Cracks Are Appearing in Europe's Property Market

Matthew Lynn (Bloomberg)
2007-05-02 02:41 (New York)

With a strong euro, a steadilyrecovering economy, and no looming threat from inflation, youmight think that Europe's property market was largely immune fromthe decline in U.S. home values.

Think again. Cracks are starting to appear in the real-estate markets of Ireland, Spain and France -- the three euro-area countries where property prices have soared in recent years.That isn't about to blow over. The housing markets in thesecountries may be on the verge of a sustained period of stagnation-- and maybe even a full-blown collapse. Why? House prices surged because interest rates were set toolow for those nations for several years in a row. Now they arelikely to be too high.

Europeans who thought investing in property was a sure betare being forced to reconsider.``Last week's sell-off marked the first real sign of panic among Spanish property investors,'' the London-based consulting firm Capital Economics Ltd. said in a note to investors. ``A keyreason for this is that Spain's latest wobble has come againstthe backdrop of the recent rapid deterioration in the U.S. housing market as well as tentative signs that Irish house prices have started to head south. This has prompted fears that asimilar situation could unravel in Spain.

''The Spanish stock market has been spooked by the threat of alooming property slowdown. Last month, Spain's 10 largest publicly traded real-estate stocks lost about 7 billion euros ($9.5 billion) in value in eight days as investors judged theeight-year boom may be over.

Declining ProfitsParquesol Inmobiliaria & Proyectos SA slumped after itreported declining profits as new properties failed to sell.Overall, prices may advance only 3 percent to 5 percent thisyear, according to Banco Bilbao Vizcaya Argentaria SA, comparedwith 15 percent gains at the height of the boom.

Meanwhile, the Irish are having to get used to fallingprices. Irish home values dropped 3 percent in the first quarter, according to the Web site http://www.myhome.ie/. They stagnated in February for the first time in more than four years, mortgage lender Irish Life & Permanent Plc said in April. That's afterIrish house prices quadrupled in the past decade, and as recently as 2005 were rising by more than 9 percent annually, according to Knight Frank LLP.

In France, housing starts dropped 15 percent in the three months through February, the biggest decline in six years. Apartment prices in Paris are rising at an annual rate of 10 percent -- but that is the slowest pace in seven years. That's hardly a sign of a healthy property market.

Low Interest Rates

There's no great mystery about why France, Spain and Ireland boomed. When all three countries adopted the euro, interest rates were set by the European Central Bank in Frankfurt. It looked at the entire euro-area economy -- not just property prices in one or two countries. The result? Interest rates were lower than they would have been if they were set by a national central bank. And now? That has been thrown into reverse. Just as borrowing costs were artificially low for those nations, now they may be artificially high.There are good reasons to think the boom in those countriesis coming to an end. Since December 2005, the ECB has raised rates seven times to the current 3.75 percent. They have almost doubled since the 2005 low of 2 percent. That's a hefty increase in mortgage payments. Tightening CycleInterest rates are likely to go higher, perhaps to 4 percent. There is no sign that the current tightening cycle is coming to an end, putting even more pressure on house prices. A strengthening euro will make life tougher for exporters, curbing wage growth in those countries. Again, that is going to make it harder for people to take out big mortgages. Interest rates are being set to keep a lid on Europe-wide inflation. Even if the ECB lowered borrowing costs to keep the property market afloat in Spain and Ireland, it would risk re-igniting inflation in one of the other euro-area countries. To put up rates when house prices, and new housing starts, are moving into free fall may seem like madness. After all, a significant property collapse could tip economies into recession, and leave mortgage lenders and banks struggling. Yet that is the way the system now works.

One consequence of the euro is boom-and-bust property markets in some member economies. We have seen the boom. Now weare about to see the bust -- and there is probably little that anyone can do about it.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)