As is well known, the current economic recession has played havoc with the real estate market. This is consistent with other countries' experience, which has shown that financial crises are usually accompanied by plunging house prices, particularly if the crisis follows a housing bubble like that in Iceland.

House prices can be expected to fall still further, reflecting expectations on both the supply side and the demand side of the market. Because of the upsurge in residential housing market activity in the past few years, a large supply of unsold property has accumulated on the market, exerting further downward pressure on prices. This is exacerbated by high - and growing - unemployment and dwindling real disposable income, which the CBI forecasts to contract by 9.7% in 2010 and another 1.6% in 2011.

The CBI's real estate market forecast has remained broadly unchanged for quite a while and has been borne out by market developments. At present, house prices in the greater Reykjavík area have declined by 15.5% in nominal terms, and by 37.2% in real terms, since peaking in early 2008. For the country as a whole, the decline is 13.4% in nominal terms and 35.1% in real terms. These figures suggest that a significant price drop is still in the wings.

Indexed bond yields up
LSS plans to issue bonds for a total of ISK 7-9 bn this year, which is similar to last year's issuance of ISK 8.8 bn. Presumably, LSS is kicking itself for having missed out on the trough in indexed yields a few days ago, for as is well known, indexed bond yields have shot upwards since, in the wake of Tuesday's unexpected drop in the CPI. However, yields on HFF24, which resembles LSS24 in structure, are still very low compared to the past few years, and the final yield in the auction could well prove advantageous for LSS.

Premia on LSS bonds have declined
Market yields on LSS24 have always been rather higher than yields on HFF24 bonds, ever since the former were first issued in the fall of 2008. The spread peaked at 170 last summer and now stands at 100 points, as LSS24s currently yield 4.79% while HFF24s yield 3.78%. Presumably, LSS bonds have benefited from the sparseness of Housing Financing Fund issuance, but now there are more players issuing indexed bonds. At the beginning of the year, the Treasury announced its intention to issue indexed bonds for up to ISK 50 bn in 2010. Added to that are ISK 34-42 bn in HFF bonds, according to the Housing Financing Fund's issuance calendar, and then, of course, the bonds from LSS. However, LSS bonds have become steadily more liquid as the series has grown, which should, other things being equal, lead to narrower spread over HFF bonds.

Surge in new company registrations in 2009