Download Model of Market Equilibrium in Regional Housing Markets in Russia

Model of Market Equilibrium in Regional Housing Markets in Russia:
Major Research Findings
Subject-Matter
Over the past 8 years Russia saw a rapid growth of real estate prices. Between 4Q2000 and
4Q2008 the average price of one square meter in the secondary housing market increased from
$236 up to $2072. In Ruble equivalent the cost of one square meter increased by 211% over the
same period.
The price surge undermined the housing affordability to population. The housing affordability
ratio, according to the computations made by IUE, reached the level of 5.3 in 2Q2008. It
effectively means that the cost of a typical 54m2-apartment is more than 5 times higher than the
average annual income of a household of three.
Chart 1: Housing Affordability Ratio Changes (1998-2008)
Housing affordability ratio, years
2Q2008
Source: IUE
Within the framework of the project “Affordable and Comfortable Housing to Russian Citizens”
the federal government has revised the town planning legislation (a new Town Planning Code),
promoted the development of mortgage lending and subsidized housing acquisition by certain
categories of population. The interim project outputs proved to be rather successful from the
point of view of an increase in the housing production, although they didn’t enhance its
affordability to population. Actually, in 2006-2008 the housing affordability ratio continued to
grow.
Project Goals and Objectives
The key goal of our research was to make a quantitative evaluation of the impact of various
factors on the price setting and volumes of housing supply in the Russian housing market. We
proceeded from the assumption that the market equilibrium is reached under the influence of
numerous factors of macroeconomic and demographic nature. In this sense, the Russian housing
market should resemble the well-studied markets in such countries as USA and Great Britain.
Factors that have already reaffirmed their importance for housing markets in other countries
account for a major part of variables we applied to describe the mechanisms of functioning of the
Russian market. Some variables were added proceeding from the frequency of media references
to them and our hypotheses. Four factors deserve special attention, and expert evaluation of their
impact constitutes the list of key issues of our research: price expectations, demographic factors,
construction costs, investment risks and administrative barriers.
Project Methodology
When reviewing housing markets we relied on the generally accepted mathematical model
of flows and stocks designed by James Poterba. This model has been applied on numerous
occasions to describe housing markets in various countries, including the US, UK, Spain and
Sweden. This model’s key feature is a separate study of the accumulated housing stock and
volumes of new housing completion. In Peterba’s model, the housing price in the short run is
1
based on the accumulated housing stock, rather than on the volumes of new housing completion
in the current period of time. In the long run, the housing supply is flexible and is determined
by the housing construction volumes.
The model consists of two key equations: housing demand and newly-built housing supply.
To properly describe the Russian housing market, we evaluated the parameters of these models
with the help of statistical methods. Toward this end, we put together the data on 68 Russian
regions in one database and processed these data applying a panel regression analysis method.
We evaluated the impact produced by some fundamental variables, such as household income,
real interest rate, unit-specific housing stock and estimated construction costs, on housing
markets. Moreover, the impact of a number of additional variables on the demand (e.g. birthrate,
migration inflow and its age structure, the proportion of expenditures on housing and utility fees
in the average household budget structure) was studied.
Model and Reality
Both the housing price setting, in the short run, and the new housing completion that influences
the changes in the long-term supply, are pretty well described with the help of the model we’ve
chosen. Thus, we managed to explain almost 65% of price variations and 60% of variations in
new housing completion volumes.
Both the price changes and the volumes of housing completion in 2000-2008 can be mainly
explained by macroeconomic and demographic factors. Thus, only the growth of household
incomes accounted for, at least, a 36% growth of housing prices in Russia over 2000-2007. The
increase in the share of the working age population resulted in price growth (almost a 30%
increase against the level registered in 2000) in the secondary housing market.
However, we cannot fully explain the housing price hike in 2006. The most likely reason behind
it was the enhanced affordability of mortgage lending. Loans enabled households to redistribute
deferred incomes to purchase housing they currently need. A less likely explanation of this
phenomenon is the price bubbles that formed as a result of high expectations of price increases.
Housing Affordability
Vast majority of factors that influence the housing prices in the short run are beyond the
government reach. According to the research data, the affordability of housing might be
increased due to the following factors: household income growth, real interest rate increases and
the shrinking of working age population.
Household income growth is the shortcut leading to higher housing affordability. Based on
our computations, we can say that household income growth by 10% leads to the housing
affordability ratio reduction by approximately 7%. Therefore, within 10 years of economic
growth at an average rate of 5% per year the housing affordability ratio should fall down
approximately by 30%. In this context housing is no exception from a large group of other
goods and services, the increased consumption of which is the primary concern of economists
and officials when they underline the importance of economic growth.
An interest rate increase can hardly be considered an appropriate tool of government
policy. The tightening of loans inevitably results in decreased investment and slowdown in the
rate of the real sector growth. Moreover, interest rate increases might lead to markdowns to
demand for goods and services and furthermore cool down the Russian economy.
2
Housing Construction
The price of one square meter of housing is a key factor for determining the volume of housing
completed by organizations. The price increases registered in 2000-2008 in Russia should have
resulted in the housing construction growth by 60% (from 30 up to 48 million m 2). In a word,
given the current conditions, high prices guarantee large volumes of housing completion.
However, high prices adversely affect the goal of assuring the affordability of housing, which
necessitates a search for other mechanisms of housing construction encouragement. Reduction
of construction costs and administrative barriers in the housing market are among the most
frequently mentioned mechanisms that serve this goal.
Unfortunately, the construction costs reduction is unlikely to significantly affect the
volumes of housing construction. Our calculations point to the fact that in the current
conditions construction costs have no sizable impact on the volumes of housing completion.
This can signify that there are too many restrictions in the land market, or that construction
markets are monopolized. Generally speaking, the insignificance of this factor means that the
chances to hit a blind alley and to increase the burden on the budget are much higher, if the
government continues to subsidize the expenditures incurred by construction organizations in the
process of erecting buildings’ bodies and working on infrastructure (within the borders of the
construction site).
Meanwhile, housing construction development can be encouraged via reducing investment risks
and administrative barriers at the regional level. Our research revealed the importance of the
factor of regional investment risks when we determine the volume of housing completion by
organizations. All other things being equal, volumes of housing completion per capita are
almost 4 times smaller in the region considered to be the most risky for investors compared to
those in the most “calm”, risk-free region. Since investment risks, as defined for the purposes of
our research, are, to a great extent, controlled by regional authorities, the housing construction
growth can be achieved by the efforts of the governments and legislative assemblies of the
constituent entities of the Russian Federation.
Household income level is a decisive factor for individual housing construction volumes. A 10%
increase in the income level leads to a 5% growth of individual housing construction volumes.
Volumes of individual housing construction by population were not significantly affected by the
estimated cost of construction, the cost of construction materials (possibly, for the exception of
the cost of bricks), or by demographic indicators. Therefore, our computations proved that the
policy of encouraging the economic growth is the only viable policy that will be good for the
development of individual housing construction.
The research outputs revealed the fact that the enhancement of housing affordability is a
complex task that cannot be accomplished over a medium-term period. Nevertheless, objective
macroeconomic and demographic factors could enhance the housing affordability faster and
ensure the sustainability of this process better than any purposeful government efforts.
Therefore, all long-term programs to address the population’s housing problems should rely on
the projected changes in macroeconomic and demographic indicators.
3