Prices of Housing in Prague: a Bubble Or Natural Progress?

Prices of Housing in Prague: A Bubble or Natural Progress?

Thesis

David Štrouf

Submitted in Partial fulfillment

Of the Requirements for the degree of

Bachelor of Science

Business Administration

State University of New York

Empire State College

2018

Reader: David Starr-Glass

Statutory Declaration / Čestné prohlášení

I, David Štrouf, declare that the paper entitled:

Prices of Housing in Prague: A Bubble or Natural Progression?

was written by myself independently, using the sources and information listed in the list of references. I am aware that my work will be published in accordance with § 47b of Act

No. 111/1998 Coll., On Higher Education Institutions, as amended, and in accordance with the valid publication guidelines for university graduate theses.

Prohlašuji, že jsem tuto práci vypracoval/a samostatně s použitím uvedené literatury a zdrojů informací. Jsem vědom/a, že moje práce bude zveřejněna v souladu s § 47b zákona č. 111/1998 Sb., o vysokých školách ve znění pozdějších předpisů, a v souladu s platnou

Směrnicí o zveřejňování vysokoškolských závěrečných prací.

In Prague, 26.04.2018

David Štrouf

Acknowledgement

I would like to thank the faculty of the Empire State College and the University of New

York in Prague for guiding me through the four years of my bachelor’s studies. I would also like to thank my mentor, professor David Starr-Glass, for his valuable insights he provided with during the writing process, and professor Tanweer Ali for consultations.

Most importantly, I would like to thank my mother for her unwavering support and insight.

Table of Contents

1 Introduction ...... 9

2 Real estate and its function in the economy ...... 12

2.1 Definition of Real Estate ...... 12

2.1.1 Zoning plan...... 13

2.1.2 Infrastructure...... 14

2.1.3 Location...... 14

2.2 Specifics of the Housing Market ...... 16

2.3 Housing as an Investment Decision ...... 17

2.3.1 Appreciation...... 18

2.3.2 Returns from cash flow...... 18

2.4 Overview ...... 19

3 Supply and Demand Perspective ...... 21

3.1 Demand ...... 21

3.1.1 Demand determinants in real estate...... 21

3.2 Supply ...... 22

3.2.1 Supply determinants in real estate...... 23

3.3 Implications ...... 24

4 Past Real Estate Crises and their Connection to Current Situation ...... 25

4.1 Japanese Asset Price Bubble 1986-1991 ...... 27

4.1.1 Changes in financing...... 28

4.1.2 Land ownership...... 28

4.1.3 Macroeconomic policies...... 29

4.1.4 Assessment...... 31

4.2 Subprime Mortgage Crisis ...... 32

4.2.1 Changes in the economic environment in early 2000s...... 33

4.2.2 Securitization of subprime mortgages...... 36

4.2.3 Assessment...... 38

4.3 Chinese Real Estate Bubble ...... 39

4.3.1 Investment availability and viability...... 39

4.3.2 Money supply and large growth...... 40

4.3.3 Access to land and vacancy rates...... 40

4.3.4 Credit and collateral...... 41

4.3.5 Assessment...... 42

4.4 Importance of Historical Context ...... 42

5 Historical Context of Prague’s Housing Market ...... 45

5.1 Current Situation ...... 45

5.2 Historical Context ...... 46

5.2.1 Housing and development under the Communist regime...... 46

5.2.2 Restitution and privatization in the early 1990s...... 47

5.2.3 Real estate market through the new millennia...... 49

6 Current Market Situation in Prague ...... 51

6.1 Increase in Prices ...... 52

6.2 Decreased Supply of Apartment Units ...... 53

6.2.1 Land scarcity and increasing prices...... 55

6.2.2 Long project approval process...... 55

6.2.3 Increased construction costs...... 56

6.3 Increased Demand for Housing ...... 57

6.3.1 Good economic environment...... 58

6.3.2 Low interest rates...... 58

6.4 Final Assessment ...... 59

7 Conclusion ...... 61

8 References ...... 64

Abstract

The real estate market in Prague has experienced a considerable increase of average prices of new apartment units. This increase started a discussion of whether a real estate bubble is inflating and waiting to burst. The goal of this work was to explore the causes behind the increase and look at the determinants of the trend. The problem was approached from the perspective of theory of supply and demand. A considerable part of the text is given to past real estate crises in the global economy. In order to analyze the current situation, it is important to collect information from the past and compare it to current events. The research indicates that the increase of prices is largely driven by the limitations that face real estate development companies. Lengthy approval process, scarcity of land, its high acquisition costs, and increasing construction costs are all significant factors affecting the industry. The findings imply that the situation is a result of natural progression of events in the market. The result confirms the opinion of most industry professionals who demand a more efficient approach from the governmental offices.

1 Introduction

Real estate is closely connected to everyday life of most of the living population. Whether we look at home ownership only from the perspective of shelter, or as fulfilling a deeper role in our lives by providing individuals and families a sanctuary of safety, it can be safely assumed that owning a home is essential for each individual. Real estate ownership is closely associated with three of the basic levels of Abraham Maslow’s Hierarchy of needs, where the need for shelter is part of the most important physiological level. The feeling of safety that home provides is just above in the security category and the fact that it also provides a space for a family to function and live together helps satisfy the need for belonging and love (Aanstoos, 2013).

Because of the importance mentioned above, the real estate market is closely observed by economists, customers and businessmen alike. A stable market helps predict the cost of housing and provides an interesting option for investment. Historically, investment in real estate can be considered to be fairly risk-free. Granted, there have been many financial bubbles and subsequent crashes that were directly linked to the real estate market, it tends to appreciate or, at least, keep its value over long periods of time.

This paper aims to explore the real estate market of Prague, the capital city of the Czech

Republic. As the capital of the country, Prague naturally possesses much higher prices than the rest of the country. However, the unprecedented increase of prices in the recent years has placed the market under major scrutiny. The average offer price of an apartment in Prague in 2014 was approximately CZK 55,600 per square meter (Deloitte, 2015), whereas at the end of August, 2017 the average price of an apartment in Prague reached

CZK 93,500 per square meter (Deloitte, 2017b). This increase has been widely discussed in the Czech press, leading to claims of a market bubble waiting to burst. For example,

9 the Czech National Bank has issued a statement in June 2017 that the market is exceeding its capabilities with overrated prices, signifying a likely arrival of an economic bubble

(Czech News Agency, 2017b). Apartments have become increasingly more expensive, especially in combination with the new regulation of mortgages which increased the required equity of the applicant to 10% (Czech News Agency, 2017a). Nonetheless, real estate development companies are confident that the prices are adequate as the demand for housing significantly exceeds the supply of units on the market. Furthermore, they are unsure whether the restrictive actions imposed by the Czech National Bank are the most adequate. They claim that the increase in pricing is mostly due to the increased appeal of

Prague and only demonstrates that Prague is nearing the values of other European metropolises like Munich, Hamburg or Berlin (Czech News Agency, 2017b).

The relationship of supply and demand is an essential determinant of prices of products on the market. The lowering supply of apartments on Prague’s real estate market has driven the price to unprecedented heights, making the purchase of a new home increasingly difficult for young adults. This topic is particularly intriguing because of the ongoing discussion whether this development is a new bubble on the market or whether it is just a natural course of Prague’s development as a capital city of a quickly developing country. By analyzing the issue from the perspective of the theory of supply and demand, it is evident that the supply of new apartments in Prague has reduced to almost half of historical values.

The goal of this paper is to examine the causes of the decrease of supply, the likelihood of market crash, and the impact of the price increase along with the recent development in mortgage policies. Through the analysis of concrete data over the period of years 2015 to 2017, along with the comparison to opinions of experts from the Czech real estate

10 industry, the aim is to explain the actual causes of the decreased supply and increased prices.

11 2 Real Estate and its Function in the Economy

Real estate is a very important part of a nation’s economy and overall public domain. As was already described in the introduction, ownership of real estate is closely correlated with the quality of life of each individual. However, that only represents the function of residential real estate in the terms of housing of the individual. Real estate industry comprises of various entities which cover the needs of different players in the market.

Development companies, construction organizations, brokerage firms, agents, banking industry, the public sector, and many others are all affected by the availability and prices of real estate. The industry overall provides other businesses with land and premises for conducting their activities, families with homes, governmental organizations with space in which they can provide their services, and many others. Because of its essential connection to the whole economy, the real estate industry is closely monitored and regulated. On the other hand, the protection of real estate ownership is very advanced when compared to other assets. It is mainly due to the importance it holds in the eyes of investors that such a system of careful registration through governmental offices was designed. (Henderson, 2013; Tetteh, 2013)

While this project is aimed only on the housing market and its situation, other submarkets and functions of real estate should be mentioned as well. It is a fairly broad topic and its variability is one of the reasons for the amount of businesses and private persons interested in its procurement.

