Tallinn University of Technology Estonian housing market - before euro adoption Angelika Kallakmaa Ene Kolbre Tallinn University of Technology

Estonia 2010 In the same time, when other EU countries deal with government debt and public deficit problems, Estonia fills Maastricht criteria

Tallinn University of Technology Maastricht criteria Reference valueEstonia Inflation rate1,0%-0,7 % Participation in the currency exchange rate mechanism ERM II 2 yearsThe Estonian kroon has been participating in ERM II since 2004 The general government deficit Must be lower than 3% of GDP 1.7% of GDP Government debtMust be less than 60% of GDP 7.2% of GDP

Tallinn University of Technology Economic situation During Estonia’s output growth was faster than in most emerging market economies Since 2008, the economy has been experiencing a hard landing period Restored growth in Estonian exports will be balanced economic situation in Estonia in the second half of 2010

Tallinn University of Technology Economic background and forecast *2011*2012* GDP (%) 10,07,2-3,6-14,11,04,03,3 Private consumption expenditure (%) 13,09,1-4,8-18,9-5,61,63,8 Unemployment rate (ILO) (%) 5,94,75,513,816,014,513,2 Real wage growth (%) 10,412,04,3-3,8-4,20,11,9 Average gross wage growth (%) 16,220,413,8-4,6-3,81,23,2 Nominal credit growth (%) 51,630,27,3-6,4-2,42,33,8

Tallinn University of Technology Employment Housing boom increased employment in the real estate and related sectors At the end of the growth period, the economy reached the stage of full employment After real the estate boom the unemployment rate skyrocketed The unemployment level will probably remain high over the next years

Tallinn University of Technology The wages and salaries The average gross wages and salaries have decreased, but the decrease slowed down in the 1st quarter 2010 The real wages,which took into account the influence of the change in the consumer price index, decreased 2.6% in the 1st quarter 2010

Tallinn University of Technology Average monthly gross wages and salaries, 1st quarter 2006– 1st quarter 2010 (EUR) 1st quarter2nd quarter 3rd quarter 4th quarterYear

Tallinn University of Technology Information asymmetries between borrowers and lenders When economic conditions are depressed and collateral values are low, information asymmetries can mean that even borrowers with profitable projects find it difficult to obtain funding When economic conditions improve and collateral values rise, these firms are able to gain access to external finance and this adds to the economic stimulus. This explanation of economic and financial cycles is often known as the “financial accelerator”

Tallinn University of Technology Procyclicality effect During an economic boom financial sector inclines to strengthen the impact of a business cycle through intensifying lending activity and vice versa

Tallinn University of Technology Männasoo 2003 “Since 2001, the growth in loans has accelerated again, reaching markedly high speed in 2002 The share of provisions has decreased and this has supported in keeping capitalisation high The banking sector’s reaction to the economic upturn indicates some rise of procyclical optimism”

Tallinn University of Technology Loans granted to individuals (stock, Mln EEK)

Tallinn University of Technology Loans granted to individuals during a month

Tallinn University of Technology Campell (2006) Household’s behaviour is difficult to measure and they are not always fully rational when they making financial decisions Households make investment mistakes, given the complexity of their financial planning problem and the often confusing financial products that are offered to them

Tallinn University of Technology Questionnaire 2010 April Purpose: Evaluate the access to bank loans during the housing boom time Expectations about real estate market movements

Tallinn University of Technology Questionnaire 2010 April There were 350 repliers (287 female, 62 male) 57 % are owners of their living space, others live with parents or rent Persons who don’t own the living space – more then half of them don’t plan to buy real estate in the next years (Reason – 34 % real estate prices are still too high, 45 % disposable income is too low to take a loan)

Tallinn University of Technology Credit availability to households housing loans 43% of repliers found that it was too easy to get loan from banks 19 % bank condition was that loan must be taken jointly with another person Only 1% answered that bank asked too high self financing amount

