Housing prices in Lithuania appear irrational

  • 2005-05-25
  • By Marius Pilibas, project manager and Kristine Kolosovska an analyst at Bridge Capital
VILNIUS - The residential real estate market in Lithuania, especially in Vilnius, resembles an out-of-control price war. On an annual basis prices for newly constructed flats have climbed 20 's 40 percent, 5 's 15 percent for the old Soviet'sstyle flats and 25 's 35 percent for downtown flats. If the value of newly constructed flats can partially be explained by construction costs, the price-rise for Soviet-type housing seems purely speculative.

Frantic borrowers, looking at the low interest rates and abundance of bank financing, are rushing to take out loans, often underestimating the hazard of currency and interest rate fluctuations.

Irrational market. The key question on the residential real estate market is price irrationality. The price difference between the old Soviet housing and newly constructed facilities should reflect the difference in quality, location, flat planning. But it doesn't. Usually, the Soviet buildings are technically and morally obsolete and will soon require major investments in infrastructure. As a rule, these houses are not in the most convenient locations. Nevertheless, they are steadily rising in price.

This may be partly explained by a lack of supply in major Lithuanian cities. Often the flats in newly constructed houses are sold out before actual construction begins. The supply of flats in the suburbs and downtown area is failing to keep up with growing demand. At the same time, development of new housing is limited by increasing construction costs and rising land prices. Nevertheless, the future demand for new housing will inevitably grow. In comparison with the EU average, dwelling space per capita in Lithuania is two times lower 's just 22 square meters.

Happy loan. Lithuania, like Europe at large, is experiencing a credit boom. It's no secret that there is a glut of idle funds that have to be put somewhere. Eight years ago around 95 percent of housing in Lithuania was bought with cash, while, in 2004, 95 percent of housing was bought on credit. Mortgages can be received on very favorable terms now, and the percentage of bank financing is approximately 90 's95 percent for new projects. It is even possible to get a 40-year loan at an interest rate of 3.7 percent in a foreign currency and 4.5 percent in litas. By comparison, in 1999 these figures were 11.2 percent and 10 percent respectively.

At the same time, the size of the mortgage market is very small in real terms, as the population's base income is very low. Around 40 percent earns just 600 litas (175 euros) per month. Just 10 percent earns more than 2,500 litas, which is sufficient to apply for a loan assuming that monthly mortgage installments should not be larger than 30-40 percent of family income.

Artificial demand. In nominal terms the mortgage portfolio of Lithuanian banks is growing very fast. In 1999, the total housing portfolio was 199 million litas (60 million euros), in 2004 this number jumped 10 times to 2 billion litas. Thus the supply creates its own demand. However, on a European scale the real estate market and the mortgage market still have opportunities for development. In the EU housing loans comprise 38 percent of GDP, while in Lithuania this indicator is only 4 percent.

Real estate cure. Apparently, policies that aim at limiting demand (e.g., limitation of lending) will have adverse effects on the economy in a market characterized by a dearth of quality housing. However, a more prudent approach to granting mortgages for old Soviet style flats should be adopted by financial institutions, and new housing development should be encouraged. This will help eliminate part of the artificial price differential created by plenty of cheap financial resources. In conclusion, the price race will not stop any time soon 's the population's income is growing along with demand for housing 's but it is necessary to make the market more "logical."