While Estonia’s real estate market appears risky, a potential adoption of the Euro could simplify home purchases and increase housing demand. Estonia has a history of rapid property appreciation with 2 room properties increasing more than 400 percent from 2000 to 2007 in multiple cities. See the following article from Global Property Guide for more on this.
Tallinn’s property market is now recovering, and the recovery is expected to accelerate if Estonia adopts the Euro in 2011.
Q4 2009 was good. The third quarter of 2009 was the nadir. At that point, average prices had plunged 59.3% (63% in real terms) from Q3 2007’s peak of EEK28,500 (€1,821) per sq. m., according to Statistics Estonia.
Tallinn’s property price crash ended abruptly during the last quarter of 2009. The average price of 2-bedroom apartments in good condition rose by 0.4% from EEK11,600 per sq. m. (€741) in Q3, to EEK11,650 per sq. m. (€744) in Q4 2009.
Q1 2010 was even better. Tallinn apartment median prices rose 4% to EEK 9,966 (€637) per sq. m. during Q1 2009, the second quarterly price increase after six quarterly declines, according to Estonian Land Board figures assembled and reported by the Swedbank.
It is not clear, however, if the stabilization of property prices in Tallinn will spread to other parts of the country. In Tartu City, Estonia’s second largest city, the average price of 2BR apartments fell by 6% in the last quarter of 2009. Data on Parnu City, the summer capital, is not available due to insufficient data on the number of transactions.
How Estonia got it right
Estonia proved wrong many forecasts that the Estonian kroon : euro peg would collapse.
Instead, in the aftermath of the crisis, Estonia did not follow other countries in pump-priming the economy.
- Estonia kept its budget-deficit within the EMU limit.
- It focused on strengthening its financial market.
This has been a tough road. But the results speak for themselves – positive GDP growth and inflation is expected in 2011. And although the Estonian economy is expected to shrink by 1% in 2010, that’s a significant improvement on Estonia’s 14.1% GDP contraction in 2009.
Deflation is expected to be -0.3% in 2020. This enough to keep expectations that interest rates will remain stable, but not low enough to create a vicious circle of deflation and economic contraction.
Despite the good news, Estonia’s property market still looks risky:
- There is an oversupply of luxury units, despite pent-up demand for new housing in the capital
- The property mismatch has been worsened by the decline in nominal and real wages, and the departure of foreign buyers
- Lending conditions remain tight, despite low housing loan rates
Estonia for the Euro in 2011?
Estonia hopes to be allowed to adopt the Euro in 2011. Joining the euro would be a psychological boost to consumers, investors and homebuyers, signifying the Estonian financial system’s strength, despite the worst recession since independence in 1991.
Estonia would be the first country to join the Euro since the financial crisis. Euro adoption could simplify the buying process for euro-zone citizens, boosting housing demand.
Plunging transaction volumes
Predictably, residential construction in Estonia has fallen sharply. Building permits were filed for only 2,081 dwellings in 2009, compared to the 10,000 dwellings average from 2004 to 2007 (including 12,863 dwellings in 2006).
In 2009 only 3,026 dwellings were completed, down from 5,300 in 2008, and 7,073 in 2007. Around 60% of dwellings completed in 2009 were flats, while 28% were single-family houses.
This had significant economic effects, since real estate is a sizable contributor to the country’s GDP.
Transactions also plunged in 2009:
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- Dwellings transactions volumes were the lowest since 2003. Contract values plunged to EEK6.68 billion (€426 million), a small fraction of the EEK30.6 billion (€1.96 billion) in 2006, and EEK25.7 billion (€1.64 billion) in 2005.
- The number of transactions fell to 12,568, the lowest since 2002.
The great boom of 2000-2007
Estonia’s housing market was in continuous boom from 2000 to 2007. Why?
- low interest rates
- low inflation
- strong economic growth
- rapid wage increases
- huge foreign demand for property, especially from other Europeans
Demand for properties in Tallinn reached an all time high in 2006, with foreigners attracted by the city’s potential. Tallinn accounted for more than half of all real estate transactions in Estonia.