Tallinn University of Technology Influence for consumption 45 % housing loan repayment amount is 30 % of disposable income 30% of repliers found that increase in interest rates will make their loan payments difficult (part of repliers did not answer at all) 6% said they have difficulties in everyday life Only 2% of repliers are ready to sell their property when they have difficulties with loan payments

Tallinn University of Technology Conclusions It is common to own your living space, not to rent it Access to bank credit was too easy during the real estate boom Clients with problems don’t want to renounce their property, only 2 % admit to the possibility of selling their flat or house Not owners are not planning to buy, they preferred to live with parents or rent the living space Housing loans have an important influence to the consuming activity

Tallinn University of Technology There was the procyclical effect in lending activity Credit risk was underestimated in the boom time It seems to be that the overheating was stronger than the downturn

Tallinn University of Technology According to the Estonian institute of economic research: In 2009 was the consumer confidence lowest of all the survey period (since 1992) 48 % of consumers assesses that the economic situation of their household was worse then a year ago Only 4% had a better situation

Tallinn University of Technology Individuals loans and deposits

Tallinn University of Technology Overdue loans and overdue housing loans ( annual basis, 2010 monthly basis)

Tallinn University of Technology Overdue loans The stock of overdue loans did not change much in 2010 The share of housing loans overdue by more than 60 days increased, reaching 4.6% Improvement in the quality of the loan portfolio is a time-consuming process, which will take years even if economic activity picks up

Tallinn University of Technology Housing finance market activity remained sluggish demand for housing loans is low ( irrespective of the relatively low price level of real estate) The stock of new housing loans issued within the April 2010 was 13% smaller than the average level of 2009

Tallinn University of Technology Housing market Prices of apartments started to rise rapidly in 2005 when the annual price rise was over 50% The growth rate of transactions started to slow down in the middle of 2006 The price rise turned to decline in 2007 when the housing prices reached the maximum Average price fall since spring 2007 has been %

Tallinn University of Technology Real estate purchase and sales transactions

Tallinn University of Technology Housing demand Total volume of housing loans has increased as a result of low interest rate and tight competition in the banking sector The rise in housing market was mostly driven by consumers expectations (stories of unprecedented price increases etc) easy access to credit (housing loan standards )

Tallinn University of Technology Average gross monthly wages and average price for a square metre of a two-room apartment in Tallinn (EEK)

Tallinn University of Technology Number of square meters of a two-room apartment in Tallinn obtainable for average gross monthly wages

Tallinn University of Technology Housing supply In 2004−2006 demand for housing was greater than supply Since the beginning of 2007 supply started to grow rapidly Since 2008 supply has been greater than demand

Tallinn University of Technology Granted building permits and completed dwellings (new construction)

Tallinn University of Technology Dwelling completions by type of owner (new construction)

Tallinn University of Technology Conclusions (1) Real estate prices are very cycle-sensitive It is difficult for banks to follow more prudent policies during an economic upturn, especially in a highly competitive environment The supervisory pressure on banks seems also to be procyclical (if real estate prices are rising, loan portfolio is rising, banks declare good earnings - it is very difficult to explain concerns with such situations)

Tallinn University of Technology Conclusions (2) Households budgets are tighten Borrowers have postponed their investment and consumption decisions despite of low interest rate If demand improves, credit growth can be expected to pick up no sooner than in the second half of the year 2010 Loan losses have increased less than anticipated in last year forecasts Improvement in the credit portfolio quality of banks will take time

Tallinn University of Technology Conclusions (3) Adoption of euro - the signals are contradictory demand is low, but experts speak about the first signs of recovery on the real estate market (Eurozone membership will give easier access to European capital markets) Some euro-area countries are experiencing a government debt crisis, uncertainties have arisen in the external environment The bottom of the Estonian real estate market is approaching, although the shape of this bottom is expected to be flat, which means a long vegetating in all economy

Tallinn University of Technology Thank you!

Tallinn University of Technology Authors Angelika Kallakmaa School of Economics and Business Administration, Tallinn University of Technology Ene Kolbre School of Economics and Business Administration, Tallinn University of Technology