Source: LinkedIn.
Discussions about real estate prices capture the public's attention, likely surpassed in notoriety only by electoral disputes.
Are prices high or low?
With the figures in front of me, I will analyze the situation and begin by emphasizing one fact: despite numerous "analyses" continuously predicting an imminent new market crash for many years, the reality is that for more than a decade, property prices have been steadily rising at a pace that seems sustainable in the medium term (probably with the exception of Cluj). What the numbers tell us is that currently, property prices are reaching new post-crisis highs, still significantly below the levels recorded during the 2008 bubble. These prices are market-driven; in every transaction, two parties are involved: someone buys and someone sells at an agreed common price, not pulled out of a hat. Nevertheless, it is no coincidence that housing prices are climbing to the highest recorded post-crisis values.
Analyses conducted by the institution I work for show that the current residential real estate market is characterized by an imbalance between supply and demand. On the supply side, data available at the beginning of the year indicates a decrease compared to the previous year in the number of building permits issued for residential buildings, the volume of residential construction works, newly completed homes, and those available for sale. In terms of demand, it has increased due to economic recovery, reduced inflationary pressures, and rising wage incomes. Thus, the upward price dynamics are supported by the reduction in supply, rising construction costs, and increased demand.
High construction costs continue to put pressure on new housing prices, and this upward trend in costs is expected to continue in the near future, driven by a severe labor shortage and fiscal measures implemented at the beginning of the year. Additionally, the increase in VAT from 5% to 9% for new homes, starting January 1, 2024, is likely to exert further pressure on residential property prices.
Wages in the economy are, however, the most important factor explaining the evolution of house and apartment prices. In the last 12 months, we have witnessed an almost 15% increase in the average net salary in the economy. In the past 10 years, national housing prices have doubled, while the average net salary has almost tripled. With these figures in mind, the recent property price increases no longer seem absurd.
My colleague, Csaba Bálint, a member of the BNR Board of Directors, conducted an in-depth analysis in the past, revealing that the most important factor contributing to rising housing prices is wage growth.
Over 50% of the price increase seems to be explained by rising wages. Moreover, this variable explains both the average increase and the territorial profile (explaining the difference from one city to another).
The second most important factor identified is long-term interest rates for mortgage loans, and a third, albeit less relevant, factor is demographics. Even though the demographics are not promising, with the country's population declining and aging, major cities are becoming more populated and have higher demographic growth rates.
But how much does a home cost?
When a price rises, we can say it is more expensive, but conversely, that money is cheaper. The same hundred lei or euros fill the shopping basket less now than it did 15 years ago. But what if we express the price in other goods or services and not in money?
Affordability (price in years of work) is calculated as the ratio between the average price of a standard home (60 sqm) in various cities and the average annual net salary earned by a resident of that city. The price-to-income ratio is a simple way to interpret property affordability, similar to the famous PER (price/earnings ratio) in stock market investments.
That's how I came to calculate the affordability index for four major cities in Romania and four capital cities in Central and Eastern Europe (CEE), for personal purposes and out of curiosity, to understand better. A first conclusion from the above infographic is that we are in a completely different situation compared to the period before the Great Financial Crisis. I don't think the 2008 scenario will repeat itself anytime soon. During the 2008 real estate boom, the cost of a home in Bucharest exceeded 20 annual salaries, even 25 (the data is less accurate for that period).
Today, the situation is much different: an average home in Bucharest requires the equivalent of six years of work. Cluj-Napoca, with 10.4 years, is less affordable but in line with the capitals of the Central and Eastern Europe region. For example, in Warsaw, the cost of a home is equivalent to about 11 years of work, in Budapest 10 years, and in Prague almost 14 years. Whether six years is a lot or a little for a home, I leave it to you to decide. What can be said with certainty, based on the figures, is that we are seeing the lowest "price" in the last 20 years and the lowest among the analyzed cities. These are data, not opinions.
Of course, cities are not perfectly comparable; there are more tourists in other CEE capitals, but perhaps urban planning rules are stricter. However, with the limited data used in this exercise, we can say that despite price increases in the last decade, homes in Bucharest remain significantly more affordable compared to other capitals in the region.
I have already received the argument several times, "you have to live too, who saves the whole salary to buy a house in six years?". It is a solid argument that comes naturally. The answer is that, on the one hand, the calculation assumes a single salary in the household; often, there are two.
