Richard McCreery's Business Editorial

Headwinds soon to buffet the French property market

Richard McCreery's Business Editorial  RLTV 09 Jun 11

Riviera based Independent Investment Adviser, Richard McCreery, has joined the expanding RivieraLife.tv team as Business Editor. Richard publishes an occasional Financial Editorial with informed comment on topical financial matters relevant to residents and businesses on the Cote d'Azur. As the local property market awaits the application of yet another tax on French homes Richard McCreery looks at the drivers of rising home prices and explains why things might be about to get even tougher for homebuyers.

The French property market hasn’t experienced the large drop in prices that countries such as the US, Ireland and Spain have suffered since the beginning of the financial crisis. This is largely to do with the fact that France didn’t have a huge speculative construction boom and it also maintained its relatively conservative lending conditions. Even though prices and transaction activity did fall during the past few years they have rebounded strongly in most areas and one could be forgiven for thinking that there was little long-term impact of the credit crunch. However, the market may merely be enjoying the calm at the eye of the hurricane as several of the key supports needed to sustain rising prices disappear.

Between 2000 and 2008 prices for residential property doubled as credit became widely available and more French people saw that they could buy a home, in spite of the fact that the average salary increased less than 2.5% a year during this period (source: INSEE). Interest rates came down and borrowers were able to obtain larger loans for the same monthly payments by taking longer mortgages – the average length of a mortgage now stands at 20 years compared to 10-15 years before the boom. Lower interest rates and easy credit in other countries also meant that foreign buyers of holiday homes in France boosted demand. The population of France increased by around 5% from 2001 to 2008 which will have added to demand for property and some of this will have been satisfied by construction of new properties but France is hardly short of space, being twice the size of the UK with a similar total population. However, most development has occurred in the heavily populated regions such as Paris and the French Riviera where building plots are more scarce.

Even though the French property market appears to have recovered most of its zest, with prices rising especially rapidly in the Paris region in 2010, it’s possible that it has only enjoyed a reprieve. The signs of excess are still highly visible. The size of the average loan required to purchase a property (€166,239 source: Empruntis.com) has increased 8% in the past year alone and the average deposit needed (€49,071) has doubled in the past 5 years. These national figures also mask the much higher amounts needed in Paris and on the French Riviera. The most striking sign of an overextended market is that the net monthly household income of the average borrower is €4,634, which compares to the average net monthly household income of all French residents of around €2500 (source: INSEE). In other words, only the wealthier section of society is now buying property, the majority of the population doesn’t have the necessary income or capital to borrow enough to purchase the average property.

‘Demand’ remains high in the sense that lots of people want to own property but the actual ability to act on that desire is determined by levels of wealth and availability of financing. In the absence of higher incomes or easier financing the ‘demand’ remains a pipedream for many people.

The boom has been prolonged by government intervention. Interest rates have fallen to record lows, fiscal stimulus has kept unemployment from rising too high and the economy has held up. However, this has come at a substantial cost and events in international financial markets mean that governments are being forced to face up to a reality where debts need to be repaid at the same time as interest rate rises are needed to combat inflation. Many people perceive that property prices are ‘high’ and the factors that have sustained these levels could be unwinding.

Base rates in France were raised in April for the first time since 2008 and this will reduce the amount that someone can borrow for a given level of monthly earnings. European banks are likely to request larger deposits in future years to protect themselves against defaults on mortgages, especially if they are forced to raise capital in the wake of losses on European sovereign debt. Interest-only loans will remain rare and it will become more difficult to extend average mortgage terms much longer due to the combination of France’s low retirement age and the rising age of the average buyer (36 years).

As property prices have doubled, so has the amount spent on transaction fees which rise in tandem. Notaire’s fees (average 3-5% for new properties, 7-10% for older properties) and estate agent fees (up to 7% of the sale price) are expressed as a proportion of the transaction value, so moving house has become an increasingly expensive business. It will be harder and harder to afford these costs, which can’t be financed, in addition to larger deposits and higher monthly payments when interest rates rise.

For Brits the cost of buying in France has increased even more rapidly in recent years because of the weakness of the Pound compared to the Euro. Regardless of the change in property prices a Sterling-based buyer in France will pay 25% more for their Euros than they did a few years ago simply because of the exchange rate. You can’t help thinking that the already-dwindling number of holiday home buyers will either opt to buy in the UK (where transaction costs are also much lower) or in a country where it’s possible to buy at prices 50% down from their peak.

Some French economists are calling an end to the boom and forecasts for property prices from sources without vested interests suggest lower prices could be on the way. In fact just 20% of estate agents believe prices will rise during the next 6 months (source: FNAIM). I believe that, at best, we could see prices stagnate for some time in the absence of widespread pressure on owners to sell because most French mortgages are on long-term fixed rates, meaning that existing borrowers will be shielded from rising interest rates, and France’s generous benefits system means the unemployed are relatively well off. But when you consider the diminishing impact of the factors that drove the boom and the new headwinds facing buyers it is difficult to see how prices can continue to rise much further unless salaries increase significantly, which is unlikely in the current economic environment.

Those with a vested interest in the property industry will tell you that people always want to buy their own home when given a choice between buying and renting, which is true, but without the ability to finance a purchase the number of buyers in the market will shrink and demand will decline, regardless of what people want. The time when all personal desires could be sated with easy credit have passed and an age of austerity is likely to intrude gloomily on the capitalist ambitions of France’s supposedly-socialist property owners.

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