2.1 Definition of Real Estate

In his book reviewing the characteristics of real estate, Nicholas Pirounakis (2013b, p. 1) defines real estate as “land, buildings, and legal rights over immovable property especially when they can be priced for possible sale in an actual or potential market.”

12 Land has a specific position in the above mentioned as it is essential for the others. Simply put, it is impossible to construct a building without a land to build upon.

This chapter will focus on two subparts of real estate. Firstly, the question of land and its specifications will be considered. A special focus should be placed on the zoning plan, which determines the use of land, the public infrastructure and the location itself.

Secondly, the submarket of residential development and the viability of investing into it will be examined.

2.1.1 Zoning plan.

The usage of land, at least in the Czech Republic, is set by the zoning plan published by local governmental offices. This plan determines the allowed use of land whether it is by construction or other activities. There are several categories which range from agrarian land to residential, commercial and other uses. All have their limitations regarding the type of buildings or other constructions which could be built on them. Pirounakis (2013b, p. 2) mentions the most basic distinction between types of real estate as the difference between housing and non-housing real estate. Dwight Merriam (2004a), in his book on zoning and its practices, further categorizes land into three categories around which zoning plans are generally created. These are the residential, commercial, and industrial zones which all have different specifications and hold different values depending on their availability, desirability, and utility.

Housing real estate forms the largest part of most urban areas. Commonly it is also paired with alternative or combined uses, especially in prime locations around city centers, where the ground floors are used for commercial tenants with residential units in the upper floors. This and all other combinations and possible usages are also described in the zoning plan. From a private view of a property owner the zoning plan is often perceived

13 as major restraint. While there is some support to such a claim since sometimes the limitations placed on a secluded piece of private land in the countryside are extraordinarily specific, the overall significance of planning of any future development is absolutely essential for the careful and successful improvement of a given location.

The theoretical framework behind the definition of land and its usage is a complicated issue even for professionals in the field. Through its examination, one can access information regarding the designed use of land, the percentage of greenery that must be preserved, indexes of gross floor area or the floor area ratio. These aspects are essential especially for the planning of construction of new projects.

2.1.2 Infrastructure.

While not entirely a product of the zone planning process, the infrastructure, an essential aspect of real estate development, also needs to be considered. Infrastructure is a term which describes all of the utilities and other support systems which need to be accessible for the residents or other occupants of the property. Access to electricity, sewage, water, gas, or the phone network is needed to make the given land viable for most uses other than agrarian. Public infrastructure does not only include the above mentioned but also other aspects which affect the value of the land. Access to road network, governmental institutions and services, schools, and other aspects of everyday life all determine the desirability of a given land. (Merriam, 2004b)

2.1.3 Location.

Location of a property is to a large degree the decisive factor of its price. There is an old saying very popular in the real estate industry – “Location, Location, Location”. While it is impossible to attribute to a single person, research suggests it originated in the 1920s.

Its implied meaning of the utmost importance of location to an investment decision

14 regarding purchase of real estate property has, however, been used as a mantra by numerous professionals in the industry. (Safire, 2009)

They are correct in assigning the location such a high importance. Its desirability is largely derived from its perception by the potential customers. Pirounakis mentions that while “location is usually demanded as mean to an end, very often it is also demanded for its own sake – without in fact becoming priceless.” (Pirounakis, 2013b, p. 3) No matter the type of construction in the given location, the perception of its surroundings affects the image of the owner extensively. In her research on the effects a location has on corporate image Petra Škevin (2011) concluded that corporations tend to be perceived as more successful if their offices are located in a more upscale location. It is deeply connected to marketing and the brand of the company is to a certain degree affected by its premises and their location.

There are certain locations in all cities that are perceived as being more appealing to the interested parties than others. These vary for the specific submarket. For example, in the manufacturing industry, real estate that is located nearby highways is deemed to be more appealing than others due to the ease of transportation access.

The commercial market can generally be divided into two categories. Firstly, large office and retail centers need to be built in close proximity to mass transportation stations, otherwise they tend to be overlooked by large corporations looking to rent the premises.

In the case of Prague, that would be the subway stations across the city. Secondly, in the case of smaller businesses a location that is in or fairly nearby to the city center is preferable as it is easier for potential customers to access. The appeal of a location for housing development is mostly affected by the surrounding area which allows for a comfortable life for the residents. The overall image of the neighborhood, access to

15 schools and public amenities, parks, and other areas for leisure all affect the decision of customers to purchase a home in an area. Logically, the more appealing a location is for the customer, the higher the price.

From the perspective of the developer, the location of the project is probably the most important choice that needs to be made. However, this choice is fairly limited by the availability of land and the possibility of construction. As the whole process of planning, approval, and construction is lengthy, a certain degree of predicting the likely attractiveness of the location is definitely present. Purchasing land and project construction is a major financial undertaking which demands a lot of time and resources.

Importantly, the supply of land in a given location is almost inelastic. While the zoning plan is frequently amended, only a limited supply is available to developers for purchase at a given point in time. Therefore, project managers need to look closely at the offers presented, and make an informed choice based on the demand for a given location. This ties closely to the current and, more importantly, the future demand in the market. Being able to decide on a location which will increase in attractiveness over the course of the whole process, and securing it provides a good basis for a successful project. (Pirounakis,

2013b, p. 5)

2.2 Specifics of the Housing Market

The above-mentioned aspect of location ties closely to the next subchapter which examines the specifics of the housing market. Essentially, the residential market is not that different from the other submarkets in this respect. As businesses look for the most adequate premises that would help them present themselves in a favorable light to their customers, so do individuals look for homes that provide them with the highest utility.

16 Personal preferences play an important part in an individual’s choice regarding the purchase of a home. Each location has different characteristics that might pose different appeal, whether it is familiarity, prestige, closeness to one’s place of employment, or the overall pleasantness of the location. Pirounakis mentions that the demand for housing is not always derived just from the utility that the location of the project gives to its residents. He argues that often the demand also includes what he calls “non-derived (i.e., authentic) element, for example when the built structure and/or the location in question have emotional, social or brand value.” (Pirounakis, 2013b, p. 5) While this behavior is mostly correlated with the residential real estate, the authentic demand is also present in commercial real estate. As was mentioned before, certain locations and buildings have a reputation of being associated with reputable companies and activities, thus adding to the brand image. Therefore, authentic demand is in a way present even in the office and retail submarket.

2.3 Housing as an Investment Decision

Investing into real estate can have many forms, which are all viable depending on the financial ability of the investors and their willingness to take on risks. Investment forms range from purchase of real estate for the purpose of personal usage, renting it out to others, all the way to investing in funds and trusts which manage large portfolios. These funds can diversify their portfolio into a range of different submarkets of real estate, or even combine them with entirely different investment vessels including stocks, bonds and other derivatives. For the purpose of this paper, the focus will be placed on the individual investor and their personal purchase of a given piece of property.

In the residential market, the distinction between a property for personal usage and one bought with commercial mindset is easily visible. Pirounakis (2013a, pp. 125–128)

17 describes it as the difference between owner-occupied and rented property. This categorization is supported by the Czech tax system. The interested paid on a mortgage provided for owner-occupied property is tax-deductible, whereas the interest paid on rented property falls under the general costs connected to the entrepreneurial aspect of renting the property out. (Alexio.cz, 2017)

In its essence, investment into real estate is not that different from stocks, bonds and other securities. It can appreciate depending on the location or generate cash flows from rent.

In his book on real estate investment Gary Eldred (2012), a real estate entrepreneur and

Stanford lecturer, examines various ways real estate can gain value for its owner. The basic concepts will now be introduced.

2.3.1 Appreciation.

Appreciation is a result of an increased demand for the particular type of property. Such an increase could be a product of an overall improvement of location, lack of certain type of property, or increased popularity of a given area. However, appreciation on its own is not necessarily of utmost importance for the investor as a relatively small increase can easily be offset by the cash flows generated by the property.

2.3.2 Returns from cash flow.

Returns generated by the property through rent are the prime source of income of the property and what largely determines the financial viability of real estate investment.

When assessed properly, it can cover the entire mortgage loan on the property, resulting in the situation where the tenants pay off the property for the owner, who stands to achieve a large capital gain in the long run. These returns can be magnified extensively by careful and clever use of financial leverage and refinancing for extra cash income available for

18 additional purchases. Such a strategy is fairly long-term, however, it can become very profitable for the investor. (Eldred, 2012)

2.4 Overview

Real estate is a significantly important part of the economy. It may take many forms and characteristics, ranging from a piece of land to a factory, office building, or a family home. As such it connects to all aspects of life and, to a certain degree, it enables the society to function. In this chapter we established the basic characteristics of real estate in the form of its physical presence, the legal regulations, location, and the public perception, which all translate directly into its price. A special consideration was given to the specifics of the housing market and the basics of real estate investment.

