Apartment price determinants : A comparison between Sweden and Germany

Abstract: Similar development of economic fundamentals in Germany over the last two decades did not lead to the same dramatic house price increases as it is in Sweden. What can explain this house price stability over a long period? This thesis attempts to find the answer this question.The first paper in this thesis contains an extended literature review on the studies focused on the factors affecting house prices in the short and in the long run. Existing literature adopts a broad variation of approaches and reaches different conclusions attempting to answer the question about what are the key drivers of house prices. Conclusions often depend on the model specifications and econometric methods applied. Though there is a considerable agreement in real estate economics theory regarding the main factors that affect house prices (or so called “fundamental determinants”), it is hard to find a consistent definition regarding what factors can be considered as “fundamentals” and what factors belong to “non-fundamentals”. The dominating factors that are presented in the majority of the studies are income, population, interest rate, housing stock and unemployment. Studies done after the recent financial crisis put more attention on such factors as the behavior of the market participants, financing conditions and regulations. The characteristics of the bank lending and valuation policies as well as regulations on the rental market have received attention in the research literature, but the impact of these factors on house price dynamics is not measured and not well described. Therefore the other two papers in this thesis aim to provide a better insight in to the factors that create fluctuations in housing markets.The second paper investigates the effects of macroeconomic indicators such as population, income housing stock, mortgage interest rate on house prices. Estimation is done by applying panel data methodology on regional data for major cities in Germany and Sweden and by using yearly observations from 1995 to 2010. Results suggest that the long-run development of apartment prices in Sweden can be explained by changes in such factors as population, disposable income per capita, mortgage interest rate, housing stock, and prices per square meter in the previous period. The price for the previous period has the highest impact in comparison with other factors in Sweden. At the same time for Germany this is the only factor that is valid for long-term house price development. Estimates for fundamental factors such as population, disposable income, mortgage interest rate and housing stock appeared as not significant in house price development in the long run in Germany. A closer analysis has shown that the fundamental factors developed in a similar way in both countries during the analyzed period, though the house prices dynamic is very different. The conclusion is that fundamental factors cannot provide an explanation for the differences in house price developments in two countries and further analysis of institutional differences in the housing markets is done in the third paper.Third paper applies a comparative analysis approach and hypothetico-deductive method in order to examine the differences in the banking policies on mortgage financing and approaches to valuation of mortgage properties in Germany and Sweden.  The results suggest that the extreme rise in Swedish house prices above the long-term trend was created by expanding bank lending policies that was supported by the general macroeconomic factors and regulation environment on the housing market. The main difference between countries in approaches to valuation for mortgage purposes is that in Germany that mortgage is based not on the market value as it is in Sweden, but on the long-run sustainable value, so called “fundamental” value. Mortgage lending value is determined in such a way that is also develops in the same tempo as fundamentals in the long-run and is not that procyclical as market value. Using a long-term sustainable value has a restrictive effect on the housing prices and in such a way stabilizes the market.  One more factor that gives stability to the housing market in Germany is the well-functioning rental market. Third paper contributes to a better understanding of necessary conditions for the house prices to rise in the long run above the fundamentals level and suggests policy solutions that can reduce the risks of housing bubbles and increase financial stability.