Lithuania’s housing prices deflate

Lithuania’s house prices continue to fall, with its economy stagnating and the credit markets frozen.

After enormous price increases from 2003 to 2006, Lithuania’s residential property prices peaked in early 2007 and then stayed flat until the first quarter of 2008. After that, the house price bubble started to deflate.

In Q4 2008, the average price of newly constructed apartments in Central Vilnius with full finish was €2,640 per sq. m., down 22.4% from a year earlier, according to Invalda Real Estate (Inreal). Given Lithuania’s high inflation, the average price actually dropped 29% in real terms.

The average price of renovated old 1-room apartments in central Vilnius also dropped by 20% y-o-y (a fall of 27% in real terms) to €2,520 per sq. m. in Q4 2008.

The housing deflation was evident all over Lithuania, in Vilnius, prices for flats of old construction plunged by 23%; in Kaunas – by 15%; in Klaipeda – by 24%; in Siauliai – by 13%; and in Panevezys – by 9%, reports ELTA, the Lithuanian News Agency.

Contagion from the global financial meltdown, combined with tighter credit conditions and government-imposed anti-inflationary measures led to economic slowdown, and this in turn pushed house prices down.

Economic growth is dramatically down - to 3.8% in 2008, from 8.9% in 2007. The economy is expected to be at a complete standstill during 2009, and then to contract by 1.1% in 2010.

Although Lithuania is in a better shape than its Baltic siblings, Estonia and Latvia, unless the government acts quickly and decisively, the housing market stagnation is likely to last until 2012.

House price boom

A massive house price boom in Latvia occurred between 2003 and 2006. The average price of old apartments in Central Vilnius skyrocketed, with a 28% increase in 2003, 29% in 2004, 45% in 2005 and a 56% rise in 2006. Average prices rose from LTL3,200 (€927) in 2002 to LTL12,000 (€3,475) at end-2006, a massive 275% increase.

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

Major house price increases were also seen in other major cities in Lithuania. In Kaunas, the second largest city, the average price of old 1-room apartments rose 32% in 2005 and 49% in 2006.

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.

Reasons for the house price boom include rapid economic growth, and loose monetary conditions that facilitated the enormous expansion of the mortgage market.

Tightening credit market conditions due to the government’s anti-inflationary policies caused the housing market to slow. When the global financial meltdown reached Lithuania, house prices started to slip.

Faltering economy

After an economic recession in 1999, Lithuania swiftly morphed into one of Europe’s fastest growing economies. Average annual GDP growth was 7.3% between 2000 and 2006, including an impressive 10.3% expansion in 2003. GDP growth reached 8.8% in 2007.

Per capita GDP in 2007 rose to US$11,350, up 77% in real terms on its 2000 level. Unemployment dropped to 4.3% in 2007, from 17.4% in 2000. Real wages rose 8% in 2005, 13% in 2006 and 15% in 2007.

However in 2008 the economy began to slow. It slowed from 7% y-o-y to end-Q1, to 2.9% y-o-y to end-Q3. The contraction at year-end was so significant, that during the whole of 2008 GDP actually fell by 1.5%.

The most optimistic projections for Lithuania see no growth for 2009. The Economist expects a contraction of 3.5%.

The slowdown has pushed unemployment sharply up, to 8.0% at end-2008, from just 4.3% a year earlier.

Mortgage growth

Developments in the mortgage market fueled the house price boom. Mortgage debt rose from a mere 0.4% of GDP in 2000, to 19% of GDP in 2008. About 80% of all purchases were made with the aid of mortgages, with 95% of property value granted in loans.

From 1994 to January 2002, the Lithuania litas (LTL) was officially pegged to the US dollar at US$ 1 = LTL4. In preparation for its accession to the European Union and the European Monetary Union (EMU), the peg was shifted to the euro at €1 = LTL3.4528 on February 2002. This led to lower and more stable mortgage rates in Lithuania.

From 1999 to 2001, the average interest rate on housing loans fluctuated widely from 8% to 14%. With the new foreign exchange system, housing loan rates steadily declined to less than 6% in 2002 and less than 4% from July 2005 to May 2006.

Credit tightening

Interest rates in Lithuania have often followed key rates set by the European Central Bank (ECB), because of the peg to the euro. Hence when the ECB began to raise key rates from 2% in October 2005, to 4% in May 2007, and again to 4.25% in July 2008, mortgage rates also rose.

The average housing loan rate in Lithuania rose to 7.36% by January 2008, before slightly falling to below 7% for the first half of 2008.

More than 90% of new loans approved 2004 to 2006 have an initial rate fixation (IRF) of less than one year. So the interest rate hikes dealt a serious blow to Lithuania’s housing and mortgage markets.

Yet when the ECB reduced key interest rates from 4.25% in September 2008, to 3% in December 2008, housing loan rates in Lithuania did not follow. In fact in November 2008 the average mortgage rate reached 8% for the first time since 2001, although it quickly moved back to 7.49% the following month.

With the interest rate increases, the volume of new loans dramatically declined.

• At the peak of the house price boom, new housing loan approvals were €132 million between March 2006 and June 2007.
• By November and December 2008, new housing loans approvals were down to €11.1 million per month. Of those, around 71% had an IRF of up to one year, down from 95% during the boom.

Under construction

During the 1980s, when the country was still under socialism, more than 20,000 dwelling units were constructed annually. Completions dropped to less to less than 2,000 annually between 1998 and 2003 - leaving a huge pent-up demand for bigger and newer housing units.

As the economy gathered steam, housing construction accelerated. Completions rose to 6,700 yearly 2004-2006. In 2007, 9,286 dwellings were completed. Total completions for 2008 will probably exceed 10,000 units.

The number of unfinished dwelling units is alarming. In 2007, almost 20,000 dwellings were authorized, but completions were less than 10,000 units. 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.

As the economic crisis worsens, what will happen? Will developers abandon the unfinished projects half way?

Yields and rent

While prices doubled or even tripled in some property segments in Vilnius from 2002 to 2006, rents generally stayed relatively flat. For instance, the average rent for a one bedroom flat in Vilnius was unchanged at €290 per month from 2003 to 2005, before rising to €319 per month in 2006, and €377 in 2007.

From 2002 to 2007, the average rent for a one bedroom flat rose by a mere 18% while the average flat sale price soared by 197% (from € 1,217 per sq. m. to €3,623).

Rental yields are now low, because during the boom, rent rises lagged property price rises.

Rental yields for luxury apartments in Vilnius typically range from 3.7% to 4.3% percent, according to Global Property Guide data. Smaller units (40 sq. m.) have slightly higher yields at around 5.2%, which is still disappointing for investors given the high inflation rate in Lithuania.

With the recent downturn, rents have slightly outperformed property prices, falling less than prices. However, this has not push rental yields back to their level early 2000s levels, when Vilnius yields typically ranged from 8% to 10%.

High inflation and budget deficit

Annual inflation has been accelerating since 2004, reaching 8.2% in 2007, the highest level in a decade. From 1999 to 2003, prices barely increased, with average annual inflation of only 0.38%.

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.

The government has no option but to spend less to bring down inflation. 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. In fact, the budget deficit in 2008 was 0.9% of GDP, above the government’s goal, but lower than 2007 deficit of 1.3% of GDP. Inflation remained high in 2008 at 11.3%.

Although inflation is expected to fall to 6% in 2009, it is still way beyond the EU limit; the deficit will likely rise to 3% of GDP. The government has to balance the need to pump-prime the economy while keeping inflation low. At the same time, it has to appease angry citizens that are now rioting due to the economic downturn. Right now, the government is obviously failing, dragging down the housing market.