Small countries, big problems

The Baltic countries hate being treated as one, but this time it is unavoidable. The Estonian, Lithuanian and Latvian housing markets have gone into reverse. In Tallinn they are even wondering whether they have hit bottom

Mladen Petrov

Estonians are a tight-lipped people, who change their expressions only when the subject of the situation on the residential market is broached. For the first time in its modern history, the market has had to cope with serious difficulties for more than a year. The diagnosis is simple – this Baltic tiger is sick. The same can be said for Latvia, with the disease already now spreading to Lithuania. The word ‘recession’ is increasingly popping up in discussions about the economy of the three Baltic states, which were once regarded as the tigers of Europe, while analysts are simply saying that “the balloon has burst”.

Statistics paint a shocking picture

Convincing proof that the Estonian economy is in recession is provided by the figures: -0.9 pct growth in GNP in the second quarter of the year, -1.4 pct since the beginning of 2008, one of the highest rates of inflation in the EU (11 pct over the year), with banks calculating losses in tens of millions of euros. And if that were not enough, the housing sector has come to a halt. The latest data published by the Uus Maa real estate agency reveals that the prices of homes in Tallinn slumped by 12 pct between the beginning of the year and the end of July, with experts talking about a drop of even 30-50 pct over the year. Prices per sqm start from EUR 1,160, reaching around EUR 2,000. The average price per sqm is EUR 1,350 – falling from EUR 1,590 a year ago (according to an Ober Haus report for the second quarter of 2008) . Has the bottom been reached? Developers are nervously awaiting the onset of winter when homes in projects started last year finally come onto the market.

Tallinn, the largest city (396,000 inhabitants), has  suffered the most. Kristiina Möldre, the new projects sales manager for the Estonian branch of the Ober Haus agency confirms the figures are correct: “All the events taking place on our residential market are a textbook example displaying that a moment of correction happens after several fantastic boom years. Journalists point to a looming crisis but forget to remind everyone about the huge percentage rise during the construction boom period.” The sharp price rise immediately prior to and after Estonia’s accession to the EU came as no surprise, but the momentum at which prices soared was astonishing – 100 pct within two years (2004-2006).

The chain of events

Local specialists point to Scandinavian banks as being the responsible parties for what happened on the Estonian residential market, showering potential customers with offers of cheap mortgages. When the US credit crunch eventually began to make an impact, these institutions changed their loan-granting policies. Another reason is that prices have reached a level unaffordable to the average citizen. The rising cost of running a home is yet another factor, with an average family having to channel 17 pct of its earnings to cover this. Only those buyers who urgently need a new home remain, while foreign customers are no longer interested in what they see as a high-risk market. Uus Maa’s data shows that in Tallinn 4,330 homes were sold on Tallinn’s secondary and primary markets between the beginning of the year and the end of July – 35 pct less than last year.

Connected vessels system

A similar situation prevails in Latvia. The fall in prices there can partly be explained by the government’s drastic anti-inflation policy. Banks have restricted access to mortgages, with interested parties currently having to cough up about 10 pct of a home’s value, with the rest having to be covered by a more expensive loan. The result was that the number of transactions finalized in the second and third quarter of 2007 was 63 pct less. Prices in some new projects in Riga slumped to EUR 1,433 per sqm towards the end of last year. Veiko Taevere, a board member and development director of Arco Vara, one of Estonia’s largest developers, describes the current situation: “In Latvia things are much more worrying than in Estonia, where there are more new flats on sale, while customers prefer to buy homes on the secondary market. In Estonia customers want to purchase new homes instead, although they may be 20 pct more expensive.” Arco Vara is also active on the Latvian, Lithuanian, Ukrainian, Bulgarian and Romanian markets. In Riga there is a worrying sales rate of only one or two homes per month, while 76 pct of the flats in the developer’s two current projects are waiting for new owners. July, however, was an exception, with 12 flats being sold due to earlier reservations.

On the other hand, although Lithuania’s economy is also experiencing a drop in growth, it seems somewhat protected against recession, with property prices going through a period of stability rather than a slump. Prices per sqm in Vilnius city centre at the end of 2007 varied between EUR 2,600 and 5,200. Even so, Arco Vara remains wary and is waiting before deciding to start work on any new residential project in the city. Such wide differences over future strategy resulted in board president Aare Tammemäe resigning from the company in late August, his final comment being: “A variety of opinions can be heard when the market situation is so problematic.”

