Since the outbreak of the global financial and debt crisis, real estate prices and rents, in particular in large cities around the world, have risen considerably. The monetary overinvestment theory of Friedrich August von Hayek helps to explain why large central banks have driven up real estate prices and rents, albeit with focus on economic centers.1
According to Hayek (1931), a central bank triggers an unsustainable upswing if it sets the key interest rates too low. As low interest rates signal high future consumption, a credit-financed investment boom sets in. Stock prices rise, as profits of enterprises and banks increase. Real estate prices rise, because real wages grow and people feel richer because of growing stock prices. The boom on the stock and real estate markets may become delinked from fundamentals if speculators bet for further increasing asset prices. So-called bubbles emerge.
Since the 1980s, rising stock and real estate prices have been observed frequently following strong interest rate cuts: In Japan between 1986 and 1989, after the Bank of Japan had strongly cut interest rates due to the post-Plaza yen appreciation. In the United States and parts of the euro area (for instance, Spain) between 2003 and 2007/08, after Fed and ECB had cut interest rates following the bursting of the dotcom bubbles (2000). In Germany, real estate prices have grown since 2010 aligned with the extensive euro rescue measures of the ECB.
In all cases, both real estate prices and rents increased faster than consumer prices. In Berlin, the per square meter price of condominiums has risen by 154% since 2010 along with rents, which have increased by 60% (Figure 1). In Spain, between 2001 and 2006, house prices increased by 148% and rents by 32%. In the United States, from a long-term perspective, real estate prices and rents have increased substantially since the dollar was delinked from gold in the early 1970s. Whereas real estate prices have increased by 1018%, rents have gone up by 855%.
Figure 1: Berlin: Apartment and Rent Price Indices and Population
Source: Statista (rents refer to newly rented apartments), Statistical office of Berlin-Brandenburg.
Does this suggest a connection between rising property prices and rents? The answer depends on the effects which low interest rates have on supply and demand for rented apartments. If an investor pays a high price he also aims to charge a higher rent, for instance to keep the ratio of rents to real estate prices constant. If the rents can rise, will depend on the additional supply of housing and the willingness of possible tenants to pay a higher rent. Although, during real estate booms rising real estate prices trigger construction booms, the supply remains rigid due to restricted supply of land, long planning periods and regulation etc. The propensity to pay for a higher rent may increase, because – as recently observed in Germany – real wages increase in euphoric boom phases. Also, those who already have real estate properties may feel richer and thereby may be willing to pay higher rents.
Even more, persistently low interest rates have regional concentration effects, which lead to a migration of labor force to economic and administrative centers. This can be observed currently in Germany where the easy monetary policy of the ECB has subsidized large firms by reducing their borrowing costs, in particular via corporate bond markets. The strong devaluation of the euro has generated windfall profits for the large, export-oriented firms. For smaller, more domestic-oriented firms, this effect is much weaker or even negative, because the low interest rates have boosted capital outflows, with domestic demand remaining sluggish. If large enterprises create more jobs in the boom, this increases the demand for housing, where the large firms are located, especially in large cities where the headquarters are clustered.
Governments benefit as well because real estate and stock market booms boost their tax revenues. When the government expands its administration, jobs are created where these institutions are located. Above all, the capitals, large, middle and university cities attract additional labor force in the public sector, where the demand for housing grows.
Because, in contrast, economic activity in the periphery remains comparatively weak, people are migrating to the centers, leaving an increasing number of properties in the periphery empty and derelict. For instance, in Berlin since 2009, the number of employed has increased by 400.000 and inhabitants have increased by 360.000, i.e. 10%. In contrast, the population in smaller cities and villages of Eastern Germany continues to fall. Thus, in the periphery, real estate prices and rents tend to level off and even to fall. Figure 2 shows that during Japan’s bubble economy, land prices in Tokyo skyrocketed, while those in Miyazaki Prefecture on the western island of Kyushu increased only to a negligible extent. At the end of a chain of migration movements “ghost villages” emerge, such as in Saxony-Anhalt in Germany,in Calabria in Italy or in Niigata Prefecture in Japan.
Figure 2: Land Prices in Tokyo and Miyazaki Prefecture
Source: Ministry of Land, Infrastructure, Transport and Tourism, Japan.
With the bursting of the bubbles, also the upward pressure on rents tends to cease. Since the collapse of the Japanese bubble economy in 1991 until the onset of the Abenomics in 2013, house prices have fallen by 44%, while average rents – which are more rigid than real estate prices – have decreased only by 4% between 1998 and 2013 (Figure 4). Also, the bursting of real estate bubbles in the US and Spain in 2007/08 has curbed the rise of rents.
Figure 3: Real Estate Prices and Rents in Japan
Source: OECD.
But with central banks responding to bursting bubbles with even more expansionary monetary policies, the upward boom tends to set in again, as for instance most recently observed in the US and in Spain. The real estate market in Tokyo was revived by the Abenomics. Particularly prices for condominiums have increased by 35% from 2012 to 2018. Housing prices can continue to rise as monetary easing has distributional effects in favor of high-income groups.2 For example, since the US has started the loose monetary policy from the end of the 1980s, the share of incomes earned by the top 1% of incomes has grown from 10% to over 20%. In Germany, the top 10% income share has risen from 24% to 30% since the turn of the millennium.
By contrast, the rise of rents is restricted relative to house prices because the wage increases for the low- and middle-income groups remain constraint. In addition, in many countries all kind of public regulation tries to put a break on rents. The upshot is that, given increasingly loose monetary policies, the ratio between rents and real estate prices tends to decline along with the central bank policy rates. Nevertheless, from the perspective of richer population groups, the purchase of real estate pays off, as interest rates are low, collateral is gaining in value and the house prices in centers can be expected to further increase as long as monetary conditions remains loose.
The distributional effects of increasingly loose monetary policies via the housing market mainly occur via real estate prices and rents. Whereas property owners in the economic centers gain, real estate becomes unaffordable for young people and jobseekers from the periphery. Property owners in the periphery, especially in many small towns and villages, are faced with the depreciation of their real estate. In the centers, young people and immigrants need pay higher rents than the old tenants who are often protected from rent hikes by the government. In the periphery, rents are low, but no jobs are available, or jobs are less well paid.
As all this is perceived as unjust by an increasing number of people, the central banks around the world contribute to increasing political dissatisfaction and growing political instability.
