The real estate market was one of the major causes of the recent financial crisis. Specifically, the mortgages were repacked in complex derivatives to gain huge profits for the investment banks. Unfortunately, this did not work, because the complexity was too great and even the banks that traded the mortgage derivatives, called collateralized debt obligations (CDOs), did not know what CDOs were doing and how exactly did they work. This led to some bankruptcies in the banking sector, Lehman Brothers being the most famous example. But, nowadays in 2016, eight years after the financial crisis, the real estate market prices are rising again. Will this lead to another bubble that creates a financial crisis? I will look at this phenomenon with the focus on the Amsterdam real estate market.
The real estate prices are rising very quickly in Amsterdam and they are approaching the danger zone. The market is overvalued, as has been proven by a research of the UBS. According to the analysts of the UBS, it is due to the fact that the European Central Bank (ECB) uses a money-expanding policy called quantitative easing. In almost all European capital cities, including Amsterdam, the real estate prices are above the level of 2007, which is the same price level when the crisis started. The central banks have three folded the money supply since that time and, as a result, the real interest rate has strongly declined. This, in turn, meant that the deflation was not as high as usual. Moreover, the mix of favorable economic circumstances, expectations and capital inflow from countries outside Europe caused the rising inflation in the recent years. Analysts state that all of this could lead to a next crash in the financial markets.
The real estate market in Amsterdam is ranked sixth in the world at this moment. Housing prices in Amsterdam declined by 25% between 2008 and 2013. But, since 2013, the housing prices have risen again by 11%, despite the fact that incomes were stagnating. Housing prices in other parts of the Netherlands are not following the trend of Amsterdam. Additionally, the historical low interest rate led to a block in the debt reduction.
But what exactly is a real estate bubble and how does it arise?
A real estate bubble is an economic bubble that appears periodically in real estate markets. This phenomenon is characterized by the rapid increase of the taxation value of real estate. Examples for these real estate are houses, office buildings etc. It is fueled by demand, speculation and the belief that the recent history is a good forecast for the future. It usually starts with an increase in demand (a shift to the right in the demand curve), taken into account that supply of real estate takes a relatively long time to increase.
Speculators enter the market, believing that profits can be made through short-term buying and selling. This further drives the increase of demand. At some point, demand decreases (a shift to the left in the demand curve) or stagnates, while at the same time supply increases, resulting in a sharp drop in prices.
The supply is slower because it is affected by the speed of construction. Constructions can be very time consuming, especially for the huge office buildings. This drop is a bubble that bursts.
To explain the theory a little more, I will give an example.
The effect of this bubble is already being seen in the real estate market. Hopefully, it will not lead to another financial crisis, but this effect is more adaptive, because the people who live in Amsterdam are affected directly.
As mentioned before, the housing prices in Amsterdam are rising much faster than the ones in the other parts of the Netherlands. The reason for this can be derived from the fact that the population growth in Amsterdam is higher compared with, for instance, the cities in the neighborhood of Arnhem or Rotterdam. Amsterdam also has a lot of students and these are likely to stay here after graduation. Moreover, other people that are willing to have a good job are also coming to Amsterdam. Therefore, they decide to leave the rural areas and settle in the capital city instead. The business center of Amsterdam, the ‘Zuidas’, is definitely an important factor. It is still growing and many notable international companies, such as Royal Bank of Schotland, Baker and McKenzie, Akzo Nobel and other huge firms are located at the ‘Zuidas’.
The attractiveness of Amsterdam as a city to live in will lead to higher prices because of increased demand, especially prices in the center of Amsterdam or near the ‘Zuidas. To illustrate this in numbers, the average price per squared meter in the center of Amsterdam is more than €5000. The price per squared meter in the ‘Zuidas’ is more than €3000. These numbers are quite high, especially compared with rural areas.
To find an answer to the increasing demand, more houses are being built in Amsterdam. However, a house is not built in one day or one week and, as a result, when the houses are finished, the demand could already have declined, thus causing prices of real estate to decline
Concluding, you can say that we have a housing bubble in Amsterdam right now. The prices are rising rapidly and it also includes the rental prices. This could mean that ‘normal’ working people cannot afford the houses anymore. This is already happening in London, where the traffic is horrible due to the fact that so many people are travelling from areas outside the city to its center. In Amsterdam, it seems that this is also going to happen. Unfortunately, there is not a single solution to the real estate bubble in Amsterdam. That is why it is very important to pay attention to it and be careful when buying a house, especially when buying it for an investment purpose. If we do not do that, we might have to fear a second financial crisis.