Baltic Real Estate Bubble to Burst?

Amid world fears of a global credit crunch, the small Baltic states are starting to see property prices falling after almost five years of spectacular gains.

Though industry players see the price falls as a correction, some analysts see the move down as the start of a long slump, exacerbated by the fact that the economies of Latvia, Lithuania and Estonia are overheated and plagued by high inflation.

Though property prices all over the world have boomed, the surprise for the Baltic states was the speed: prices have risen five-fold since 2002, among the fastest in the world, though the three countries are among the poorest in the European Union.

With the market having now plateaued, speculators are looking elsewhere for fast capital gains. This has left uncertainty over the extent local demand will support prices.

"We get a lot of the speculative money going to Romania and Bulgaria now," said Peter Morris, managing director of estate agent Oberhaus, one of the most active on the Baltic market.

Oberhaus says the average price per square metre for a city centre flat in the Baltic capitals has soared 500 percent from 500 euros ($674) in 2002/2003 to 2,000-3,000 now, depending on location or quality.

This means that a two-room apartment in the centre of Riga of about 50 square metres that could have been bought for 25,000 euros would now set a buyer back up to 150,000 euros.

"Everyone knew they were going to converge (to Western levels), but everyone thought it would be a 20 or 25 year process, instead it seemed to be five or 10 years," said Morris.

After years of growth, which put Baltic property prices close to the level of much richer Nordic countries, prices have been going down slowly since early 2007.

Estate agent Latio says Latvian prices are down about 8 percent this year, with the falls beginning in May. They are still 30 percent up on the same time last year.

The development is similar in Estonia, with prices down between 5 and 10 percent so far this year. In Lithuania, prices are still rising, though at a much slower pace and more or less in line with inflation, which was at 5.1 percent in July.

The reasons for the change are that banks, encouraged by governments, have introduced stricter lending rules.

Another reason for a slowing market is that prices got beyond what people could afford and interest rates have also risen. For investors, yields have also been falling due to rising property values as rents have not kept pace.

"Prices started to fall mainly because they had gone way too high and people were worried about a crisis," said Annika Jakobson, analyst at Estonian estate agent Uus Maa.

"Our media has been talking about a price fall for almost a year and a half, but it has not happened so far. Still, we can't say it is a crisis, it is more like a correction."

Morris at Oberhaus also expected prices in the long run to rise even further.

But others are more pessimistic, pointing to the overheated property market and other signs of economic strain such as high inflation and large current account deficits in each country.

Ratings agency Fitch was the latest on Friday to downgrade Latvia due to overheating. Others have also cited such fears.

"It is very difficult to assess how far property prices in the Baltics could potentially fall," said Denmark's Danske Bank.

"But given the large imbalances in the Baltic economies we think the downturn could be quite severe and long-lasting."

Raimondas Kuodis, chief economist at the central bank of Lithuania, said he expected inflation to eat into the values of property to the tune of 25 percent over five to seven years.

"That is what I would call disinflation of the bubble."

Industry experts say buyers are now cautious, wondering whether to wait for more price falls or negotiate discounts before demand kicks in again and prices begin to go up.

Buyers are also more discerning, looking more at the quality of what they are buying, rather than purchasing anything they can get their hands on in the hope of a fast capital gain. This has led to a waiting game between buyers and sellers.

The time of uncertainty is leading to some unusual gimmicks: one developer in Estonia has even offered a free car or a labourer for three months in the price of a house.

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