armenia’s housing boom-bust cycle 1 i. … · armenia’s housing boom-bust cycle 1 ... 1 04-7...
TRANSCRIPT
ARMENIA’S HOUSING BOOM-BUST CYCLE 1
I. BACKGROUND AND CROSS-COUNTRY PERSPECTIVES
During 2004-2008 Armenia experienced a large housing boom. Real estate construction
output increased four-fold between 2004 and 20082, with the share of the overall construction
sector in GDP increasing from 10 percent in 2000 to 25 percent in 2008.3 Other well-known
episodes of real estate booms pale in comparison: in Spain, the share of the construction
sector in GDP grew around 3 percentage points of GDP during this period. In the U.S., the
U.K., and Russia, the construction sector share in GDP was considerably smaller and barely
changed during the boom years.
During 2004-08, Armenia also experienced a house price boom, with prices increasing by
2.5 times over the four-year period. This increase was much larger than the house price
booms taking place during this period in some advanced countries (e.g., the U.S., the U.K.,
Spain)4, and also high compared to the very large increases in other former Soviet Union
1 Prepared by Armineh Manookian and Guillermo Tolosa, benefiting from comments from Mark Horton, Deniz
Igan, Mariana Colacelli, Edouard Martin and Gohar Minasyan.
2 There are no data for real estate investment in Armenia, but real estate construction output is an appropriate
proxy.
3 While this note makes references to the entire construction sector because of data availability; real estate
accounted for 60 percent of construction activity in 2008, largely concentrated in residential real estate.
4 The house price boom in advanced countries started in the early 2000, but given lack of data availability for
Armenia before 2004 it is impossible to compare the magnitude of the increases for the whole boom period.
- 2 -
countries.5 However, the increase in few countries, like Russia, Latvia and Georgia, was even
higher.6
During this period, house prices in Armenia seem to have clearly drifted away from
fundamentals, as shown by
marked increases in the house
price to income ratio and the
price to rent ratio.
The boom in Armenia turned
into a bust in the wake of the
global crisis. Real estate
construction output collapsed to
almost one third from its peak
in 2008, although to a level
5 Documented in Stepanyan et al (2010).
6 In Armenia and these countries, it is possible that part of the boom in house prices reflected a catch-up from
fall during Russian crisis years.
Russia
Armenia
Latvia
Spain
UK
USA50
100
150
200
250
300
350
400
450
House Prices(SA, 2004 Q1=100)
Russia 1/
Armenia 2/
Latvia 3/
SPAIN 4/
UK 5/
USA 6/
Germany 7/
Japan 8/
1/AVG house prices 5/Halifax HPI2/AVG apartment prices 6/ S&P/Case-Shiller home prices3/Standard type apartments 7/New houses price index,
4/Free housing prices 8/Tokyo AVG price per dwelling unit
12.6
22.2
10
15
20
25
30
12
13
14
15
16
17
2004 2005 2006 2007 2008 2009 2010
Price to Rent and Price to Income Ratios in Yerevan
Price to income
price to rent
- 3 -
similar to 2005.7 Against the backdrop of the large increases that had taken place, the fall in
prices was more moderate (15 percent, or back to 2007 levels). The volume of transactions
took a larger hit, falling more than 30 percent as the property market was on hold for some
time due to uncertainty on prices.
Two years after the bust, there are only limited signs of recovery in real estate
construction output and prices. Output remained flat during 2010 and experienced a slight
upward trend in the first half of
2011. After hitting a floor in the
middle of 2009, prices
experienced a mild recovery in
the first half of 2010, possibly
associated with a stimulus
package of the government
undertaken in the second half of
2009 and involving, among other
measures, the creation of a
mortgage fund and granting
government guarantees to
7 Based on NSS Statistical Yearbook.
0
2
4
6
8
10
2004 2005 2006 2007 2008 2009 2010 09-H1
10-H1
11-H1
9.5 9.2
10.4 10.3
7.97.4
8.6
2.83.8
4.4
Tho
usa
nd
s
Number of Transactions in Yerevan
Apartments Houses
200
250
300
350
400
450
500
400
500
600
700
800
900
1000
1100
1200
1300
08
-1
08
-5
08
-9
09
-1
09
-5
09
-9
10
-1
10
-5
10
-9
11
-1
11
-5
do
llar
pe
r sq
uar
e m
ete
r
SA House and Apartment Prices(2008-2011H1)
Yerevan-House
Yerevan-Apt.
