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Regional Statistics

Feb 12, 2009

Challenging times for the Czech property market

Czech residential property prices started falling in the third quarter of 2008, after insignificant price increases during the year´s first half.

Although official house price figures are published only after a year´s delay, the house price falls were reported by the local media and real estate firms.

The average price of flats in the Czech Republic fell 7% between September 2008 and December 2008, from CZK 2.26 million (€ 85,996) to CZK 2.1 million (€ 79,907), according to the portal Euronet Media, based on selling prices of 42,000 new and old flats. Euronet Media began collecting data in September 2008.

In June 2008, the Czech Business Weekly reported that developers had started offering discounts ranging from 10% to 30%. Some projects include free furnishing or parking space, the magazine added. Some developers shoulder the entire cost of property transfer, with a free year´s mortgage payment. The value of free items can range from CZK50,000 for kitchen facilities, to CKZ300,000 for parking space.

Prices of flats in the Czech Republic surged between 2000 to 2003 by 16.4% per annum (13.5% p.a., in real terms), according to calculations by the Czech National Bank (CNB) based on property transfer tax figures from the Czech Statistical Office (CZSO). Since then, the housing market has fallen slightly every year, except in 2007.

The average price of flats dropped in 2004 by 2.4% (a 5% fall in real terms). This was followed by a 0.5% fall in 2005 (a 2.1% drop in real terms), and a minuscule 2% price rise in 2006 ( a drop of 0.5% in real terms).

House purchases increased in 2007, because households feared a sudden price increase once the VAT on construction work was raised from 5% to 19% starting January 1, 2008. The price of flats rose by an average of 7.9% (4.8% in real terms) in 2007.

Sales of real estate have plummeted in 2008. Members of the Czech Chamber of Real Estate Agencies (CKRK) reported sales of 4,038 flats in the first three-quarters of 2008, a year-on-year decline of 38%.

In 2009, Czech Republic´s property market is expected to weaken further, as the economy slows, and the credit market remains frozen. Changes in foreign ownership rules may provide additional demand, but this is unlikely to be significant, due to the weak global economy.

House prices lacklustre since joining the EU

House prices rose rapidly during the years up to 2004, prior to Czech accession to the European Union. Speculative buyers, mostly locals, anticipated waves of foreign buyers, once foreign ownership limits were lifted, a requirement for EU accession.

From 1998 to 2003, the CNB overall house price index rose 65%. Apartment blocks registered the highest average price increases during this period, at 117%; followed by individual apartments, at 97%. The price of single family houses rose 58%, while building plot prices rose only 29.8%.

However, the foreign ownership limit was not totally lifted. After long and intense parliamentary discussions, it was decided that citizens of the EU without Czech residence permit would be restricted from buying property for a 7 years transition period, i.e., until 2009.

In practice things have become much less restrictive. Citizens of EU-member countries and ‘favoured nations´ i.e. Iceland, Norway, Liechtenstein and the US can get permission to ‘reside´ in the Czech Republic on demand, quickly, without providing any special reason.

The process for non-EU, non-US citizens is more complicated. They must have a visa, remain in the Czech Republic for seven years (or marry a Czech citizen) to obtain a green card allowing them to buy property.

Alternatively they can buy property through a limited liability company (known as an s.r.o.). But only an EU citizen can control the company without Czech participation. A non-EU citizen must recruit a Czech person, EU citizen or person holding a long-term visa to be the company´s executive director.

Although it is debatable whether the ownership restrictions dissuaded foreign buyers, it is clear that the flood of foreign buyers never came.

From 2004 to 2006, the average price of detached houses fell by 0.7%. The average price of apartments rose only 1.8% between 2004 and 2006; apartment blocks rose only 3.2%. On the other hand, building plot prices rose strongly, by 22.8%, pulling the over-all house price index up by 7.4% over the same period.

Will easier foreign ownership save the market?

A cabinet proposal likely to take effect in May 2009, will make residential and commercial land ownership much easier for foreigners, removing the s.r.o requirement.

The measure is expected to increase the demand for property. However, Martin Beník of Younique, an independent insurance and mortgage broker, plays down the significance of the current s.r.o. requirement.

“In general, the process of property purchase by non-EU citizens will be more convenient, but, from my experience, property investors are considering many factors, which influence their decisions relating to investment,„ says Benik.

“The necessity of company formation is definitely not the most significant discouraging factor in their decision-making process. Moreover, in specific cases, investments through a legal entity have positive tax benefits, and, in such cases, investors tend to invest through a company," he adds.

The global crisis may also dampen the amendment´s impact. Foreigners from countries initially enthusiastic about Czech property, such as Japan and Russia, may now wait until their countries recover from recession.

Czechs don´t like being in debt

Although mortgage financing is freely available to both Czech nationals and foreign investors, only about 5-7% of the potential mortgage market has been tapped, despite rapid growth since 2001. Outstanding housing loans surged between 2000 and 2008, from CZK 23 billion (€8.35 million) to CZK613 (€22 billion). But this is a mere 16% of GDP, way below EU average of 50% of GDP.

The underdevelopment of the mortgage market is generally ascribed to the traditionally debt-resistant psychology of Czech households. Yet Czechs are now starting to embrace mortgages. Mortgage loans are now typically granted with 20 year maturities. A few years back, most loans had maturities ranging from five to fifteen years.

Average LTV ratios were 56% in 2007, well up from the 30% to 50% LTV ratios typical in the early 2000s, but still very conservative by international standards. The maximum LTV ratio possible in the Czech Republic is 85%.

Short-term mortgage interest rates strongly up

The Czech Republic is required to adopt the Euro by the EU Treaty of Accession 2003 - at some point. However the target date for EU adoption has been moved several times, from the original goal of 2008 or 2009, first to 2010, then to 2013. Current conditions now make EU adoption unlikely before 2015.

