[Viewpoint] Housing Prices Likely Entering a Downturn in the Economic Cycle

Kim Young-ik, Adjunct Professor at Sogang University Graduate School of Economics

Since hitting a low point in March 2009, housing prices, centered on apartments, have been rising for 11 consecutive years. However, looking at the macroeconomic variables that determine apartment prices, it seems highly likely that the upward trend in housing prices will slow down or decline in the future.

The macroeconomic variables that determine apartment prices include the stock market (KOSPI), household loan interest rates, the amount of household loans by financial institutions, and the coincident index cyclical component. By constructing a vector autoregression model, a statistical analysis method, with these variables and performing variance decomposition, it is possible to identify which economic variable has the greatest impact on apartment prices.

First, apartment prices depend on their own trend in the short term. For example, the change in apartment prices one month later is explained 98% by the price of the previous month. This means that if apartment prices rose last month, it is highly likely that apartment prices will also rise this month. Even up to six months later, 90% of the variation in apartment prices is explained by their own past values. However, this explanatory power drops to 73% after one year and 50% after two years.

As time passes and the explanatory power of apartment prices themselves decreases, the explanatory power of other economic variables increases. Household loan interest rates and the coincident index cyclical component were analyzed to have higher explanatory power than other variables. Household loan interest rates explained 6% of apartment price changes from six months later and increased to 8% after one year. The explanatory power of the coincident index cyclical component, a representative variable indicating the current economic situation, rose from 0.5% at six months to 9% after one year, and significantly increased to 32% after two years. This means that over time, the most important factor determining apartment prices is the economy.

The household loan interest rate, which determines apartment prices, has been moving around an all-time low of about 2.5% since August last year. Considering it was 7.8% in October 2008, this is a dramatic change, but it is likely to fall further. Interest rates incorporate future economic growth rates and inflation rates. Due to factors such as a decline in labor, our potential growth rate is expected to fall to the 1% range soon. The GDP deflator, which represents the overall price level of the national economy, has been falling for five consecutive quarters from the fourth quarter of last year to the first quarter of this year, indicating increasing deflationary pressure. Additionally, with more savings than investments, a surplus of funds continues, and as loan demand from households and businesses relatively decreases, banks are purchasing bonds.

Theoretically, when interest rates fall, asset prices such as stocks and housing prices rise. However, since 2016, reality has differed from theory. The correlation coefficient between interest rates and stock prices is positive and very high at 0.81. This means that even if interest rates fall, if another factor determining stock prices, corporate earnings, declines further, stock prices fall. A similar pattern appears between housing price growth rates and interest rates, with a lower correlation coefficient of 0.21. This suggests that an era has arrived where stock and housing prices rise only when interest rates increase.

According to the Statistics Korea's reference cycle dates, the Korean economy has been in the longest contraction phase in its economic cycle history since peaking in September 2017. Especially due to the impact of COVID-19, major economic indicators representing the current economic state, such as the coincident index cyclical component, have sharply declined since March, deepening the recession. The leading index cyclical component, which predicts future economic conditions, has also continued to decline through May. According to my forecast, a full rebound will only begin in the second half of next year.

Housing prices continue to cycle along with economic variables. Even when extracting the medium- to long-term trend of apartment prices, the current phase is one of slowing growth. Soon, the level itself is expected to decline. Just as apartment prices fell sharply from 2010 to 2013, leading to the term "reverse jeonse" (a type of lease), housing prices repeat cycles.