Abstract

This article introduces some factors that play a significant role in moving the real estate market. Although some of these factors suggest a theoretical relationship between the factors and the market, in practice, the relationship might be very different. We analyze factors that drive the real estate market. The paper studies the determinants of house prices for transition economies. House price model explain how the fundamental determinants of house prices, such as GDP per capita, real interest rates, housing credit and demographic factors, have driven house prices.  The paper also discusses the aspects of dynamics of house prices in Georgia. 

The system of leading economic indicators, first developed by the National Bureau of Economic Research (NBER), has been widely used in the United States to appraise the state of the business cycle. The Organization for Economic Cooperation and Development (OECD) set up a working party to develop this type of analysis and most of the member countries participated. Leading economic indicators are major key markers that shift in advance ahead of the economy. Estimating and use this indicators is very important for transition economies. Residential transactions are among leading indicators and can predict economic activity.

Housing plays an important role in a country's economy and are seen by many to be a leading indicator. Housing can be useful in observing the impact of current monetary policy. For instance, housing starts have a tendency to rise when interest rates regarding construction loans and mortgages are low to developers and potential home buyers. It is important to study the determinants of house prices in transition economies. The main question addressed is how fundamental determinants of house prices, such as GDP per capita, real interest rates, housing credit and demographic factors, have driven observed house prices in transition economies.  House prices are determined to a large extent by the underlying conventional fundamentals and some transition-specific factors, in particular institutional development of housing markets and housing finance. 

Demand-side determinants (“fundamentals”) are: Real disposable income; Real interest rates – measure both financing and opportunity costs; Labour market trends (employment growth, unemployment rate); Demographic factors (population growth, migration trends, size of households);  Credit availability – housing finance products, lending practices.

Supply-side factors are  Land for development – availability and price; • Construction costs – construction wages, material costs.  On house prices influence also Institutional factors: How developed is the housing finance market; Types of housing loans; Secondary mortgage market; Collateral and bankruptcy legislation; Tax system (mortgage interest deductibility, imputed rents, property and wealth taxes).

Demographics  factors are the data that describe the population, such as age, race, gender, migration and population growth. These statistics are significant factor that affects how real estate is priced and what types of properties are in demand. Major shifts in the demographics of a nation can have a large impact on real estate trends. There are several ways how this type of demographic shift can affect the real estate market.

Interest rates also have a major impact on the real estate markets. Changes in interest rates can influence a person's ability to buy a residential property. That is because the lower interest rates go, the lower the cost to obtain a mortgage to buy a home will be, this creates a higher demand for real estate.  It's important that as interest rates rise, the cost to obtain a mortgage increases, thus lowering demand and prices of real estate. When looking at the impact of interest rates on an investment, rather than on residential real estate, the relationship can be thought of as similar to a bond's relationship with interest rates.

Key factor that affects the value of real estate is also the health of the economy. This is generally measured by economic indicators such as the GDP, employment rate, the prices of goods, etc. However, the cyclicality of the economy can have varying effects on different types of real estate. For instance, if an interest rates has a larger percentage of its investments in hotels, they would typically be more affected by an economic downturn than an interest rates that had invested in office buildings. Hotels are a form of property that is very sensitive to economic activity due to the type. On the other hand, office tenants generally have longer-term leases that can't be changed in the middle of an economic downturn.

Legal system is also another factor that can have a impact on property demand and prices. Tax credits and subsidies are some of the ways the government can temporarily boost demand for real estate for as long as they are in place.

House price dynamics are usually modelled in terms of changes in housing demand and supply. In models built for house prices on the demand side, key factors are typically taken to be expected change in house prices (PH), household income (Y), the real rate on housing loans (r), financial wealth (WE), demographic and labour market factors (D), the expected rate of  return on housing (e) and a vector of other demand shifters (X). The latter may include proxies for the location, age and state of housing, or institutional factors that facilitate or hinder households’ access to the housing market, such as financial innovation on the mortgage and housing loan markets: 

                                    (1)

The supply of housing is usually described as a positive function of the profitability of the  construction business, which is in turn taken to depend positively on house prices and negatively on the real costs of construction (C), including the price of land (PL), wages of construction workers (W) and material costs (M): 

                                             (2)

Assuming that the housing market is in equilibrium, with demand equal to supply at all times, house prices could be expressed by the following reduced-form equation:

                                                   (3)

House prices in all countries increase in last years. As we see on table below in most OECD countries prices rise more than  60%

Table 1.

 Changes in Real House Prices across OECD Countries

According Colliers International Research the selling price of newly-built residential flats in Tbilisi varies from USD 400 to USD 3,000 per square m. From 2016-2017, the weighted average selling prices on the primary and secondary markets fell. The primary market price fell to USD 663 per squared m, reflecting a 7% drop, while the secondary market selling price decreased by 1% to USD 612 per squared m. The weighted average selling price on primary market is more correlating, mainly caused by the segment of completed project. Transactions reached their highest point since 2012. In 2017, the number of residential transactions rose to 28,000 units. In accordance with registered sales transactions, the overall transaction volume grew by 10%, reaching USD 1.17 billion.  The same trend was seen in other big cities of Georgia (Batumi, Kutaisi). During recent years, the weighted average selling price by segment remained stable in both the primary and secondary markets. However, the average price by market type decreased when compared to 2016, motivated by the drop of premium and medium segment shares in total transactions.  

In 2017, the number of residential transactions in Tbilisi increased significantly as compared to 2016. The total number increased by 21% and peaked at 28,000 units. The majority of that number was represented by newly-built flats (54%), which is attributable to the large number of recently-completed projects. Older flat sales grew by 10% as compared to the previous year. Since 2012, the number of residential unit transactions has increased every year with the exception of 2015. In 2017, the total volume of residential unit transactions reached its peak at USD 1.17 billion, reflecting a 10% growth as compared to 2016, and a 45% increase from 2015. The change in advertising regulations, forcing sellers to specify the price of real estate in Georgian Lari instead of US dollars, did not significantly influence residential unit prices. Analyses of residential real estate transactions, however, revealed significant increase in transactions listed in Georgian Lari as they raised  from 29% in Q1 2017 to 55% in Q2 2017. 

Table 2.

Average Selling Prices on Primary and Secondary Markets (Tbilisi)

Selling  price  of residential properties in 2017 amounted 980 USD per square m . In comparison with other cities with transition economies average selling prices of residential properties  Erevan – 942USD,  Baku – 1145USD,  Sofia – 1194USD, Kiev – 1088USD and Vilnius – 1861USD.

On the demand  side key factor is incomes per capita. As shows the graph bellow average monthly income per capita rise in last years in Georgia. There are other factors in Georgia affected on house prices.

Table 3.

Source: Geostat.ge

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