Tuesday, June 26, 2007

Net Migration and the Real Estate Market

by Claus Vistesen

Cross posted from Alpha Sources

I don't know whether you follow my little note scrapbook in the form of Beta.Sources but if you do you will have a noticed that I have begun to compile notes for a paper on housing and real estate markets and demographics. Of course it does not constitute a sensational claim to note that demographics have an impact on the real estate market since over the long term demographics constitute the most fundamental and direct proxy for demand on the market for residental real estate. However, precisely because demographics often is branded as a long term variable it is also often neglected because the long is term is not here yet, is it? Well, I think that we can slowly but surely say that it is and given the pace and lenght by which some countries have moved in the last stage of the demographic transition with fertility levels persistingly and for a prolonged period staying under replacement level we should begin at this point to see some real traces. Having said that, it is also at this point very clear to me, after having read a fair share of articles on the basics of price and demand dynamics in real estate markets, that it is very difficult to distinguish between variables from a statistical point of view. In short; real estate markets exhibit notable heterogenity on a cross-country basis but also within countries themselves and while demographics are undobtedly important so are institutional differences in terms of capital/mortgage markets and cultural specifics/customs.

Now, some of the work I have been doing so and thus data I have been looking at concern the potential impact on the real estate market from net migration which in a macroeconomic context would constitute a positive demand shock for housing and in fact also a positive supply shock from the point of view of the labour market. So far, I have been particularly interested in two countries within the Eurozone which have both experienced important property booms in the last decade or thereabout. The two countries are consequently Spain and Ireland. The main discourse in the broad literature on these two countries is that especially the process, throughout, the 1990s and well into 2000s, of nominal convergence effectively leading to negative real interest rates was what predominantly fuelled the boom in the real estate market. I have a feeling however that there is more to the story than this and especially in the Spanish case this is evident I believe. As such it serves to remember that before Spain had its real estate boom which began in the latter part of the 1990s and really took off from 2000 and onwards was destined to become the oldest society on the planet even surpassing Japan. However, something indeed happended as we shall see in the graph below. Turning to Ireland, the picture is more blurry regarding the importance of net migration and the general demographic environment. Like Spain, Ireland also benefitted hugely from the stimulus of low real interest rates through out the 1990s and in the first part of the 2000s. Perhaps some of you will recall the Ireland being denominated as the Celtig Tiger. As we move along I will have more to say about these two economies and their real estate/housing boom at the end of the 1990s. For now, you should think about a real estate boom as not only a fast appreciation of house prices (and subsequent domestic demand through the wealth effect) but also as a surge in construction as new houses are being built. The two graphs below plot (in real units for both series) net migration and construction of new dwellings/households in Spain and Ireland from 1997 to 2006.



As we can see the correlation is pretty strong. In fact, the correlation coefficient between the time series is almost dubiously strong at 0.89 and 0.92 for Spain and Ireland respectively. However, as we all know correlation does not denote connection/causality but still the remsemblance is interesting. From an economic point of view the correlation is not strange I think since net migration clearly constitutes a de-facto proxy for a demand shock in terms of housing. Another thing which is interesting to ponder is the magnitude of migration especially in Spain. Quite frankly it is extraordinary to see how the country has received a steady inflow of +600.000 people in the last five years, something which without a doubt has a 'facilitated' the extraordinary spurt of domestically driven growth in Spain in the recent 7 years. Turning to Ireland the picture remains largely the same with inward migration being the driver, at least, for a part of the new homes built in the last 10 years. However, if we take a strict demographic perspective it is also clear that Ireland's population structure differs fundamentally from Spain. Quite simply, Ireland is much younger and has not seen its fertility slump to the levels of Spain which suggests that the natural demographic dynamism also has contributed somewhat to the increase in household construction.

This was a first crack at a much larger set of issues and as such some obvious questions are pressing ...

- How do price dynamics square with the perspective above?

- Why have some countries in the Eurozone seen their real estate markets appreciate to a much higher degree than other Eurozone countries given the fact that interest rates after all have been low for all the countries, especially in begininng of the 2000s? Within this question also lies the fundamental question as posed recently by Edward in his notes on macroeconomic adjustment in the Eurozone about whether in fact there is an 'age limit' in terms of whether a country can sustain/experience a housing boom?

- What does it mean (relatively to other countries with comparatively lower rates of real estate appreciation) that Spain and Ireland have a fairly high rate of home ownership? I mean, I am sure this is an important aspect, but how important compared to other aspects?

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