Regions-House-RHS
Regions-Apt.-RHS
- 4 -
construction companies. However, in the context of large unsold inventories, prices have
mildly fallen since then.8 Transactions in the property market have recovered, although they
are still less than the annual number of transactions during 2004-2007.
II. DEFINING FEATURES
Armenia’s housing boom-bust cycle featured a number of characteristics that set it
apart from other episodes of this nature. For example, it was largely concentrated around
the capital city, Yerevan. Construction outside Yerevan increased only at a relatively
moderate pace during the boom, and therefore an increasingly larger share of total
construction in Armenia took place in Yerevan (reaching close to 90 percent at the peak).
The real estate price boom was generalized, however, affecting the country as a whole.
The pace of the increase considerably differed between Yerevan and the regions, and also
between the center of Yerevan and non-center areas. Armenia average prices grew almost 3
times in dollar terms, with growth being considerably higher in the regions (about 5 times),
than in Yerevan (3 times) or in Yerevan center (less than 2.5 times). Yerevan center
apartment prices fell from 2.5 times of Armenia average price to 2 times. In contrast, average
prices in the regions relative to Armenia increased from 20 percent to 30 percent, probably
associated with the much higher supply response in Yerevan.
8 While there are no formal data on unsold inventories, anecdotal evidence suggests pervasive empty apartments
in Yerevan.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Share of Yerevan and Regions in the Output of Construction and Assembly
Work (in percent)
Regions
Yerevan
0
100
200
300
400
500
600
700
Real Output of Construction and Assembly Work in Yerevan and Regions
(in billions of drams)
Yerevan
Regions
- 5 -
The cycle was dominated mostly by activity in apartments rather than houses.
Apartments are the predominant housing style in Yerevan, where the boom was based.
Transactions of houses mostly took place in the regions (64 percent), where construction
activity was more subdued. The trend of prices for houses and apartments, however, was
very similar.
Yerevan
center
Yerevan
average
Regions
average
Armenia
average
2004 2.5 1.4 0.2 1.0
2008 2.0 1.4 0.3 1.0
2010 1.9 1.3 0.4 1.0
2004 4.6 2.7 0.5 1.0
2008 3.5 2.3 0.6 1.0
2010 3.3 2.1 0.6 1.0
1/Prices were put together by State Committee of the Real Estate Cadastre based on a
study of the contract price of transactions.
Relative Prices1 in Yerevan and Regions Compared to Armenia
Avearge
Apartment
Houses
0
200
400
600
800
1000
1200
1400
1600
1800
04
-1
04
-7
05
-1
05
-7
06
-1
06
-7
07
-1
07
-7
08
-1
08
-7
09
-1
09
-7
10
-1
10
-7
11
-1
House Price(USD per Sq. meter)
Yerevan center
Yerevan average
Armenia average
Regions average
0
200
400
600
800
1000
1200
1400
1600
1800
04
-1
04
-7
05
-1
05
-7
06
-1
06
-7
07
-1
07
-7
08
-1
08
-7
09
-1
09
-7
10
-1
10
-7
11
-1
Apartment Price (USD per Sq. meter)
- 6 -
The construction boom was undertaken by households to a larger extent than
developers. Households mostly tend to finance renovations of apartments rather than
building of new units, indicating
a very significant relative role of
renovations in the boom
episode.9 The increase in new
units was still large in absolute
terms (see chart).
The bust affected developers at
an earlier stage, but hit
households harder. Real estate
construction funded by
developers collapsed fell first, by 29 percent in 2008, while Armenian household-financed
construction continued to increase. During 2009, household-financed construction fell by 70
percent, while developer-financed construction had already stabilized. In 2010, household-
financed construction continued to decline by 40 percent and still there is no sign of increase
in the first half of 2011 (even though remittances increased by 12 percent compared to 2009,
the financial sources of households used in the construction sector decreased by 38 percent).