House prices in Estonia rose by double-digit levels from 2000 to 2007. In Tallinn, the average price of 2 room flats rose by an average of 27% annually from 2001 to 2005. House price growth accelerated in 2006, with prices rising by more than 50% y-o-y.
The average price of 2-room flats in Tallinn rose by 448.7% from 2000 to 2007, in Tartu prices rose 431.5% and in Parnu 440%. Prices of three-room flats were equally impressive, rising 412% in Tallinn, 481% in Tartu, and 471.5% in Parnu.
Meanwhile owner-occupancy rates rose strongly, up from 85% in 2002, to 96% in 2004. The rental market shrank from 12% of households (with 9% privately renting and 3% in social rents) in 2002, to just 4% in 2004.
The house price falls in Estonia in 2008 were among the biggest in the world, rivaled only by Latvia. These falls were in sharp contrast to enormous annual price increases in the past, peaking at an annual price increase of 77.5% during the year to end-Q1 2006.
The fastest mortgage market expansion in history?
The house price boom was supported by a massive expansion of the mortgage market, growing by an average of 62% yearly from 2002 to 2006.
Outstanding housing loans grew from 4.7% of GDP in 2000, to 37% in 2007 (from EEK4.5 billion (€286 million) in 2000 to EEK88 (€5.6) billion in 2007 and EEK 97 (€6.2) billion in 2008).
The mortgage market boom was pushed by:
- the favorable macroeconomic environment
- financial market reforms
- the entry of foreign banks and lower interest rates
At the peak of the boom, banks were willing to provide loans with a maximum lending period of 30 years, and a loan-to-value ratio of 100%.
Interest rate conundrum
One of the factors that contributed to mortgage and house price boom was the pegging of the Estonian kroon to the deutschemark in 1992 and eventually to the euro in 2001. In June 2004, Estonia entered ERM 2 in preparation for the eventual adoption of the euro. Although the kroon is allowed to fluctuate within a 15% band, Estonia preferred a peg of EEK 15.6466 per euro. This led to lower inflation and lower interest rates.
Mortgage interest rates fell from over 10% during the late-1990s, to below 4% between 2004 and 2006. Estonia managed to bring down inflation from 89% in 1992 to the single-digit level of 8.2% in 1998. Between 2002 and 2006, inflation was below 4.5% (an average of 3.3%).
As a consequence of the peg to the euro, interest rates in Estonia followed key rates set by the European Central Bank (ECB). Hence when the ECB began to raise key rates in mid-2005, mortgage rates also increased in Estonia. ECB base rates were gradually raised in 25 basis point steps, from 2% in October 2005 to 4% in May 2007, and again to 4.25% in July 2008.
Clearly these rates were lower than warranted by Estonia’s inflation. Yet the monetary authorities have been relatively powerless because the kroon’s peg to the euro means the central bank cannot raise interest rates further. Nevertheless there has been a divergence in mortgage rates between euro and kroon-denominated loans, with kroon-denominated mortgage rates rising above Euro rates.
Kroon-housing loan rate volatility
By November 2008, the interest rates for kroon denominated housing loans were at 7.37%, up from below 4% from July 2004 to April 2006. For euro denominated loans, housing loan rates rose to 6.27% in October 2008, from below 4% from November 2004 to May 2006.
These interest rate hikes proved too much for Estonia’s housing market to bear and contributed to massive house price falls.
In an effort to ease the credit crunch and economic downturn, the ECB reduced key interest rates. It adjusted the key rate successively from 4.25% in September 2008 to 1% in May 2009, where the rate has remained until now. With this, the euro housing loan rate fell to 3.43% in February 2010.
Interest rates on kroon-denominated housing loans have been volatile since Q4 2008. For instance they fluctuated from 10.04% in October 2009, down to 5.89% in December, up again to 10.02% in January 2010 and down once more to 4.56% in February 2010.
After the break-up of the Soviet Union in 1991, housing construction in Estonia dramatically decelerated. From 1996 to 2001 less than 1,000 dwellings were added to the dwelling stock annually – not enough to meet demand. Most apartments were sold before completion.
