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Jan 05, 2014

Estonia's property boom


 Estonia house prices

Estonia is experiencing a property boom, despite slow economic growth. Property demand is rising. House price rises continue to accelerate.

During the year to end-November 2013, the average price of apartments in Tallinn, Estonia’s capital, soared by 13.75% (12.12% inflation-adjusted) to €1,307 per square meter (sq. m), according to Ober Haus Real Estate Advisors. During the latest quarter, apartment prices in Tallinn rose by 4.31% (5.43% inflation-adjusted).

This is in line with figures released by Statistics Estonia, which shows that the average purchase price of dwellings in the whole country rose by 8.43% (5.54% inflation-adjusted) in the third quarter of 2013 from a year earlier, to €835 per sq. m.

The country’s major cities saw the biggest price-rises during the year to end-Q3 2013:

  • In Tallinn, the average price of dwellings purchased skyrocketed by 15.5% to €1,272.4 per sq. m. in 2013.
  • In Tartu City, the second largest city and the intellectual capital of Estonia, the average price of dwellings purchased soared by 12.1% to €1,073.9 per sq. m.
  • In Parnu City, the country’s summer capital, located in the southwestern, the average price of dwellings purchased rose by just 1.9% to €806.5 per sq. m.
  • In Estonia excluding Tallinn, the average purchase price of dwellings rose by 3.8% to €527.1 per sq. m.

After Estonia's amazing 36% annual house price rises from 2004 to 2006, prices of dwellings started to fall in 2007, partly due to the global financial meltdown.

  • In 2007, the average price of dwellings dropped by 1.5% (-9.7% inflation-adjusted)
  • In 2008, the average price of dwellings plunged by 18.3% (-24.5% inflation-adjusted)
  • In 2009, house prices plummeted by 30.5% (-29.1% inflation-adjusted)

After these 3 horrendous years, a house price recovery began in the second half of 2010, with the average price of dwellings rising modestly by 4.1% (-1% inflation-adjusted). In 2011, nationwide house prices soared by 12.3% (7.9% inflation-adjusted). In 2012, house prices also increased by 5.4% (1.6% inflation-adjusted).

Property demand continues to increase. During the third quarter of 2013, the total number of purchase-sale contracts of real estate in Estonia rose by 15.6% y-o-y to 11,037, according to Statistics Estonia. Likewise, the total value of real estate contracts also increased 22.8% to €555.2 million in Q3 2013 from the same period last year.

Residential construction activity continues to rise. Dwelling permits soared by 30.2% to 784 in Q3 2013 from the same period last year, according to Statistics Estonia. Dwellings completed also increased by 13.2% y-o-y to 436 units in Q3 2013.

The average housing loan interest rate stayed steady at 2.5% in October 2013, based on figures from the Bank of Estonia, the country’s central bank. Over the same period more than 2,000 new housing loan contracts were signed, the highest since 2008. The total value of housing loans taken out in October 2013 increased by 28% y-o-y to €71 million.

Estonia’s housing market is expected to grow even stronger in 2014, as the country’s economic growth accelerates next year. House prices are expected to continue rising next year, according to local property experts.

Estonia's economy is expected to grow by just 1% this year, before growing by 3.1% in 2014 and 3.8% in 2015, according to Nordea Bank.

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

Estonia average price apartments tallinn graph

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.

Estonia housing loans graphThe 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

Estonia interests housing loan rates graph

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.

Oversupply

Estonia construction activity graph

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

Estonia Tallinn house prices and rent graph

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%.

Modest economic growth, rising inflation

Estonia GDP inflation

From 2000 to 2006, Estonia’s economy expanded by an average of 8.4% annually, including resounding 10.1% GDP growth in 2006, and 8.9% growth in 2005. In 2007, GDP growth was 7.5%, one of the highest growth rates in the EU. Unemployment fell from 13.7% in 2000, to just 4.7% in 2007.

However, Estonia’s economy entered recession in Q3 2008, mainly due to the adverse impact of the global financial crisis. The economy contracted by 3.7% in 2008, and by a staggering 14.3% in 2009. Unemployment surged to 13.8% in 2009.

As the country fell deeper into recession, the government cut spending by about 7.8% in 2009. It kept its income tax rates low, but hiked VAT by 2% to 20% in July 2009. By 2010 Estonian unemployment had risen to 17.3%.

The economy recovered in 2010 with GDP growth of 2.6% and a fiscal budget surplus. In January 2011, Estonia was the first country since the financial crisis to join the Eurozone.

Estonia had astounding growth of 9.6% in 2011, with strong exports. Unemployment fell to 12.5%. Then in 2012, the economy expanded by 3.9%, bolstered by construction and export growth.

Nordea Bank projects that Estonia’s economy will expand by about 1% this year, down from its initial forecast of 1.9%, mainly due to the high reference base of government sector investments, weakness of exports and rising inflation. However, Nordea expects the country’s economic growth to accelerate to 3.1% in 2014 and to 3.8% in 2015.

Unemployment fell to 8% in the third quarter of 2013, from 9.7% during the same period last year, according to Statistics Estonia.

In November 2013, Estonia’s inflation rate stood at 2.1%, the highest among the EU countries, according to figures released by Eurostat.  Inflation is expected to reach 2.9% in 2013, 2.3% in 2014 and 3.1% in 2015, according to Nordea.

In 2012, Estonia, together with Sweden, had the EU's lowest government deficit of just 0.2% of GDP, according to Eurostat. In 2013, the country is expected to register a budget deficit of about 0.4% of GDP, according to Ernst & Young. Estonia’s budget is projected to be in balance next year.

In Q2 2013, Estonia recorded the lowest government debt to GDP ratio across the European Union of about 9.8%, according to Eurostat.






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