Lithuanian Real Estate Price Free Fall Expected To Continue

Increased sales and corporate taxes, depressed export levels, double digit unemployment and declined personal income levels, have all contributed to a double digit contraction of Lithuania’s economy. With …

Increased sales and corporate taxes, depressed export levels, double digit unemployment and declined personal income levels, have all contributed to a double digit contraction of Lithuania’s economy. With the worst recession in the EU, Lithuanian housing prices have fallen for more than two years, and experts believe the trend will continue through 2010. The following article from Global Property Guide has more on this.

The agony continues for Lithuania’s housing market.  The average price of apartments in Lithuania’s five largest cities fell 20% during the year to March 2010, both in nominal and real terms, according to Ober Haus, a realtor.

Although price falls are decelerating, March 2010 was the 28th consecutive month of price declines since the peak in December 2007.  The March price index was 40% below peak in nominal terms, and 46% down in real terms (not the worst fall – several countries have fared worse).

Double-digit annual price falls are expected to continue for the rest of 2010, due to Lithuania’s dire economic condition. The government has implemented severe cost cutting measures such as reducing government wages by 20% to 30% and pensions by 11%.

In 2009, Lithuania’s economy shrunk by almost 15%, the worst recession in the EU, largely due to the bursting of the property bubble, higher tax rates, the end of cheap money and a large exports contraction. In 2009, private consumption fell 19%, fixed investment plunged 39% while exports fell 15%.

After contracting almost 15% in 2009, the economy is expected to shrink around 3% – 4% in 2010.  Unemployment is expected to rise to 16.6% by end-2010 from 13.7% in 2009. Real wages are expected to fall 6% in 2010, and 9% in 2011.

The government exacerbated the budget crisis

The Lithuanian government compounded its difficulties by actually lowering its income tax rate in the middle of the crisis.  Lithuania’s tax rate is now lower than Estonia’s 21% and Latvia’s 26%.

In the mid-1990s, like its Baltic neighbors, Lithuania implemented a flat-tax on personal income. The idea was that a simple and uniform tax is conducive to business and economic growth.

After achieving double-digit GDP growth rates, the flat tax was reduced from 33% to 27% in 2007, and 24% in 2008. Despite the ongoing crisis, in 2009 Lithuania pushed through with a final planned reduction of personal income tax to 15%.

The Value-added tax (VAT) was raised to 21% (from 18%) (the sale and lease of immovable properties remains VAT-exempt). Corporate taxes were also raised to 20%, from 15%.

Tax-deductibility on housing loan interest payments was abolished in January 2009, adding to borrowers’ problems.  As of early-2010, the mortgage market remained frozen.

Its neighbors reacted differently to their budget crises. Estonia abandoned its earlier plan of lowering its flat tax to 18% after 2012 (from 21%) – having introduced a 26% flat tax in 1994, and reduced it gradually.

Similarly in January, Latvia raised its flat tax to 26%.  Latvia had lowered its personal income tax rate to 23% in 2009, from 25%.

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Large revenue shortfall

Lithuania’s sharp reduction in personal income tax rate was not sufficiently covered by tax increases elsewhere (corporate income tax was raised from 15% to 20%, and VAT was increased). Income tax collection is relatively stable in periods of economic crises, while VAT collection falls drastically during a crisis, as households and corporations reduce spending. The higher corporate income tax rate has been largely ineffective, since most companies are reporting losses.

Government income and wealth taxes fell in 2009 almost by half from LTL 10.4 billion (€3.016 billion) in 2008, to LTL 5.5 billion (€1.6 billion). Yet despite the VAT rate increase, VAT-type revenues fell from LTL8.7 billion (€2.5 billion) in 2008, to LTL6.6 billion (€1.9 billion) in 2009.

Total government revenues plunged 17%, while expenditure declined by a mere 4.6%. The revenues/expenditure mismatch pushed the budget deficit to 8.9% of GDP in 2009, from 3.3% in 2008, and 1% or less from 2005 to 2007.

Unless the government imposes higher or new taxes and/or reduces spending, the deficit is likely to exceed 9% in 2010 and 2011. The current deficit is way beyond the EU limit of 3.5% of GDP.

Dramatically higher unemployment

Unemployment rose to 15.6% in Q4 2009, and is expected to increase to 16.6% by end-2010, thus undoing the work of the boom years when Lithuania successfully reduced unemployment from 17.4% in 2001, to 4.3% in 2007.

The higher corporate income tax rate may have exacerbated the situation by forcing some companies to shut down.

On the other hand, nominal wages fell by 3% in 2009 while real wages fell by 2%, the first time since 2000. Real wages are expected to fall 6% in 2010 and 9% in 2011.

