House prices have been fluctuating noticeably in recent months, after the market downshifted suddenly this past August. Detached housing prices have been particularly erratic, but they are typically more volatile, as the data are based on a smaller number of purchase agreements concluded in any given period. The year-on-year rise in capital area house prices has now lost pace four months in a row. In November, the twelve-month rise stood at 20.3%, down from its 25.5% peak in July. Condominium prices rose by 20.2% YoY in November, and detached homes by 21.6%.

The housing market has cooled

The housing market landscape has been more bucolic recently than in the preceding period. A total of 550 purchase agreements for capital area properties were registered in November, about the same as during the autumn months, after the market started to cool late this summer. In both May and June, for instance, over 700 contracts were registered. The number of transactions concluded in November was a fifth lower than in the same month of 2021. The same can be said of turnover, which has been broadly stable this autumn after a buoyant summer and was also down by a fifth YoY in November.

According to HMS’ monthly report, the number of properties selling at a premium on the asking price has fallen significantly in the recent past. In October, for instance, 25% of homes that changed hands in the capital area sold at a premium, down from 47% in July. Furthermore, supply has risen rapidly in greater Reykjavík. According to our tally, nearly 1,800 homes were advertised for sale in early December, a jump of 157% from the December 2021 total of roughly 700. If developments continue in this vein, the YoY increase in supply will be even larger in coming months, as the number of properties for sale fell to a trough in February 2021. This upturn in supply indicates that the market is growing healthier and perhaps approaching something resembling equilibrium.

Inflation in December

As the chart below illustrates, there is a fairly strong correlation between the HMS house price index and the market price of housing as captured in Statistics Iceland’s (SI) inflation measurements. Both indices are based on three-month moving averages according to registered purchase contracts, but the main difference between them is that SI’s index also captures regional Iceland, while the HMS index covers only the capital area. The chart shows the market price of residential housing with a one-month lag in terms of the house price index; therefore, the newly published index could give a reasonably sound indication of housing market prices in SI’s December measurement, due for publication tomorrow.

In our inflation forecast for December, we projected that imputed rent would rise by 0.7% MoM, with half of that increase attributable to house prices. It could well be, though, that imputed rent according to the house price index will rise somewhat less than we had anticipated, although this will not have a discernible impact on the inflation forecast as a whole. Imputed rent is based on two underlying factors: house prices and an interest component. The interest component is derived from the twelve-month average of indexed mortgage lending rates, which have been on the rise recently. It has to be considered highly probable, then, that the interest component will push imputed rent upwards, and furthermore, we think it likely that house prices could rise a bit. There are two reasons for this: On the one hand, house prices in regional Iceland have risen in recent months and are quite likely to keep climbing. On the other hand, the market price of housing did not fall in the wake of the MoM decline in the house price index in August., as is noted above. So it will be interesting to see how these two metrics have developed when housing market data are published in SI’s inflation measurement tomorrow.

House prices are falling in most neighbouring countries – but will they fall here?

The surge in house prices during the pandemic is not a uniquely Icelandic phenomenon: the same occurred in most neighbouring countries. What is interesting, though, is that housing markets appear to have cooled somewhat faster abroad than in Iceland. In Norway, for example, real prices fell by 2.5% in Q3/2022, and in the US they fell by 1% over the same period, whereas in Iceland, they rose by 2%.

During COVID-19, prices skyrocketed in other countries for broadly the same reasons as they did in Iceland: government authorities introduced stimulative policy measures in the wake of the pandemic. But it is clear that demand has tapered off much faster in most foreign markets than it has here. Presumably, this is mainly because most other countries are not dealing with supply shortages as severe as those that have plagued Iceland, and demographic changes there are less likely to push demand upwards. It is also interesting to ponder whether neighbouring countries are more sensitive to interest rate movements, as central banks in much of the world have raised rates in an attempt to rein in raging inflation. On the other hand, Icelanders are inured to high interest rates and may well be less inclined to let rate hikes stop them from buying a home.

In our macroeconomic forecast from September, we projected that the housing market would cool swiftly in the remaining months of 2022 and that the YoY rise in prices would measure 19% over the year as a whole. Because our forecast covers house prices for the entire country, we base our projections on the market price of housing. Thus far in 2022, house prices are already up 20%, and according to the most recent numbers, the outlook is for little or no increase in December. Our forecast for the year is therefore quite likely to prove reasonably accurate. Forecasting developments in the next few months and quarters is more difficult. We expect the housing market to move towards a better balance and sail in calm waters over the next several months. House prices have been swinging this way and that, and they could even fall in the short run, but over the medium term we expect them to develop in line with the general price level.