What is driving up home prices?

3 min readJun 23, 2021

In May 2021, home prices in the Netherlands were 12.9% higher than year-earlier, research by the Dutch Central Bureau for Statistics (CBS) shows. This is the largest increase since April 2001 — yes, the largest increase in 20 years. Compared to the lowest point in 2013, home prices were 66.8% higher.

Being a fresh homeowner myself, stats like these pique my interest but also trigger a feeling of unease. What is driving up home prices to these historical levels?

If you have to believe politicians, it is the shortage of supply, and the answer is in building more homes. But the Dutch Central Bank (DNB) found that the relationship between a shortage of supply and the home price index is actually quite weak (see Figure 2, source: DNB). It is the financing capacity of home buyers that really matters (see Figure 1, source: DNB).

When I think about the financing capacity of home buyers, three components come to mind.

1. Income (growth).

2. Lending conditions applied by mortgage providers.

3. The interest rate.

Starting with income growth: Assuming everything else equal, when people’s income growth is higher than inflation, financing capacity improves. The Dutch CBS showed that incomes in the Netherlands did indeed grow over the past decades (these figures are not compensating for inflation, which has been modest). But we do not see the big movements that would explain the steep increase in home prices.

Lending conditions include elements like the income-to-loan factor: how many times your annual salary can you take out as a mortgage. I believe the current range is around 4–5x. I don’t think there have been any big movements here, either.

Finally, interest rates. Interest rates are at historical lows. In my lifetime, debt has never been cheaper. In the 1990s, interest rates on mortgages hovered around 8%. Today, you can get a mortgage with interest rates of less than 2%. A difference of 4x. Average inflation in the 1990s was also higher than in the past decades, but not 4x as high. Other economic factors come into play as well but the point is that interest rates today are very, very low. Indeed, interest rate movements have been significant and, therefore, are an important factor to watch.

Interest rates are set by central banks, such as the Federal Reserve in the United States and the European Central Bank (ECB). In times of economic crises, central banks typically keep interest rates low, making it attractive for governments, consumers, and companies to take out loans and increase spending. To support the economy during the covid-19 pandemic, central banks did just this.

Everyone, from investors to home buyers, is now eyeing the central banks. Will they be raising interest rates? All else being equal, higher interest rates will reduce the financing capacity of aspiring home buyers. This can be expected to exercise downwards pressure on home prices and may reverse the trend of increasing prices.

The Federal Reserve is expected to increase rates as soon as 2022 in response to higher inflation. As inflation is also picking up in Europe, keep an eye on monetary policy announcements from the central bankers in Frankfurt (where the ECB is headquartered).

You can find this and other stories on my website www.thalein.com.

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What is driving up home prices?

Written by Tim de Rooij