Why savvy investors have started selling their Budapest properties in 2019
Since 2008, low entry points and yields of up to 8% have made Budapest a real estate investor’s darling. Fueled by a rapidly rebounding economy, record growth, a flourishing tourist scene and high demand, 2018 will close with the market rising 20,8% in the past year and record high GDP growth. The numbers have never looked better and the euphoric housing market is reflecting it tenfold. But as the global economic boom and national GDP growth projections slow, alert property investors and economic institutions are becoming wary of signs the market will turn. With the exception of relatively recession proof property investments, selling an investment property is a question of when, not if. Since the National Bank of Hungary issued a report in October 2018 on the risk of overheating in Budapest’s housing market, we’ve investigated the micro- and macro-economic factors affecting the market to advise investors on exit strategy.
Property prices hit record highs in 2018 with year-over-year growth hitting. While, quarterly survey results confirm that home market companies and homebuyers are more optimistic than before the 2008 crisis, the National Bank of Hungary has already begun to question the integrity of current housing prices, signalling a potentially manic market.
In October 2018, the National Bank of Hungary’s biannual Housing Market Report reported risk of housing overvaluation in the capital for the first time since the 2008 recession:
“Despite the steady increase, on a national average house prices remain below the level justified by macroeconomic fundamentals, but in Budapest the risk of overvaluation has increased, and consequently careful monitoring of market developments in the capital has become even more important.”
Statistics on market growth confirm the report’s red flags. Eurostat, the statistical office of the European Union, reported that property prices rose by 4.7% in the EU in the first quarter of 2018 compared with the same quarter in the previous year In Budapest alone, the annual nominal growth rate of house prices was 20.2%, significantly faster than the 15.6% rate registered at the end of 2017. In numbers: a downtown apartment in Budapest’s 5th, 6th and 7th rose from an average 403,230 HUF in July 2017, to 414,960 HUF in July 2018. With some V. District apartments selling at 2.5M/m2 (where the average m2 is 1.1M/m2) it’s clear that there is overvaluation on the market. Spurred on by a decade of growth, a majority of the market continues to develop and invest optimistically. In a quarterly survey synthesizing expectations of real estate companies for the coming 12 months, GKI’s real estate index increased by 11 points, reaching a historic peak. Though this may seem positive, historically speaking, optimism by housing development stakeholders is a sign of economic mania, a phenomenon that has led to many an abandoned crane dotting the skylines of downturned markets.
The average long-term length of real estate cycles since 1800 is 18 years long, with the past three measuring 6 years, 10 years and 17 years long respectively averaging at 11 years, from recovery to recession. With exact data and a precise graph, the 11 year cycles inevitably show a long run of steady growth during the recovery and expansion phases, followed by a quick fall after the market enters hypersupply.
Budapest property prices began rising in earnest in 2013. At the time, the square meter price of an apartment in the downtown rose from 258,000 HUF/m2 in 2012 to 282,000 HUF/m2 by January 2013. Year-over-year growth has risen exponentially since. The latest January 2019 price indices report a square meter price of 523,000 HUF/m2, which is an overall 185% increase from 7 years ago. The question is: As growth reaches manic levels no longer sustained by the local economy, how big is the window of time before the market turns?
Large asset price bubbles are almost always associated with economic euphoria. Household consumption rises with household wealth, and rising stock prices lower the business cost of undertaking less profitable projects. During “expansion,” businesses borrow more, while banks increase loans and often relax their loan criteria. The association between rapid property development and asset price bubbles is also strong. Economic euphoria is often linked with construction booms because a substantial amount of the stock market valuation consists of real estate companies, construction companies, and firms closely associated with real estate, including banks. Thus, economic cycles and real estate cycles have become linked — following real estate trends can help predict the next housing bubble. When the bubble bursts, the downturn in economic activity disrupts credit channels and large-scale projects, which is why so often unfinished cityscapes have become a hallmark of urban areas in a recession.
In other markets, price rises are stabilized with a new supply that satisfies demand and levels out steep price increases. But adding new inventory to the real estate market is a time and resource heavy process. In Budapest, slow growth is compounded by the recession which forced most dispersed construction workforces to move abroad. As such, during this expansion phase, we haven’t yet seen substantial amounts of new inventory. The housing stock’s renewal rate was just 0,36% at the end of the second quarter, which is low even in comparison to neighboring countries. Over the past 5-7 years, short supply has contributed to high prices, rent and occupancy rates. However, as hotel and property developers catch up and AirBnB regulations continue to tighten, housing stock is expected to rise — especially as the first round of the 5% VAT scheme comes to an end.
The original 2019 deadline for the 5% VAT development scheme will soon come to pass. The scheme was extended to 2023 in October, but this won’t considerably delay the completion of most existing timelines. On the other hand, in the current maniacally optimistic market, the VAT scheme extension almost certainly means the next round of new builds will begin development immediately. According to economic portal Portolio.hu, the delivery of the first round of new builds will peak in 2019 and fall back in 2020. Most of these new builds are purchased by speculators who purchase properties at a fraction of the price before construction begins. Ideally they will resell the finished properties to local residents at market price and reap the profit margin. However, with the MNB’s housing report on market price overheating in mind, there is a risk that a percentage of the units will ultimately go unsold. In this case, speculators will be forced to lower prices and make a run on the market in order to sell their properties so that they don’t lose out. If this happens at a larger scale, with hundreds of speculators flooding the market, the overall trend will reach hypersupply, prices will drop and the market will turn.
