The Housing Market in Major Dutch Cities
The Dutch housing market is recovering strongly from the crisis, with considerable regional differences. Major cities such as Amsterdam, The Hague, Utrecht and Rotterdam, are witnessing stronger house price rises than the rest of the Netherlands. Despite signs of overheating in the large urban housing markets, there is no credit-driven bubble in cities as yet. Spiraling house prices in the cities are mainly attributable to scarcity pricing: ongoing migration to the cities is spurring demand for urban housing and supply is failing to keep pace. The result is a shortage of affordable housing, particularly in the non-rent regulated rental sector, putting middle-income earners in a tight spot. Supply in the non-rent regulated sector is growing slowly due to planning restrictions on new-build developments, a lack of planning and construction capacity, and the absence of effective incentives for mainly municipalities. The government should encourage municipalities to increase supply in the non-rent regulated sector, and mortgage interest deductibility should be lowered further to level the playing field between buying and renting.
This chapter asks why prices have risen so rapidly in the four major Dutch cities and what consequences this may entail for financial stability. We investigate whether a credit-driven bubble is forming in the cities and analyze differences between cities and the rest of the Netherlands in the mismatch of demand and supply. Then, we will set out the consequences that rising prices can have for the position of middle-income earners and the differences between renters and buyers. The chapter ends with some policy recommendations.
2 Price Movements in Major Urban Housing Markets Dissected
2.1 Signs of Overheating in Major Urban Housing Markets
Price-to-income and price-to-rent ratios are commonly used to measure price movements and the degree of overheating (ECB 2011, 2015; ESRB 2015; IMF 2016). The price-to-income ratio is a benchmark for affordability: if house prices rise faster than incomes, owner-occupied properties will, given interest rates, become less affordable. The price-to-rent ratio is, at a given interest rate level, a benchmark for the degree of equilibrium between owner-occupied and rental housing. This equilibrium should be achieved through arbitrage: if house prices rise much more sharply than rents, potential house buyers will be inclined to rent instead of buy.1
Alongside price benchmarks, transaction-related indicators can thus help to determine the degree of overheating. Overheating stems from increasing scarcity in the housing market: when more properties are sold than come on the market, supply shrinks, potential house buyers have less choice and the market tightens. This drives up prices. Another factor is the time it takes to sell a house: quickening house sales could point to overheating. Finally, when selling prices are structurally higher than asking prices, this may indicate the market is overheating.
Price-to-income and price-to-rent ratios confirm this overheating, as they are both substantially above pre-crisis average in the major cities. This is particularly visible in Amsterdam and Utrecht (Charts 3d, 3e); this level has not yet been reached in the rest of the Netherlands. The sharp decline in mortgage rates is an important contributing factor here, and it suggests that prices of owner-occupied properties are rising faster than rents in the private rental sector.
2.2 As Yet no Indications of a Credit-Driven Bubble
Another reason for the lower growth in mortgage credit is that more buyers in major cities are using own funds to help finance their home purchase. Land Registry figures indicate that house sales without an accompanying mortgage in the Netherlands have more than doubled from 8% in 2008 to nearly 17% in 2017. These non-mortgage sales are more common in the major cities. For instance, over a quarter of the transactions in Amsterdam since 2013 were financed without a mortgage at all. The relaxed tax exemption for gifts used for house down payments or mortgage repayments, which was in effect until the end of 2014 (and again since January 2017), has probably contributed to this trend. The number of first-time buyers who did not take out a mortgage peaked in December 2014, while tax records show that gifts made under the relaxed gift tax exemption topped EUR 10 billion in 2013 and 2014. Low interest rates on savings, of course, are another persuasive reason for using personal or family savings to buy a house.
In sum, housing markets in major Dutch cities are showing signs of overheating, but there are no strong indications of a credit-driven bubble as of yet. Despite the tightening urban housing markets, credit indicators currently do not point to a credit-driven bubble. Even after adjusting for repayments, mortgage lending growth is limited and home-buyers are not borrowing closer to the maximum permitted amount than before. Interestingly, the LTV ratios in the cities are in fact lower than in the rest of the Netherlands. Therefore, it seems that price increases are mainly driven by the tightness in the housing market in the major cities.
3 Differences Between the Major Cities and the Rest of the Netherlands
3.1 Demand for Housing
Mainly young people are flocking to the city to study or work, and because of cities’ cultural and recreational offerings. The migration of young people to the cities is partly caused by the higher number of students enrolling in universities and colleges (PBL Netherlands Environmental Assessment Agency 2015). Another reason is that, between 1999 and 2013, the percentage increase in the number of jobs for highly educated persons was many times higher in the cities) than in the rest of the country (Brakman et al. 2015). This has to do with the rise of the service economy and technological developments in logistics and ICT (Parlevliet et al. 2016). In addition, natural growth also plays an important role: the presence of many young people in cities also means that a relatively large number of children are born. Finally, immigration is increasingly driving population growth in the four major cities, as many immigrants go to the large cities in search of work and education, and to connect with communities of the same origin (PBL Netherlands Environmental Assessment Agency/Statistics Netherlands 2016).
Buy or Rent?
Buying is financially more attractive than renting in the Netherlands. Due to mortgage interest deductibility and the current low interest rates, debt servicing costs are currently lower than rents in the private sector. By way of illustration: middle-income households who own their house spend approximately one fifth of their income on debt service, while middle-income private sector tenants spend a third of their income on rent (Netherlands Bureau for Economic Policy Analysis 2016).