While all the above-mentioned aspects of real estate need to be closely examined, there are several other features of real estate investment and development which need to be acknowledged. First of all, the length of the planning process and its approval by the local authorities are a major driver of costs of any given project. The longer such a project takes, the larger the costs. Secondly, the overall economic viability of a project determines its capability of becoming successful. There are many costs that must be considered by the project manager, and a careful approach needs to be taken in order to assess all risks of such an undertaking. Thirdly, the project needs to be attractive to potential customers.

Identifying the target market segment and its needs is very important. A project with bad public reputation that is not properly thought out, will likely be met with a low demand by customers. Characteristics of the project such as the quality of the location, construction, interiors and exteriors of the building, access to public amenities, and design of the building all affect the desirability of the project. Only when the customers perceive the development as satisfactory, will they consider the purchase. Dwight Merriam

19 provides a good summary by saying that each investor must first try to analyze the market and according to the gained knowledge design the best project possible for such a market.

“In the end, every project must be marketable, profitable, and approvable.” (Merriam,

2004b, p. 18)

20 3 Supply and Demand Perspective

As all other products in a free market, real estate is also directly affected by the rules of the relationship between supply and demand. These two phenomena and their interaction in the marketplace directly affect the price of a product and quantity available for purchase. In order to understand the current market and provide support for the conclusion of this work, it is necessary to briefly visit the theory and explain the basic terminology and identify the major determinants of both, supply and demand.

3.1 Demand

According to David Colander (Colander, 1998, p. 60) “as prices change, people change how much of a particular good they’re willing to buy” and “more of a good will be demanded the lower its price, other things constant.” It is a fairly basic description which describes that if a product is cheaper than it was before, one could purchase more of it.

However, there are other aspects that affect the demand of a product. Demand is represented as a downward curve representing the inverse relationship between the price of a good and quantity demanded. That is when the statement about other variable remaining constant becomes important. There are various factors that will affect demand and shift the curve. Customers will be affected by other aspects apart from the price and quantity demanded. Therefore, demand varies depending on factors which do not fall under these two categories.

3.1.1 Demand determinants in real estate.

David Colander identifies four major shift factors of demand. These are the income of society, prices of other goods, personal tastes of customers, and their expectations.

(Colander, 1998, p. 63) Judy Whitehead identifies other factors which are very relatable to the field of real estate. Among others she mentions the availability of credit, cultural

21 determinants and behaviors, external influences from, for example, the media, and the behavior of other consumers in the market. (Whitehead, 2014a, pp. 58–59)

All of the above mentioned are very important to the field of real estate. Credit availability in the form of mortgages and the income of society both directly affect the households’ ability to purchase real estate. Additionally, cultural behavior and tradition towards ownership of real estate, the preference of a certain category of real estate, the prices of alternative investments, and the public image of the industry also affect the demand in different ways. These all need to be considered for analysis and could have an implication on the behavior of customers. In the last two chapters of this paper, these determinants and their relations to the market will be examined. The way they affect the current situation will be described in order to identify their direct impacts.

3.2 Supply

Opposite to demand is the other side to the relationship in the form of supply. For the purpose of this work, the focus will generally be placed on the supply of new apartments built by real estate development companies. Supply refers to the quantity of the good available in the market for purchase. The law of supply states that “the quantity supplied of a good is positively related to that good’s price, other things constant.” (Colander,

1998, p. 68) Essentially, as the price of a good rises, it will become more attractive to other market players as the opportunity to increase revenues by participation in the production of a good increases. The supply curve has an upward slope, showing the increase in price as the quantity supplied increases. Similarly to the law of demand, the law of supply assumes that all other factors will remain constant. However, that is very unlikely resulting in the shift of the supply curve dependent to outside determinants, which will now be identified

22 3.2.1 Supply determinants in real estate.

Like the behavior of demand, supply also reacts to external factors which affect its behavior. These can affect the producers, in this case the development companies, or the economy as a whole. According to David Colander (1998, p. 70) these factors include

“the changes in the prices of inputs used in the production of a good, changes in technology, changes in suppliers’ expectations, and changes in taxes and subsidies.”

Additionally, it is assumed that the producer is going to utilize all capabilities in order to maximize the efficiency and effectivity of production through maximization of production capability using all means available including resources, labor, and knowledge. (Whitehead, 2014b, p. 124)

In the case of real estate development, the suppliers will mostly be affected by the costs of each project which include land, construction costs, and all other costs connected to the operation of the company. Land price is largely affected by its location and availability. Construction costs are dependent on the cost of labor and materials used in the process.

Aside from construction, other costs will be incurred, which include marketing, sales, administration, and various others. Additionally, there are other hidden costs which will often be linked to the prolongation of the project, increasing the opportunity cost. For example, the length of the approval process directly affects the risks connected to each project.

Furthermore, as each organization has different goals and measurements regarding the required return on their investments, they will likely behave differently. Interest rates on loans also need to be considered as it is very rare for a project to be financed entirely by equity. Therefore, the costs can vary significantly depending on the changes in the

23 financial market. All of the above-mentioned determine the behavior of suppliers shifting the supply curve in different directions.

3.3 Implications

The relationship between supply and demand will affect the prices of real estate and its quantity significantly. However, it is essential to stress the importance of a holistic perspective. Real estate market is an important part of the public domain and it reacts to all current events. Changes in other industries are going to affect it through the impacts they have on the customers, who are an essential aspect of the market. Purchasing real estate is very likely to be one of the largest investment an individual makes in their lifetime. Thus, their decisions will be very thought-out and carefully considered. In order to penetrate the market successfully, each supplier needs to cautiously select their target customers. The variability in the types of real estate provides a wide choice of options, allowing the companies to distinguish themselves from their competition.

The mentioned supply and demand determinants are all applicable to the current situation in Prague, although they vary in their significance. As the current market values will be presented, it will be necessary to identify the possible underlying causes. Since the current situation is a result of a combination of the changes in factors affecting both, demand and supply, most of them will be analyzed more thoroughly in order to come to a viable conclusion.

24 4 Past Real Estate Crises and their Connection to Current

Situation

In order to be able to assess current development on the market, one needs to examine the actions that led to past bubbles. By comparing the causes of former bubbles to recent development, a comparison can be made, and we can conclude whether the similarities signify a likelihood of an upcoming crisis. However, it is not uncommon for crises to bear similarities to past development, and still be ignored by the market in general.

For example, the recent development surrounding Bitcoin can be compared to certain, seemingly unconnected, bubbles of the past. As James Rickards, a lawyer and financial market expert associated with the New York Times, has mentioned in his interview with

Business Insider, the development of Bitcoin can be compared to south sea bubble, the dot-com bubble, or even the Nikkei bubble, which is directly connected to the real estate bubble in Japan in the second half of the 1980s. (Jacqui & Chin, 2017) Generally, we can assume that the market players do not learn from past mistakes. High confidence arising from new booms and technological inventions leads investors to forget past mistakes and lessons, while indirectly forcing them to make decision leading to another crisis.

In his book on the anticipation of financial crises, Harry Dent (2010) mentions the governmental actions of Japan that contributed to the extreme appreciation of real estate and land in Japan. While the development of the Nikkei, an index of the Tokyo Stock

Exchange, was similar to that of the Dow-Jones in between 1922 to 1929, investors still felt confident that the market is healthy. Dent summarizes investor behavior with a claim that “the truth is that it does not take most people long to forget even the hard lessons when strong gains stimulate their greed again.” (Dent, 2010, p. 102) In essence, the

25 investors are very often affected by the overconfident behavior of others, rather than by careful calculation and proper assessment of all the benefits and drawbacks of a particular market.

Real estate prices are determined by changes in factors that are significant for construction and sale. People’s ability to buy real estate is closely connected to their employment, income, and to the interest rates on mortgages. Furthermore, companies need to consider construction costs, and the price of land and its availability. When combined, these factors determine the pricing policy of the real estate development companies. (Auerbach, 2013b)

Important question needed to answer is what lies behind a creation of a market bubble.

Real estate bubbles develop when the factors of their price mentioned above cease to be the only determinants of prices in the market (Bourassa, Hendershott, & Murphy, 2001).

As with most markets, if investors start considering other aspects than the ones directly connected to the creation of prices, the market starts to move further away from the realistic value of the assets. According to Charles Bean (Bean, 2004, p. 14) “price bubbles tend to be associated with a broader set of symptoms, typically including high investment and buildup of debt.” Furthermore, as the market becomes overly optimistic, the investors begin to factor in high expectations for future returns, which drives the prices up. An important determinant of a price of an investment are the expected returns that an asset generates. The value is highly connected to the rent it could generate for the owner. As rents increase, the price of the asset increases accordingly. When an investment promises a high passive income from ownership, investors will look to borrow more from institutions in order to be able to invest more.

