Arion Research

January 2019

The Icelandic Housing Market:

Finally levelling off

- Increasing supply, slower population growth

and tighter credit

• Completed residential buildings and the number of residential buildings under construction in the

capital area has increased rapidly in the last year. At the same time housing price increases

have slowed down. Expectations of increased supply have undoubtedly contributed to

moderate price increases.

• Recent economic developments, with the troubled airline industry at forefront, all point to slower

growth ahead, giving reason to slower population growth than in previous years. Slower

population growth and increased housing supply means that the housing shortage will

decrease throughout the forecast period. This development should subdue housing prices.

• Credit growth has rapidly increased in recent years, as mortgage rates have come down to

their lowest level in documented history. Only last year net bank lending to households and

businesses amounted to around 350 bn.ISK. However, a turning point has been reached as it

looks like the banks' credit growth this year will be considerably lower along with tighter

credit terms. Signs of this can already be seen in lower LTV ratios and deteriorating terms of

additional loans.

• We forecast minor nominal housing price increases throughout the forecast period, but

the rate of increase will slow down as time goes on. Real prices will fall as soon as this year as

inflation continues to climb. According to our forecast, the imbalance between housing

prices and wages will slowly correct itself.

2

Summary

Sources: Registers Iceland, Arion research3

The rollercoaster ride coming to an endHousing price increases have slowed down in the past 18 months. Housing prices in the capital area increased

by 6.2% in 2018, compared to 18.9% increase in 2017.

0%

5%

10%

15%

20%

25%

30%

2014 2015 2016 2017 2018

Housing prices- YoY %-growth

Capital region - multi family dwellings Capital region - single family dwellings

9831112

1392

1725

2243

0

500

1000

1500

2000

2500

2014 2015 2016 2017 2018

Yearly supply of residential housing- new, finished residential housing per year

Capital area Rural areas Municipalities at the periphery of the capital area

Sources: Register Iceland, Arion research4

Moving to the country, going to pay a lower priceRelatively speaking, municipalities close to the capital area, i.e. in 45 minutes drive or less, are the main driving

force behind supply increases in 2018. More and more people are choosing to live close to the city, not in the city

itself, both due to high housing prices and tourism related job opportunities.

The real economy indicates that further construction is underway

5

98

364

385

0

50

100

150

200

250

300

350

400

1988 1993 1998 2003 2008 2013 2018

Building cranes - number of

Sources: Statistics Iceland, CBI, Arion Research

The building crane index has never been higher, cement sales have increased and more and more

are working in construction

0

50

100

150

200

250

300

350

400

19

95

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

20

16

20

18

Cement sales- index

Cement sales 12 month MA

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

Jan-0

8

De

c-0

8

No

v-0

9

Oct-

10

Sep-1

1

Aug-1

2

Jul-1

3

Jun-1

4

Ma

y-1

5

Apr-

16

Ma

r-1

7

Feb

-18

Number of employees in construction

Sources: Statistics Iceland, Arion Research6

Nearly 9,000 new homes in three yearsAccording to our residential housing investment forecast, nearly 2,600 residential buildings will be completed this year. This is the highest number since before the financial crisis. Furthermore, the number of projects that began last year has probably never been higher.

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2015 2016 2017 2018 2019 2020 2021

Completed residential buildings per year- in the whole country

Forecast

Slower population growth + increased supply = the housing

shortage decreases

7

If our forecasts of increased residential housing supply and slower population growth are combined, one can see that the number of

people per home starts to decline, for the first time since 2010. This of course implies that a certain group is waiting on the sidelines

for the opportunity to enter the market when circumstances allow.

Sources: Statistics Iceland, Arion Research

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

20

21

Population growth

Total population 22 years old and older

Fo

rec

ast

1.55

1.60

1.65

1.70

1.75

1.80

1.85

2.20

2.30

2.40

2.50

2.60

2.70

2.80

Number of people per home

Number of people per home (l.axis)

Number of people 22 years old and older per home (r.axis)

Fo

rec

ast

Sources: Register Iceland, Statistic Iceland, Central Bank of Iceland, fasteignir.is, Arion research8

Price of residential housing has increased more than average

income…

...while mortgage rates have decreased. Because of lower interest rates, monthly mortgage payments have not

increased as much as housing prices

0%

1%

2%

3%

4%

5%

6%

7%

0

100

200

300

400

500

600

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Housing prices, average income and mortgage rates

List price per square meter Average income of all individual over 16 years of age

Lowest rates available indexed mortgage rates of pension funds, r.ax. Lowest rates available indexed mortgage rates of banks, r.ax.

