The next European crisis: the real estate sector

If you’re curious to see where the seeds of the next financial crisis are in Europe, take a look at what’s happening in the real estate sector.

As money-printing by the European Central Bank is underway, the funds are mostly going into the real estate sector, creating bubbles where there weren’t any and exacerbating existing ones.

Credit rating agency Standard & Poor’s recently published a report on property in Europe, in which it said: “Within the eurozone, the European Central Bank’s (ECB’s) large quantitative easing (QE) programme and ultra-low interest rates are spurring improvements, even in housing markets that were most deeply affected by the financial crisis.”

The agency’s experts forecast that house prices will rise in most markets in Europe this year, helped by very low mortgage rates and improved economic conditions.

The fastest housing price rises this year in the eurozone will be experienced by Ireland, around 9%, followed by Germany with 5%, Portugal with 4% and the Netherlands with 3%, they predicted.

Spain, which has seen a deep crisis in its real estate sector, will finally see house prices return to growth, increasing by about 2.5% this year, while even slow-growing Italy will see the end of real estate prices decline this year.

Property prices in France are likely to decline by 3% this year as the economy is still weak and unemployment is high, while in Belgium a new decision to cease granting tax relief on mortgage payments is expected to push real estate prices down by 2%.

In the UK, they see house price inflation remaining strong, at 7% this year, although an interest rate rise by the Bank of England later in the year could slow down price rises.

It is true that in many of these places (the UK excluded) we cannot yet talk of a proper, fully-formed real estate bubble.

(Check out the chart below to see why the UK real estate market is probably in a pretty big bubble.)

Real estate bubble in the UK

A real estate bubble in the UK. Source: S&P

Many analysts believe that the chart above shows what years of quantitative easing pushing interest rates on mortgage loans to record lows, combined with insufficient supply of homes and an increasing population, do to the real estate sector, and that there is actually no bubble.

But the real problem, as Julien Noizet from Spontaneous Finance points out, is that real estate lending has overtaken business lending ever since the Basel banking regulations came into force.

This is because Basel regulations force banks to set aside more capital when lending to small and medium sized companies than when they lend to house buyers, so naturally, in order to make efficient use of capital, banks prefer mortgage lending to business lending.

This has skewed the source of economic growth slowly towards relying on ever-rising house prices and real estate purchasing, rather than on more productive sources of growth such as businesses, and nowhere is this more obvious than in the UK.

The consequences of this are that while rent-seeking and the accumulation of wealth are encouraged, experimenting and creativity in business are ignored, if not actually discouraged.

This article in the Guardian showing young, creative Londoners heading to cheaper Berlin because they believe London will soon become “a very expensive ghost town” illustrates the problem of boosting the real estate sector at the expense of the business sector: talent will have no choice but move on to the cheaper destination, leaving the expensive city to the rent-seekers.

Sooner or later, driving young, bright talent away from expensive cities is a recipe for disaster: these cities need the young people to live in them and drive progress.

So, if you’re a long-term investor, don’t join the real estate bubbles. Go for the real thing, put your money in productive businesses.

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