Something is rotten in the state of Sweden. That something is housing — or, more accurately, the lack of it.

The shortage is leading to record home prices and a homebuilding boom as cheap credit lures consumers, unable to find affordable rental properties, into the housing market.

Real house prices in Sweden have risen by more than 200% since the mid-1990s, according to a financial stability report for the second half of 2016 by Sweden's central bank, The Riksbank. Prices of tenant-owned apartments in the country's largest city, Stockholm, have increased by more than 600% in that time.

The Swedish capital has felt the impact of the housing shortage most severely, along with Gothenburg and Malmo, the country's second and third largest cities, respectively. These metro areas have been the focal points for surges in Sweden's rates of urbanization and immigration, which have been among the highest in Europe in recent years.

Stockholm's population increased by 1% in 2016, according to a report by Stockholm Business Region, building on a roughly 20% increase between 2005 and 2015. A large portion of the 163,000 immigrants who entered Sweden in 2016 — 100,000 more than in 2000, according to Statistics Sweden — settled in Sweden's three largest cities. And of all European countries, Sweden has been among the most welcoming to asylum seekers, with 162,877 applications for asylum received in 2015 before a change in government policy cut that number by 80% in 2016.

But this recent upsurge in demand is only part of the Swedish housing shortage story. As the eye-watering growth in Swedish house prices since the mid-1990s suggests, the country's supply-demand imbalance is not a recent phenomenon.

The country's reluctance to build new homes in the last quarter-century is partly the legacy of the collapse and subsequent bailout of Sweden's banking system after a housing bubble burst in 1992. But even in the decades before that, the country tended to keep a very tight lid on housing development.

"Sweden has always been a country that produces very little in the way of new residential, new condominiums," Joachim Pelles, national director at JLL Capital Markets Sweden, said in a telephone interview with S&P Global Market Intelligence from his office in Stockholm.

One of the policies that is exacerbating the problem stretches back to just after the Second World War, an analyst at one of Sweden's largest banks, who declined to be identified because he was not authorized to speak to the press, said in an interview. Sweden has no buy-to-let market, as most other countries would understand it, due to the ownership structure of tenant-owned apartment blocks. These buildings are run as cooperatives, which give tenants a share in the building and the right to live in a specific unit.

But the renting out of these units is restricted under certain conditions and limited to a period of about two years. With small investors prohibited from making reliable returns over the long term from the rental of these properties, the potential demand for new supply from this section of the market has been quashed.

The restrictions have been eased somewhat in recent years since Sweden's last conservative government, which was voted out of power in 2014, tried to introduce a buy-to-let market, Pelles said. "But you still can't let your apartment just because you make money doing it," he added, largely because the last government "screwed up the legislation."

Another legacy of Sweden's post-war efforts to develop a more equal society — known as "Folkhemmet" or "the people's home" — is rent regulation, which applies to both municipal and privately owned properties. While millions of Swedes have benefited from the highly affordable rent levels set since the 1960s, the caps have had a damaging effect on the provision of new housing.

Historically, the low returns from rents for private landlords have made the investment case for building new rental properties difficult to justify, the Swedish bank analyst said.

Newly built, privately developed apartments by commercial landlords such as Wallenstam AB and Fastighets Balder AB can be leased at close to market rates when first put on the market, but rent increases are capped each year thereafter. Rents on apartments built in the '60s and '70s may have only ever seen 1% to 2% annual increases — and often only after protracted negotiations between the owners and tenant institutions, a second real estate equities analyst at a Swedish bank said in an interview. The analyst also declined to be identified because of company policy.

Swedish authorities aren't oblivious to the barrier rental caps pose to prospective developers of rental properties. Discussions have taken place about deregulating rents in Stockholm, in particular. But the issue is a political hotcake. "The risk for a politician is you will struggle to win reelection if you deregulate housing rent," said Simen Mortensen, real estate equities analyst at DNB Capital Markets.

The love for rent-capped municipal properties among the Swedish people is strong. Almost 500,000 people were on Stockholm's waiting list for public housing, according to figures released in 2015, double the number from seven years prior. In 2014, the average waiting time to get an apartment in Stockholm was 9 years. Once a person is given an apartment, they often stay there for life. "People are sitting in 300 square-meter apartments because they are so cheap that they can't leave them," said Pelles.

Resistance to the rent deregulation that would encourage more movement in the housing market also comes from some surprising quarters, such as the real estate industry. If the existing stock is put to much more efficient use, the demand for new real estate shrinks considerably.

"The worst thing that could ever happen as a residential developer is if someone did anything about rent control. Because that would mean there would be a lot of output into the market — and the existing stock is 99% of the market," said Pelles.

Inefficient use of the existing stock is a major contributing factor to Sweden's housing crisis, said Mortensen. But rent-capped municipal properties aren't the only culprit when it comes to failing to get the most out of what's available. The equivalent of a capital gains tax on the sale of properties is also discouraging many prospective sellers from downsizing their residences. "Old widows have large houses because they don't want to pay the tax," Mortensen said.

For all those on waiting lists for rent-capped municipal properties, the options are limited. Renting an apartment from a private landlord is simply unaffordable for many, Pelles said. "They are so expensive that they are more or less poverty traps. If you rent there you will never be able to save enough money to get out of there."

This combination of factors restricting the supply of rental properties has left many in Sweden with only one option: buying a property. While normal economic circumstances would usually leave home ownership out of reach for many people, it has become a viable alternative. Consumer borrowing costs have stayed at record low levels off the back of The Riksbank's negative interest rate policy, which has been in place since 2014.

"Many people, if they have the chance, they will buy," said Pelles. "But it means that they will be heavily in debt when they buy. The options are really, really poor."

Still, the demand from buyers newly flush with cash has gone some way to bringing new supply to the market. Rising home prices have made more pieces of land financially viable for residential development. More than three times as many homes were under construction in Sweden in 2016 than four years earlier, according to a forecast from Sweden's National Board of Housing, Building and Planning.

Despite the newfound hunger for residential development — led by JM AB, which has 40 residential multi-unit properties under construction — the taps on supply aren't fully open. "In Sweden, bringing up new zoning plans takes a lot of time and that process is tedious and slow," says Pelles. "Usually that takes between 3 to 5 years."

The number of residential units under construction is expected to rise to almost 70,000 in 2017. Despite the progress, that will still fall short of the 88,000 construction starts per year needed between 2016 and 2020 to meet demand, the National Board of Housing, Building and Planning estimates.

After decades of undersupply, though, a rebalancing of the Swedish residential market is slowly taking shape. Whether the current forces driving the shift are sustainable is another matter.

"All we know is that so far, if we look at demographics, the undersupply will probably provide a pipeline for several years to come without any serious disruption," said Pelles. "But, of course, no market ever progresses without disruption."