The quality-adjusted purchase price used to calculate the new house price index is obtained by dividing the purchase price of each property by its official property value. According to the HMS, this adjusts the index for changes stemming from a larger share of new or relatively new properties in any given month, or for other characteristics taken into account in the official property valuation. The weight of condominiums and detached homes is then determined by the share of each in Iceland’s total nationwide residential property valuation. Detached housing therefore weighs relatively heavily, which explains its effect on the overall index value. Naturally, the detached home price index can be more volatile, as price formation is determined by a smaller number of purchase agreements.

Booming rental market

Next week, Statistics Iceland (SI) will publish the June CPI, which will be the first one compiled using the new methodology for calculating imputed rent. The new methodology entails making a statistical estimate of rental equivalence for all properties in use at the time in question, thereby obtaining the most likely rent price for homes not rented out. The model is based on market rent charged according to currently valid leases. The HMS rent price index shows changes in new rental leases over a two-month period; therefore, the measure is not the same. Nevertheless, the rise in the rent price index suggests that the rental market is quite tight, although it does not indicate what the rental equivalent used to calculate the forthcoming CPI value will be. As the chart below indicates, the rent price index fluctuates quite a bit. We expect the new imputed rent calculation method to mitigate volatility over time.

The new rent price index is based on leases finalised in the previous two months; in other words, the May index is based on leases finalised in the capital area in May and April. The increase illustrates the changes in new leases over this period, where negotiated rent was 3.2% higher in April/May than in March/April. Over the past year, the index has risen each month apart from December, when it fell by nearly 1.9%. The 3.2% increase this May is the largest in the past twelve months, followed by the June 2023 rise of 2.7%.

What lies ahead for the housing market?

In our most recent macroeconomic forecast, we project that prices will rise 5.8% this year, 5.1% in 2025, and 6.1% in 2026. In our opinion, three main factors will contribute to a continued increase: the ultimate impact of the Government’s home buy-up programme in Grindavík, growth in population, and a change in mortgage loan composition. Borrowers have been shifting to indexed loans in ever greater measure, as maximum debt service ratios are subject to stringent requirements and non-indexed mortgage rates are at a historical high. It can be said that borrowers have accepted indexation once again – at least for the present – which may well explain some of the influx of new buyers into the market. Concurrent with the monetary easing phase that we expect to begin in H2/2024, and with increased construction of new homes, we project that house price inflation will ease slightly in 2025. In 2026, when interest rates and inflation start to realign with previous levels, we expect stronger inflationary pressures to come to the fore again. The number of homes under construction has fallen, as high interest rates have started to bite and the construction cost per dwelling has increased. Contractors want to finish projects already underway before starting new ones, and new construction should gain momentum again, as sales of newly built properties have been brisk in 2024. As a result, while we do not expect house prices to mushroom like they did a few years ago, we do anticipate a rise in real prices over the forecast horizon.