Real estate prices are rising, yet at a slower pace than incomes

Warsaw, Poland (Wistula, CC BY-SA 4.0)

Nominal prices of real estate in Poland have approached the 2006-2008 level but adjusted for inflation they continued to be lower. Also household income saw a stronger rise than home prices

Poland’s central bank, NBB has published its annual “Report on the situation of the residential and commercial real estate market in Poland in 2018”. Housing is a good satisfying people’s elementary needs, and for many also the most important asset and a form of fund accumulation. The real estate market is of interest to home owners and even more to those who are planning to purchase their own dwelling. Even those, relatively scarce in Poland, who, for various reasons decide to rent instead of buying, closely follow the situation in the residential real estate market as it determines rent rates.

The way people meet their housing needs depends not only on their preferences, but also savings, income and creditworthiness, which is largely affected by a changing economic situation. The Polish economy has been growing rapidly for several years, and nominal interest rates are at historically low levels. As the income is growing steadily, people assess their current situation as favourable. At the same time, residential mortgage loans are relatively cheap and affordable.

These are cyclical factors that strengthen fundamental demand for housing. In Poland, the housing stock, measured by the number of dwellings per 1,000 inhabitants, is still below the level recorded in Western European countries. Importantly, part of the housing stock is also of a poor standard.

In cities and metropolitan areas, the dynamically developing labor market should support affordability of rental housing. The number of inhabitants of large cities and their wealth increases, and at the same time, according to global trends, smaller towns are depopulating, which additionally boosts demand for housing in the largest cities. There are also reverse processes that lead to the development of metropolitan areas around large cities. The phenomenon of substitution, when people opt for a larger usable area giving up better location, urges some residents to move to larger housing outside the city’s administrative boundaries. The suburbanization is observed in all the major cities in Poland, especially in Poznań.

Growing demand for housing can only be met by the construction of new residential real estate. Real estate developers compete for well-located land and production capacities of construction companies. The entire construction sector, which consists of general construction, residential and commercial real estate, is currently in the phase of strong recovery. The implementation of projects financed with EU funds under the current financial perspective has just entered the phase of the highest activity. This results in a considerable utilization of production capacity of construction companies involved in general construction projects, including construction of road and rail infrastructure, as well as public buildings.

In the commercial sector, increased construction activity observed especially in the office and warehouse sector is driven by a strong inflow of foreign capital, which is supported by very low financing costs due to low interest rates in the Eurozone. Investors are looking for investment opportunities in new commercial real estate, competing primarily for land in good location whose supply is limited and regulated by local area development plans. In some cases, old office buildings are demolished to make room for the construction of new, better quality ones.

As a result, the residential and commercial real estate sectors compete for limited resources with other construction sectors, and the high demand for new residential real estate boosts the desire of real estate developers to build. In such conditions, the land and construction costs are increasing. Buyers are paying the higher costs while developers maintain relatively constant margins. As a result, prices of real estate in the primary market are on the rise. These, in turn, translate into higher prices in the secondary market. In 2018, average prices per square meter of housing in local primary and secondary markets followed an upward trend. Nominal prices in Warsaw and 6 largest cities approached the 2006-2008 levels, and in 10 cities even exceeded them.

Indeed, home prices should be analyzed in a broader context, accounting for changes in the prices of other goods and services, and household income. The level of home prices in 2018 in the major markets, adjusted for inflation (deflated by the CPI index), was still below the record high values in 2006-2008. Moreover, household income has increased faster in recent years than real estate prices, which means that despite a nominal rise in housing prices, real estate is more affordable.

The highest nominal prices per square meter (sq. m.) in primary and secondary markets were recorded in Warsaw and in the six largest voivodship cities (6M), especially in Gdańsk and Gdynia. Interestingly, on these markets the price of a medium-sized dwelling’s sq. m. was lower than the prices of small housing (up to 40 sq. m.) and the largest housing (over 80 sq. m.). In the markets of the remaining 10 cities, the highest prices were recorded in the segment of small dwellings.

The rental market has been developing for several years now. Home rental allows to meet housing needs without the commitment of significant funds or long-term borrowing. Yet, increased demand for rental housing boosts prices. Average rental rates (both offer and transaction ones) per sq. m. in the majority of the analyzed markets increased in 2018 (offer rates by 4 per cent y/y, and transaction rates by 10.4 per cent y/y).

Increasing rental rents also encouraged wealthier households to purchase real estate for investment purposes. Persons investing in rental housing achieved higher nominal rates of return (calculated as interest rate differentials) than from government bonds or bank deposits, and similar to generated by professional investors from investments in commercial real estate. It should be emphasized that buying housing for investment purposes involves significant transaction costs, as well as a significantly higher risk and lower liquidity compared to, for example, treasury bonds or bank deposits, which are risk-free and completely liquid.