26 An important part of a mortgage is the value of the collateral, most commonly the real estate itself. In a period of appreciation, the increasing prices of real estate will be able to offset the increased borrowing on the balance sheets. However, when the bubbles burst, the price of collateral decreases accordingly. If the loan defaults, the lending financial institution could end up with assets that do not cover the overall cost of the debt. (Bean,

2004)

In conclusion, there are various aspects that can lead to overvaluation of real estate and a creation of a bubble. By examination of the past crises, this chapter aims to identify the causes of each bubble and summarize the findings in order to compare them to the current development of the real estate market in Prague.

4.1 Japanese Asset Price Bubble 1986-1991

The Japanese economy experienced a massive boom in overall asset prices in the second half of the 1980s. The most commonly mentioned index of stocks on the Tokyo Stock

Exchange, the Nikkei index, appreciated from ¥8,800 in 1983, all the way to the annual average of ¥38,915 in 1989. This increase of over 440% signified a time of incredible growth of the Japanese economy. Commonly, as stocks appreciate, the land prices rise along proportionally to the increase in the growth of the national economy. However, in the later part of the decade, asset prices stopped behaving according to the trend described above and soared to heights that could not be attributed to the regular changes in growth.

The 1980s showed extraordinary increase in land prices in Tokyo and the surrounding area, and subsequently other major regional cities like Osaka. In a short period of two years, the average price of land approximately tripled in Tokyo, and other parts of Japan saw a similar increase. (Noguchi, 1994)

27 4.1.1 Changes in financing.

Additionally, there was a fundamental change in the way businesses funded their operations. Major corporations started raising money through the issuance of equity stocks and corporate bonds. In the manufacturing sector, companies decreased their share of borrowing from 70 percent to 56 percent, and the largest corporations valued over ¥1 billion decreased their borrowing even more significantly, from 59 to 34 percent.

(Noguchi, 1994)

Such a fundamental change in the structure of financing of major corporations meant that the banking industry had excess resources that could be borrowed to other industries. Real estate companies were among the ones who decided to seize the opportunity and access this pool of finances in order to buy land, speculating on further increases in its prices. In fact, in 1984 the total loans provided to the industry amounted to approximately ¥16.5 trillion, whereas at the end of 1990, this figure has increased to approximately ¥40 trillion.

This excessive lending was one of the major factors that contributed to the increase in land speculation and the overall increase in land prices. (Noguchi, 1994)

4.1.2 Land ownership.

Ownership of land is considered to be a very sound investment in the Japanese culture due to its important position in the business environment. Consequently, it strengthened its position especially during the bubble period in the late 1980s. In her book on investment into Japanese real estate, Mary Hines mentions that “the importance of real estate in Japan is shown by the nature of institutional, government, corporate, and consumer investment in Japanese real estate” (Hines, 2001, p. 12). Furthermore, the bubble only strengthened the desire to own it. Hines adds that “a person who sought great wealth considered that the shortest route to this financial success was to buy real property”

(Hines, 2001, p. 4). In fact, investment into real estate overshadowed investment into

28 typical savings deposits provided by postal services or banks. As prices rose and the

Japanese saw the possibility of increasing their wealth, they started investing more than before. In the first half of the 1980s purchases of land made by nonfinancial corporations on average totaled just under ¥1 trillion annually, but this amount increased extraordinarily during the second half of the 1980s. In the period of 1985-1990, these

Japanese corporations alone managed to buy land worth approximately ¥40 trillion.

(Noguchi, 1994)

Although the growth of the economy was fairly high in the second half of the 1980s, it can safely be assumed that there was no need for corporations to suddenly require so much real estate in connection to their daily business. Thus, the logical explanation is the speculative character of these purchases. Through the purchase of land, corporations believed that they could increase their wealth more than by investing the money in improving their production and operations.

4.1.3 Macroeconomic policies.

As the dollar appreciated against other currencies in the first half of the 1980s, Ronald

Reagan’s administration had to react to this development as their trade partners started to raise issues. This led to a meeting in September of 1985, which would lead to the devaluation of U.S. Dollar in relation to other foreign currencies, Japanese Yen among those. This meeting entered history by creating what is called the Plaza Accord of 1985 with Japan being one of the signatories. Its effect was a depreciation of the U.S. Dollar by approximately 40 percent in the 1985-87 period. However, this magnified issues in the

Japanese economy which led to the rise of the real estate bubble. (Frankel, 2015)

Macroeconomic policies in the second half of the 1980s are closely correlated to a reaction to the sudden appreciation of Japanese Yen due to the Plaza Accord. Overall, the

29 government made it easier to obtain funding for businesses by lowering interest rates.

Parallel to that, the Japanese managed to achieve a surplus in the government budget.

Both had a share in increasing the prices of assets.

First of all, the government lowered interest rates from 5 percent in October 1983 all the way to 2.5 percent in February 1987. According to Mitsuhiko Iyoda (2010), a Japanese professor of economics, this was deemed necessary facing the changes after the Plaza

Accord. Additionally, the United States put strong pressure on the government to lower interest rates. However, the interest rates remained at the low level of 2.5 percent until

1989. This was all based on an argument that if the government raised interest rates, it would pose problems for countries that wanted to invest in Japan. Furthermore, the further appreciation of the Yen added to the delay in changes to the monetary policy.

Secondly, the Japanese budget went from a deficit of around 4 percent of GDP in 1980 to a surplus of 2 percent in 1989 (Trading Economics, 2017). The government managed to collect more taxes from corporations, mostly in asset-related factors. Thus, we can assume that the popularity of investment into real estate led to higher taxes for the government. However, the increase in tax collection was not met with an increase in government spending. Noguchi (1994) claims that, contrary to popular belief, the surplus was not used to fund spending programs in secondary budgets. Instead this money was mostly used to diminish the problems connected to previous issuance of deficit-financing bonds. As the quantity of these bonds reduced, financial institutions were faced with fewer possibilities of investment. That led to a need to allocate more of these funds into loans, forcing banks to look for alternative to an already established portfolio of clients.

30 4.1.4 Assessment.

In a paper on credit availability in the 1980s, Hiroyuki Nemoto (2017) argues that as it became easier to gain access to credit, land prices in areas with increased banking activity rose accordingly. He concludes with a claim that the combination of surplus of funds, low interest rates, and competition among banking institutions led to the creation of the real estate bubble. As was already established above, most of the excess funds were invested into real estate companies, which proved to be riskier for the financial market than previous clients. If the improvements in productivity are added to the equation, it can be concluded that the extra resources generated by the economy went into purchases of real estate as a long-term investment made by the producers and distributors of goods. Instead of returning back into the economy and benefitting the public, the extra money remained unused and placed into an asset that would later on depreciate significantly. Noguchi

(1994), argues that through the excessive cut of government-issued bonds, banks were forced to find alternative possibilities of investment. He adds that “if the national debt had continued to be the same percentage of GDP from 1986 on, it would have been about

¥20 trillion more at the end of fiscal 1990 than it actually was”, and that the ¥20 trillion mentioned “is approximately the amount by which loans to the real estate industry increased during the second half of the 1980s” (Noguchi, 1994, p. 299).

To conclude, the Japanese government provided conditions which allowed the development of the asset bubble. The free monetary policy of low interest rates meant that loans were particularly cheap allowing the real estate companies to acquire funding fairly easily. As major corporations reduced their loan financing, financial institutions had to invest someplace else. Reductions in the amount of government bonds led them to invest in riskier alternatives, mostly real estate companies interested in expanding their activity. As the demand for real estate increased, the prices rose correspondingly. The

31 speculation on increasing prices only fueled the desire of market players to invest more, driving the price even higher. The subsequent crash meant that a large amount of the growth generated by the expansion of the Japanese economy in the 1980s disappeared with the crash of real estate prices. According to Iyoda, the “land prices for commercial and residential use in six major cities continued to decline until 2005, which became 13 and 34 percent (1975 and 1983 levels), respectively, against the peak [in 1991]” (Iyoda,

2010, p. 70). This summarization shows the devastating effect, the speculation on real estate in the second half of the 1980s had on the Japanese economy.

4.2 Subprime Mortgage Crisis

The Subprime mortgage crisis would grow to be at the center of the largest economic downturn since the Great Depression of the 1930s. Publicized by the media worldwide, the impacts of the housing bubble subsequently affected the whole financial sector, leading to default of many large banking institutions. The absolute core cause of the crisis was the subprime mortgage market and its massive boom which resulted in large number of defaults of mortgages. The problem laid mostly with the managers and agents of those financial entities who used very undemanding acceptance criteria during the mortgage approval process. Subsequently, banks found themselves with a large number of non- performing loans and assets with an overvalued price which went down as soon as the bubble burst. Additionally, the rating agencies were not doing their job properly as they often classified lower-quality investment opportunities to belong in a higher-quality bracket. Through cooperation with investment fund managers, this fraud led to investors believing in high quality of the subprime mortgage bundles in which they had the opportunity to invest. (Lewis, 2010)

32 Other causes of the crisis include low interest rates in the first half of the 2000s, which caused the investors to search for alternative higher-yield investments apart from the US

Treasury securities. Additionally, the regulations regarding investment banking were considerably weakened by the repeal of the Glass-Steagall Act by the Clinton administration, resulting in higher-risk activity in the banking sector. This led to an environment which allowed the representatives of various market players to come up with ways of exploiting the weaknesses in the system in order to multiply their gains, while at the same time contributing to a massive bubble which would change the future of the financial world. (Auerbach, 2013a; Mari, 2013)

4.2.1 Changes in the economic environment in early 2000s.

Two main factors influenced the housing market in the first half of the 2000s and led to creation of an economic environment, in which the subprime mortgage bubble grew, and eventually, indirectly crashed the global economy. The combination of low interest rates and extensive deregulation in the form of repeal of the Glass-Steagall act of 1933 meant that the financial industry had the freedom to create novelty products based on seemingly safe investment like mortgages and bundle them in a way that created additional hidden risk, unnoticed by the eyes of investors. Secondly, the low interest rates also brought new customers who sought mortgages, especially since borrowing money became much cheaper than before. The combination of these two factors will prove to be deadly as will be described later on.

