The reason why the residential real estate sector’s boom-bust cycles are propagated across the economy and can define the economic trajectory for a number of years is because the real estate sector is able to affect the real economy, the banking sector and financial stability and finally public sector’s revenues and the overall position of public finances.
Starting from its impact on the real economy, households invest a substantial amount of their entire life-time wealth in their real estate assets. Furthermore, they devote a substantial portion of their annual disposable income to servicing their mortgage debt. As a result, fluctuations in the valuations of their houses can create substantial wealth effects, while changes in the cost of servicing their mortgage loans (due to i.e. higher policy rates) have an immediate impact on households’ disposable income. Both these wealth and income factors affect households’ consumption and consequently the level of economic activity and GDP growth (or contraction).
On top of this direct effect, real estate developments affect economic activity indirectly through the construction sector. New residential real estate developments count directly as the investment (more officially gross fixed capital formation) component of GDP. Furthermore, construction is a highly labour intensive activity, linked to many other sectors in the economy, As such, boom or bust in residential real estate and construction could have a substantial impact on both activity and employment.
Turning to real estate’s impact on banking sector and financial stability, the interaction between house prices and bank lending should be all too well understood by now: Higher house prices create a fear of missing out (FOMO), forcing households to increase their leverage while banks are willing to extend more credit because they take comfort from higher collateral values. This leverage, in turn feeds into a new round of higher prices until an economic slowdown or a policy intervention (i.e. tighter monetary policy) or both, put the cycle into reverse with households facing difficulties servicing these larger mortgages and being unable to deleverage because of negative equity. This in turn leads to higher defaults, banking sector losses, demands from supervisors for higher capital ratios and ultimately financial stability concerns.
Last but not least in this catalogue of real estate worries is the impact of a real estate boom-bust cycle on public sector finances. On the boom part of the cycle, construction activity and real estate transactions create an abundance of fiscal revenues only for these to evaporate as soon as boom turns into bust. All too often their deterioration in public sector revenues coincides either with an economic recession (due to construction slowdown) or with a need to support the banking sector (due to real estate related loan losses) or both.
By using a hedonic model and data provided by real estate sales, the bank's analysts can calculate the price per square meter, for example of a flat on the 1st floor of an apartments building built in 2002, 100 square meters in size, with two bedrooms, one bath, parking or storage space, solar boiler, secure door and autonomous heating that is located in central Athens and with issued Energy Certificate (ECP) “class G” . At the same time we can estimate how much the same property would had cost if it was on the 2nd or 5th floor or if it had an EPC A+ or if it was located in an another region of Greece.
The key finding of the analysis is that the hedonic modelling approach, i.e. the idea of decomposing a property’s asking price to its underlying attributes and characteristics such as location, size, property type plus other amenities such as heating type, pool etc., is supported by the data, given that the model is able to explain 82% of the variability of property prices across Greece.
More specifically we find that:
- There exist a positive but relatively inelastic relationship between property size and sell price so that price per m2 is a decreasing function of a property’s area, i.e. for typical 100 m2 the price/m2 = €1606 while for a 50 m2 property the price/m2 =€1722.
- Detached properties command a 6% premium over flats, while maisonettes a 7% discount.
- Extra amenities such as a pool, autonomous heating, natural gas connection or the existence of a parking / storage space can command a premium between 7.5% (parking) to 25% (pool) versus an identical property lacking these amenities.
- Furthermore, the old adage “location, location, location” holds in the case of Greek real estate. Properties in the Cycladic Islands command a 38% price premium and in the South Athens Suburbs a 36% premium over a comparable property in Central Athens.
- Conversely, properties located in Thessalia or Macedonia face a 43% & 50% discount over Central Athens.
- Last but not least, in terms of property price decomposition the house size, location, the number of bedrooms and bathrooms and energy efficiency attributes (solar boiler, autonomous heating and natural gas) contribute the most in a property’s sell-side assessment.
- A milder relative contribution is obtained from the house type, parking/ storage place and number of amenities provided with the house.
- Quite interestingly, the property’s age, EPC score and floor level do not play a very important role for the sale price despite the fact that if considered individually have a large impact on the property’s value.