As a result of a strong increase in household wages and historically low nominal interest rates (both on deposits and loans), the housing market posted an increase in consumer demand, i.e. purchases to meet buyers’ own housing needs. This was also driven by a rise in purchases of developer dwellings due to the depletion of funds for subsidies for home purchases under the government housing scheme Housing for the Young (MDM). Real estate purchases were mainly financed with buyers’ own funds, in particular in the case of dwellings for investment purposes. Purchases for consumer purposes were mainly financed with a mortgage. Bank lending increased by 11.8 per cent y/y.

The time of selling a dwelling may be used to measure how demand and supply in the market are matched. By the end of 2018, in the primary markets of seven cities home selling time slightly exceeded three quarters. Such a short home selling time meant that buyers had limited possibilities of choosing housing in the primary market. On the other hand, in the secondary market home selling time, considering only closed deals in all markets, fluctuated around four months. It should be noted that in Warsaw home selling time decreased as compared to the previous year by about two and a half months, in six cities by about a month, and in 10 cities by about half a month. This means that the number of dwellings on offer has dropped significantly on the Warsaw real estate market.

Residential construction was at a record peak level, however, due to the increased demand and high sales, the market did not see any surplus in housing supply. In 2018, over 184.8 thousand dwellings were completed, which is a 2 per cent increase y/y. A relatively strong increase of 7.7 per cent y/y was observed in the case of commenced housing construction (approx. 221.9 thousand new housing projects), while the number of permits issued for housing construction increased slightly — to approx. 257.1 thousand. (by 2.7 per cent y/y).

The good economic situation of development companies, especially the largest ones, was supported by the high demand in the housing market. The estimated share of developer profit in the price of new housing remained at a relatively constant, high level. Considering rapidly rising construction costs, it can be concluded that development companies have managed to pass on a significant portion of those costs to buyers. However, rising prices of construction and assembly works and staff shortages had a negative impact on developers. Another negative factor was a significant increase in land prices for multi-family housing in major cities. However, developers did not expect the land for housing construction to be getting scarce in the next few years.

Some problems were reported by large construction companies, which, despite the favorable economic situation in the primary housing market and in infrastructure construction, gained significantly lower economic benefits than development companies. In the market of broadly understood construction services, the rising costs of building materials and labor generated losses and limited activities of some construction companies. Construction companies are trying to hedge against further cost increases by signing contracts for smaller stages of works. They choose shorter periods of work or higher indexed contracts that account for the growing risk of construction costs.

So what could the future of the housing market look like? This will largely depend on the situation in the entire economy, including the European Union, as Polish economy is strongly linked to the economy of the EU, in particular, to the German one. NBP’s July projection of inflation forecasted a stable, though relatively low GDP growth in the Eurozone trending at 1.4 per cent. At the same time, risks were identified which, if materialized, could curb growth. Unfortunately, some of these risks have recently materialized and the situation in the Eurozone is worsening at a stronger pace than expected.

The prolonged weakening in international trade and recession in the German industry are the main driving forces behind these developments. Brexit is also a factor likely to have a negative impact on the European economic situation in the longer term. Fortunately, Polish economy has so far shown considerable resistance to the economic downturn abroad and continues to grow rapidly. According to the NBP projection, GDP growth will gradually decline. Such a scenario would most likely support the continuation of the trends currently observed in the real estate market.

If the global economic situation further slackens, it cannot be ruled out that GDP growth will slowdown in Poland. A slowdown in economic growth is often followed by a decline in the demand for real estate, which is due to a lower growth in household income and higher uncertainty. Some people may then postpone the decision to purchase housing and some buyers of developer housing may withdraw from the contract if they expect future drops in home prices to cover possible contractual penalties.

The factor that allows us to look into the future with relative confidence is the robust situation of development companies, especially the large ones. In financing their activities these companies continued to rely largely on equity, buyers’ down payments, bonds and loans, as well as the late repayment of liabilities. A high share of equity (exceeding 40 per cent) constituted the financial buffer with a small share of loans (approx. 10 per cent). However, it should be remembered that in the event of a turmoil in the real estate market, developers’ assets invested in land, finished dwellings and work in progress will lose their value and will become less liquid, thus causing problems with the timely payment of liabilities.

Therefore, although the negative scenario is not very likely to materialize, companies operating in this market should be cautious when signing contracts, planning future projects and making commitments. Also prospective home buyers should be aware that the real estate market — just like the entire economy — is subject to periodic, though irregular fluctuations. Therefore, when buying or selling a property it should be remembered that its price may change in a different direction than assumed. The belief that the purchase of real estate is a risk-free investment is a myth. Naturally, price changes affect those who buy housing to meet their own housing needs to a lesser extent.

Opinions expressed by the author do not represent the official position of NBP.

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