But not everyone can live in an owner-occupied property, so there is also a growing demand for rental housing. After the financial crisis, mortgage lending regulation (LTV and DSTI) has been tightened, which means that homebuyers need to muster more own funds. This can be a hurdle for first time buyers, who usually do not have large savings. A more flexible labor market contributes to this growing demand for private rental housing. In 2009, 5% of all home-seekers wanted a rented home in the private sector; by 2015, the figure had risen to 12% (Ministry of the Interior and Kingdom Relations 2016). This flexibility is particularly important for self-employed people and flexi-workers. Evidence suggests that flexi-workers are indeed more likely to prefer rental housing compared to households in permanent employment (Boumeester and Dol 2016). Finally, the limited accessibility of the social rental segment for middle-income earners is also spurring demand for private sector rentals.
3.2 Housing Supply
The Structure of the Dutch Housing Market
The supply of mid-market private rental housing, therefore, falls short of demand in large cities. The non-rent regulated sector throughout the Netherlands has contracted steadily since the 1970s to less than 10% of all homes. This is partly because social rental and owner-occupied housing are subsidized (Whitehead et al. 2016; PBL Netherlands Environmental Assessment Agency 2017). Most Dutch rental housing is owned by housing associations and falls largely within the social segment. The result is a shortfall in the mid-market segment (monthly rent between EUR 700 and EUR 1000), particularly in Amsterdam and Utrecht (Schilder and Conijn 2015).
Obstacles to Increasing Housing Supply
The price elasticity of the housing supply in the Netherlands is very low in an international perspective (OECD 2011; Swank et al. 2002). Saiz (2010) and Hilber and Vermeulen (2016) demonstrate that geographical restrictions constrain the elasticity of supply, and urbanisation leads to price increases. This is the case in the Randstad conurbation: much of the land surface is already built up, and the expansion of some large cities in the Randstad conurbation is impeded by their location on the coast or near green belts shielded by nationally determined zoning restrictions on construction.
Municipalities lack effective incentives for developing private rental housing, partly because they depend on revenues from land development. This makes municipalities reluctant to grant building permits for land they do not own. Moreover, due to mortgage interest relief, land purchased for owner-occupied properties fetches more than land for rental housing. The land price is often determined on the basis of residual value, i.e. the difference between sale proceeds and construction costs. As buying a house is subsidized, owner-occupied housing fetches a higher price than rental housing and thus (assuming comparable construction costs) land prices are also higher for owner-occupied housing. Municipalities must lower the land price in order to make construction of the non-rent regulated housing profitable. However, they will not be keen to sell land for less than the relatively high price they paid themselves (PBL Netherlands Environmental Assessment Agency 2017). Moreover, municipalities will also want to keep existing residents satisfied, who may see new-build developments as contrary to their interests: the so-called NIMBY (not in my backyard)-effect.
Lastly, new-build development has only slowly recovered since the crisis due to capacity constraints. Both builders and municipalities reduced their capacity after the onset of the crisis. By way of illustration: in 2010 still 377,000 people were employed in the construction sector, but since then nearly 80,000 jobs have been lost leading to a shortage of construction workers.
4 Conclusions and Policy Recommendations
The strong house price rises in major cities signal a three-way divide in the Dutch housing market: an overheated housing market in major cities, a buoyant housing market in surrounding municipalities and a lagging housing market in shrinking regions. Indeed, spillovers from major cities put increasing pressure on satellite communities and cause price rises there. And the departure of young people from shrinking municipalities is creating a supply surplus in peripheral housing markets, worsening their plight.
Middle-income earners threaten to become stranded: living in the city is increasingly inaccessible for these groups. Their income is too high for social housing, they face fierce competition in the private rental market and they are not always able to buy a house in the city. As a result, prospective first-time buyers in particular are more or less forced to choose between relatively expensive rental housing in the city and buying or renting a more affordable place outside the city.
Housing supply shortages abound in and near major Dutch cities, and local governments do not always have the right incentives to ensure the right type of housing to be built. Municipalities are constrained by cuts in planning capacity and focus on owner-occupied instead of rental properties. Housing associations, playing a major role on the Dutch housing market, mainly focus on social housing. Therefore, the necessary increase in private rental housing supply does not take off.
The government can encourage municipalities to provide more private rental housing by setting minimum targets and through arrangements about the inclusion of a minimum percentage of mid-market rental housing in their zoning plans. But this is only possible if the land prices charged by municipalities are sufficiently low to make mid-market rental housing profitable. And to ensure that landlords also receive effective incentives, clear arrangements must be made about long-term rental and rent increase caps. Moreover, housing associations can contribute to a larger supply of private rental housing by renting out their more expensive homes in the private sector.
Finally, accelerated phasing out of mortgage interest relief is vital to ensure a long-term level playing field between owner-occupied and rental properties. Social rental housing and owner-occupied properties are both subsidized. Private rental housing is not, which makes it relatively expensive and often unaffordable for highly educated young people and middle-income earners (who are also ineligible for the social segment). In addition, mortgage interest relief means that people can pay more for owner-occupied properties than for rental housing. This gives property developers and municipalities an incentive to concentrate on the owner-occupied market. In 2017, the Dutch government has lowered interest deductibility from a marginal rate of 52% to 37%, effective 2023. While this is a necessary first step, a further phasing out of mortgage interest relief would reduce the subsidy on owner-occupation. This would make it more attractive to build for the private rental market and give municipalities an incentive to include mid-market private rental in their zoning plans.
The effect of interest rates is not fully factored into these benchmarks. Interest rates influence both the price and the financing cost of housing: lower mortgage rates lead to higher house prices but lower financing costs. The price-to-income and price-to-rent ratios do include the impact of interest rates on prices, but not the effect on financing costs (Himmelberg et al. 2005). Our own calculations show, however, that in recent years financing costs have followed a similar pattern to the price-income ratio.
This limit is based on the financing costs standards of the National Institute for Family Finance Information (NIBUD).
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