The National Bank of Hungary (MNB) reported that while salaries have shown overall growth between 2008, they have not increased in parallel with the average price of square meterage. In 2013, the price of a 65 square meter apartment purchase was equal to 5.9 years of an average salary. In 2018 the MNB reports, the same property costs 10 years worth of average salary. While salaries have increased nationwide, averages are less allocated to the median. In concrete numbers, between 2010-2016, the gross average salary per capita of the top two tenths grew by 34.6%, while the bottom two tenths also grew almost exactly the same amount, 34.57%. This means, that overall salary growth didn’t really increase even to the reported levels, as it grew much more significantly in the top deciles. This phenomenon affects long-term rental properties the most. As rent prices fail to keep up with the cost of property, the yield is lower. And while salaries haven’t kept up with prices, they have increased enough to spur locals to buy rather than rent. At a downtown luxury rental rate of 3000€/month, locals prefer to simply purchase their own home.
In September, economic research institute GKI modified their GDP prognosis for 2018 from 4.2% to 4.5%, while stating that the growth rate will peak in 2018. The nation’s record growth, fueled by EU funds and election supported consumption, is expected to decrease to 3.2% in 2019. The research institute supported their reasoning for the slowed growth by citing reduced EU funds to energize the economy, the uncertain near future of the global economic boom, and Hungary’s overall unchanged competitiveness on the global market.
The upward growth in Hungary’s recovering economy was spurred in large part by EU funds, inciting an increased GDP forecast by economic research institute GKI from 4.2% to 4.5% in 2018. In the next funding round in 2020, EU funds are expected to decrease, leading the institute to maintain its decreased 3.2% GDP growth prognosis for 2019. At the same time, inflation is growing as internal and external balances sway. Between August and October, the price of the Euro has increased from 311 HUF to 325 HUF,12 and in a recent speech prime minister Viktor Orban has maintained that the government is in no hurry to introduce the Euro to Hungary. Reduced EU support will slow national investment projects, the main driver of national economic growth since 2006. Thus despite the comparatively low prices on the global market, high yields and high demand in Budapest property are ultimately fueled by national growth, which comes into question especially as we reach the end of the economic cycle and GDP growth slows.
The expansion phase is currently maintained by a supply shortage in both vacation properties and residential homes, driving prices and occupancy rates. However, an influx in hotels and new builds set for completion in 2019 will begin to tip the balance towards oversupply.
A recent calculation of short versus long-term rental schemes in Budapest showed that well located short-term vacation rentals with at least 80% occupancy can yield up to 7.4% in profits. This figure is persuasive, but with AirBnb facing tightening regulations in most major cities across Europe, the possibility that restrictions will bite significantly into profits is a real risk. Budapest’s downtown districts have already begun imposing tighter rules. In the 5th and 8th party districts it’s long been difficult to get a short-term rental license. And beginning January 6th of this year, District 7, the last safe AirBnB haven has also fallen prey to heightened bureaucratic procedures as well. Renovating an apartment for short-term let in the 8th District is all but impossible, as it requires that the building’s housing committee approve the process in writing. In the 6th District, apartment accommodations require a property registration procedure and carry a 1.2M-1.5M HUF parking space fee. Until now, AirBnB apartments have provided much needed accommodation for the ever rising tide of visiting tourists. But with 13 new hotels and 850 new hotel rooms scheduled to open this year, and another 26 set to open their doors a year after, popular and national tolerance for the apartment sharing platform can be expected to decline. If the government decides to crack down across the board and rental investors are forced to sell, a huge amount of former vacation rentals will suddenly hit the market. Coupled with the near completion of hundreds of new builds, this flood of housing stock would certainly push the real estate cycle towards hypersupply.
While with foreign calculations Budapest prices can still seem relatively low, it’s catching up to its neighbors in Warsaw and Prague. Rising prices are predicted to slow compared to previous years, while rising salaries may create a more budget friendly market in the future if they can keep up with the slowed rise in prices. Professional property investors have already completely pulled out of the property market, indicating that the opportunity for large-scale gains is gone. Today, the Budapest real estate investment market is moved largely by expats and homebuyers, students, and permanent residents looking for an EU residence and students.
While it’s not for us to say when exactly 2018’s record growth will take a turn, today’s economic cycle coupled with warnings by financial institutions signal that it’s time to think about when to exit. In the current market, property owners have two broad strategies and risk levels to assess:
Sober investors who sell in good time while the market is just starting to level out are guaranteed a fast and lucrative exit. At the moment, the residential market is still at its peak. Exiting now brings a fast, approximately 3-month-long selling process and a low price negotiation range.
Risk-takers will choose to wait for that small window of time when prices just begin to fall, squeezing out the last drops of value on their property, even as value growth slows. This strategy reaps any low-key growth left in the market, but exiting will be much more difficult as the residential market begins to dry up. Not only will the selling process double to at least 6 months, but negotiation ranges will also increase. Additional growth in the market will likely be at a lower rate than throughout the previous decade, and last-minute exits that don’t sell the property in time risk losing both any additional profit gained from waiting, as well as previous earnings. Those investors who choose to stay until the end of the cycle or maintain their property for the next cycle also have options to maximise profit.
Historical real estate cycles show us, that the inevitable market correction is slowly approaching. While the exact turning point can never be predicted to the minute, red flags are on the horizon with both the Hungarian National Bank’s report and the flood of new inventory and hotels. In Budapest, professional investors have already exited the market, and those who purchased property at least five years ago are beginning to follow, making sure they secure a fast and high-value exit at the top of the market. Armed with this in-depth assessment of micro and macro-economic events, investors should start to consider their exit options. Those who purchased property as an additional revenue stream of risk-free profit should consider exiting soon, while the market is still high. We’re here to answer all of your questions about the current market and the exit process to help your decision with on the ground, in-depth knowledge on the local market. If and when you choose to exit, we’ll ensure you realise maximum profit on your investment with a best-in-class sales and legal team that will guarantee you get the highest possible price for your property.