That crazy house price boom

The average price of old apartments in Central Vilnius rose 275% between 2002 and 2006:
2003: prices increased 28%
2004: prices increased 29%
2005: prices increased 45%
2006: prices increased 56%

The average price of newly constructed one-bedroom apartments in central Vilnius rose 162% from 2002 to 2006.

Major price increases were also seen in other major cities. In Klaipeda, Lithuania’s third largest city and only seaport, the average price of one-room apartments rose 282% from LTL2,200 (€637) per sq. m. in 2003, to LTL9,000 (€2,607) per sq. m. at end-2007.

Mortgage debt rose from a mere 0.4% of GDP in 2000, to 19% of GDP in 2008, with about 80% of all purchases made with the aid of mortgages, and typically 95% of property value granted in loans.

Rental yields in Vilnius still very low

While prices tripled in Vilnius from 2002 to 2006, rents stayed mostly flat. From 2002 to 2007, the average rent for a one bedroom apartment rose by a mere 18% while the average apartment sale price soared by 197% (from € 1,217 per sq. m. to €3,623).

Despite the crash in prices, rental yields are still low.  In August 2009, luxury apartments in Vilnius yielded 4.44% on average, according to the Global Property Guide. Smaller units (30 sq. m.) achieved higher yields at around 6.3%, while slightly bigger units (90 – 200 sq. m.) had yields ranging from 3.8% to 4%. In contrast in 2002, Vilnius yields typically ranged from 8% to 10%.

Interest rates and currency risk

Recently, interest rates on Lithuania litas (LTL) housing loans have increasingly reflected worries about currency risk.

From 2005 to mid-2007, there was not much difference between interest rates on new housing loans whether denominated in litas or in euro. The divergence widened in January 2009 and from mid-2009 they seemed to follow different paths. Interest rates on litas-denominated new housing loans surged to around 10% from April to October 2009, before falling to 6.2% in March 2010, while interest rates on euro-denominated housing loans simply followed the key ECB rate downward.

The litas-dollar peg lasted from 1994 to January 2002 (US$ 1 = LTL4), and from 1999 to 2001, average housing loan rates fluctuated from 8% to 14%.  In February 2002 the litas was re-pegged to the euro at €1 = LTL3.4528. Housing loan interest rates declined to less than 6% in 2002, and to less than 4% between July 2005 and May 2006.

The interest rate hikes of 2006-2009 had disastrous effects, as almost all new loans approved between 2004 and Q3 2006 had an initial rate fixation (IRF) of less than one year.

As well as causing distress to borrowers, the interest rate hikes caused the market to shift to Euro. In 2006, only 44% of new loans were denominated in Euro, but from 2009 to Q1 2010, the ratio of Euro-denominated loans rose to around 80% to 90% of new loans. If the litas does disconnect from the euro, the consequences for borrowers would be disastrous.

Deflation takes hold

Similar to other countries with currencies pegged to the euro, Lithuania has surrendered its ability to raise interest rates to control inflation. To be able to maintain the peg, interest rate movements set by the European Central Bank are mirrored in Lithuania.

From 1999 to 2003, consumer prices in Lithuania barely increased, with average annual inflation of only 0.38%.  Inflation then accelerated, reaching 11.1% in 2007, the highest level in a decade.

In November 2007, the government passed the Fiscal Discipline Law which mandating that starting 2008, the annual fiscal deficit cannot exceed 0.5% of GDP.  However, the deficit still reached 3.3% of GDP in 2008.

The sharp economic contraction in 2009 pushed down inflation to 4.2%. Lithuania is expected to experience deflation of 1% in 2010 and 2011.

The government plans to keep the deficit back to 3% of GDP by 2012, a highly ambitious plan.

Half-completed buildings everywhere

During the 1980s, when the country was still under socialism, more than 20,000 dwelling units were constructed annually.

Completions dropped to less than 5,000 annually between 1998 and 2003 – leaving huge pent-up demand.

As the economy gathered steam, housing construction accelerated:

  • In 2004-2006 dwellings completions rose to an average of 6,700 yearly
  • In 2007, there were 9,286 completed dwellings
  • In 2008 dwelling completions rose to 11,286, the highest since 1992

In 2009, completions dropped to 9,400 units, due to the economic crisis.

The number of unfinished dwelling units is alarming. From 2005 to 2008, 15,000 dwellings were authorized annually – around three times the number of completions. While some authorized dwellings may never have gone beyond the drawing board, the amount of ongoing construction in Lithuania, especially Vilnius, suggests that many are still being built – but are not yet finished.

The drop in construction activity was also reflected in the drop in the number of dwellings authorized; from 19,229 units in 2007 to 15,928 in 2008 and 7,553 in 2009. The number of dwellings completed and authorized is expected to fall further in 2010.

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.

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