Investment in the residential construction sector in the euro area as a whole has declined significantly compared to its post-pandemic peak. In the euro area they decreased by approximately 4 percent between the first quarter of 2022 and the fourth quarter of 2023: the decline was particularly pronounced in Germany and France, while a slight increase was observed in Spain, and in Italy, of significant magnitude. This was revealed by the European Central Bank in an analysis included in its latest Economic Bulletin
The downturn in the euro area was preceded by a sharp increase in construction costs during the pandemic and from a significant increase in long-term rates risk-free, recorded since the beginning of the recent cycle of tightening of monetary policy, starting from the end of 2021. The rise in interest rates was also accompanied by a tightening of bank credit granting standards, which, explains the The analysis, in turn, contributed to the rise in mortgage rates and the slowdown in credit flows.
Due to these dynamics, to which the decline in house prices was then added, owners of residential properties had to face a higher implicit cost of living, measured in terms of “cost of use of housing”.
Rising mortgage rates and falling home prices sappear to be recording a slowdown, or even a partial reversal of trend, making the evolution of investments in the residential construction sector in the near future uncertain. The ECB study aims to shed light on this aspect by analyzing the current level of such investments in the euro area using an innovative measure of the cost of using housing.
The cost of using homes, we read, represents a key determinant of investment in the residential construction sector. Housing affordability can be measured by the cost of capital that a homeowner invests in their home, i.e. the cost of using the home. This measure corresponds to the opportunity cost of living in home ownership compared to using other consumer goods and services (present or future), which represents a significant determinant of investments in the residential construction sector.
The cost of using homes, continues the work published by the ECB, it is usually expressed as a percentage of the value of the accommodation and includes both costs and compensatory benefits. These include:
a) interest expense on mortgage loans, which measures the cost of servicing the debt to finance housing;
b) foregone earnings, which measures unrealized profits from investing in non-housing assets;
c) expected capital gains, which reflect the reduction in costs due to the expected increase in value of the house; d) loan-to-value ratio (LTV), which determines the relative weight of the cost of debt service versus lost earnings;
(e) net taxes, including those on real property, as well as tax deductions on debt service and taxation of lost earnings;
f) other items, including maintenance and repair expenses, depreciation and risk premiums5. Grouping items d), e) and f), the cost of using homes increases as the following items increase: debt service costs, lost earnings, expected capital losses, or (net) tax charges and other expenses , thus reducing the amount that families may want to invest in home ownership.
In summary, the cost of using housing offers an extended measure of the expenses resulting from living in owned accommodation, as well as reflecting the consumption of housing services, a factor underlying a family’s decision to invest in purchasing a home Property.
Cost of use of housing growing in the euro area
Over the last two years, the cost of using housing has increased significantly across the euro area, mainly due to the increase in the cost of debt servicing. The cost of using housing has shown clear fluctuations in the euro area since 1999, reaching a historic low at the start of the global financial crisis in 2007-2008 and a peak at the end of the euro area sovereign debt crisis. euro in 2010-2012 (see Chart A). After the prolonged decline that followed the sovereign debt crisis, the cost of using housing increased significantly during the recent period of monetary policy tightening.
At a national level, the study continues, the increase was particularmind marked in Germany. As for the determinants, fluctuations in the cost of using homes derive largely from changes in expected capital gains.
However, the recent rise has been determined for mostly from the higher debt servicing cost, in line with previous episodes of marked changes in monetary policy interest rates. In France, Italy and Spain the most determining factor was the increase in the cost of debt servicing, while in Germany the expected capital losses are more relevant, reflecting the relatively sharp decline in house prices since the start of the recent policy tightening monetary.
The proposed analysis uses an empirical model in order to relate the level of investments in the residential construction sector with the cost of using homes. A linear regression model highlights the link between the level of investment in the residential construction sector and contemporary and lagged values of the cost of use of housing, as well as the lagged level of real estate for residential use. The model therefore reflects the relationship existing in historical terms between investments in the residential building sector and the cost of using homes; the lagged values of the cost of use of housing allow the gradual reaction by families to changes in housing costs and the modeling of market frictions, such as the shortage of building land or excessive bureaucracy.
If the forecast obtained through the model corresponds to the actual level of investments in the residential construction sector, the relative variations can be related to those of the cost of use of housing and the factors that influence it. However, a temporary deviation of investments from the model’s predictions could depend on other reasons and not appear explicitly in the model itself. Nonetheless, investment in residential construction should gradually adjust to the cost-of-use value of housing, as any significant deviations are expected to correct over time.
At the end of 2023, investment in the euro area residential construction sector remained above the level inferred from the cost of use of housing, despite the significant decline observed in 2022-2023. According to the results for the euro area, investments in the residential construction sector and the values predicted by the cost of use model show a clear positive correlation, confirming that the cost of use of housing represents a significant determinant of investments in residential construction.
Before the global financial crisis, investments in residential construction exceeded the level deduced from the cost of use of homes, and then fell below the level suggested by the model, reflecting the cycle characterized by a strong rise and sudden decline (boom-bust). of such investments in this period.
In the recovery phase following the sovereign debt crisis, investments in the residential construction sector substantially followed the model’s forecasts, while after the pandemic they significantly exceeded the level, possibly because following the health emergency, families changed their housing preferences.
At the end of 2023, residential investment in the euro area was still more than 4 percent above the level predicted by the model, despite having already fallen significantly. At the national level, such investments in Italy in the fourth quarter of 2023 were significantly above the level inferred from the model, probably due to the generous tax incentives linked to the Superbonus, which in the fourth quarter of 2023 led to an unprecedented peak in investments in residential construction, but which is not captured by the cost of use. On the other hand, the work concludes, such investments in the same period in Germany and Spain were substantially in line with the model’s prediction, while in France they were lower than this level.
