Latvian real estate market cautiously optimistic

The following is an article by Valery Engel, board chairman of Century21Baltwest published in The Baltic Course.

In 2009, there was a record decline in prices for all segments of the Latvian real estate. According to Global Property Guide only in Riga for this year the cost per square meter of the real estate has fallen to 59,7%. Latvia on annual recession of cost of habitation follow the United Arab Emirates (on 48,1 %), Bulgaria (on 28,7 %), Iceland (on 21,2 %), Russia (on 9,5 %) and Slovakia (на15,3 %). It is necessary to note a situation in Dubai where in the past year the rise in prices on the real estate has made 61,50 %, in Bulgaria – 13,01 %, in Russia – 6,42 %, and in Slovakia – 14,12 %.

Latvia has entered into the last year, having stepped over a boundary of cost of one square meter in the mass produced apartments of Riga (secondary market) in 900 EUR and in 1500 EUR/m2 for the sq.meter of habitation in a new building. This falling compared with the price peak in April 2007 (about 48%), which was already considered like a record compared with other countries.

Nevertheless, the decline continued in the past year, which, incidentally, was quite expected for both the expert and for the majority of the population. So in April 2009 According to SEB-indicator of housing prices, 62% of the population was confident of further falling in the prices, 19% believed that prices will not change, and 6% of the population had hoped for growth.

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By April 2007, before the Government effectively ended the practice of issuing mortgage loans to insolvent borrowers, the cost of one square meter of mass housing on the secondary market reached 1700 EUR, the price in new buildings worth 2000 – 2300 EUR/m2, and elite real estate reached staggering marks in the 8-10 thousand Euro per 1 sq. m. According to statistical data for 2008, industrial production was only 10% of Latvia’s GDP, agriculture – 3%, trade – 20%, but the construction and real estate operations – 25%. It should be borne in mind that about half of total industrial production was also associated with construction – building materials production, cement production, mining of dolomite limestone, gravel, etc.

The decrease of consumption, withdrawal of foreign investments coupled with pessimistic expectations of the population determined the collapse of the property prices in 2009. In January, the cost of mass housing dropped to 863 EUR/m2, in late February it had dropped a further 11%, and in March, the market fell by almost 22%, having fallen to a mark 605 EUR/m2. Further, until September the market was falling steadily, demonstrating a sure decline by 5-8% per month.

The falling of the market was accompanied by a sharp deterioration in economic situation of the country, by the liquidation of the mortgage market and by the real impoverishment of the population.  

All this has further deepened the economic depression and reduced tax collection. It would seem that such a development would inevitably lead to a further collapse in real estate prices and the exodus from the market of remaining foreign investors. However, since September 2009, the market began to show first signs of stability, and then cautious, but sustained growth. As can be seen from the above chart, the cost per square meter of new housing fixed at 800 EUR (in some projects it rose up to 1000-1200 EUR), and mass housing on the secondary market, reaching in August the price of 455 EUR/m2, became gradually win back the position and reached in December the price of 495 EUR. At an average elevation on 2’000 EUR/m2 stop real estate prices in the elite sector.

As a result, the market reached by August-September the lowest point of the fall and have fallen compared with the peak of its value in April 2007 to 75%, suddenly changed the trend and played to the end of the year more than 5%. Why did this happen?

First, in the second half of the year sharply reduced the quantity of the real estate proposed for sale. In the market today are only those Sellers who must sell – problem borrowers of banks and socially not protected residents, preferring to move from the big apartment in small-sized in view of high municipal payments. The quantity of sold apartments is reduced every month. The biggest quantity of the Sellers – the people who got the loans in 2005-2007 – already gone from the market: the modern prices will not save them. Most sellers, including banks, have postponed their intentions to better times. As a result the volume of transactions dropped sharply. And if the proposal falls, it means that housing market is becoming less and the real estate becomes more in demand.

However, there are not too much buyers in the market. According to the service of a public opinion poll DnB NORD Latvijas barometrs, only 3% of the population is already ready to buy real estate today. Another 4% would like to buy, but they lack funds. However, this three percent is enough to support a growing trend.

Secondly, and most importantly, by December 2009, the number of optimists has increased compared with January of that year by 10% – up to 16%. These are people who believe that the market will grow in the near future. Twice – to 38% in December (2009) according to SEB-indicator of housing prices was increased the number of the people who believes that prices will not change and 35% of the population (27% less than in January last year) continue to be pessimists. I.e. the number of optimists has exceeded number of pessimists on 17 %. The main reason of optimism is the depth of falling of the market. As said the Chairman of board SEB Eesti Ühispank Ahti Asmann in interview to magazine Saldo, «the good news is that the situation in the real estate market cannot be even worse».

This phrase has been told concerning the Estonian market of the real estate, but it quite approaches and for the Latvian market too. The majority of the residents have considered that today's buyer in any case will not lose.

