Global crisis contagion reaches Bulgaria, house prices start to drop

Bulgarian house prices started to slip in the last quarter, as the property bubble starts to burst due to the global financial meltdown. During the first three quarters of 2008, Bulgarian house prices, nationwide, were still rising.

In Q4 2008, the average price of dwellings in Bulgaria was BGN1,359 (€695) per sq. m., down 4.1% from the previous quarter (-5.3% when adjusted for inflation), according to figures from Bulgaria National Statistical Institute (NSI).

At the end of 2008 the average price of a dwelling in Bulgaria was up 11.7% from a year earlier, but Bulgaria’s high inflation rate pared these gains to 2.3%, in real terms.

Sales prices in southern Sofia dropped by 2% to 9% from the first half to the second half of 2008, according to Colliers International Bulgaria. Average prices in Sofia, however, remain above €1,000 per sq. m.

This is clearly the end of a cycle. Much stronger annual house price increases took place in previous years, around 27% in 2007, 16% in 2006, and 37% in 2005. With the expected accession of Bulgaria into the EU in 2007, Britons and other Europeans joined a buying frenzy leading to a house price and construction boom. Russian buyers also followed.

Foreigners were keen to get their hands on properties along the Black Sea Coast. Demand then spilled to areas near or along the Danube River. The increase in construction activity led to GDP growth of more than 6% from 2004 to 2008.

With the global financial crisis crippling the economies of UK, Germany, and other developed countries, demand for properties has dried up. Residential permits were 15% down by the end of 2008 compared to a year earlier. Many new developments have been put on hold.

In January 2009, around 5% of property agencies in Bulgaria shut down, according to ERA Real Estate. More agencies are expected to go bankrupt within the year. Recovery is not expected within the next two years.

Foreign demand

Bulgaria was the fourth most popular destination for Britons buying overseas property in 2007, according to the Association of International Property Professionals.

Bulgaria is also the number one destination of choice for Russian buyers - who often buy properties the Britons sell.

Bulgaria’s strong economy also attracted many European and international companies. Demand also came from foreigners working for the big multinationals in Sofia.

But with the UK in recession in 2008, and Russia encountering economic difficulties due to falling oil and energy prices, the previous flood of buyers has dried up. Many projects that target foreign buyers have been delayed or cancelled due to lack of financing.

Danube river boom

Unlike other countries where the property price increases in the capital led the rest of the country, in Bulgaria oblasts (provinces) along the banks of the Danube River have led the price rises.

The four oblasts with the highest price increases were near or on the Danube River: Vratsa (306% price increase from 2007 to 2008), Razgad (266%), Ruse (251%) and Vidin (248%). Silistra and Montana both saw 210% price increases over the same period, and are also along the river’s bank.

Almost all oblasts surrounding Sofia registered higher price increases than Sofia itself (moving clockwise from north; Montana 210%, Vratsa 306%, Lovech 223%, Pazardnik 192%, Balgoevgrad 155%, Kyustendil 214%, and Pernik 188%). Only Plovdiv registered a lower price increase than Sofia Oblast (143% vs. 149%).

From 2004 to 2008, average dwelling prices in Sofia City and Sofia Oblast rose by 129% and 149%, respectively, both lower than the national average of 152%, according to NSI.

Black Sea woes

While Sofia City has the most expensive properties in Bulgaria (BGN2,330/ €1,191 per sq. m.), the two oblasts with the highest property prices in 2008 were Varna (BGN2,117/ €1,082 per sq. m.) and Burgas (BGN1,723/ €881 per sq. m.).

These two Black Sea oblasts registered price increases way below the national average: Burgas 124% and Varna 122%.

The Black Sea is suffering badly from overbuilding. About half all new dwellings constructed in Bulgaria from 2004 to 2007 were either in Varna or Burgas. Power failures, sewage problems, pollution, poor quality building work, noisy building sites, have spelt trouble for the Black Sea’s seaside resorts.

Dobrich, also on the Black Sea but in the north bordering Romania, had a 210% dwelling price increase from 2004 to 2007.

In the past, the Black Sea was the Eastern block’s summer playground. Then it became the third most popular holiday destination after Spain and France for British holidaymakers. Then the Russians came again, and flocked to the beaches.

However, the water treatment system at Golden Sands can serve 15,000 people, but not the current 40,000. In 2007, the beaches became so polluted that, for a time, they had to be closed.

