As both demand for premises and rent levels have remained relatively unchanged, it is therefore likely that the price upturns in recent years are due more to a decline in investors’ required rate of return. The required rate of return depends partly on the yields on long-term government bonds, as these function as a risk-free alternative to investment in property. The required rate of return also depends on how much investors demand in compensation for investing in higher risk assets, such as property, that is, what risk premium they demand. Interest on government bonds rose in total during the first quarter of the year. All other things being equal, t his should raise the required rate of return. However, over the past year the required rate of return has fallen. This could either be due to investors expecting rents to rise in future, or that they have demanded a lower risk premium. A lower risk premium is in itself not surprising. The risk premiums on a number of different assets have fallen around the world in recent years. But as for a number of other markets, there may be reason to wonder whether the low risk premium on office premises is reasonable. However, one must remember that property companies have had very strong profit growth in recent years. Unlike the crisis years, property companies currently have much better margins to manage some dampening of prices. I therefore do not believe at present that developments in the commercial property market comprise any threat to financial stability.
In the United States it is common that the bonds issued by institutions are tied to different parts of the credit portfolio, which have different risks. These types of instrument have been an attractive investment for many investors in recent years, as the return on more traditional investment instruments, such as government bonds, has been considered too low. The high demand for the higher risk parts of the portfolio, which includes subprime, have meant that the banks’ financing costs for the higher risk loans have declined in recent years. This may have encouraged the rapid growth in the subprime market in the United States. The US method of securitisation is very rare in the Swedish mortgage market. In Sweden, mortgages are traditionally financed through the institutions and banks  4  BIS Review 56/2007  issuing bonds with the total assets as collateral. If a Swedish bank were to have a larger percentage of loans with poorer credit ratings, it would mean that the total financing cost would rise. Although the market for subprime in Sweden is currently small, it is conceivable that it could grow with time. Essentially, this is a positive development as it enables more households to enter the housing market. More types of mortgage do not necessarily mean that credit management in mortgage institutions will deteriorate.