After many years of sizeable price gains, the Greek residential real estate sector appears to be entering a new phase characterized by much slower growth. Whether this will cost the country in terms of economic output depends on the ability of other segments of the real estate market to pick up the slack. It is known that real estate has been one of the drivers of economic growth in Greece, contributing more than 1.1 percentage points to annual Gross Domestic Product (GDP) growth so far this decade, as residential investment grew faster than the economy as a whole. Moreover, residential investment accounts for an estimated 5.0 percent of GDP, compared to 25 percent for total private investment spending. It is no secret that the positive contribution of the residential real estate sector to economic activity has taken place via two channels. First, residential investment activity and second the wealth effect of higher house prices on aggregate consumption spending, the biggest component of GDP. This has been the result of a number of factors at work at the same time. The sharp decline in real interest rates, that is, nominal interest rate minus inflation, from the 1990s to the middle of the present decade – to the tune of 8 percentage points – boosted purchasing power and provided support to the housing market and the Greek economy in general. Also, wages have grown at a faster rate than inflation annually since the late 1990s, fuelling strong growth in real per capita disposable income. The fact that employment has also increased by more than 1 percent annually served to push up house prices. The Greek residential market also benefited from demographic trends. The average size of the Greek household declined during this period, falling to 2.6 persons in 2005 from 3.1 in 1994. This trend was underpinned by a rising number of divorces and a change in lifestyles. Also, the portion of the population in the household group with the greatest purchasing power, that is people in their 30s and 40s, also rose. According to experts, the latter partly reflects the arrival of young immigrants who account for 5 to 9 percent of the total population depending on the estimates. The majority of the immigrants belonged to the 25-45 age group and gradually shifted from renting to owning a house. All these demographic factors combined to increase the number of households much faster than the total population. It is estimated that households increased by more than 8 percent in the first half of this decade compared to less than 2 percent for the overall population, contrary to what happens in other eurozone countries. But the residential real estate market appears to be facing the first headwinds. The increase in the ECB (European Central Bank) base rate to 4 percent this year from 2 percent two years ago has raised the monthly installments on floating rate mortgages taken out by many Greeks. Although banks have tried to mitigate the impact by squeezing their own spread margins or/and extending the life of the loan to help the borrower, the impact has been felt by a large number of households. It is worth noting that over 90 percent of households have taken floating rate loans adjusted at regular time intervals, usually every three months. While the ECB has stopped its policy of raising its key interest rate further for the time being, following the summer turbulence in credit markets, money market rates in the interbank bank, where banks lend and borrow funds, have stayed at eight-year highs above the ECB base rate of 4 percent. So, some local banks have started changing the base rate on which floating mortgage rates are based from the official ECB rate to the three-month Euribor rate to reflect market conditions. This means higher costs for borrowers. A second headwind for the residential real estate market has been the rising supply. The imposition of Value Added Tax (VAT) on the construction of new houses from 2006 onward led to a sharp increase in the number of building permits issued in the second half of 2005. Analysts, brokers and executives at real estate firms confirm a noticeable slowdown in house price increases in the first half of the year. Against this background, prices of large apartments in many areas appear to have dipped while prices of medium-size apartments in the major urban centers appear to be holding better. An oversupply of new studios and small apartments in towns and cities around the country, often bought as an investment by a number of individuals, have led to a sharp drop in demand for older properties and kept rents and sale prices for new homes relatively unchanged in Athens, according to market players. On the other hand, prices and rents have weakened even for new studios and small flats in other cities. The latter development is partly attributed to the late educational reforms which led to a decrease of new entrants into universities. In addition, the prospect of new areas being incorporated into city plans could also have had a dampening effect on prices, since the limited land available for construction has been one of the reasons behind the sharp rise in real estate prices in the last decade or so. Still, this incorporation is not expected to happen any time soon. There is no doubt that the residential real estate market is losing steam. But disposable income is projected to rise this year and next and interest rates remain low by historical standards, even after picking up. This should generate some demand, although the higher cost of construction materials, VAT and high acquisition cost of land are unlikely to convince developers to lower new house prices significantly, even though new buyers may be able to find a better bargain. Moreover, one cannot rule out strong growth in the second home component of the market, which may help to partly alleviate the impact, as well as a positive effect from the new tax laws on real estate announced by the government but yet to be specified. Nevertheless, the residential real estate market appears to be entering a new, slower phase and the extent of its effect on the economy is not expected to be as strong as in the past.