As a consequence, after the crisis there is a change in the structure of financial sources of
construction sector in favor of construction by developers, rather than by individuals.
9 It is possible that the extent of this development is exaggerated in part by statistical shortcomings (e.g., some
developers may not have been registered as such, for example, for tax reasons).
60
65
70
75
80
85
90
95
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Total Space of Housing in Armenia(in millions of square meter)
- 7 -
Remarkably, the boom was unleveraged and consequently the bust spared the banking
system. Banks did not intermediate foreign flows into real estate construction, and in contrast
with most housing booms, lending was not at the center of financing in Armenia.10
By and
large, housholds did not use mortgages, which represented only 2.3 percent of GDP at the
peak, compared to 40 percent of GDP in Latvia or 94 of GDP in the U.S. Developers
accounted for 22 percent of total construction and financed themselves by the way of presales
with deferred payments). Therefore, the housing bust was not associated with major stress in
the banking system.11
However, several projects could not be brought to fruition as pre-
financing dried up, and developers went bust. Hence, some buyers who had pre-financed
construction took losses on their investments.12
10
Only 7 out of 30 real estate booms surveyed by Crowe et al. (2011) did not take place with a credit boom.
11 Interestingly, unleveraged booms do not usually tend to create such large recessions (Crowe et al, 2011) as
the one Armenia suffered.
12 It was common for investor to lose the entirety of their investments as contracts typically lacked provisions to
protect the right of investors in case of developers insolvency.
-120
-100
-80
-60
-40
-20
0
20
40
60
80
100
120
-60
-40
-20
0
20
40
60
2003 2004 2005 2006 2007 2008 2009 2010
State and local budgets International Loans
Humanitarian help Developers
Household sources remittances (annual % change)- Right scale
Contribution of Financial Sources in Construction Sector Growth
(in percent)
- 8 -
III. INTERPRETATION, DRIVERS AND OUTLOOK
By early 2000’s there were significant unmet needs of real estate in Armenia. Prior to
this period, the Armenian housing stock remained limited and poorly mantained. Amidst the
economic decline of final years of the Soviet Union and the important challenges of post-
independence, Armenia’s construction sector had not been particularly vibrant. Therefore,
resident Armenians experienced a clear need for an upgrade in quality and quantity of the
housing stock. At the same time, the large Armenian diaspora had been awaiting the
emergence of prime real estate to purchase housing units for vacations or as a base in their
home country.
Improved country and regional economic conditions in the early 2000’s triggered a
large increase in inflows associated with demand for prime real estate. The improved
economic situation in Russia allowed the diaspora and temporary guest workers to meet their
housing needs in Armenia.13
14
Also, it was becoming increasingly clear that the economic
situation in Armenia had stabilized, and prospects for growth had considerably improved
compared to the 1990s. In the absence of other attractive assets, a motivation to invest in real
estate was to gain portfolio exposure to the growing Armenian economy.15
The government
further encouraged the process by actively reaching out to wealthy Diasporans and local
businessmen to invest in the sector.16
Therefore, the increased demand was most marked for
prime real estate segment. Other segments of the market also improved. For example, newer
migrants also directed remittances to relatives, who in turn used these resources for real
estate (either renovations or acquisitions). Better economic conditions in Armenia also
contributed to increased demand from local Armenians.17
The sharp increase in demand triggered a large increase in prices and in construction
activity. Increased demand for real estate was not met by significant idle capacity, thereby
putting pressure on prices of existing dwellings and increased construction activity. The
13
While there were also inflows from other countries, Russia accounted for the largest share (Russia accounts
for 90% of total non-commercial inflows to Armenia).
14 Statistics are likely to have recorded in practice investments in real estate as remittances (while they should
actually be recorded in the capital account).
15 Empirically established by Stepanyan et al. (2010).
16 In some cases, the government contribution was engaged directly in real estate development projects.
17 Other fundamentals of house prices are not likely to have played a role. For example, there is a general sense
that demographics were particularly favorable, but very limited data on migrant flows render this conclusion
tentative. Also, domestic monetary/financial conditions were largely irrelevant given funding sources of the
boom.
