Are Swedish House Prices Too High? Why the Price-to-Income Ratio Is a Misleading Indicator

Appropriate indicators of housing valuation are important for macroprudential policy and assessments of risks to financial stability. Overvalued housing may result in a correction and a fall in house prices. This would weaken households’ balance sheets, reduce the collateral of mortgages and covered housing bonds, and threaten financial stability. According to ECB and the European Systemic Risk Board, Swedish owner-occupied housing (OOH) was overvalued by about 55% in 2021q2, the largest overvaluation in the EU and EEA; according to the European Commission, by about 30% in 2022. These assessments affect warnings and recommendations issued for Swedish economic policy and the shocks in EBA stress tests of Swedish banks. But these large overvaluation assessments are due to the use of misleading indicators: the deviations of price-to-income (PTI) and price-to-rent ratios from their historical averages. It is shown that according to the appropriate indicator, the user-cost-to-income (UCTI) ratio, Swedish owner-occupied houses have since 2010 instead become increasingly undervalued (not overvalued), by about 30% in 2019q4. Due to rising mortgage rates, they are less undervalued in 2023q2, but still about 20%. For Sweden, the UCTI and PTI indicators are in fact strongly negatively correlated and have opposite signs. If the UCTI indicator is right, the PTI indicator is consistently wrong. The PTI ratio disregards mortgage rates and other housing costs and lacks scientific support. According to a large housing literature, it is not the purchase price but the user cost that is the appropriate measure of the cost of living in OOH, the cost of the housing services that the OOH delivers. New improved estimates of the user cost are constructed, including an adjustment for a preference shift during the coronavirus crisis in favor of larger and better housing. The valuation assessments of the ECB, the ESRB, the Commission, the OECD, and the IMF are scrutinized and compared. The problem of misleading indicators and overvaluation assessments—and resulting distorted warnings and recommendations—is not restricted to Sweden but concerns several other countries in the European Union.