mojeNovosti.com
By Djordje Radulovic | It may not be a surprise to most that everything from basic commodities to housing is very expensive in Serbia relative to average wages yet no measure exists that specifically quantifies the financial stress experienced by most citizens of Serbia.
Focus on housing in Belgrade could illustrate the enormity of the current and future financial concerns of Serbia. For simplification all figures have been converted to US dollars relying on the exchange rate as of July 30, 2010 and all metric units have been converted to the US system of measures.
According to the Statistical Office of the Republic of Serbia (SORS) the average monthly gross salary as of April, 2010 is $593 and the average net income is $427, with corresponding annual wages of $7,122 and $5,130, respectively.
To provide some perspective, average US annual gross wages are $50,233 (US Census Bureau, 2007).
The average Serbian thus makes roughly 1/7 of the gross annual wages of the typical US citizen and, as it will be elucidated shortly, is forced to bear expenses for basic necessities at the same or higher rate.
Currently, the typical two bedroom flat in and around the greater Belgrade area is estimated to be between 430 and 650 sq ft and the price per sq ft ranges between $121 and $297, with an average price of $170/sq ft.
At the height of the US market for housing the average price for a home was around $250,000 and considering an average of 1,500 sq ft, this equates to a per sq ft price of $167.
Not only were prices of flats in Belgrade about the same or higher during the housing boom in the US, but even during the depths of the recession these same prices in Belgrade prevailed, whereas in the US housing prices experienced and continue to experience significant declines, despite massive government support.
What can account for this seeming anomaly?
Serbia, and Belgrade in particular, experienced a significant increase in population due to the influx of refugees, displaced persons, and those wishing to live in and around the Belgrade area. Investment poured into new construction to eliminate the excess demand, but there is strong reason to believe that too many housing units were developed.
As demand for housing abated one would expect that prices of existing units would drop and provide a natural, market oriented signal to curb further construction.
However, to stimulate demand and maintain unit prices at their current levels, the government introduced a subsidy towards the purchase of a newly constructed unit. The loans are to be provided by private banks that needed to affirm their participation in the program through a formal agreement with requisite government agencies.
The basics of this program are as follows:
1.) The loan amount is not to exceed 50% of the net income of one wage earner or 50% of the aggregate income of two wage earners.
2.) It must be new construction and the funds paid directly to the investor.
3.) The government is to provide a 20% down payment (the original loan term is 360 months with the 20% down payment applied towards the last five years effectively amortizing the original loan amount over 300 months).
4.) Loan amounts vary, but can be as high as $130,000.
5.) The borrower is required to provide a 5% down payment and pay a one-time fee of 0.5% of the loan amount for the portion provided by the bank.
6.) $39 fee to the benefit of the Serbian National Mortgage Insurance Company, which ultimately insures 75% of the net loss to the banks.
7.) The interest rate is tied to the 6-month EURIBOR rate (currently slightly above 1%) plus 4.9% and can be adjusted quarterly. The total rate can be further increased by 0.25% for those with no life insurance.
8.) Until October 2012 the borrower is required to make payment on principal only, while the Republic of Serbia Ministry of Finance is the provide payment on the interest at a fixed 5.25%. (This simply implies that the borrower’s payment will be drastically lower for several years and following October 2012 the borrower would incur a significant increase in the monthly payment by paying both principal and interest).
To provide a practical perspective for the above points let us assume a four person household with two working adults and two adolescent children with a total monthly net income of $854.
The monthly payment for the flat would be calculated as follows:
- Average two bedroom flat at 538 sq ft for $170/sq ft equates to a total purchase price of around $91,500.
- The borrower’s 5% down payment is $4,575, the government’s 20% contribution is $18,300, and finally the bank’s portion at $68,625.
- The monthly payment on the bank’s portion, after October 2012 and assuming a rate of 6.125%, amortized over 300 months, would be $445/month.
If we conservatively estimate the monthly utilities, including gas, electric, water, phone, TV, internet, etc. at $175/month, the borrowers’ total payment for housing is $620.
Setting this total against the household’s monthly net income of $854 suggests that nearly 73% must be allocated towards housing.
In the absence of any growth in income, this huge income outlay for housing suggests that the current housing prices in Serbia appear to be unsustainable and will likely experience a severe correction without government subsidies. This is likely the case considering an even 50% increase in real incomes over the next several years.
Huge drops in home values usually precipitate banking crisis and a severe economic malaise.
The government subsidy, by attempting to stimulate the demand for housing and other loans for purchases of cars, home improvement, vacations, is diverting resources away from where they are truly needed, investment in new and existing productive capacities leading to long-term job creation and stable employment.
Moreover, it is doubtful that borrowers understand the intricacies of this mortgage lending program and how they will be affected by the change in their monthly payment, especially after October 2012. One cannot say how many, but a significant number of homeowners may not be able to afford their payment and the market may be flooded with vacant homes leading to a general and substantive decline in the overall price of homes.
Serbian National Mortgage Insurance Company, obliged to reimburse lenders for 75% of the net loss, may have severe and substantial funding concerns in an environment of significantly decreasing home values.
Unless the government provides a clear signal of when (if at all) the subsidy is to be eliminated and provides for its gradual extinction many unassuming investors in new construction may be negatively impacted by the subsequent decline in home values. It would be prudent for all prospective investors to monitor and understand the current program and how it might impact their future investment decisions.
Borrowers need to be aware that every 1% increase in the interest rate will on average increase the monthly house payment by about 10%.
It works this way: The interest rate is tied to the 6-month EURIBOR rate plus 4.9%. Currently that rate is slightly above 1% and since 1999 has fluctuated between 2% and 5.5%, not considering the current low points. The rate used in our example was 6.125% and assumed the current low point of around 1%. As the world economy improves interest rates are likely to rise as individual governments consider stricter monetary policies and investors diversify into riskier equities while reducing their bond portfolios causing bond prices to decrease and yields/interest rates to increase.
All current and prospective home buyers/owners should be aware that current prices appear to be artificially inflated and should strongly reconsider any financial initiatives related to an expectation of higher home values in the future.
The above example suggests not only a total lack of savings but a prevalent dissaving in the form of pools of consumers enslaved to living off credit.
Lack of private savings will not only intensify the need for credit but an ever expanding reliance on government programs and a growing bureaucracy intent on its survival. This might lead to a further class division consisting of a minority of the privileged and everyone else.
The real estate sector problems may signal the beginning of a deeper and a more protracted economic problem ahead for Serbia.
Mr. Radulovic holds a postgraduate degree in economics and his credentials include teaching as well as work in the private sector.
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