- 9 -
pressure on prices continued unabated as supply persistently lagged the demand, even when
there were no obvious land constraints or regulatory restrictions for expansion of cities.
During the early years of the process, it was still not clear to economic agents the persistency
of the shock, and developers were wary of taking risks. Subsequently, a sharp increase
construction did take place but did not immediately translate into larger supply of units as it
was concentrated in construction of multi-unit buildings which take considerable time to
complete (compared to single-family homes). The eventual increase in supply was mostly
tailored to the increased demand for prime real estate, but drove construction costs up more
widely, significantly impacting real estate prices in all segments of the market.18
19
The increase in foreign demand for housing continued unabated until 2008. Economic
conditions in Russia continued
to improve with increases of
oil prices, making it possible
for an ever larger share of
diasporans and guest workers
to jump in to the market,20
Also, the steep increase in
prices created the prospect of
attractive short-term returns.
The investment was further
sweetened by price increases
that were even steeper when
measured in U.S. dollars.
Foreign purchases created an upward impact both on real estate prices and on the value of the
Armenian currency, which compounded the effect.21
In the wake of the global crisis, real estate demand was brought to a sudden halt. On the
basis of deteriorating conditions in Russia, together with suddenly negative prospects for
Armenian real estate prices, inflows associated with real estate purchases drastically
18
Also, given widespread renovation, in some cases price increases reflected housing upgrades.
19 Those cost-driven increases in prices appear to have dwarfed demand in regions outside Yerevan as suggested
by subdued construction in them.
20 Diaspora population is estimated to be more than 7 million, at least twice as large as population in Armenia.
21 The relative stability of real estate in dram terms raises a puzzle regarding saving behavior towards real estate
purchases, which usually takes place in USD.
0
50
100
150
200
250
300
350
400
450
500
04
-1
04
-6
04
-11
05
-4
05
-9
06
-2
06
-7
06
-12
07
-5
07
-10
08
-3
08
-8
09
-1
09
-6
09
-11
10
-4
10
-9
11
-2
Apartment Prices in Yerevan per Square Meter (Index, 2004 Q1=100)
dollar
dram
- 10 -
contracted and have barely recovered since. The early collapse in 2008 of demand for new
units (as suggested by data on developer-funded real estate), suggests that Armenians abroad
started to sense the upcoming fall in the real estate prices, while they were still able and
willing to help fund home renovations for a while until the crisis hit. With the uncertain
environment of the world economy, funding for this purpose has continued to fall.
The prospects for the sector are uncertain. The market for new units is likely to be
currently in excess supply. There seems to be a considerable unsold inventory (from
anecdotal evidence, as data are lacking). This would point to subdued real estate construction
of new units going forward. This notion is strengthened by the fact that cross country
comparison regarding overall construction share of GDP suggests that its level in Armenia
continues to be high (in part though also because of considerable foreign-financed energy
production and distribution and transport). However, as the economic recovery in both
Russia and Armenia strengthens, it would be reasonable for demand from households for
renovation to pick up from current depressed levels. The perceived excess supply would also
point to future reduction in real estate prices. However, the downside risks do not appear to
be large, given that prices against fundamentals do not appear particularly high by
international comparison. In addition, the recovery of transaction levels typically operates as
a leading indicator of a recovery of prices.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2001 2004 2008 2009
Share of Construction by Types of Economic Activity
others
transport
community, social and personal
communication
energy production and distribution
real estate
- 11 -
IV. LINKS TO THE WIDER ECONOMY
The construction boom was a
key driver behind double digit
growth of Armenia for seven
successive years. During 2001-
2007, Armenia recorded double-
digit growth rates each year, on
average by 12.5 percent. More
than 30 percent of this growth was
directly due to construction.22
In
addition, construction benefited
GDP through spillover effects into
other industries (e.g., quarrying).
The effects on consumption were limited by the fact that the increased collateral value of
homes was generally not used for increased consumer credit.23
It is likely, however, that
proceeds from sales to foreign-based investors at increasingly higher prices eased local
Armenians’ liquidity constraints and supported consumption. Against this background,
imports soared.
22
Calculated based on NSS published data on GDP.
