Estonia’s housing boom has stalled

Last Updated: Jun 10, 2008

Estonia’s housing boom has stalled

Property prices in much of Estonia’s residential real estate market fell in 2007, after remarkable increases during the past few years. Higher interest rates, combined with strong supply have caused the market to stall.

In Tallinn, Estonia’s capital city, the average price of 2-room apartments fell 3.9%, according to Statistics Estonia. This was in sharp contrast to enormous annual price increases of 28.6% in 2006, and 56.7% in 2005.

Prices of 3-room apartments continued their upward movement, although at a much slower pace. The average price of 3-room flats in Tallinn rose 7.2% during 2007, a lesser rate of increase than the 20.5% appreciation in 2006, and 42% increase in 2005.

The average price of 2-room flats in Tartu, the second largest city, fell 9.8% during 2007. In Parnu, known as Estonia’s summer capital, average prices rose by an insignificant 0.65% during 2007.

The number of building permits for dwellings has also fallen. Permits for only 1,128 dwellings were filed in Q1 2008, significantly down on the 2,709 dwelling permits filed in Q1 2007, and down on the peak level of 3,946 dwelling permits filed in Q2 2006.

Extraordinary price rises

Estonia’s housing market has been in almost continuous boom since 2000, due to low interest rates, low inflation, strong economic growth, and rapid wage increases.

The average price of 2-room flats in Tallinn rose by 433% from 2000 to 2006, in Tartu by 497% and in Parnu by 397%. Single room flats went up equally impressively, in Tallin by 418%, Tartu by 443% and Parnu by 478%.

The owner-occupancy rate has rapidly risen from 85% in 2002, to 96% in 2004. The rental market has meanwhile shrunk from 12% of households (with 9% privately renting and 3% in social rent) in 2002, to just 4% in 2004.

The mortgage market also expanded rapidly; from 3.7% of GDP in 1998, to 32.7% in 2006. Currently the maximum lending period is 30 years, and loans may be granted for up to 100% of the property value.

One reason for the strong boom was that mortgage interest rates fell from over than 10% during the late-1990s, to below 4% between 2004 and 2006. Estonia managed to bring down inflation from 11.2% in 1997, to below 5% between 2002 and 2006 (an average of 3.3%). In 1993, the Estonian Kroon was pegged to the Euro.

However when the ECB began to raise key rates in mid-2005, mortgage rates also increased in Estonia. These higher rates were certainly justified. Rising fuel and food prices had pushed inflation up to 6.6% in 2007, the highest rate since 1998, and inflation reached 11.4% in April 2008. By April 2008, mortgage rates were 6.6% for Estonian kroon (EEK) dominated loans, and 5.5% for EUR dominated loans.

These interest rate hikes have proved too much for the housing market to bear.

Clearly these rates are lower than warranted by Estonia’s high inflation. Yet the monetary authorities are 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.

Supply has constrained rents, and lowered yields

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, and 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, for middle class Estonians seeking to upgrade from their Soviet-era block buildings.

The construction of new apartments has exerted pressure on rents, which have risen only modestly, while property prices have risen much faster than rents. 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 5% - 6% per annum.

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. In 2007, the average rent for a 2 room apartment in Tallinn rose by a mere 2.3%, the average rent for a three room flat rent rose 3.8%. The average rent for a one room flat fell by 8.3%.

Estonia’s economic growth is slowing

Estonia’s economy has been growing at Asian rates, previously unheard of in Europe. 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.

Now that the housing boom has ended, demand for construction materials and services has fallen, and GDP growth is expected to decline to around 2% - 4% in 2008. In turn, this will lead to weaker demand for property.

The cycle that pushed prices up in Estonia is now pulling them down again.