4.2.1.1 Interest rates.

First of all, the interest rates decreased dramatically in the first half of the 2000s. While the Effective Federal Funds Rate was 6.52 percent in September 2000, it dropped to 0.98 percent in December 2003 (Federal Reserve Bank of St. Louis, 2018). Such a drop meant that the US Treasury securities and bonds decreased their interests accordingly, thus

33 making the investment less viable for investors looking to earn high interest.

Additionally, low interest rates transferred into low effective bank rates on mortgages, enabling the general population to achieve financing for their housing fairly cheaply.

(Mari, 2013)

Low interest rates generally follow a considerable crisis in the United States as the government is trying to breathe new life into the economy by making access to funding easier and cheaper. The particular drop in the first half of the 2000s was no exception. Following the fall of the dot-com companies, many investors sought to remedy themselves through investment into traditional options, especially after the negative experience in the dot-com bubble. Since the regular investment options became less profitable, they looked towards the traditional financial institutions and their investment options. (Bilginsoy, 2015) However, as will be discussed, many of these options were very risky without the investors actually knowing so.

4.2.1.2 Repeal of the Glass-Steagall Act of 1933.

The Glass-Steagall Act of 1933 was created under the experience from the Great

Depression. Its main goal was to limit the impact of market speculation of financial institutions on its regular customers, who deposited their money with belief that the bank will take good care of their money. Furthermore, the Act also included limitations on keeping a minimal amount of deposits through the creation of the Federal Deposit

Insurance Corporation. Overall, the aim was to limit the risk regular commercial banks would be allowed to take. Instead, it separated commercial banks from investment banks.

Investment banks on the other hand were allowed to operate on the market through purchases and sales of stocks and bonds, and underwriting securities. On the other hand, they were not allowed to come in contact with collecting retail customers’ deposits.

(Wirth, 2013)

34 The Glass-Steagall Act was repealed in 1999 by passing the Gramm-Leach-Bliley Law, ending the era of relative security of the financial markets. Banking institutions were allowed to transfer the gap between regular commercial banking and investment banking, creating a highly risky banking environment which, if it failed, would have a similar potential of damaging the economy to an extent that the Great Depression had. (Dobre &

Răsăuţeanu, 2017)

The repeal had been criticized widely by experts, among them by the world-renowned economist Joseph Stiglitz who mentions that “Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail” (Roosevelt Institute, 2009). The repeal and the reasons for it have been discussed widely. In his paper examining law changes as reaction to changes in the market, Charles L. Schwarcz (2017, p. 165) mentions that “the market deregulation and re-regulation cycle more broadly illustrates political under-reaction and over-reaction.

During economic prosperity, lobbyists for the financial industry, as well as a delighted constituency, push politicians for deregulation, which can leave markets under-protected.

Once the bubble of prosperity inevitably bursts, investor confidence in the integrity of the market and its institutions dissipates leading to a public demand for new [over-protective] laws and regulations.” Furthermore, the repeal was also opposed by the senators who voted on it, claiming that it is a step back and a mistake which will be regretted at some time in the future. (Dobre & Răsăuţeanu, 2017) Overall, the repeal and the effects it will have on the world economy could have been prevented by leaving it in place. However, as we could see in the financial crisis in towards the end of the 2000s, greed has overcome carefulness. The human society has made another mistake similar to one it has been making throughout its entire history – failure to learn from its past mistakes.

35 4.2.2 Securitization of subprime mortgages.

Under the influence of the deregulation and low interest rates mentioned above, banking institution sought to maximize their profits by providing investors with new opportunities of investment. As interest rates fell, it became easier for the general population to borrow money in the form of mortgages. Deregulation allowed banks to bundle these mortgages into new investment products called mortgage-backed securities and further sell them on the bond market. As they had higher yields than regular bonds, while having a relatively low perceived level of risk, they quickly caught on and became a significant form of investment for many investors. (Mari, 2013)

Securitization became an essential part of banking in the United States in the first half of

2000s, as it had a significant impact on their liquidity and the speed with which they were able to circulate money into new loans. In her paper Bonnie Buchanan (2014, p. 316) defines securitization as “the sale of underlying assets or debt so that they are removed of the issuer’s balance sheet, the pooling of illiquid assets, credit enhancement and tranching of the underlying pool.” Through securitization banks were allowed to bundle the loans currently in their balance sheet and sell them to other investors including global insurance companies and hedge funds. Thus, they freed up large portions of their capital and could invest further by issuing further loans, cumulating additional cash flows. This newly created model of functioning came to be known as the originate-to-distribute

(OTD) model. (Buchanan & Choudhry, 2014) This practice, which allowed the financial institution to move assets of their depositors around in a much riskier manner, is in direct violation of the thought by Joseph Stiglitz on the conservative approach banks should hold when managing their depositors’ assets mentioned above.

Securitization of assets and their further sale to other interested parties, i.e. hedge funds, is not in itself a problem. It allows the banks to free up their cash and provide more people

36 with funding in times when the demand is high. However, the enhanced pressure and greed as mentioned by Dobre & Răsăuţeanu (2017, p. 38) led to lenders creating novelty types of mortgages with repayment models that were in many instances taken by borrowers who did not necessarily know they are doing. Securitization of mortgages put further pressure on agents of lenders by giving them incentives to find new clients and lend them money even if they were not capable of handling the extra expenses coming from having to repay their debts. As their profits depended largely on the amount of mortgages they were capable of issuing, they overlooked the borrowers situation and signed mortgage contracts even if borrowers did not fulfil the criteria. Furthermore, as these mortgages were securitized and sold to other parties, the risk coming from possible default of such a mortgage were passed to another entity. Therefore, the managers overlooked the low quality of such mortgages and the damage it could do to their balance sheets. (Bilginsoy, 2015, pp. 381–382; Peicuti, 2013, pp. 445–446)

Additionally, under the OTD model, the portfolio of loans was used to create securities with various levels of yields and risks. Similarly to other investment opportunities, securities required a rating which describes their level of risk. Issued by major credit rating agencies like Fitch or Standard & Poor’s, these ratings were essential in the creation of what would become a large investment bubble. As they rated the mortgage-backed securities based on the premise of their perceived low-risk character, they received ratings which indicated a much higher quality than they actually possessed. (Buchanan &

Choudhry, 2014, pp. 317–320)

All of the above-mentioned aspects meant that over the course of the early 2000s the quality of the US real estate and financial market deteriorated extensively. In their paper on the Subprime mortgage crisis Yuliya Demyanyk and Otto Van Hemert (2011, p. 1875) found that there were increases in “the subprime share of the mortgage market (from

37 around 8% in 2001 to 20% in 2006) and in the securitized share of the subprime mortgage market (from 54% in 2001 to 75% in 2006).” Furthermore, they found that the closer the size of the loan was to the perceived value of the property it was connected to, the more likely the mortgage was to default.

4.2.3 Assessment.

The Subprime mortgage crisis demonstrates the extent to which a bubble connected to real estate can affect the whole financial system of a country. Real estate is traditionally deemed to be a conservative investment with relatively low risk. That transmitted to the general perception of investors that any investment connected to real estate, in this case in the form of mortgage-backed securities is to be deemed safe. However, the increase in delinquency rate of the mortgages which formed up the securities transferred into massive liquidity problems for their owners. (Demyanyk & Van Hemert, 2011, p. 1849)

The overall unsatisfactory knowledge of financial assets in their portfolios led to the default of large financial houses which had to be bailed out by the US government. This escalated into a large financial crisis in the United States, which transferred into a global economic crisis. It exhibited the interconnectedness of the global economy and pointed out the significance of regulations regarding the management of deposits and financial assets by commercial banks. The repeal of the Glass-Steagall Act was one of the direct causes of the environment in which the other practices leading to the crisis had the opportunity to manifest. The crisis led to an introduction of the Dodd-Frank Wall Street

Reform and Consumer Protection Act which contained parts of the formerly effective regulation with the addition of further norms regarding the protection of consumers, restrictions on innovative financial products, and practices connected to their creation and trading. (Dobre & Răsăuţeanu, 2017)

38 4.3 Chinese Real Estate Bubble

Chinese real estate market has often been described as an inevitable bubble throughout the entire 2010s. The massive growth that China experienced throughout much of the

1990-2010 period translated into an environment which allowed the prosperous part of the Chinese population to consider investing their money into real estate and other alternatives. However, since the situation itself is far from reaching an exact end, for the purpose of this research, only the causes of the current market bubble and its likely implications will be examined. The reasons for the current situation are various but can be summarized by a few major ones, such as the availability of investments, the increased money supply, high vacancy rates, and increased indebtedness.