23 It is possible that wealth effects supported consumption, but they could have been offset by the increase in
housing costs.
15.8
39.7
0 10 20 30 40
Baku, Azerbaijan
Tallinn, Estonia
Sofia, Bulgaria
Budapest, Hungary
Warsaw, Poland
Yerevan, Armenia
Tehran, Iran
Bucharest, Romania
Prague, Czech …
Kiev, Ukraine
Riga, Latvia
Paris, France
Vilnius, Lithuania
Minsk, Belarus
Beirut, Lebanon
Moscow, Russia
House Price to Income Ratio
Source: http://www.numbeo.com/property-investment/
43.74
8.07
-5 15 35 55
Paris, France
Prague, Czech …
Tallinn, Estonia
Vilnius, Lithuania
Warsaw, Poland
Moscow, Russia
Riga, Latvia
Bucharest, Romania
Beirut, Lebanon
Tehran, Iran
Kiev, Ukraine
Sofia, Bulgaria
Budapest, Hungary
Minsk, Belarus
Baku, Azerbaijan
Yerevan, Armenia
House Price to Rent Ratio
Source: http://www.numbeo.com/property-investment/
-60
-40
-20
0
20
40
60
-15
-10
-5
0
5
10
15
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Construction Sector Contribution in GDP
GDP growth construction contribution construction growth-right scale
- 12 -
The construction boom
hurt Armenia’s structural
external position. The
outsized growth of the
construction sector implied
an absorption of a larger
share of resources from other
sectors. Partly because the
boom was financed with
external flows that
appreciated the currency, the
tradable sector was
particularly affected. Exports
as a share of GDP and Armenia’s share in key world markets declined over the period with
various firms being permanently displaced from the international market. Despite this fact
and above-mentioned higher imports, the current account deficit remained moderate until
2008 in part because it is likely that foreign inflows associated with real estate transactions
were recorded as inflows in the current account.
Armenia’s double digit growth turned into double digit contraction in 2009. The
contribution of construction to the fall in GDP was about 70 percent. The spillovers to other
sectors of the economy were, however, rather limited, including because a larger share of
foreign citizens in the market at the end of the boom implied a considerable shift of the
negative wealth effects to outside Armenia.
While the construction
sector played an
important role in the
growth of the economy,
its contribution to tax
collections appears to
have been modest.
Informality in the sector
appears to have been
widespread. For instance,
formal employment in the
construction sector
reached at its peak only
46.541.2
36.1
37.2
33.3
34.6
29.7
31.1
60.4
49.5
0
10
20
30
40
50
60
70
Employed Population in Construction Sector (in thousand people)
10
15
20
25
30
35
90
95
100
105
110
115
120
125
130
135
140
REER and Export to GDP Ratio
REER (1997=100) Export/GDP-(RHS)
- 13 -
5.4 percent of total formal employment. Some estimates point to more than 50 percent of
employees in the informal sector.24
Also, as mentioned above, the construction during the
boom period was mainly financed and undertaken by households and individuals, a group
that was exempted from paying VAT and income tax up to 2007. Also, before 2007, the
valuation base of profit tax for legal entities was not clearly specified, although it was subject
to tax. In order to strengthen taxation of the construction sector, amendments to the laws on
VAT, income tax and profits tax became effective in January 2007.25
26
Profit tax collected from large construction companies increased in 2007-2008, but still
the share of large construction companies in total profit tax collections was small. Profit
tax paid by construction companies listed among the 1000 largest taxpayer increased by 86
and 154 percent in 2007 and
2008, respectively and reached
AMD 5.6 billion before the
crisis (2008).27
While the
breakdown of the total taxes by
industries is unavailable, taxes
paid by seven large companies
that covered most of the activity
in the sector was about 1 percent
in 2005, it increased to 3 percent
and 6.5 percent in 2007 and
2008, strikingly low compared
to the sector’s contribution to the
economy.28
24
See ADB, “The informal sector and informal employment in Armenia.”
