April 22, 2008

Are houses overvalued in the Netherlands?

Houses in the Netherlands not overvalued

Press release
On average, the house prices in the Netherlands in 2007 have adhered fairly closely to their long-term equilibrium level. This means that, on average, house prices were not overvalued last year.

This follows from a recent empirical analysis on house price development during the period 1980-2007 in the Netherlands. The actual house prices are more or less in line with their fundamentals. Recent IMF research in the World Economic Outlook, which indicates a substantial overvaluation of Dutch house prices, is thus not confirmed by the CPB analysis.

These results follow from empirical research by Henk Kranendonk and Johan Verbruggen, which was published today in the CPB Memorandum, Are houses overvalued in the Netherlands?The authors show that the development of real house prices in the Netherlands can be explained rather well by fundamental demand- and supply factors, such as real disposable income, the real interest rate, the real financial wealth of households and the stock of dwellings.

Causes of rising house prices
During the period 1991-2000, house prices increased substantially, with average yearly growth rates of 9.7% in nominal terms and 7.1% in real terms. This was caused mainly by the growing prosperity of Dutch households and by a low interest rate. In this period, also the stock of dwellings increased (by 0.7 million houses), which had a downward effect on house prices. Without the enlargement of this stock, house prices would have risen much more. During the period 2001-2007, the house price increases were more moderate, with average yearly growth rates of 5.3% in nominal terms and 3.0% in real terms. The most important factor in this period was the increase of the financial wealth of households. Next to this, the growth of real disposable income contributed to the real house price rise, while the effect of the real interest rate was small. During this period, the increase in the stock of dwellings was relatively small, which meant that the downward pressure on prices was also relatively small.

No overvaluation in 2007
In 2005, CPB determined that house prices in the Netherlands in 2003 were overvalued by about 10% (see CPB Document 81: Which factors determine house prices in the Netherlands?, in Dutch). The analysis published today confirms this overvaluation in 2003. After 2003, the overvaluation has diminished, and has disappeared entirely in 2007. This was due not to a downward house price correction, but to the fact that between 2003 and 2007 the increase of actual house prices lagged behind the increases of the long-term equilibrium price. This was caused by a relatively favourable development of some fundamental demand factors (income and wealth) and a relatively moderate increase of the stock of dwellings during this period.

Differences between the analyses of CPB and the IMF
The CPB results differ from those in the most recent issue of the IMF's World Economic Outlook, which indicate a substantial overvaluation in the Netherlands in 2007. The main reason for this is that the IMF does not take into account the specific Dutch situation of restricted supply conditions. In the Netherlands, the supply of new houses is severely regulated and therefore restricted. This fundamental supply factor has a significant upward effect on house prices in the Netherlands.

Empirical research has shown that the overvaluation of approximately 10% that existed in 2003 shrunk to approximately 0% in 2007. This was not caused by downward correction of house prices, but by the circumstance that the increase of the actual house price between 2003 and 2007 lagged behind the increase of the long-term value of the house price. Therefore, this does not confirm the IMF's recently published research results, indicating that approximately 30% of the house price increase between 1997 and 2007 cannot be explained by fundamental factors.



Johan Verbruggen

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