4.3.1 Investment availability and viability.

Real estate market in China is so prominent mainly due to two aspects. Firstly, ownership of real estate is historically and culturally deemed to be very important in the traditionally agricultural society. Owning real estate shows wealth, the ability to provide for the family, and is often an important part of marriage negotiations. Secondly, real estate is to a certain extent the only viable investment as the interest rates on financial products have been very near to zero in the 2000s. Stock market fares no better with average zero annual returns in the 2001-2015 period. In contrast, real estate in Shanghai has shown to have above 10 percent return over the same period. The closed characteristic of the Chinese economy and the controls imposed by the government also make it very difficult to invest money abroad. All these aspects make the real estate market very important as it represents the only viable traditional opportunity of investment in China. Therefore, the demand is fairly high which initially drives the price upward. (Glaeser, Huang, Ma, &

Shleifer, 2017, pp. 105–106)

39 4.3.2 Money supply and large growth.

The growing money supply due to the improving economy has been identified to be a sign of impending crash even back in 2010. In an article by Dexter Roberts (2010) the economy has been described as becoming overheated and that the recovery from the financial crisis is perhaps too fast. The resulting increase in money supply and growing real estate prices have been mentioned to be correlated in more recent research done by

Zhao, Zhan, Jiang & Pan (2017, p. 155). In fact, the prices in mainland China have grown exponentially, especially in significant cities such as Beijing or Shanghai. While such an increase could be simply an effect of the improving Chinese economy and a larger purchasing power of the Chinese people, experts have identified it to be at the least very questionable.

Additionally, the expectations of continuous growth of the economy could possibly become the downfall of the whole real estate market. As Zhao et. al (2017, p. 156) mention in their research “over-optimistic market confidence leads to the overshooting of property prices and the prices of related financial products, like loans, asset-based securities and related financial sector services”. Inevitably, the increased pressure as showed by wide media coverage of the current situation will further lower the expectations and, if coupled with a decrease in GDP and policy-making mistakes, might trigger the burst of the bubble. (Real Estate Monitor Worldwide, 2016)

4.3.3 Access to land and vacancy rates.

The increase of money supply has already been discussed above and has enabled the population to invest into real estate and for the development and construction companies to expand their business activities. In order to capitalize on this the development companies had to cooperate with the Chinese government which is very involved in land development and construction of housing. It is in fact the sole provider of land in China.

40 (Zhao et al., 2017, p. 157) Therefore, developers have been forced to build on land made available to them, which very often meant construction in less desired regions of the country. As Glaeser, Huang & Ma (2017, p. 100) mention in their research, the housing construction was concentrated mostly in the less-developed regions, essentially wherever the local governments allowed new housing construction. However, as the supply of new apartments rose so did their vacancy rate. In fact, throughout the 2010-2012 period, the rate increased from below 10 to around 20 percent in the metropolitan areas of Beijing,

Shanghai, Shenzhen and Guangzhou. The rest of China experienced an increase from single digits to an average of around 13 percent. (Glaeser et al., 2017, p. 101)

Additionally, the research shows that much of this vacant supply of apartments is being held by the development companies, placing their ability to remain in business at a considerable risk.

4.3.4 Credit and collateral.

One of the main reasons why the high prices have been able to increase, is the system of lending to the local public sector and the private construction sector. At its heart lies the principle of using land as collateral for a loan. Local governments are prohibited from approaching banks directly and request funds for their projects. A system has been created to overcome this problem. The local governments form state-owned enterprises, which own land, and use that land as collateral to procure funds from banks. These funds are then used to complete the projects of the local government and are only paid down-the- line. Commercial and residential developers use land as collateral in the same way as the before-mentioned state-owned enterprises. As the amount of funds available in the form of loans for both, the private and the public sector, is directly affected by the value of the land used as collateral, it is in the interest of both to keep the price up. (Zhao et al., 2017, p. 158)

41 In order to repay the debts mentioned, the government uses the revenue generated by the land. This revenue mostly includes the payments from developers for the rights to construct new homes. If the bubble burst, the market would become flooded with a wide supply of additional housing units for a low price. But more importantly, it would lower the value of the collateral used in the loans and impact the ability of local governments to function. The described process might as well become what eventually transfers the possible real estate crisis into financial and economic crisis.

4.3.5 Assessment.

The Chinese real estate market is in a very peculiar position. The significant increase in its value due to the need for viable investment has made it very integrated into the economy. Furthermore, as land is extensively used as collateral, the negative effects of a crash would have reached into the financial sector and indirectly into the entire Chinese economy. While the government still has many resources at its disposal to minimize the impact of a potential crash, the pressure of the situation can be felt throughout the economy and it will be very interesting to see how it unfolds. Nonetheless, it shows the importance of a healthy market for investments overall, not just real estate. In order for the economy to function effectively, the investors need viable options to invest in. China would likely benefit from further opening of the governmental and economic system.

However, at this point such a policy seems highly unlikely.

4.4 Importance of Historical Context

The three above-described crises show the importance of having a healthy real estate market. In all three cases the irregularities in the prices of real estate signify much further implications on the economy of the given country. The interconnectedness of the real estate market with the financial markets means that an irregularity in one will

42 consequently affect the other. In their paper on dealing with real estate booms Crowe,

Dell’Ariccia, Igan & Rabanal (2013) argue that it is in fact difficult to correctly react to real estate bubbles because it becomes very difficult to identify when such a bubble is unsustainable. While it was formerly popular to wait for the result, as the costs of preventing the crash often outweigh the costs of allowing its natural progress, the method of prevention should be proactive, not reactive. Through their research they proved that most countries, which saw a simultaneous increase in real estate prices and credit, inevitably experienced a crash of the market or at least a significant reduction of the GDP.

However, in countries which experienced only an increase in real estate market, but not a significant increase in credit, the risk of a large systemic crisis was much lower. (Crowe et al., 2013, pp. 301–304)

These claims correspond to the findings in the separate subchapters above. All of the three mentioned bubbles were coupled with an increase in borrowing. As prices rose in Japan, investors invested heavily into real estate while borrowing at low interest rates. In the

United States, the whole crisis was built around the fact that banks were giving out loans to almost anyone who applied. Agents of financial institutions were more interested in increasing their own incomes through unsustainable lending practices. Thus, the overall amount of credit given out to debtors increased significantly. While China’s possible bubble has not burst yet, we can see a clear trend, which promotes borrowing in order to keep the local governments investing in their constituencies. Coupled with the increased activity in real estate development and construction, the credit market is certainly thriving.

Nonetheless, the above-mentioned combination does not provide conclusive proof that a market crash is imminent. Other factors also need to be taken into account. For example, the health of separate loans and the borrowers’ ability to repay them is a major issue. If

43 an economy is growing and doing well, the general population will likely be looking for ways to invest their financial resources. In such cases real estate provides a relatively safe opportunity to do so. Furthermore, if the mortgage approval process is watched and adequately regulated, the risk of default reduces considerably.

Last but not least, adequate governmental oversight and regulation of the banking system is absolutely essential. As can be observed from the case of the Subprime mortgage crisis, the repeal of the Glass-Steagall Act, which limited the ability to create risky financial products, enabled the practices that caused the crisis. However, inaction and inability to adapt, as shown by the Japanese government in the second half of the 1980s, can prove to be as damaging.

In conclusion, it is essential to stress the importance of a healthy real estate market. As a widely popular investment, which presents low risks of losing value, any negative impact on real estate will translate into losses for most citizens. Therefore, real estate market needs to be closely watched by the national governments and risks connected to its unusual behavior carefully assessed. Failure to do so can have major negative impacts on the national economy of each and every country in the world.

44 5 Historical Context of Prague’s Housing Market

The main goal of this project is to explore the current development in the housing market and, based on a careful analysis along with comparison to the past, attempt to answer the question of whether the current situation could be described as a real estate bubble. In order to do so, it is important to look into the general information available on the market today, but also look at its history in order to explain the current situation. Furthermore, the focus will be placed on new housing construction in projects built in recent years by various development companies. The decrease in supply will be examined with a brief look at possible causes, as well as the increase in demand. The findings will then be used in the next chapter focused on the analysis of the market values, which will attempt to find the conclusion and prediction for the future.

