Estonian real estate market the day after

Estonian real estate market – the day after housing boom Angelika Kallakmaa Ene Kolbre Tallinn University of Technology

According to the data of Global Property Guide Estonia was 2006 the leader of the global house price boom Estonia was followed by Denmark, Norway and Ireland Tallinn University of Technology

Housing price bust Equity price busts occurred on average every 13 years, lasted for 2 1/2 years, and were associated with GDP losses of about 4 percent of GDP Housing price busts were less frequent, but lasted nearly twice as long and were associated with output losses that were twice as large, reflecting greater effects on consumption and banking systems, which are typically heavily exposed to real estate (IMF World Economic Outlook, April 2003, When Bubbles burst) Tallinn University of Technology

Economic indicators and forecast 2006 2007 2008 2009 2010 2011 Real GDP growth (%) 10, 4 6, 3 -3, 6 -12, 3 0, 2 4, 7 Real private consumption growth (%) 12, 8 7, 8 -4, 0 -9, 5 -1, 7 4, 7 Unemployment rate (%) 5, 9 4, 7 5, 5 12, 8 13, 7 12, 5 Real wage growth (%) 11, 6 3, 3 -4, 7 -3, 2 3, 7 Nominal credit growth (%) 51, 6 30, 2 7, 3 -7, 5 -0, 5 4, 9 Tallinn University of Technology

Average Monthly Gross Wages and Salaries, EUR 2002 2003 2004 2005 2006 2007 2008 2009 year 393 430 466 519 604 725 819 1 Q 366 405 431 475 550 660 788 776 2 Q 406 442 474 530 609 738 850 Tallinn University of Technology 3 Q 374 411 449 498 580 697 800 4 Q 416 455 492 555 653 784 838

Problem for households House or flat is mostly the largest investment of Estonian households Increasing house prices result in greater housing wealth and also made it possible to borrow more using housing wealth as collateral Tallinn University of Technology

Stock of household loans and housing loans (1997 - 2008, EEK mln) Tallinn University of Technology

Interest rate on households housing loans 1997 -2008 Tallinn University of Technology

• Total volume of housing loans has increased as a • result of low interest rate and tight competition in banking sector Econometric model what was constructed 2007 by using 8 different economic indicators for describing their influence to price of 2 -room apartment in Tallinn shows that only 2 of them – money supply and interests rate were significant indicators to price changes of housing market in Estonia (Kolbre, Kallakmaa 2007) Tallinn University of Technology

Credit Growth in Central and Eastern Europe: Trend, Cycle or Boom? 2006 Gergely Kiss, Márton Nagy, Balázs Vonnák • “The estimations show that large part of the credit • • growth in new member states can be explained by the catching-up process, and, in general, credit/GDP ratios are below the levels consistent with macroeconomic fundamentals However, in some countries credit growth is significantly faster than what would be justified along the equilibrium path The study finds that credit growth in Latvia and Estonia can be considered as potentially the most risky, beyond any plausible adjustment” Tallinn University of Technology

Loans granted by groups of customers (1997 -2008, EEK m) Tallinn University of Technology

Overdue loans and overdue housing loans (1997 -2008 annual basis, 2009 monthly basis) Tallinn University of Technology

Don't worry – left and right scales are different! (1997 -2008 annual basis, 2009 monthly basis) Tallinn University of Technology

Resent developments • The volume of loans overdue by more than 60 days • • increased in April (making up 5. 2% of the portfolio. In March the respective indicator was 4. 5%) Nearly 75% of the loan portfolio quality deterioration in April derived from the corporate credit sector; households have so far been more successful in loan servicing Thus, loans overdue by more than 60 days accounted for 6. 4% of the credit issued to enterprises and 3. 9% of the credit to households Tallinn University of Technology

Access to credit and credit constraints (1) • • Unemployment rate is growing Wage increase has stopped No more unrealistic expectations Housing living cost are growing (thermal energy etc) Tallinn University of Technology

Access to credit and credit constraints (2) • No more “customer-friendly” credit conditions • Parent banks might have difficulties in raising external funds because of situation in global financial markets This is supply-side constraints - less loan money for the Estonian market Tallinn University of Technology

Despite of global finance crisis Estonian Banking system is still stable • The average capital adequacy of the banking • • sector stayed at the level of 22% in April 2009 Banks have made remarkable provisions during this year to avoiding possible loan losses The capitalisation of banks continues to be sufficient to cope with the forecasted loan losses Tallinn University of Technology

The accelerated price increase in housing sector and high demand was mostly driven by: • High economic growth leading to an increase • • in disposable income The rapid expansion of credit to the private sector A low ratio of living-space per capita and deteriorating housing stock Tallinn University of Technology

Real estate purchase and sales transactions 1997 -2008 Tallinn University of Technology

Housing market • Prices of apartments started to rise rapidly in 2005 • • when the annual price rise was over 50%. The growth rate of transactions started to slow down in the middle of 2006. The price rise turned to decline in 2007 when the housing prices reached the maximum Average price fall since spring 2007 has been 40 -45% During 2008 prices of apartments in Tallinn dropped 30% Tallinn University of Technology

Average Purchase-Sale Prices per Square Metre of a 2 -room Apartment and number of transactions in Tallinn, EEK/ sqm Average price Number of transactions Tallinn University of Technology

Housing market today • In 2004− 2006 demand for housing was greater • • • than supply Since the beginning of 2007 supply started to grow rapidly 2008 supply has been greater than demand Approximately 1700 vacant apartments are in Tallinn on the market today as a result of the rapid growth of the volume of new developments Tallinn University of Technology

Tobin’s q of the Estonian and Tallinn apartment market Tallinn University of Technology

Average gross monthly wages and average price for a square metre of a two-room apartment in Tallinn (EEK) Tallinn University of Technology

Number of square meters of a two-room apartment in Tallinn obtainable for average gross monthly wages Tallinn University of Technology

Housing affordability • Households budgets are tighten • Households living costs are raised (especially • • thermal energy) There is one group of households who can't afford to buy a new house or flat And other group who might be have difficulties to repay their home loans Tallinn University of Technology

Conclusions (1) • In Tallinn or in its close vicinity no new major • projects are expected to be launched within the next year or two The bottom of the Estonian real estate market is approaching, although the shape of this bottom is expected to be flat, which means a long vegetating in all economy Tallinn University of Technology

Conclusions (2) • Despite of global finance crisis Estonian Banking • • system is still stable Most of housing loans was taken in economic growth conditions and full employment expectations Households with repayment difficulties should sell their property or change it for affordable variant To build up the “building society” system The government should disclaim for the possibility to deduct the housing loan interest from taxable income Tallinn University of Technology

Thank you! Tallinn University of Technology

Authors • Angelika Kallakmaa • School of Economics and Business Administration, • • Tallinn University of Technology e-mail: angelika. kallakmaa@tallinnlv. ee Ene Kolbre School of Economics and Business Administration, Tallinn University of Technology e-mail: ekolbre@tseba. ttu. ee Tallinn University of Technology