In 2001, housing construction started accelerating. In 2007, around 7,200 units were added to the dwelling stock, up from 5,100 units in 2006. Developers have been mainly building suburban homes and luxury apartments, for middle to upper class Estonians seeking to upgrade from their Soviet-era block buildings.
The massive increase in dwelling completions combined with the mismatch between demand and supply led to oversupply, pushing house prices down. Despite the decline in construction activity in 2008 and 2009, the overhang remains, due to the decline in foreign demand.
Constrained rents and yields
The construction of new apartments exerted pressure on rents, which have risen only modestly compared to property prices.
From Q1-2003 to Q4-2007, the average rent for 2 room flats in Tallinn rose 34%, while the selling price rose by 179%. For 3 room apartments, the average rent rose by a mere 10.6%, while prices soared 203%.
Relatively, stagnant rents combined with rocketing prices have lowered rental yields. From around 20% at the beginning of the decade, gross rental yields are now down to around 3% -4% per annum in 2009, according to Global Property Guide research.
Rents can be expected to move ahead now that prices have stalled – because those who would previously have bought are now somewhat more likely to choose to rent. But this has not happened yet:
- The average rent for 2-room apartments in Tallinn rose 8% in Q4 2009, compared with a 0.4% increase in prices.
- The average rent for 3-room apartments rose 2.7%, while selling prices fell 0.86%.
- However the average rent of 1-bedroom units (dwellings with a room and a kitchen) dropped 10.7%.
During the boom Estonia’s economy grew at Asian rates, earning it the moniker The Baltic Tiger.
The real growth spurt began in 2000, with 9.6% GDP growth. From 2001 to 2006, Estonia’s economy expanded by an average of 8.7% annually, including resounding 11.2% GDP growth in 2006 and 10.2% growth in 2005. In 2007, GDP growth was 7.1%, one of the highest economic growth rates in the EU.
GDP per capita increased from US$4,100 in 2000, to US$15,850 in 2007. Likewise, real wages rose by an average annual rate of 7.5% from 2001 to 2006. Unemployment fell from 13.6% in 2000 to just 4.7% in 2007.
The economy entered recession in Q3 2008 with GDP shrinking 3.3% from a year earlier (after a 1.1% y-o-y contraction to Q2 2008). GDP to 14.1% contraction in 2009. Real wages fell by 5% in 2009 while unemployment surged to 13.8%.
The recession is expected to ease in 2010 with GDP shrinking by 1%. Economic growth is expected to resume in 2011 with a 3% GDP increase. Nevertheless, unemployment is expected to rise to 15.5% in 2010 before easing to 14.7% in 2011.
High hopes for euro-adoption
Estonia originally planned to adopt the euro in 2007, but was forced to move it to a later date due to inflation. High global fuel and food prices pushed inflation to 6.6% in 2007, and to 10.4% in 2008, way above the EU limit of 3.2%.
The recession has now brought inflation down to -0.1% (a deflation).
However the EU’s convergence criteria require low government debt and deficits, and after years of budget surpluses, post-crisis Estonia began to incur budget deficits, due to lower revenues and higher spending.
Unlike other EU countries, Estonia however resisted from pump priming the economy. Instead, it implemented politically unpopular cost-cutting measures. Its budget deficit of 2.9% of GDP in 2008, and 1.7% in 2009, was within the EU limit. Estonia has vowed to keep the deficit within the 3.0% EU limit until 2012.
With inflation and the deficit in check, Estonia is likely to be allowed to adopt the Euro in 2011. European Commission President Jose Barroso said that in terms of Euro adoption, “Estonia is on track and moving in the right direction.” The reaffirmation was pronounced in a press conference in Brussels last March 2010.
In late-2009, EU Economic and Monetary Affairs Commissioner Joaquin Almunia suggested that Estonia could receive an invitation to the eurozone as early as June 2010. Estonia’s Prime Minister Andrus Ansip is confident that they can use euro adoption as an exit strategy from recession.
This article has been republished from Global Property Guide. You can also view this article at Global Property Guide, an international real estate analysis site.