Are we facing a new crisis in the real estate market or still struggling with the consequences of the previous one?

  • 2019-11-07
  • Olga Rudzika, Managing Director and member of the board, Pro Kapital Latvia

More than ten years has passed since the financial crisis of 2008. This is a seemingly significant time to consider whether one cycle of the economy is about to end and if we may face another recession. Regardless of the gloomy forecasts that have been circulating for at least a year and the often-cited geopolitical risks, the economy continues to grow, and people's purchasing ability follows. Another question is, however, if the previous crisis in Latvia is completely over? Unfortunately, the developments of the real estate market do not suggest this.

The Latvian, Lithuanian and Estonian real estate markets are a good indicator of broader economic and social processes of each country. What is the reason for Latvia to lag behind its neighbors year after year? For example, when comparing the number of new apartments that came on the market last year, there are about 2,400 apartments in Riga, over 3,000 in Tallinn and 4,300 apartments in Vilnius. This trend has continued for at least six years. One of the reasons for this is the cautiousness of the Latvian buyers but also banks, which is one of the consequences of the 2008 crisis. People still remember the events of that period, therefore it can be psychologically difficult to make the decision to buy a new apartment or build a house using the loan. In Estonia and Lithuania such a "side effect" of the crisis is less pronounced. Also, the banks that finance the projects are much more lenient in both neighboring countries.

In addition, Latvia has the most unfavorable tax policy in the Baltic States for purchasing and maintaining real estate. This significant detrimental factor for the development, is in the hands of the Latvian policy makers. It is a question whether to harness the development potential, which becomes an even more important factor in the country's competitiveness as economic growth decreases.

The third major challenge for the real estate market today is rising construction costs. It is clearly not possible to maintain the cost and property ratios at a current level - either the construction costs will fall or real estate prices will rise. Due to the limited availability of specialists, the labor costs suggest that a decline in construction prices is unlikely at this time, but rather a rise in real estate prices. Moreover, the prices in Latvia, in all real estate segments, have long been lower than in Lithuania and Estonia. We do see the demand for quality real estate projects in Latvia. Thus, new projects are expected to enter the market and are likely to be priced higher.

Given the persistent domestic demand in Latvia, it is more likely that these are the effects of the 2008 crisis rather than the beginning of a new crisis. Despite some caution, people are looking for new housing, businesses are investing in offices, shopping centers are being developed and industrial projects are being carried out. As Martins Kazaks, a member of the Bank of Latvia Council, has stated in an article on forecasting the economic developments: “This year's growth of Latvian economy will be below 3%, compared with 5% GDP growth in the previous two years. It means that the economic growth continues, however at a slower and more uneven pace than recently experienced.”

The slower growth rate combined with the rising prices and a notably cautious buyer mean an even greater challenge for real estate developers. They must be able to provide projects that meet today's needs, are functional and of high quality. Gradually this would allow to replace the outdated houses, which we know as the ‘sleeping districts’ from the Soviet era. The good news is that there is a growing number of foreign workers and students in Latvia, many of whom are sure to look for a home in the future. As a result, that will stimulate the market and encourages the local buyers.

In fact, it is in the hands of policymakers to create a supportive legal environment and tax policy, to encourage foreign labor and demographics to unlock the economic potential of Latvia and make attractive new buildings in our cities for people and business. Quality living environment is one of the key conditions for the development of a particular area, which can shorten the period of stagnation and replace it with economic growth.

 

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