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May 19, 2023

News in Charts: Swedish real estate — a sign of things to come?

by Fathom Consulting.

Sweden’s real estate market has been booming for the past few decades, with house prices growing by more than 80% between 2009 Q1 and 2022 Q1. This growth speed far exceeded that of average earnings, which rose by 36% in the same period. This was driven by a mix of domestic and global factors, such as a low supply of rentals, generous mortgage tax relief policies and a long period of low interest rates.

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This trend has been broken by the sudden tightening in monetary policy seen in the past year, which has reduced affordability for new buyers and increased borrowing costs for those with short fixed-interest-rate periods on existing mortgages. Sweden is particularly sensitive to changes in interest rates as it has an unusually large share of variable-rate mortgage lending, with 51% of outstanding borrowing for house purchases having an interest rate linked to the policy rate. This market structure has speeded up and amplified the transmission mechanism of policy-rate changes to house prices.

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Now house prices are falling rapidly as affordability declines for both existing homeowners and new buyers. Swedish house prices have declined more rapidly than in any of the other G10 economies in the past year, with residential real estate falling by 15% since its peak in Q1 2022. There is trouble in Sweden’s commercial real estate (CRE) sector too, which is reporting office vacancy rates that are 5 percentage points higher than pre-pandemic levels. And when the property fund SBB announced plans to delay its dividend payment, investors took fright.

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Following increased investor focus on the Swedish real estate sector, share prices have been falling across Swedish banks.

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A sudden decline in house prices can trigger a banking crisis. Not only does it weigh heavily on economic growth and employment by reducing construction activity and consumption, but it also reduces the value of the collateral behind mortgages, leaving a hole in bank balance sheets if households default. Mortgages make up 45% of Swedish banks’ lending portfolios, while CRE is responsible for a further 19%, making the Swedish banking system particularly exposed.

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Fathom warned about the risks to the Swedish real-estate sector back in March. Our Financial Vulnerability Indicator (FVI) tool flagged the vulnerability of the Swedish banking sector to falling house prices. According to the FVI, the G10 banking systems most at risk from falling prices are Sweden, Canada and France. All three of those countries have experienced strong private sector credit growth in the past decade, which research has shown tends to make the aftermath of housing bubbles worse.

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When similarities in behaviour between residential real estate prices across a wide set of countries are mapped, the resulting relationships can be expressed in the following minimum spanning tree chart (MST), where countries are represented as a series of nodes in a network. The MST makes it clear that Europe is key to the network, and that Sweden is one of the most central nodes, alongside France, Denmark, Spain, Canada and the UK. Sweden’s central location in this global network means that it is the market most likely to signal a global, systemic shock to residential house prices. In real terms, prices are down by an average of 2.3% in the central nodes, compared to a 0.3% average fall in the rest of the OECD. This suggests that the residential real estate sector, and in turn perhaps banking sectors, will become increasingly at risk globally as the decline in house prices transmits through the network.

The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

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