5.1 Current Situation

The structure of Prague’s housing market can be divided into several subcategories. As a member of the UNESCO World Heritage List, Prague’s city center is mostly formed by historical buildings and any development is going through careful approval process by the governmental offices. (UNESCO, n.d.) The limited space and prime location determine the high value of most properties in the area. Moving further away from the city center, the structure of properties changes slightly. For the purpose of this work, three categories of housing properties will be introduced. These are based on the current categorization used by Delloitte in their comprehensive analysis of the housing market.

First category are brick houses built usually before the second half of the 20th century.

These form most of the inner parts of the city. Moving to the outskirts the structure changes as these parts were largely developed during the Communist era. Prefabricated apartment blocks were the dominant type of construction built at the time and they provide a viable alternative at relatively lower cost. This paper will focus mostly on the

45 last category of housing, which are new projects built by real estate developers after the year 1994. These provide modern quality of living and are built across the whole area of

Prague. While they are more expensive than the other categories, customers are allowed the freedom of choice based on their priorities. For example, if one owns an older apartment in a good location, he or she should be able to find an apartment in a new building in a slightly cheaper location. The tradeoff between a slightly worse location in exchange for a higher standard of living is up to the consideration of each customer.

5.2 Historical Context

The current market is still affected by the history of the country in the second half of the

20th century. While the historical center of the city mostly contains brick buildings built in the eras before, the outskirts are to a large degree formed by prefabricated building built under the communist regime in the second half of the 1900s.

5.2.1 Housing and development under the Communist regime.

The effects the Communist regime had on the housing market and its functioning after their victory in February 1948 are closely connected to their political ideas. The rights of individuals to own property were very limited, with the state imposing control on various aspects of real estate. First of all, many people, who were considered unfit for the regime mostly due to their wealth, were stripped of their property under the process of nationalization. The socialist state became the sole owner of land and real estate in the country, giving it full control over the means of production in the economy. As a part of the centrally planned system, the government had the right to centrally allocate all resources essential for the population and the economy, including real estate and housing.

Various norms and standards were created, based on which the decision to provide a family with a home was made. These included quantifying how much living space a

46 single person needed or how close the accommodation was to one’s place of employment.

These norms and standards along with price and rent regulations allowed the government to create an egalitarian society, although the steps that were taken meant that such society was only artificial. (Sýkora & Šimoníčková, 1994; Sýkora & Stanilov, 2014)

Besides the actual buildings, one invention from the Communist era is still around. That is the zoning plan of Prague. Its current version is still largely based on the version created by the government in 1952. It has been heavily amended but the basic structure remains the same. Needless to say, as it was a product of centrally planned economy, it was quite well thought out with sections reserved for housing, recreational facilities, schools, greenery or retail. The fact that the government had the ultimate power in development allowed it to be effective in constructing functioning areas integrated within the industrial zones of the city. Therefore, workers lived in an environment which allowed them to function with relative ease. Under this methodology, socialist cities developed to have quite a compact design. Whereas in Western countries the trend towards decentralization started to grow, development in the Czech Republic concentrated on increasing urbanization with almost no development in areas outside of large cities. (Sýkora &

Stanilov, 2014, p. 6)

5.2.2 Restitution and privatization in the early 1990s.

The year 1989 brought major changes to the political spectrum of the countries behind the so-called Iron Curtain. 17th November 1989 marks the date of the Velvet revolution, bringing the rule of the Communist regime to the end, along with the centrally planned economy. The new government of the former Czechoslovakia needed to create a system under which the country would turn back towards the principles of a free market economy. One of the major steps crucial to implement was the reintroduction of property rights and privatization of state-owned businesses, along with the real estate they owned.

47 5.2.2.1 Restitution.

According to Ghanbari-Parsa & Moatazed-Keivani (1999, p. 1387) “transformation and economic restructuring towards a free-market economy require a reaffirmation of corporate and individual rights to property.” In order to do so, the government devised a plan for restitution of the property confiscated by the Communist regime. Any original owner of a property that was confiscated, was allowed to apply for restitution, provided he or she had at least some proof of ownership based on which the restitution or compensation could be awarded by the court. Restitution was defended based on two main reasons. Firstly, there is the economic necessity for protection ownership of real estate which allows for the certainty of long-term investment. (Ghanbari-Parsa &

Moatazed-Keivani, 1999)

However, the second reason was more idealistic and perhaps more important in order for the government to win the favor of its constituents at the time. As Sýkora & Šimoníčková

(1994, p. 50) put it “restitution was driven not as much by economic reasons as by the desire to give moral compensation to those who lost their ownership rights after the

Communist coup in February 1948.”

Restitution fulfilled its original purpose by allowing the Czech population to establish rights over the real estate property. It is important to point out that restitution mainly affected the properties in prime locations, especially near the city center. The prefabricated buildings on the outskirts of Prague remained almost untouched by the policy. This difference added to the large variance of prices depending on the location of the property. As real estate investment and ownership became popular, the prices, especially in the city center increased significantly. Additionally, many properties were in the ownership of the city and rented out to current tenants. Over the period of the next

10 to 15 years many of them were privatized by the means of sale to private entities.

48 While many buildings still remain in municipal ownership, Prague’s real estate quickly became mostly privately-owned. (Ghanbari-Parsa & Moatazed-Keivani, 1999; Sýkora &

Šimoníčková, 1994)

5.2.2.2 Privatization.

Privatization was another step necessary in order to transform into a free market economy.

Along with privatization of large publicly-owned businesses, their assets also became available for the private sector. Additionally, as businesses became private they expanded into new activities, which often facilitated other services into the real estate market.

Whether it was development, construction, investment, or brokerage, all of these functions helped the real estate market to grow. Coupled with foreign investment, both restitution and privatization allowed the real estate market to develop into its current state.

(Ghanbari-Parsa & Moatazed-Keivani, 1999; Sýkora & Šimoníčková, 1994)

5.2.3 Real estate market through the new millennia.

The modern history of the real estate market was largely affected by the traditional determinants present in all other countries. In the early 2000s the market experienced a boom largely connected to the anticipation of the Czech Republic entering the EU. In the

1998-2003 period, prices nearly doubled for most real estate assets in Prague. (Global

Property Guide, 2017)

Because of the EU membership Prague became even more popular amongst foreign investors. However, they were prevented from investing as the government introduced a new a restriction on purchasing property, which resulted in a stagnation of the market.

Real estate property could only be purchased by a person with a residency permit or through an established Czech company. Coupled with low interest rates on mortgages, investment into real estate was very popular. The regulation was lifted in 2009 after the

49 financial crisis had already hit the market. (Czech Point 101, 2009; Jilemnická, Berka, &

Hromada, 2008) Under the effects of the financial crisis house prices fell by approximately 20%. After the crisis, there were a few years of stagnation, which the

Czech National Bank tried to mitigate by significantly lowering the interest rates.

Mortgage rates hit their historical lowest and the market slowly recovered. (Czech

Statistical Office, 2018a)

50 6 Current Market Situation in Prague

As reported by most national and global news outlets, the prices of housing in Prague have increased considerably. Numerous experts, analysts, and writers have gone to the extent to call it the next bubble. (Cox, 2017; Czech News Agency, 2017b; Ummelas &

Tomek, 2017) The essential question that most stakeholders are now asking is whether it is in fact true. A crash of the real estate market would bring potentially large losses to all investors in the market, ranging from financial institutions like investment funds, development companies to all the households and individuals who own real estate property in the market. Considering the possible wide impact of such a crash, it is important to look closer at the specific market indicators and interpret what led to the current situation. It is simple to prophesize a bubble and its crash based on a large increase in prices, however, without knowing the actual causes of the increase and the details, such a statement does not provide much value.

First of all, it is important to actually assess the increase in prices over the few years. For the purpose of this chapter, the focus will be placed on prices of apartments offered in new projects constructed by real estate development companies in the area of Prague.

Deloitte (2018) provides the most thorough analysis of this area by collecting the information for all available projects and publishing them in a report, for a charge, through their subsidiary company Společnost pro cenové mapy ČR. This report will be the prime source of information for the purpose of this chapter as it is, to the author’s knowledge, the most comprehensive set of data currently available in the field.

Afterwards, the analysis will explore the drop in the supply of new apartments on the market, the increase in demand, and the likely causes.

51 6.1 Increase in Prices

Prague’s housing market has experienced a major increase of prices over the last two years. As evident in Figure 1, the average offer price of a new apartment, over the course of years 2015-2017, has increased by approximately 30,000 CZK per square meter of floor area. This represents an increase of almost 44% over the course of three years and represents a major concern for the reasons that have already been mentioned. (Deloitte,

2018)

100 000 CZK

95 000 CZK

90 000 CZK 040

490

364

343

92 92

85 000 CZK 289

231

89 323

80 000 CZK 87

85 954

75 000 CZK 80

629 587

70 000 CZK

507

336

450

72 600

65 000 CZK 71

133

071

990

855

67 67

60 000 CZK 66 65

55 000 CZK

07-08 2015 07-08 2017 05-06 01-02 2015 01-02 2015 03-04 2015 05-06 2015 09-10 2015 11-12 2016 01-02 2016 03-04 2016 05-06 2016 07-08 2016 09-10 2016 11-12 2017 01-02 2017 03-04 2017 07-08 2017 09-10 2017 11-12

Figure 1. Price per square meter 2015-2017. The figure illustrates the progression of the average offer price of a new apartment.