Banks in dire straits

The Estonian crisis has also been a kick in the teeth for the banks, particularly the Swedish contingent, which gives out the majority of mortgages in the Baltic countries and dictates the conditions there. The International Monetary Fund has been heard saying that the problems Swedish banks are facing in the Baltics could result in them having liquidity problems. Hansa Pank and SEB are among those, the latter announcing it had experienced a loss in Estonia of EUR 20.6 mln due to so called ‘bad loans’, compared with a loss of only EUR 1.72 mln a year ago. In Estonia alone, the bank’s profit in the first half of the year fell by 77 pct to EUR 11.8 mln compared with the first half of 2007.

Project for immediate sale

An accompanying phenomenon is the number of residential projects being put up for sale. There are said to be more than 100 projects under development and still at the design stage in Tallinn alone that developers are anxious to get off their hands. The most expensive project – a seven storey building with an office section developed by Bestok Kinnisvara – has been sold for EUR 25.5 mln. However, it is still possible for investors to find, with a little effort, a ‘housing bargain’ – even for around a EUR 1 mln. Veike Taevere is of the opinion that: “Developers with smaller projects that they are unable to complete have been in contact with us but we are rather not interested in such offers. In fact, were we to receive an attractive offer we would be willing to sell some of our projects”. The brokerage company, part of Arco Vara, is now looking for firms ready to take over two projects, one at 80 Narva avenue and the other at 10 Raua street in Tallinn.

Pack up and move out?

Baltic real estate developers confined to their local markets are now seeking ways to escape. Some are cutting down on residential projects in their portfolios and turning instead to construction services. Ukraine projects a more positive picture, where Arco Vara’s construction division and Eesti Ehitus are busy building a number of shopping centres. In Bulgaria, ArcoVara is developing two residential projects: Boulevard Residence and Manastirski Livadi. It is also on the lookout for new attractive development sites. A similar situation exists in Romania. Maria Raudsepp, marketing and sales manager of Koger & Partnerid, believes that: “Firms with diversified activities are less exposed to problems in a crisis situation. We cut the price of homes, look for other construction contracts and survive. We even thought of entering the office market, but eventually decided against such a step.” The firm does not focus entirely on the residential sector. It has also won a contract to build Estonia’s embassy in Tbilisi, and has other potential projects in Bulgaria, Norway and Latvia. Veiko Taevere adds that: “Our growth strategy assumes that all our projects will be situated outside Estonia by 2011-2012.”

Hanging in there

But there are a few people who believe the recession will soon ease and are already preparing new ventures. There are also those who are surprised at such optimism, since data published by Uus Maa shows that only 150 new homes are sold every month in Tallinn. Assuming that this rate of sales is maintained and that there will be no new projects, it will take about 18 months to get rid of all the 2,300 residences. But construction work has not come to a halt in Tallinn, with new residential projects launched by YIT of Finland and Besqap of Sweden, among others. Good times have arrived for those who want high-standard homes in attractive location and at a reasonable price. Maria Raudsepp feels that: “Indeed, customers can now take their time when choosing what and where to buy and have become very demanding along the way.” Top-shelf apartment buildings in the best locations have not been subject to price cutting. Kristiina Möldre of Ober Haus points out that: “We shall soon start selling apartments in a small attractive building in an excellent location at a price of around EUR 3,500 per sqm. I am sure the project will be a success, since a section of people exist in Tallinn who are looking for high-class apartments, and there are around 10 such projects in the pipeline”.

When will the indicators start picking up?

Danske Bank forecast in mid-2007 that the Baltic countries are entering a protracted period of recession. But what does ‘protracted’ mean here? The people we talked to expect that the first signs of an improving economic situation are expected towards the end of next year. Capital Economies, the London advisory company, in its prognosis for Estonia and Latvia stresses that there can only be one scenario: recession during the next 12 to 18 months. The International Monetary Fund is of the same opinion, expecting an improvement in 2010. The Baltic tigers are entering a moment of truth. ν