Fundamentals and dynamics of house prices : the case of the Capital Region of Helsinki (1995–2019)

Abstract

This thesis attempts to answer whether house prices are at their long-term equilibrium level, whether house prices converge towards their long-term equilibrium level and what drives house prices in the Capital Region of Helsinki (CRH). Our sample period covers 1995Q1–2019Q4 on behalf of the stability of the estimated coefficients, avoiding the distortion from periods of great volatility and structural changes (financial deregulation during the 1980s and the economic crisis of the 1990s).

This analysis is sustained on Oikarinen’s (2009) life-cycle model, although keeping an eye on other relevant research (e.g., Meen 1990, Hort 1998, Meen 2002 and Oikarinen 2007). We run Johansen cointegration test to test for cointegration relationships and thereafter we estimate three different Vector Error Correction Models. Thus simple, these models capture the fundamentals underlying house prices in the CRH. The demand side of the housing market is catered by the real rental price determinants (such as aggregate income and some demographic variables), the real user cost and a loan stock variable. Construction costs and housing stock (real rental price determinant) cater for the supply side of the market.

Demand side fundamentals, aggregate income (and therefore, demographic factors), loan-to-GDP ratio, lagged house prices and real user costs are driving house price in the Capital Region of Helsinki. Supply side fundamentals are proven irrelevant as house price determinants. Based on our “best-fitted” model, results suggest the existence of a long-term relationship among house prices, aggregate income (and therefore demographic factors) and loan-to-GDP ratio. Whereas in the short-term, only lagged values of house prices and real user cost show short-term causality on house prices.

We find that lagged values of house prices are far from following a random walk process. As DiPasquale and Wheaton (1994) state. The three models show short-term causality between lagged values of house prices and current prices. Estimated income elasticities, range from 0.492 and 0.697 and loan-to-GDP ratio elasticities range within 0.237 and 0.302, in line with previous research in Finland (see e.g., Takala & Pere 1991, Barot & Takala 1998 or Oikarinen 2009).

Moreover, this thesis’ results suggest that house prices converge towards the long-term equilibrium level. Real house prices converge, albeit at a slow pace, about 4.5–6.8% a quarter. Results are in the line of previous research conducted in Finland (see e.g., Takala & Pere 1991, Barot & Takala 1998 or Oikarinen 2009). Hence, the assumption of market clearing in housing markets has to be relaxed as some authors suggest (see e.g., Case & Schiller 1990, Mankiw & Weil 1989). Some degree of inefficiency in housing market describes better why market prices are sluggish in CRH.