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If the proposed higher Value Added Tax (VAT) rate gets implemented in the Czech Republic, prices of unsold new flats in Prague would suffer. In the bigger picture, this VAT could affect the general economy. Read more about this in the full article from Global Property Guide.

Residential prices in the Czech Republic stagnated during 2010 and early-2011, and things are not likely to improve if the Czech Republic's government, in dire need of funds, unifies value-added tax (VAT) at a high rate. Higher VAT would certainly depress the prices of the around ten thousand unsold new flats in Prague. And though VAT only directly affects new property, higher VAT would impact the economy generally. 

  • Average Czech apartment prices this February were 7% down on last year, at CZK1,719,229 (‚¬70,603), according to realitymorava.ck.  This continues the downward trend of 2009. House prices were 3% down in Q4 2010 compared to a year earlier, according to Knight Frank.
  • In Prague-2, which covers much of prestigious Vinohrady cadastral district, apartment prices increased 1.1% from the previous month, but were 3.2% down on last year, with an average apartment price of CZK5.75 million (‚¬236,062).
  • Average apartment prices in Brno, Czech Rep.'s second largest city, were down 10.3% on the same month last year, but relatively unchanged since April 2010.

The VAT increase will cause pain

VAT was increased by 1% in January 2010, pushing the higher VAT rate to 20%, and the lower rate to 10%. The lower rate applies to goods such as food, medicines, books, new housing and housing-related expenses (water and heating).

The government had earlier proposed to unify VAT at the higher 20% rate by October 2011. In March 2011, the government backpedalled, deferring unification to 2013.  Under the new plan, the 10% VAT will rise to 14% by January 2012, while the 20% rate will remain. By 2013, VAT will be unified at 17.5%.

The planned unification of VAT rates may cause demand worth CZK 57 billion (‚¬2.32 billion) to CZK 70 billion (‚¬2.85 billion) to disappear from the economy, according to a survey conducted by MindBridge Consulting and RE/MAX. Compare this to the total value of  Czech real estate transactions, which fell by 9% y-o-y to CZK 160 billion (‚¬6.51 billion) in 2010, after experiencing a 5% fall in 2009.

Rents and yields falling


The price-to-rent ratio in Czech Republic was 180.4 in 2009, far higher than 119.6 in the UK and 118.4 in the US, according to data from the Czech National Bank (CNB).

Gross rental yields on apartments in Prague are low, according to Global Property Guide research of June 2010.  An apartment of 120 square metres has a rental yield of around 3.8%, which most people would not consider a reasonable return on their investment.

This is a major change from the period 2000 to 2005, when the average rental yield in Prague was 6.8%, and in Brno 7.8%, according to the CNB. By 2009, rental yields for Prague apartments had dropped to 3.9%, while Brno yields fell to 4.9%.

Rents for luxury flats and villas in Prague have fallen 20-70% since the year 2000, with the top end units getting hit the hardest, according to local real estate analysts.

In 2010, rents again dropped in most cities. In Prague rents were 7% down, according to Czech Point 101. In contrast, Brno rents rose slightly (+0.6%).

End of rent regulation might boost market

It could be positive for the housing market that regulated rents are due to end in 2011. Under the rent deregulation law (Act No.107/2006), affecting about 750,000 apartments, by the end of 2011 all rents will reach market levels. Regulated rents cover about around 80% of all rented apartments in the country, or 20% of all permanently-occupied apartments. Around 300,000 affected units are privately-owned, while the rest are owned by municipalities.

rague, along with Ostrava, Ústí nad Labem and a few other central Bohemian cities were given an extension until 2013 to prevent a sudden shock to formerly subsidized renters.

How the crisis started

In anticipation of EU entry in 2004, from 1998 to 2003 the Czech Republic's house price index rose 64%, according to the CNB, basing itself on property transfer tax figures from the Czech Statistical Office (CZSO). This price rise was also partly encouraged by a government-led spending binge, with rising public deficits.

Apartment blocks registered the highest average price increases during this period, at 118%; followed by individual apartments, at 91%. The price of single family houses rose 58%, while building plot prices rose only 31%.

After long and intense parliamentary discussions, it was decided that even EU citizens, if they were not Czech residents, would be restricted from buying property for a 7 years transition period, i.e., until 2009.

Although it is debatable whether the ownership restrictions dissuaded foreign buyers, the housing market stagnated from 2004 to 2005, arguably because foreign ownership limit was not totally lifted, but equally because of measures taken to cut the budget deficit.  The average price of flats dropped by 2.7% in 2004, a 5.2% fall in real terms. This was followed by a 2.7% increase in 2005, a 0.5% fall in real terms.

