IN FRANCE, RESIDENTIAL REAL ESTATE HAS PEAKED

REAL ESTATE MARKET ANALYSIS

From Paris to Bordeaux, via Lyon, the housing market has begun to tighten, and the outlook is gloomy(see Chart of the Week). While prices of houses and flats are stagnating in the existing sector, they arealready falling in the new-build sector. In recent years, the property market has been characterised bylimited supply and strong demand. This phenomenon was amplified during the Covid-19 pandemic, whenthe shortage of materials on the one hand and the need to live comfortably on the other gave sellers anexcessive advantage over buyers. Between 2019 and 2022, residential property prices in France rose by 20%.

Today, as during the Great Financial Crisis (GFC) of 2008, a balance between supply and demand canonly be found if prices fall. There are many reasons for this :

▪ House prices were too high. As we analysed in our previous study (see WIF, 4 July 2022), house priceshave reached levels that are inconsistent with household disposable income. After hitting a centuryold record, the ratio has only erased a small part of the accumulated excess (see Fig. 2). Thecomparison with rents is no rosier and highly unfavourable to property purchases (see Fig. 3).

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Fig. 2 - House prices / household income

Fig. 3 - House prices / annual rents

▪ Household purchasing power erodes with inflation. The average hourly wage in France rose by 5.2%between March 2022 and March 2023, slower than the consumer price index, which rose by 6.7% overthe same period (see Fig. 4). What's more, property developers have the contractual ability to pass oninflation in building materials to purchasers if their prices rise relative to the initial estimate. As aresult, the final selling prices of new homes have soared. Some households are unable to cope withthese unforeseen costs and the resulting higher monthly payments. Faced with this difficulty, somehave no choice but to sell their new home.

▪ Lending conditions have tightened in two ways. On the one hand, mortgage rates have risen from1% to 3.5% in the space of 24 months (see Fig. 5) and, on the other, banks' requirements forgranting mortgages have tightened. Faced with the growing risk of non-performing loans, banksare asking borrowers for more collateral. In June 2023, French banks issued 41% fewer mortgagesthan a year earlier

▪ The initial deposit required to buy a property is higher than in the past. Not only have propertyprices risen, automatically increasing the amount of the downpayment, but this now has torepresent almost 35% of the property, compared with 5% four years ago. In the event of a forcedsale of the property in deteriorated conditions, the creditor thus increases the probability ofrecovering his capital.

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Fig. 4 - Household purchasing power

Fig. 5 - Average mortgage rate

Beyond theoretical arguments, the deflation of the housing bubble is a reality. Let's take an example:

▪ In 2019, an average French household wishing to buy a property worth €218,274 would have had tomake an initial deposit of €11,040 and could have borrowed €207,234 from their bank at 1.2% over25 years. At maturity, after paying 31,884 euros in charge of interest, the property would have cost250,158 euros (see Fig. 6).

▪ In 2023, the same property is worth €258,000 but, in view of the rules governing the granting of loans,the bank will ask him for €89,422 as a deposit and will only lend €168,075 at a rate of 4% over 25years, for a final cost of €355,570, including €98,073 in charge of interest.

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In four years, as a result of soaring property prices and rising interest rates, households' borrowingcapacity has fallen by 19% and therefore their capacity to purchase property by 30%.

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Fig. 6 - Average property purchase in France and financing sources

Although house prices are falling across most of France, there are major disparities between thedifferent administrative regions (see Fig. 7). While prices are falling significantly in Bordeaux, Lyon, andParis, they are resilient in cities that are highly attractive, such as Nice and Marseille, or that are catchingup, such as Strasbourg.

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Fig. 7 - Property prices, by administrative regions and in the main cities

Other factors will amplify the housing market correction:

▪ Rising unemployment. As new jobs give way to layoffs, household incomes will fall. Their ability tobuy new homes or repay existing mortgages will weaken. The weakness of demand will accentuatethe downward pressure on property prices

▪ Market sentiment is turning from optimism to pessimism. Until recently, and given the rise in lendingrates, buyers were looking to make the move quickly. Now, 7 out of 10 say they want to postponetheir purchase plans. They are hoping for a fall in interest rates or property prices.

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The main victims of this problem are first-time buyers. They now account for just 27% of buyers,compared with over 50% previously. In most cases, floor space is the adjustment variable. To be able togo through with their property purchase, they would buy a room or two less. Tomorrow, they will haveno choice but to drive down the cost of the property they want... either by moving away from theirpreferred location, or by giving up some of the usual luxury of home comfort options (refurbishmentworks), or by persuading sellers to give them a lower price.

As unpleasant as it may seem, this housing cycle is relatively classic. It took almost seven years for thebubble to form, and it is deflating in stages:

1- By early 2022, house prices had stopped rising.

2- In the second half of 2022, as sellers refused to lower their prices and buyers no longer had the samefinancial resources, transactions dried up. What's more, some homeowners were reluctant to movebecause selling their home to buy a new one would have involved a much more expensive mortgage

3- In the first few months of 2023, there was a wait-and-see attitude: sellers were hoping for a recoveryin the market, while buyers had become cautious as the property crisis made headlines. With thesupply of existing homes low, new buyers were turning to new builds.

4- Today and for the next 18 months, some sellers, those in a hurry, are accepting a discount and startingthe wave of price falls. For the others, it will be a race to lower prices, with the aim of staying one stepahead and avoiding a heavy loss.

5- At the end of the cycle, some homeowners will be forced to sell at a loss, creating a general mistrustof residential property investment among households and putting the brakes on the market's futurerecovery. It will be time to buy.

Conclusion:

A 20% fall in house prices would be needed, assuming a constant interest rate environment, to enablebuyers to obtain a loan and thus become homeowners. Without this, the property market will remainfrozen.

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RETURN ON FINANCIAL ASSETS

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