The logic of reasoning is that: if the price went back today to the level of 2004, when has begun rally on the real estate market, and hundreds of thousands of Latvians rushed for mortgages in the banks, the further decline to the level of, for example, 2003 will lead to a sharp reduction in supply, because the sellers who bought the real estate and, therefore, took a mortgage in bank, in the same year 2004, will automatically left the market. The bank simply will not permit owners to sell their property below the loan amount. And this amount, as already indicated, was equal, as a rule, to the volume of the transaction. Consequently, the market will quickly return again on the level of 2004-th.

Prices are so small that some Russian investors do not even go to watch purchasing real estate, and pay money through a trusted realtor companies, simply enjoy photos and general descriptions of the object, because in their view, 20’000 EUR for one or two bed-room apartment in Jurmala – is very cheap and anyway will pay off. Besides they get also the Schengen visa «as a gift».

All this is true, but the market, of course, still can not be called healthy. If among the 52% of optimists who believe that prices in the country in 2010 will not go down, there is in the presence of only 3% confident buyers, this means that the market is quite volatile and move forward solely on expectations of growth and the narrowness of the proposal.

Optimism in the market, based, largely, on the only psychological factor – the belief of the majority of the population that “there can not be worse” – is today the main motive for its growth. The fact that the market is still ill, proves the position which has developed in the market of rent, first of all in the market of the rent of office areas.  Today about 30% of all offices in Riga is empty – business suffered heavy losses last year. Rent was reduced to three to four times compared with 2007. The average price of a good rental office is today 5 EUR/m2 per month. Rentals of housing accommodations, as well as rental of warehouses are in a worse condition. Often the warehouses are rented out just for utility payments. Currently, in the center of Riga, you can rent a warehouse in perfect condition for 2-3 LVL/m2 (around $ 6) per month. The yield from rental apartments dropped to 7-10% per annum, while another 1,5 years ago, it was not less than 20%. And not all apartments can now lease. The advantages have here the small-sized habitation in sleeping areas of Riga – Purvtsiems, Pljavniki and Kengarags.

The market rent of office and retail areas drags down and commercial real estate market. Six months ago it was possible (with difficulty) to find an investor (mostly foreign) ready to invest in the office areas. Of course on one condition – full or nearly full occupancy of the office area by tenants. Today, with such profitability  of  the  market  rent, it is  almost  impossible  to  find  the commercial real estate buyers – for example, the British market, which also survived the crash, though not so strong, today the profitability of the market of rent has twice higher.

And this despite the fact that retail and office real estate is on sale today under more than attractive prices – from 300-400 EUR/m2 in sleeping areas and to 1'000-1'500 EUR/m2 – in the Old city.  Warehouses in the center are sold at prices ranging from 70 to 250 EUR/m2. Neither on the rent market, nor on the market of the commercial real estate in the last some months of influence have not rendered rise in prices for habitation.

It is very important to understand that growth based solely on the optimism of small players (and there are no other players in this market today) – there is the quite unstable process with a lot of limitations. It is likely that in 2010, the number of the real buyers will increase by one or even a few percent, which with the current narrowness of the market may lead to a sharp takeoff. But on the other hand, we must understand that once this happens, the market will automatically sift the part of buyers, who can operate today with the sums to 30-40 thousand euro – this is the main part of today’s investors. And then in the next short period of time, the market will get the reverse trend.

To prevent this situation the market needs the serious buyers who operate with an order of magnitude larger amounts. Will they come or not depends on fundamental economic indicators, which are still very far from ideal, as well as on the state of the mortgage market.

 Let’s start with the last factor. Obviously, the real estate market in the medium and small metropolitan areas can develop only in the presence of an affordable mortgage. In Latvia, mortgage was “killed” with the start of the global financial crisis and the collapse of prices for Latvian square meters. Banks unwilling today to lend to real estate, they have evolved a kind of allergy to these operations. The only thing they are ready to do today – lending to the real estate pledged them as their property. But such transactions practically are not present – this real estate can be sold only under the prices is considerable above market, because it was bought mostly in 2005-2007.

Let's not forget also that banks since 2007 are legislatively limited in mortgage delivery – borrowers should give now the documentary proof of their solvency. Today not everybody may to do so – there are the mass impoverishment of the population and the withdrawal of income “in the shadow”. No wonder that DnB NORD Latvijas barometrs said about 4% of the population who want to buy real estate, but do not have the financial means for it. This figure exceeds the number of the real buyers. According to most experts, the Latvian banks will return to mortgage lending only when there will be fundamental changes in the economy. As we see here, this factor plays a decisive role too.

In the case if a serious deterioration in the economic situation does not happen, we will see the growth in average 15-20% in annual terms. If the economic situation will be worsen (and the topic of the economic collapse of Latvia discussed in the domestic press for almost half a year), we’ll see the short-term collapse of the real estate market, followed by a fairly quick restoration of it on the background of the gradual recovery of the national economy. In this case, as it may seem strange, the market will begin to actively recover that in the past has already occurred in several countries of the world – from Russia to Argentina and Brazil.

 Thus, everything indicates that the following, 2011 the Latvian market of the real estate will meet with reserved optimism.

Toomas Hõbemägibbnatchararipaev.ee