Does the Czech Republic have a real estate bubble?

Post date: Sep 29, 2018 7:5:56 PM

Does the Czech Republic have a real estate bubble?

The current situation of the residential real estate market in the Czech Republic and Slovakia – what are the risks?

The excellent economic performance of the Czech economy has resulted in high demand for residential real estate assets and prices are accordingly on the rise. In contrast to Slovakia, where this trend is country wide, in the Czech Republic it is concentrated primarily in Prague. At this point, however, we cannot speak of a real estate bubble in these states because income is rising in tandem with real estate prices.

The Slovak economy is booming. Indeed, the latest GDP growth rate figures confirm this. The excellent conditions in the labor market have resulted in the lowest unemployment rate in Slovak history, pushing income rapidly upwards. Positive economic developments have resulted in high consumer trust, bringing about a rise in consumer spending. 

As a result, residential real estate prices in Slovakia have continuously risen since 2014. However, growth has been gradual, and real estate prices have only rarely registered double figure growth in the Czech Republic, by contrast, economic performance parameters are similar to those of Slovakia, at least in regard to domestic consumption – however, the real estate prices dynamics are very different.

There are a number of explanations for the differences between the states in the field of real estate. One is the relation between supply and demand. Prague, unlike Bratislava, is experiencing rapid demographic growth, and it is a more attractive target of international real estate investment. Another conspicuous difference is the location of the capital in regard to the dynamic of real estate prices. Prague is the vanguard of real estate prices in the Czech Republic, whereas the price dynamic in Slovakia is more evenly spread, with the capital not being so different from the rest of the country.

Is there evidence indicating the growth of a real estate bubble?

This is an important question which always arises in times of economic expansion. As we previously noted, the economies of both states are doing very well indeed. An additional fact which must be taken into account is the loose monetary policy in the Czech economy and in the Euro zone. Furthermore, the rising household income (both in the Czech Republic and in Slovakia) and the high rates of home ownership encourage real estate demand.

In order to determine whether there is or is not a real estate bubble, one should consider the OECD findings

The OECD report compares real estate prices to prices in other consumer fields. This data includes nominal real estate prices, as well as real prices. In other words, the real estate prices are calculated in relation to the price levels of other consumer products. These findings indicate that for both countries, the real estate prices are higher, as of 2011 – 2012, than those of long term consumer prices.

A similar trend can also be seen in the present (2018). In other words, the nominal real estate prices are rising at a similar rate to the rate of inflation of other consumer products. That is why investment in real estate is a relatively small item for households in both the Czech Republic and Slovakia. In addition, the households in both states enjoy significant benefits from the current situation – the rise in real estate prices is not significant compared to the rise in their income.

Furthermore, we used the OECD findings to compare the real estate prices between various Central European states. The ration between lease rates and income shows that the rise in the Czech Republic, Slovakia and Hungary is significant in relative terms as well. Still, the lease rates in Germany and Austria has consistently risen in spite of the financial crisis – which indicates a real estate bubble. Nonetheless, the ratio between real estate prices or lease rates in the Czech Republic and Slovakia remain far from the level registered prior to the financial crisis.

It is important to recall that rise in the ratio between lease rates and/or real estate prices to income is not indicative of a bubble. In fact, the comparison of the Czech Republic and Slovakia to two other real estate bubbles (Spain and Ireland) is proof of one thing – there are significant differences in the ratio of rent and the price of real estate relative to income prior to and post the economic crisis, so this is not a real estate bubble.

However, the identification of a real estate bubble is a difficult task and can usually only be done retroactively. In spite of this, our comparison did not identify any indication of a bubble in real estate prices, so that while prices in Slovakia and the Czech republic are indeed rising, they are not rising any swifter than the household income. In fact, the economic accessibility of apartments remains just as it was prior to the 2008 financial crisis. 

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The author David Kocourek is an economist at Komerční banka. The article was first published in Connection magazine