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House prices are more closely related with borrowing capacity than with housing shortage


Published: 16 July 2020

Huis in de steigers

Lower capital market rates increase borrowing capacity

The increase in house prices is primarily attributable to homebuyers’ access to ever cheaper finance. International developments have put capital market rates on a downward trend in recent decades. As a result, mortgage interest rates in the Netherlands have also fallen sharply from an average of 7% in 1995 to around 2% now. As mortgage interest declines, households can take up higher loans at the same monthly cost, and thus bid more for the same house. Moreover, real estate investors can afford to pay higher prices when interest rates are low and related required returns are lower. After all, the discounted value of future rental income increases as required returns fall. This causes the investment value of a home to go up due to discounting effects. 

House prices are closely related to borrowing capacity

Figure 1 shows that house prices have moved closely in line with the trend in income standards for mortgage loans and the resulting maximum loan amounts in the past 25 years. The maximum loan amount has increased in recent years as income went up and mortgage rates fell. It was also affected by changes in the income standards set by the National Institute for Family Finance Information (Nibud). The close relation between house prices and maximum loan amounts is hardly surprising. In the Netherlands, the vast majority of homes are financed by mortgage loans, and relatively many households – both first-time buyers and homemovers – take out loans close to their maximum borrowing capacity. This is due to the favourable tax treatment of mortgage debt and home ownership wealth, in addition to the discounting effects referred to above that can drive up a home's investment value to levels that exceed the borrowing capacity of most households. House prices have therefore been strongly driven by the borrowing capacity of households over the past decades. In the shorter term, however, house price trends may differ from that borrowing capacity, for example due to concerns among households and investors about their future financial situation.

Price Index English

Source: Statistics Netherlands, Nibud, DNB and own calculations. Note: The maximum loan amount is calculated on the basis of Nibud's tables of the financing cost percentages from 1995 to 2019. The maximum mortgage loan amount is then calculated for each year based on average household income in that year and the average interest rate for mortgage loans taken out in that year. 

House prices are only related to housing shortages to a limited extent

While price increases in recent years coincide with increasing physical housing shortages, historically no close relation can be observed between house prices and housing shortages. Figure 2 shows the housing shortage since 1945, as a percentage of the total housing stock, and the price level of owner-occupied properties, after inflation adjustment. What immediately strikes the eye is that housing shortages existed throughout this period. Definitions of a housing shortage have changed over time, however. Until recently, they were based mainly on housing preferences of households as inferred from surveys. Currently, the main element in the definition is the discrepancy between the number of households and the number of homes. At present, the shortage amounts to 331,000 homes, or 4.2% of the housing stock. Although the contribution of this housing shortage to high price levels is difficult to measure, empirical estimates (for both countries with housing shortages and countries with surpluses) suggest a relatively small contribution. A 1 percentage point reduction in the current housing shortage – meaning a housing stock increase exceeding the growth in the number of households by 80,000 – could result in a price drop of 1-2%. It should be noted that reducing the housing shortage is not easy in practice, which further limits the options for relieving price increases in this way.

Figure 2 English

Source: Housing shortage: Ministry of the Interior. House prices: OECD, Statistics Netherlands and, until 1970, the JST Macrohistory database, which uses the Herengracht index. Note: Data on the housing shortage are not available for every year and are subject to changing definitions. 

Accessibility for first-time buyers

The foregoing suggests that in practice Dutch house prices mainly depend on households’ borrowing capacity and to a lesser extent on physical housing shortages. This means increasing the borrowing capacity of first-time buyers will not help them a great deal. Granted, in the short team increased borrowing capacity gives them a higher budget for their purchase, but in the end prices of houses and, more particularly, of the land, will go up. First-time buyers will then end up buying the same home but with a higher loan with higher associated risks.  Further reducing the mortgage interest tax relief facility by the current pace of three percentage points annually will therefore benefit them more. This limits house price growth and required mortgage loan amounts, with the added advantage of reducing the distortion of the choice between buying or renting a home. The latter benefits the development of a smoothly functioning rental market, which is important to accommodate new entrants on the housing market. In addition, improved accessibility of the housing market for first-time buyers requires that additional homes are built to reduce the housing shortage. Although a larger housing stock is not likely to make houses much cheaper, they will become available to more households.

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