Sources: Central Bank of Iceland, Arion research. * Desember figures for pension funds haven´t been published9

Who is lending households?Banks and pension funds are the main lenders

0

50

100

150

200

250

2013 2014 2015 2016 2017 2018*

New mortgages to households- in billion ISK

Banks Pension funds

Sources: Central Bank of Iceland, Arion research10

Since 2018 key interest rates have increased by 25 bpsHowever, mortgage rates (banks) have risen more sharply and started rising long before the CBI

hiked rates

25 pkt

58 pkt

80 pkt

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18

Key interest rates and mortgages rates (banks)

Key interest rates Lowest mortgages rates Fixed rates 5Y

Limited scope for loan growth

11

Since 2017 loan growth in the Icelandic banking sector has exceeded GDP growth following period of negligible real growth. In 2018

net domestic bank lending to households and businesses amounted to 350 bn.ISK. Strong balance sheet growth coupled with

sizeable dividend payments and tighter capital buffers lead us to the conclusion that the current leeway for loan growth now amounts

to 150-200 bn.ISK (in picture below estimated at 180 bn.ISK).

Sources: Central Bank of Iceland, Statistics Iceland, Arion Bank, Islandsbanki and Landsbanki Q3 reports, Arion Research. * Maximum loan growth

given full utilization of capital base based on capital requirements as decided by legislation, FME and the bank´s themselves.

569 607

2,654

2,833

0

500

1,000

1,500

2,000

2,500

3,000

RWA and capital requirements of the three largest banks*

4,7x

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2013 2014 2015 2016 2017 2018

Domestic bank´s outstanding loans- trailing 12m change by type of lending

Businesses Households Nom GDP Growth

Sources: CBI, Registers Iceland, Arion Research12

Leverage ratio of home buyers has been rising since 2014Although leverage ratio was at its highest last year the price increases are getting more marginal

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2013 2014 2015 2016 2017 2018

Leverage in residential housing purchasing and housing prices

New loans by banks and pension funds in ratio to turnover (l.axis) Housing prices, YoY (r.axis)

Sources: Registers Iceland, Arion Research. * The report was published in January 2018. 13

(Almost) spot on!Housing price has developed in line with our expectations. In our previous report on the housing market* we

forecast 6.6% price increases in 2018. According to the actual figures housing price increased by 6.2%, when

comparing annual averages.

90

95

100

105

110

115

120

125

Forecast and actuals- nominal price, index = 100 in January 2017

Housing price index Arion Research's forecast from January 2018

A forecast is only as strong as its weakest link - assumptions

14 Sources: Statistics Iceland, Arion Research

If the assumptions that the forecast is built on are incorrect, the forecast is likely to be incorrect. The main

variables in our housing price model are listed below. The forecasts for these variables are mainly based on our

Economic outlook from the end of October.

0%

2%

4%

6%

8%

10%

12%

20

15

20

16

20

17

20

18

20

19

20

20

20

21

Wage index- YoY %-growth

Forecast

-5%

0%

5%

10%

15%

20%

25%

20

15

20

16

20

17

20

18

20

19

20

20

20

21

Residential housing investment

- YoY %-growth

Forecast

0%

1%

1%

2%

2%

3%

3%

4%

4%

5%

20

15

20

16

20

17

20

18

20

19

20

20

20

21

Population growth- YoY %-growth

Forecast

We expect minor nominal price increases

15

The rate of increase will slow down as time goes on. Real price* will fall as soon as this year as inflation

continues to climb. According to our forecast, the imbalance between housing price and wages will slowly correct

itself. Equilibrium on the horizon?

Sources: Registers Iceland, Arion Research.* Real prices are calculated using CPI.

-5%

0%

5%

10%

15%

20%

2015 2016 2017 2018 2019 2020 2021

Housing prices- YoY %-growth, between annual averages

Nominal Real

Forecast

80

90

100

110

120

130

140

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

20

21

Housing price relative to wages

Housing price relative to wages Average

Fo

rec

ast

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