Trends on the real estate market in 2004 and the first quarter of 2005 have shown a continuous rise in prices. Despite market experts' frequent forecasts that the "bubble" would burst on the back of speculative transactions, nothing of the sort has happened. Is there a "bubble," or is the price-growth due to structural reasons?
Only recently have both builders and buyers received access to financing for new housing. The lowest-ever interest rates has sparked the development of a mortgage market in Latvia and facilitated competition among banks for customers. Naturally, the low rates have also made this new housing available for a broader number of clients.
However, the average level of income is still very low, with the average monthly wage in Latvia amounting to 250 euros. Taking into account the level and rate of growth of real estate prices, only 10 percent of the population can afford a new dwelling, assuming that the housing serves as collateral and a bank requires that mortgage payments comprise 30 percent 's 40 percent of net monthly income.
Therefore, the risk of oversupply in some real estate segments may be deemed as being relatively high. Riga and the surrounding regions need approximately 8,000 new flats per year, but before 2000 there had been almost no new projects commissioned. Soviet-era houses, meanwhile, deteriorated and outlived their usefulness. In 2004, around 1,900 flats were commissioned, and in 2005 this number will rise to approximately 3,300. Despite the high demand for housing among the low and middle classes, many companies built luxury houses that, as a rule, do not sell very fast. What are the consequences of such a situation?
First, the question of the Latvian banking system's capacity to sustain an increasing number of non-performing loans arises. A 2004 IMF report on the stability of Latvia's banking system indicates the healthiness of loan portfolio. The capital adequacy ratio is well below the FCMC specified rate of 10 percent, and the share of non-performing loans is below 3 percent. If the share of non-performing loans double, the total losses of banks may amount to 9.8 million euros, but none of the banks will be insolvent. This is quite affordable for the country. In other words, banks have room to take additional risks and issue more "junk" credit. This explains the recent "cheap credit" fight among leading banks that drove flat prices even higher.
Other than interest rates, another important factor in mortgages is the amount of possible financing and the terms of credits. Banks now offer 90 's 95 percent financing for newly built houses and up to 85 percent for older Soviet-style houses built in the '60s. The credits are issued for 20-30 years. As a result, prices for older flats and newer ones are similar. In addition, prices in older houses tend to increase faster. In order to avoid the risk associated with older flats, the banks must have required stricter restrictions on financing and terms for old house credits. That may have helped to restrict the price growth.
Nevertheless, what are the potential measures that may help to slow the pace of price growth? Recently, the government proposed an introduction of a "tax" on real estate transactions. If realized, the country would restrict the real estate development market and face a severe shortage of housing. The obvious measure is to draft stricter mortgage application requirements for risky projects.
Apparently banks are not able to compete with interest rates as they are set outside their control, but they can regulate the amount of bank financing and the term of credit and screening procedures. However, not much can be done with newly built houses. Construction companies will eventually pass the increasing transaction costs on to buyers.
Despite some apparent speculative transactions, a majority of flats are still acquired for living purposes. So the price rise on the Latvian market is quite natural, and thus current market trends are more structural than speculative in essence.
