European Economy Economic Briefs Issue 038 | September 2018
CAP
=
(
)
8
+
(
)
+⋯
(
)
=
(
)
(1)
This purchasing capacity represents the value of a
loan at fixed interest rate (i
t
) and maturity T that a
household can sign up to if it devoted to its payment
a constant fraction (k) of its income, where Y
t
is
disposable income per household. Abstracting from
credit frictions (such as down-payments, collateral,
and other credit constraints) and assuming that
demand and supply in the property market balance
out, a simple long-run model relating house prices
t emerges (in logs):(P
t
), o purchasing capacity
ln
(
)
= + ln(
) (2)
17
In Cyprus t
he purchasing capacity of residents
alone may not be the best indicator of the buyers'
purchasing capacity up to 2008, as sales to
foreigners represented about 50% of the market, but
data constraints make it difficult to capture the effect
of foreign buyers in the market. The two main
foreign markets for Cyprus are the UK and Russia,
but considering a weighted average of the domestic
purchasing capacity and that of the UK in euros does
not improve the results (the required data to
construct a Russian purchasing capacity is not
available). Information on sales to foreigners could
also be used but the data only exists from 2004 on an
annual basis and from 2008 on a quarterly basis,
reducing the sample considerably.
Household deposits may also be important to
determine housing demand in Cyprus, as it is a
social custom for parents to save to provide housing
to children. In Cyprus, a measure of purchasing
capacity of households based on income may not be
the best indicator of affordability, as it has been a
social custom for parents to save up to provide
housing to their children, typically when they marry.
As other savings instruments are less developed in
Cyprus, household deposits could also be a good
indicator of housing demand.
Given the importance of the foreign segment of
the market in the case of Cyprus it is also
important to test for the impact of developments
in sales to foreigners. While the foreign segment of
the market was in great part a driver of the boom in
construction investment up to 2007, it is also greatly
responsible for the burst of the bubble. Also, to the
extent sales to foreigners yield now a better yield,
the recovery of the foreign market may also play a
significant role in explaining the recovery. The
number of sales contracts by nationality (foreigners
versus Cypriots) is available from the Department of
Land Surveys of Cyprus. Between 2004 and 2007
the data is annual and has been interpolated to
quarterly, using the seasonal pattern of the quarterly
data, available from 2008 to date.
18
Both the
numbers and the share in total sales have been
considered in the analysis.
A range of other variables may also contribute to
explaining house price developments, including
indicators of housing over-/under- supply. Data
on the house (dwellings) stock is only available on
an annual basis but can be interpolated using
investment in dwellings. The ratio of the housing
stock to population, which has been found to be
significant for other studies, can be used as an
indicator of over/under supply.
19
An increase in this
variable should signal a shift in the bargaining
power towards buyers and point towards a reduction
in prices.
Credit market indicators may also play a role but
the data has its limitations. Conditions in the credit
market can also be important to explain house price
developments as liquidity strapped households may
not afford to buy a house, even if their income is
relatively high, without having access to credit.
20
However, the ECB bank lending survey indicator of
credit tightening has a very short sample in the case
of Cyprus and would limit the estimation sample
considerably. It is possible to use instead credit to
households, which is available for a reasonable
number of years, with the caveat that this variable is
likely to be endogenous to house prices when
housing loans represent a large part of total loans.
This variable has nevertheless proved to be a useful
indicator of house price developments in other
studies, and the endogeneity problem can be
addressed to some extent with the estimation
methodology. An alternative variable, which is
highly correlated with credit conditions, both as a
driver and as a consequence is the ratio of non-
performing loans (NPLs) to total loans. Since in
Cyprus there have been changes in the definition of
NPLs over the sample, we use a spliced series over
the period from 2005Q1, with its caveats in mind.
21
Finally, the unemployment rate can also be used
to proxy for demand constraints.
22
A higher
unemployment rate can signal more inequality in the
distribution of income among households. It also
indicates a higher probability of getting unemployed,
increasing uncertainty over future income flows.