Also, the calculation is the same for all cities: it tells us rather that city X is more affordable than city Y and that city Z is much more affordable than it was 15 years ago, see the case of Bucharest. It is not perfect. However, it gives us a good idea of where we are compared to where we were. Also, everything is based on averages: the average salary in that city, the average price per sqm, etc. We know Moisil's example. We know that two people can eat an average of a chicken, one person two, and the other nothing. In short, the average hides a lot, but otherwise, we cannot look at the subject.
When it comes to the possible long-term evolution of house prices, I like to use a mind trick. If we assume that wages increase by a certain percentage (say 5%), and house prices remain constant, in 50 or 100 years, we could buy a house with just a few months' salary, right? What is now equivalent to six years of work in Bucharest would become one or two months. Sounds nice, but totally unrealistic. Similarly, if wages perpetually increase by a certain percentage, and rents remain unchanged, at some point, a rental apartment would cost only 1% of the monthly salary. It would be nice, of course, but we know it is unrealistic.
That's why I consider the affordability indicator, the price of a house in years of salary, to be very relevant, because in the long term, it cannot be either 100 or subunitary; it would be too much or too little. Everything derives from the fact that:
- Goods are rare by nature;
- Space is limited; we cannot all live in the city center;
- Houses are made with work: at the end of the day, a large part of construction costs are salaries: including the salaries of those who produce building materials, those who design, those who authorize, etc. The minimum wage in the economy has increased by 43% in the last two years alone, by 57% in the construction sector. It will increase by another 12% in June. Someone has to pay it.
- Productivity in the construction sector does not increase as quickly as in other sectors: building a home has remained labor-intensive and slightly automated despite some technological advances. In addition, quality, finishes, and thermal comfort requirements have increased. This way of thinking helps us better understand the dynamics of prices and housing affordability.
Have houses become more expensive, or is money cheaper?
Another important aspect is inflation. In the last decade, cumulative inflation in Romania was 52%, and in the last three years, 34%, of course, due to overlapping crises. In these last three years, housing prices have increased by 26% in Romania and 20% in Bucharest.
In other words, in real terms, housing prices have decreased in the last three years. Adjusted for inflation, they are lower.
Over long horizons, when the general price level rises, real estate prices tend to follow the same trend, as both replacement costs and potential rental incomes tend to increase. Thus, rental incomes should be viewed more as real returns, adjusting broadly with inflation. This dynamic makes real estate investments relatively attractive during periods of high inflation, as they are real assets and not financial ones, offering some protection against long-term inflation. In finance books, real estate investment remains one of the safest methods to protect wealth during high inflation periods, being considered an effective hedge against inflation.
It also matters what the city "offers."
And the infrastructure projects under development in Bucharest or other major cities in the country, aimed at improving connectivity and quality of life, contribute both to raising living standards and increasing property values. Infrastructure development is an essential factor in the long-term attractiveness of the real estate market. For example, extending/creating the metro network in Bucharest/Cluj, modernizing roads, and developing commercial and residential areas contribute to the overall attractiveness of the city. One is a city with a ring road around it, another without.
Capital accumulation increases asset values in general. When you have nothing, as was the case in 1990, it is normal for a studio apartment to sell for a pittance. However, Romania has accumulated capital stock (especially after joining the EU) and continues to accumulate, both financial capital and equipment, knowledge, etc. We are no longer the poorest country in the EU. This is reflected in the price of real assets.
To summarize:
- Rising Prices: Property prices have been steadily rising for over a decade, although still below 2008 bubble levels.
- Supply and Demand Imbalance: The current market is characterized by decreased supply and increased demand, driving prices up.
- Construction Costs: High and rising construction costs, influenced by labor shortages and fiscal measures, contribute to higher property prices.
- Wage Growth: The most significant factor in rising property prices is wage growth, with average net salaries increasing substantially.
- Affordability Index: Despite price increases, housing in Bucharest remains more affordable compared to other Central and Eastern European capitals.
- Inflation Impact: Real estate prices, adjusted for inflation, have actually decreased in recent years, highlighting the impact of inflation on real property values.
- Infrastructure Development: Ongoing infrastructure projects contribute to the long-term attractiveness and value of real estate in major cities.
In conclusion, while property prices are rising, they are driven by factors like wage growth, construction costs, and inflation. The affordability index shows that, compared to other cities and historical data, housing in Bucharest is relatively more affordable. Infrastructure developments and capital accumulation further enhance the attractiveness and value of real estate in major Romanian cities.
This article was originally published on the Comunitatea Liberală 1848 platform.
