The Latvian example is a shocking reminder that an increase in real estate values is not inevitable. The property meltdown that has befallen the Baltic over the past year did not stem from economic conditions in Europe. Rather, it was a serious disintegration triggered by internal political, micro and macroeconomic developments.
Back in 2005, however, the real estate markets in Lithuania, Latvia and Estonia looked more like investment heaven than a financial trap. All three countries boasted robust economies and low inflation rates: 1.4 per cent in Lithuania, 4.2 per cent in Latvia and 1.3 per cent in Estonia. The property boom, which had begun in 2001, had reached its peak.
In 2004, the average price for residential properties in Vilnius (Lithuania's capital) was 880 euro a sq m, in Riga (Latvia's capital) 1000, and in Tallinn (Estonia's capital) 940. Just a year later, prices shot up to 2500 euro a sq m in the relatively affluent regions of Vilnius, 3000 euro in Riga and 2600 euro in Tallinn. In the centres of these picturesque cities – all of them of architectural and historic value – prices were about 3000, 5000 and 3500 euro a sq m, respectively.
Prices’ upward trend continued in 2005. In Lithuania, demand and supply for real estate properties were fairly balanced, while in Latvia and Estonia demand exceeded supply. Investors bought apartments, offices and commercial buildings because of rising prices and high levels of guaranteed rental income. The following graph illustrates the pattern.
(Graph 1 will be inserted here on rental rates/prices}
Altogether, from 2001 to 2006, prices in all property sectors in the three Baltic countries jumped fivefold. At the end of 2006, experts were ready to concede that their gloomy forecasts about the Baltic real estate bubble were mistaken. But then, in 2007, disaster struck. Between January and July, property prices fell by 14 per cent in Latvia and six per cent in Estonia. In Lithuania they remained stable. Shockingly, the Baltic real estate “champion” - Latvia - suffered the biggest price drop of all, becoming the first European country to be so severely affected by the global credit crisis. Was the global real estate crisis the only factor that disrupted Latvia's property market? And how bad was the slump?
January 2007: The average price for apartments in Riga was 3000 euro a sq m and the average price for a standard apartment was 2200 euro a sq m. In January 2006, property prices were nine per cent higher than in December 2005. In January 2007, however, they were only 0.5 per cent higher than in December 2006. This was the first sign of Latvia’s real estate collapse. Even so, 38 282 deals were concluded within a month.
October 2007: The inflation rate was already 16 per cent, meaning that entry into the euro was totally unfeasible. Because of its ineffective economic strategy, the government’s approval rating was the lowest since the beginning of the 1990s. Its anti-inflation policy, introduced in July, also contributed to falling real estate values. Saturation of the real estate market was already evident as supply exceeded demand by around 30 per cent. Prices dropped three per cent on the previous month. From January to October 2007, the price drop was 16 – 20 per cent. Owners in some of the new housing projects began to offer apartments for 20 – 25 per cent less than they had purchased them at from developers. The average price a sq m of residential property was 2320 euro and for standard apartments, 1800 euro a sq m. Some local experts assured investors this was just a “slight correction” of prices while others foresaw the beginning of a long-term slump.
Rental rates, however, continued to rise, as illustrated by the following graph.
(Graph 2 will be inserted here) In October, only 15 689 deals were concluded – in fact, the number of the deals dropped back to 2001 levels, the dawn of the property boom.
The real estate meltdown in Latvia can be attributed to three factors: “easy credit”, “oversupply” and “buying-up”.
Easy credit
Latvia's property boom coincided with the entry of many foreign banks on the credit market. Strong competition substantially lowered interest rates for mortgage loans, which were 4.5 per cent in 2002 and 3.5 to four per cent in 2005. The liberal bank policy led to fast and easy credit access. This, in turn, allowed many Latvians to purchase properties with non-existent money. The noose around the Latvian economy was tightening. In January 2007, a third of those who had purchased property through credit were unable to meet monthly installments. In June 2007, the country's official inflation rate reached 10 per cent. Prices for basic goods continued to rise against a background of stagnant salaries. Several banks responded by implementing a more conservative lending policy and soon other institutions followed.
Oversupply
Most countries that enjoy a property boom also suffer from excessive building and over-development. Latvia is no exception. In 2005, 403 000 sq m of newly built living space was released on the market. In 2006, it was already 812 000 sq m. In 2006, new retail space covered 100 000 sq m; in 2007, this increased to150 000 sq. m. These are huge numbers for a country with 2.5 million citizens, especially considering that the market of local buyers is shrinking and foreign investors are withdrawing. As if there were not enough other troubles, Latvia also reaped problems associated with fast building during a period of high demand, namely the poor quality of some new projects.
Buying Up
This is not a strictly Eastern European phenomenon but Latvia is an excellent case in point. At the beginning of the 21st Century, Latvians with higher purchasing power exploited low real estate prices by purchasing whole blocks of flats, houses and hotels. These people gradually owned the lion’s share of the property market and kept prices at unrealistically high levels. Thus they manipulated the market, instead of leaving it to its own regulatory mechanisms.
The real estate market in Eastern Europe has started to slow down. Prices in Bulgaria and Slovakia are predicted to rise by 15 per cent this year and by 12 per cent in Croatia. Prices in Estonia and Lithuania will remain stable, but in Latvia will continue plummeting. Yet the situation is Latvia is not beyond redemption. The country has been adapting successfully to the European Union and has gathered sufficient economic momentum to leave this difficult period behind. Nevertheless, the Latvian example will give serious pause for thought to all property buyers who used to believe that a European price collapse is inconceivable.