25 Also on simplified tax, before abolishing in 2009.
26 For the VAT law, the disposition of residential buildings owned by individuals had not been considered a
VAT-taxable transaction. The amendments specified that the constructor-individuals who are not individual
entrepreneurs should be taxed. For the profit tax law, the amendments specified the method of calculation of
taxable profit not less than the value specified in the property tax law. For the income tax, before the 2007
amendment, income received from the sale of buildings and construction works by constructor-individuals was
not subject to the income tax. With the amendments, this income became subject to taxation, with the valuation
not be less than the value specified in the property tax law.
27 This doesn’t include the related contractor companies.
28 This is consistent with a large share of the activity financed by households, some of them likely to have been
developers in disguise.
2004 2005 2006 2007 2008
Construction companies 0.7 0.8 1.2 2.2 5.6
Total profit tax 32.0 46.6 65.3 75.5 86.2
Construction companies 25.7 43.0 85.9 154.0
Total profit tax 45.4 40.3 15.6 14.2
Construction companies 2.1 1.8 1.8 2.9 6.5
Construction companies 1.2 1.9 10.0 31.6
Profit Tax Paid by Construction Companies Listed in the First 1000 Large
Taxpayer
(in bln. AMD)
Annual Growth rate (in percent)
Share in total (in percent)
Contribution in growth of profit tax (in percent)
- 14 -
V. CONCLUDING REMARKS
Armenia experienced a real estate boom-bust cycle with unique characteristics.
Armenia’s boom was the largest in the world in terms of the share of the economy that the
construction sector absorbed, with also very large house price increases by international
comparison. In contrast with other experiences, Armenia’s boom was un-leveraged (mostly
foreign financed), concentrated in the capital city and apartment buildings, focused to a large
extent on renovations and development of prime real estate, and developed by households or
by developers in the informal sector.
Its benefits for Armenia’s economy appear to have been rather limited, while its costs
were considerable. During 2004-08, the country made great strides towards upgrading and
expanding its housing stock. More generally, the real estate boom was at the core of very
successful macroeconomic performance during that time. However, the pace of the
expansion of housing supply, and more generally of economic growth, proved to be
unsustainable. Also, the benefits of the boom for the country’s long term prospects beyond
the improved living conditions of an upgraded housing stock are not evident. The impact on
government revenues, and therefore the capacity of the government to benefit from it to
attend to the country’s long-term development needs, appears to have been very limited.
Also, the disproportionate share of resources that this sector absorbed during the boom
crowded out other sectors and displaced firms from world markets permanently. On the other
hand, given the unleveraged nature of the boom, the bust did not represent a threat to
financial stability, thereby avoiding more severe dislocations to the Armenian economy.
The aftermath of the cycle is marked by uncertainties and challenges. The outlook for
the real estate sector appears difficult, as construction initiated during the boom comes to
completion, the already large unsold inventory of units continues to grow. Therefore, the
prospects for renewed strength of construction of new housing units are unclear (there are
however less obstacles for investment in housing renovation). In the meantime, a reallocation
of resources towards the tradable sector does not appear to be taking place, in part because of
the disappearance of some formerly successful tradable firms tend to make this process slow
and costly. In addition, the intersectoral allocation of resources has been prolonged by
strength of the nontradable sector on the back of relatively strong demand backed by new
external flows, this time more dangerously in the form of loans intermediated by the banking
system (and recovering remittances for consumption purposes). As the country progresses in
the structural reform agenda, growth is likely to become broader, more balanced and more
sustainable.
- 15 -
REFERENCES
Asian Development Bank, 2011 “The Informal Sector and Informal Employment in
Armenia” (Manila: Asian Development Bank)
Crowe, Christopher, and others, 2011a, “Policies for Macrofinancial Stability: Options to
Deal with Real Estate Booms,” IMF Staff Discussion Note 11/02 (Washington:
International Monetary Fund).
———, 2011b, “How to Deal with Real Estate Booms: Lessons from Country Experiences,”
IMF Working Paper 11/91 (Washington: International Monetary Fund.
International Monetary Fund, 2008, World Economic Outlook, April 2008 (Washington:
International Monetary Fund).
Stepanyan, V., Poghosyan, T. and Bibolov, A. (2010). House Price Determinants in Selected
Countries of the Former Soviet Union. IMF Working Paper 2010-104.