The Czech housing market is now very oversupplied

Interest in the housing market recovered as interest rates fell in 2006. The overall house price index rose 14.1%, an increase of 12.2% in real terms. Anticipating a rush to buy before the VAT increase from 5% to 19%, developers ramped up construction, and in 2007 and built 41,649 units - a large increase from the 27,300 annual completions from 1998 to 2006. The developers' view of the market's mood was correct, and the overall house price index skyrocketed 31.3% in 2007, a 24.5% rise in real terms.

From 2008 to 2009 the mania continued. Completions continued at a high rate of 38,400 units p.a., and In 2008, and the average price of flats rose 10.7%, a 6.8% rise in real terms.

It was only in 2009 that, due to the global financial crisis, the average price of flats fell 14.4%, a 15.2% drop in real terms.

Nevertheless there was a substantial completions overhang. From 2008 to 2009, dwelling completions were an average of 38,400 per year. In 2010, completions fell only slightly, to 36,446 units.

Finally in 2010, dwelling starts dropped sharply, to 28,135 units.  Yet today the Czech housing market remains in dire shape, because of the oversupply of newly built apartments, and low consumer and investor confidence.

Fiscal consolidation will slow economic growth

Pressure is also being placed on housing market by the government's spending cuts. The deficit is now seen as a key problem, partly because it prevented acceptance of the Czech Republic's application to join the Eurozone. The deficit was successfully reduced to 0.7% of GDP in 2007, down from 6.6% of GDP in 2002. However, it rose again to 2.7% in 2008 and 5.8% in 2009, mainly due to the spending package launched in the wake of the global crisis. 

The soonest the Czech Republic can adopt the euro is in 2017, If the government can keep the deficit and inflation under control.  The deficit remained relatively high at 5% of GDP in 2010, but the government expects to be able to comply with the EU's goal of 3.5% deficit by 2013. With new taxes and reduced spending, the Czech Republic's fiscal balance is expected to improve to around 4.5% in 2011 and 3.5% in 2012.

The Czech Republic's GDP growth was 2.2% in 2010, mainly due to strong exports growth. Almost 85% of the country's exports go to the EU; around 30% to Germany which has led the economic recovery in the EU.

However the ongoing budget cuts will slow growth. GDP Growth is expected to be 1.8% for 2011, and 3.3% in 2012.  GDP rose by an average of 6.6% annually from 2005 to 2007, then slowed to 2.5% in 2008. The economy contracted by 4.1% in 2009 due to the global credit crunch and economic slowdown.

The unemployment rate, which jumped from 5.5% in 2008 to 9% in 2010, is expected to ease to 8.7% in 2010 and 8% in 2012.

Inflation remains benign. Consumer prices rose by 6.74% in 2008, up from less than 3% in 2006 and 2007. With the recession, inflation slowed down to 1% in 2009. It is expected to inch up from 1.4% in 2010, to 2.1% in 2011, and 2.4% in 2012.

Interest rates falling

One positive for the housing market is falling interest rates. As the economy weakened, the CNB began to adjust key interest rates. By January 2011 the average housing loan rate had fallen to 4.53%.

The average interest rate for loans with IRF of up to 1 year fell to 4.28% in January 2011, from 6.13% in August 2009.

  • For loans with IRF of between 1 to 5 years, the interest rate was 4.46%, from 5.68% in December 2009.
  • The average interest rate for loans with IRF of 5-10 years was 4.93% in January 2011, slightly down from 5.07% from the same month last year.
  • The average interest rate for loans with IRF of 10 years and up was 4.95% in January 2011 from 5.07% in the previous year.

However, it is worth noting that the Czech Republic's mortgage market is relatively small, so the impact is less. Total mortgage loans were 19% of GDP in 2010, way below EU average of 50% of GDP. In 2010, new housing loans amounted to CNZ139.5 billion (‚¬5.68 billion), down 32.2% from CNZ 205.7 billion (‚¬7.35 billion) in 2007.

Loans with interest rate fixation (IRF) between 1 and 5 years were over 50% of the new housing loan market in 2010, followed by IRFs of more than 10 years, with a 26% market share.  New loans with IRF of up to one year had an 18% market share.

Mortgage loans in the Czech Republic are typically granted with 20 year maturities, the maximum LTV ratio being 85%.

This article was republished with permission from Global Property Guide.