Sharp economic slowdown

Bulgaria, with Romania, is the EU’s newest member after joining in January 2007. It is also the poorest country in the EU in terms of its GDP per capita, around 40% of the EU-27’s average in 2008.

Mainly due to the housing boom, the economy grew by 6% in 2008, slightly down from 2007’s 6.2% growth. Average annual growth was 6.4% from 2004 to 2006 and 4.7% from 2000 to 2003. Unemployment fell to 5.6% in 2008 from 18.2% in 2002 and 6.9% in 2007.

Foreign direct investments (FDI) flow into the real estate sector soared from just €13.4 million in 2001 to €2.3 billion in 2007; from 1% in 2001 to 35% of total FDI in 2007.

With the housing market bust combined with the global credit crunch and economic recessions in Europe, the economy sharply slowed during the fourth quarter of 2008 with 3.6% y-o-y growth, in sharp contrast to the average annual growth rate of 6.9% during the first three quarters of 2008.

Bulgaria’s economy is expected to slow further in 2009, with estimates ranging from 1% to 2%. The Economist expects the economy to contract by 0.6%. All estimates point to a mild recovery in 2010.

The main reasons for the slowdown are the dramatic fall in foreign direct investment and reduced access to finance mainly due to the global financial meltdown. Foreign direct investments in Bulgaria shrank 16.68% to €5.4 billion in 2008 from €6.5billion in 2007 and €6 billion in 2006. FDI in real estate fell 39% to €1.4 billion. Industrial production also registered an 8.8% drop in November 2008.

Cash remains king

After 2000 Bulgaria’s house price boom was partly fueled by rapid mortgage market growth.

Bulgaria’s mortgage market was around 11.2% of GDP in 2008, a dramatic increase from a mere 0.4% of GDP it represented in 2000 - though despite this growth, most house buyers still rely on savings.

Almost all (99%) new housing loans have a maturity of more than five years, with an initial rate fixation of up to one year, leaving the market extremely vulnerable to interest rate changes. About 57% of outstanding debts are denominated in Bulgarian lev, with the remaining 43% euro-denominated (there are some US dollar mortgages, but they represent less than 0.1% of total loans).

When the Deutschemark was replaced by the euro, Bulgaria shifted its lev peg to euro at €1= BGN1.95583 Lev, leading to lower interest rates.

However after the European Central Bank (ECB) aggressively raised key interest rates in 2006 and 2007, interest rates on BGN–denominated loans rose to more than 10.4% in January 2009, from an average of 8.35% in 2007. Interest rates on euro-denominated loans also rose to more than 8% after October 2008, from an average of 7.4% in 2007.

To make matters worse, banks are giving lower loan-to-value (LTV) ratios to borrowers. Banks used to loan 80% to 90% of a property’s value. Now, banks lend only 50% to 70% of the property value.

Moderate yields

In Sofia, there has been a sharp rise in residential construction during the past few years.

Rental market supply has increased, particularly high-end properties in middle-class areas of Sofia. Most of the new supply of high-class rental apartments is in Doctor’s Garden, Lozenetz, Iztok, Ivan Vazov and Hladilnika, mostly one and two-bedroom apartments.

The result is that rents have hardly increased, despite property prices rises of more than 10% annually from 2006 to 2008, according to Colliers International. Annual rent increases in Sofia’s prime neighborhoods have ranged from 1% to 3% from 2006 to 2008.

During the second half of 2008, rents remained relatively flat, or fell by 1% from a year earlier.

The lackluster performance of rents compared to prices has led to low yields in Sofia, at 4.6% to 4.9%, according to Global Property Guide research. In Sofia’s suburbs, rental yields are slightly higher, ranging from 5.45% to 6.1%.

Rampant corruption

There is general consensus that corruption has reached an intolerable crisis point in Bulgaria. Politicians and the mafia appear indistinguishable. Judges are linked to criminal groups. Ordinary Bulgarians are in despair, feeling that there are no clean politicians. Bulgaria’s slow progress in reforming the judiciary and fighting corruption has even caused the European Commission has suspended around €450m (US$655m) in assistance.

Investors who buy in Sofia and use a reputable agent are unlikely to suffer directly from such corruption. However, the high cost of corruption is partly tolerated due to strong economic growth. But with economic contraction, these issues are likely to enrage people.

The political situation is already volatile with a series of protests in Sofia in January of this year. As the economy deteriorates further, more protests can be expected in the future. And this will hamper the economic recovery, and pull house prices down.