Nevertheless, interest rates declined from over 5% in 2004, to around 4.5% between April 2005 and May 2007.

To tame inflationary pressures, in line with the rest of Europe, the key policy rate – the 2 weeks repo rate - was hiked rapidly between June 2007 and February 2008. Average housing loan interest rates rose above 5.5% in July 2008. As of December 2008, the average rate was 5.59%.

Interest rates on loans with shorter initial rate fixation (IRF) were particularly hiked. For instance, the average interest rate for loans with IRF of up to 1 year was just 4.12% in 2005; for loans with IRF of 10 years or more the average rate was 4.99%.

In 2008, the average rate for loans with IRF of up to 1 year was 5.48%, higher compared with the 5.09% for loans with IRF of 10 years or more.

The share of new loans with IRF of up to one year had risen from 11% in 2004 to 40% in 2006, making it the most popular option. However, with the rapid interest rate hikes in 2008, its ratio went down to 24%.

Only 24% of new housing loans had IRFs of 10 years or more in 2004. The ratio rose to 30% in 2008.

Loans with IRF between 1 and 5 years are now the most popular, with a 39% share of new housing loans.

The credit crunch saw new housing loans fall in 2008, after rapid growth since 2004, to CNZ192 (€6.86) billion, from CNZ 205.7 (€7.35) billion in 2007.

As the economy weakened, the CNB adjusted key interest rates down. The 2 weeks repo rate was slashed from 3.75% in July 2008 to 1.75% in February 2009. However, housing loans have yet to follow. Housing loan interest rates remained above 5%, at end-2008.

Worrying over-supply of newly built property

Similar to other European transition countries, dwelling construction in the Czech Republic declined strongly in the early 1990s. Completions dropped from 31,509 units in 1993, to an average of 15,500 units annually from 1994 to 1997.

Housing construction started to recover in 1997. Completions rose steadily to 27,300 units annually from 1998 to 2006. In 2008, VAT on new constructions rose to 19% from 5%. So developers expedited completions in 2007, pushing them up to 41,649 units.

Despite the historically high level of completion in 2007, a significant bulk of the dwelling supply is still under construction - 178,831 units by the end of Q3 2008. Dwelling starts for the first three quarters of 2008 reached 33,845 units, higher than the 31,818 units over the same period in 2007. Dwellings completions have similarly risen over the same period: 25,986 in 2008 compared with 23,826 in 2007. The huge amount of units under construction is a cause for alarm for property investors.

Rent deregulation might boost market

The deregulation of the rental market may give additional boost to the housing market amid the economic slump. Regulated rents cover about 20% of all permanently-occupied apartments. There are 4 categories of controlled rents (pegged per square metre according to the size of the town and the category of flat), and in addition, materially regulated rents (calculated according to costs).

Under the rent deregulation law (Act No.107/2006), affecting about 750,000 apartments, rents will be adjusted annually until they reach market levels, by the end of 2010. Around 300,000 affected units are privately-owned, while the rest are owned by municipalities.

In January 2009 regulated rents again increased, by about one third on average. However the position varies by area. In some buildings rents have risen by more. Landlords in selected areas have raised rents by up to 50%. In other locations, rents have been unchanged.

In Prague, the average regulated rent is set to increase to CZK100 (€3.57) per square per month by the end-2010 , from CZK60 (€2.14) at end-2008.

Foreigners, renters of housing built after 1993, and new renters of houses with vacant possession, live in housing units outside the rent control law. Rental yields in this market range from 4% to 6.4%, with the smallest units (40 sq. m.) earning the highest returns, according to Global Property Guide research.

The high rental rates achieved in Prague in the past were largely driven by expatriate demand. However, the senior and middle expatriate managers who flooded into the country a decade ago have now largely been replaced by equally qualified Czechs, who are much more cost-effective for international companies, their skills honed by 10 years of “market economy„ experience plus Western training.

The result has been an oversupply of luxury rentals. Rental prices for luxury flats and villas in Prague have fallen 20-70% since the year 2000, with the top end units getting hit the hardest.

Rapid economic slowdown

GDP growth in the Czech Republic slowed to 4.4% in 2008, after growth of 6.6% annually from 2005 to 2007. The slowdown was primarily due to falling exports and weaker domestic demand. In Q3 2008, exports were down 10.7% y-o-y.

Almost 85% of the country´s exports go to the EU; around 30% to Germany, which is now in recession. Several companies have started to lay off workers, particularly in the financial, banking and manufacturing sectors.

Over 45,000 people lost their jobs in January 2009. This pushed unemployment to 6.8%, up from 4.3% in Q3 2008, the lowest level in a decade. Unemployment is expected to reach 7.5% in 2009 and 8.5% in 2010.

There is a strong possibility the country will enter recession in 2009. The government is preparing a crisis package worth CZK75 (€2.68) billion, equivalent to 2% of GDP.

Budget deficit woes

Because of past budget deficit problems, the government has been reluctant to launch big spending packages similar to those in the UK, US and other countries. Doubts that such measures will work have been admitted by Prime Minister Mirek Topolanek, but he adds that there are few alternatives.

The budget deficit was a major cause of delay in the Czech Republic joining the eurozone. The deficit was successfully cut to 1% of GDP in 2007, from 6.6% of GDP in 2002. However, in 2008 it rose once more to 2% of GDP, and is expected to rise to 2.4% in 2009, above the eurozone limit.

Inflation is another stumbling block; consumer prices rose 6.74% in 2008, up from 2.5% in 2006, and 2.8% in 2008. With the economy slowing, inflation is expected to fall to 3% in 2009.



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