House prices have begun to fall in the Greater Riga area – a fall of 3.5% in the month of June 2007, following a fall 1% in May 2007, according to the leading Latvian real estate agent Latio. Prices have fallen “for the first time in history”, says Latio, which if not quite accurate, emphasizes the sense of shock.

These figures are consistent with recent warning signs. But they are all the more shocking in that year-on-year to Q1 2007, Latvia was Europe’s strongest performing housing market with house price rises of 44.23% during the year, according to Latvia’s Central Statistical Bureau.

The Global Property Guide ( believes these latest figures signal the end of the Great Baltic House Price Boom. Estonia started falling before Latvia, as is normal in the Baltics. We have long suggested that low rental returns in the Baltics mean that investors should be very cautious.

The decline of house prices also reflects several serious economic problems which have accumulated in Latvia:

  • The current account deficit rose to 26.3% of GDP in 4Q 2006, from 15.2% a year earlier.
  • Inflation was sharply up at 8.9% in April 2007, up from 6.5% last year, and 1.9% in 2002.
  • Loans to residents grew 60.4% in the year to Q4 2006 (58.2% and 61.7% in the previous two years).
  • Long-term interest rates are sharply up.

(See the Global Property Guide’s coverage of Latvia)

In February Standard & Poor’s (S&P) put on negative watch its rating in Latvia’s long-term forex-denominated liabilities, and then on 17 May lowered the rating from A- to BBB+. This brings Latvia back to the rating it held in 2002.

The Lats, pegged to the Euro since January 1, 2005, came under pressure in February in response to the S&P revision, and the Bank of Latvia had to intervene. The Euribor interest rate on Euro variable rate loans jumped to 10% in June 2007, from 5% this January. Obviously, this rise in interest rates has had a substantial effect. So too have government attempts to cool the market through the banking system. So too have recent legislative changes, e.g., the imposition of a 25% tax on personal income from real estate sold within a year of purchase.

Painful adjustments needed

Till recently Latvia was Europe’s No1 house price performer. Now Latvia is in deflationary mode, with house prices falling and spending restrained.

Local players can be expected to adjust to the new realities, but with a delay, which can be expected to exaggerate the downturn. In June, 2007, 19 new housing projects were announced, after 15 projects in May, April, March, and January this year (February saw a spike in apartment project launches to 26). This means that by historical standards, a very large number of new apartment projects continues to come on to the market.

Lower residential returns signal stop!

The price of good quality used apartments in prime locations in Central Riga ranges from €2,900 to €3,143 per square metre, according to the Global Property Guide (survey conducted 24 Nov 2006). Houses in similar locations are slightly cheaper, ranging from €2,521 to €2,700 per square metre.

These prices are high relative to Latvia’s GDP per capita, being on a par with Scandinavian countries (see table).

In Riga, city centre average prices rose from around €1,264 per sq. m. in August 2004, to around €3,011 at end-2006 – a 138% increase in just over two years.

Meanwhile, in Riga average monthly rents have risen, but not nearly so much, from around €8.20 per sq. m. to around €12.64 per sq. m. – an increase of around 54%. Riga rental income returns (average for all sizes) have therefore fallen over the past two years, from around 7.85% to an average of 5.04% (the figures in the table above represent not average yields, but yields for apartments of 120 sq. m.).

These yields are not unreasonable. However in the particular situation of Latvia, such moderate yields, in the context of a continued very strong stream of new apartment offerings, and a sharp uptick in local long-term price of money, would make us very cautious.

Unless the economic cycle has disappeared from economics, it would seem to us that a cyclical peak has approached, and that for the moment investors should pause.