disciplined him and made him think more European. The average Greek who takes out a mortgage loan does not want to lose his house. So, he makes a budget and follows it closely to be able to repay his loan,» says the head of a foreign bank in Greece who is optimistic about the prospects of the Greek property market. The optimists also refer to the huge inflow of immigrants who have created a demand for small apartments in major cities such as Athens, making it possible for their previous Greek owners to buy bigger houses or land in the suburbs. The extension of the Athens metro, the new roads encircling the capital and other cities have also facilitated this mobility and should continue to do so. Although some of the arguments advanced by the pessimists are valid and may well be vindicated, we still believe it is more likely that the optimists will win out, but they may have to revise their forecasts for next year. As many people rush to buy houses and land this year to build before tax reforms, resulting in higher tax burdens for buyers and contractors set from January 1, 2006, it is reasonable to expect a lull in price appreciation in the property market next year. However, the two main driving forces in the Greek real estate market, namely GDP growth and low borrowing rates, should remain intact in 2006 and 2007, supporting prices. If GDP growth remains buoyant at 3.5 percent or more, as expected, and real interest rates remain low or ECB raises its intervention rate by no more than 150 basis points during the 2006-2007 period, there is no reason to believe Greek holders of variable mortgage loans will default or that demand for new mortgages will fall off to undermine the property market. So, even if 2006 turns out to be a dull year for the property market, 2007 should be better and signs of overheating or bubble bursting in other markets should not be seen in Greece.