The increase in prices is a result of two important aspects of the current housing market.

First of all, there is the massive reduction in the number of units available for sale in the same period. Secondly, the demand for new apartments has been stimulated by the relatively positive results of the Czech economy and the low interest rates, spurring the demand for housing higher. Both will now be examined closer.

52 6.2 Decreased Supply of Apartment Units

The decreasing supply of apartments provides a valuable insight into why the prices increased in such a manner over the 2015-2017 period. In fact, as can be observed from

Figure 2, the number of apartments being offered to the general public decreased by

29.3% since January 2015. (Deloitte, 2018)

7500

7000 6953 6974 6827 6500 6758 6574

6000 6279

5500 5511 5314 5000

4852 4840 4847 4850 4500 4647 4432 4347 4000 4189 4110 4109

3500

03-04 2017 03-04 01-02 2015 01-02 2015 03-04 2015 05-06 2015 07-08 2015 09-10 2015 11-12 2016 01-02 2016 03-04 2016 05-06 2016 07-08 2016 09-10 2016 11-12 2017 01-02 2017 05-06 2017 07-08 2017 09-10 2017 11-12

Figure 2. Number of new apartments offered. The figure provides insight into the decrease of supply of new apartments in the market.

It is important to point out the increase in supply over the period of July to October 2017.

This increase has to a certain degree stopped the increase in prices, providing a low reduction in the average price. However, it did not signify a clear end to the trend of high sales and low supply. (Deloitte, 2017a) While, it certainly showed that an increase in the supply could possibly slow the increasing prices, the potential for long-term decrease ended with the last two months of 2017. A very important representation of the current

53 trend is the comparison of apartments sold in each period in contrast to the new apartments supplied. In Figure 3, the comparison clearly shows that the supply is slowly selling out in the long-term perspective with only the period between July and October

2017 being an exception. (Deloitte, 2018)

1800

1600

1400

1200

1000

800

600

400

200

0 11-12 01-02 03-04 05-06 07-08 09-10 11-12 01-02 03-04 05-06 07-08 09-10 11-12 2015 2016 2016 2016 2016 2016 2016 2017 2017 2017 2017 2017 2017

Sold Units Newly placed for sale

Figure 3. Sold v. new units. Figure shows the number of apartment units placed on the market v. the number sold each period.

As the supply is decreasing, the price is clearly increasing. The consensus among the experts is that this situation needs to be changed in order for the market to start behaving normally again. (Jones Lang LaSalle, 2018; Trigema, Central Group, & Skanska Reality,

2017) The decrease can largely be attributed to the overall increase in costs due to complicated and lengthy process of approval of new projects along with high acquisition costs. Furthermore, the increasing construction costs also provide an important aspect.

These will now be explored.

54 6.2.1 Land scarcity and increasing prices.

In Chapter 2, the topic of low elasticity of land has already been introduced. After the restructuring of the Czech economy Prague enjoyed a period of broad development which transformed it into a modern metropolitan city. However, the zoning plan is to a large degree still a product of the former Communist regime with the last amendment being done in 2006. (Szentesiová, 2010) That resulted in the current situation, in which it is very difficult to find viable land for a new project. Current owners are aware of the increase of value of land suitable for construction and raised the prices accordingly, resulting in very high acquisition costs of new land. Prague has a municipal office whose sole job is to create a new metropolitan plan called Prague Institute of Planning and

Development. They created a new concept of Prague’s Metropolitan plan, but they were unable to meet the original deadline of its introduction in 2017 and postponed it to 2020.

A realistic projection for its approval by the Czech Parliament is now deemed to be in

2022. (Heller, 2017; Prague Institute of Planning and Development, 2015)

If approved, the new plan would introduce new areas suitable for development and possibly shorten the excessively long approval process. Investors have already begun to purchase currently unsuitable land which is supposed to be transformed into residential areas. Nonetheless, such investment poses considerable risk due to the uncertainty connected to the final form of the plan. This risk transforms into higher costs for individual companies which they need to cover by increased revenue. This revenue often has to come from selling their current portfolio of projects for a higher price.

6.2.2 Long project approval process.

Another problem negatively affecting the supply side of the current issue is the length of the project approval process, including the length it takes to obtain a construction permit.

According to the World Bank (2018), Czech Republic ranks 127th in the world in dealing

55 with construction permits. On average it takes 247 days to obtain one, whereas the average of OECD high income countries is 154.6 days. The CEO of the largest real estate developer in the Czech Republic, Central Group, Michaela Tomášková said that “the rankings only reflect the length of the procedures provided under the law. In fact, the process of obtaining the necessary permits takes much longer. In the Czech

Republic building a typical apartment house takes about 10 years. For many issues, the administrative office requires opinions from the authorities concerned. And they do not have any deadlines.” (Johnston, 2017)

The overly long process that faces each construction project means that developers take on increased risks due to the uncertainty of their investment. Because of the length, they have to account for systemic risks that are absolutely unforeseeable, aside from the fact that they need to invest money in land which will remain unused for a long time before being allowed to progress with the project.

In addition to the above-mentioned, the supply is very likely affected by one additional aspect closely related to the time-demanding process of approval. Since most projects take between 6-10 years to complete, the current market supply is directly affected by the economic downturn of the global financial crisis of 2008. Many developers reduced their activity significantly, while awaiting better economic environment and postponing their projects. This likely has an effect on the current supply levels because of the 6- to 10-year project period.

6.2.3 Increased construction costs.

Another factor that is affecting the cost of a project is the increase of overall construction costs. According to CEEC Research (2018, pp. 18, 30–32) Czech construction companies are currently operating at 93% capacity. Additionally, the industry is dealing with a

56 shortage of qualified workers. Coupled with approximately 8% increase in the costs of construction materials, development companies will have to pay more to their contractors, increasing the overall construction costs. If they intend to keep their margins on levels similar to last few years, they will be forced to increase prices.

6.3 Increased Demand for Housing

Interesting characteristic of the current market is that, even though the price of an average new apartment is increasing, the demand is not decreasing at any alarming rate. Figure 4 illustrates the percentage of apartments sold out of the total amount currently in offer.

While there is a decreasing trend that certainly should be addressed, the demand behaves in a way that is not indicative of any massive problems in near future.

40%

35% 35%

30% 28% 27%

25% 25% 25% 25% 22%

20% 21% 20% 17% 20% 18%

15% 16%

10% 11-12 01-02 03-04 05-06 07-08 09-10 11-12 01-02 03-04 05-06 07-08 09-10 11-12 2015 2016 2016 2016 2016 2016 2016 2017 2017 2017 2017 2017 2017

Figure 4. Percentage of stock sold in period. The figure illustrates the percentage of units sold out of the total stock of available units in the period.

57 Furthermore, the customer behavior is very much dependent on the current season and popularity of investment. The deviations of the peak values of data are so high that the observed trend should not be given much importance. However, with increasing prices the quantity demanded should be getting significantly lower, especially if the prices increase by almost 50%. There are two plausible explanations for the high demand which, if combined, could explain the current situation. These are the positive economic situation and cheap mortgages due to low interest rates.

6.3.1 Good economic environment.

The Czech economy is enjoying a time of prosperity at the moment, which directly translates into ability to purchase more products and investments including real estate.

The GDP growth for 2017 is at 5.2%, inflation rate at 2.4%, the real average gross wages and salaries increased by 5.3% in 2017, and unemployment rate is at EU’s lowest of 2.4%.

(Czech Statistical Office, 2018b) According to the governor of the Czech National Bank

Jiří Rusnok, there has been a significant boost in the number of mortgages. However, the

Czech household indebtedness stays below the levels typical for other European countries. He even mentions the constraints that low supply places on the housing market as a potential hazard, which directly support the statements in subchapter 6.2. of this work. Overall, the environment for investment is very good and has been for some years now. (International Monetary Fund, 2017)

6.3.2 Low interest rates.

After the financial crisis, the Czech National Bank lowered interest rates to extremely low values of 0.05%. This helped the ease of investment and made credit extremely cheap for investors. However, in 2017, it started to increase the two-week repo rate, with the latest increase being done on February 1st, 2018. Currently the interest rate is at 0.75% and could possibly increase even further. (Czech National Bank, 2018) This has resulted

58 in increased cost of credit, making it harder for households to invest in real estate.

Additionally, the Czech National Bank introduced new legislation which forces banks to keep 85% of their mortgage portfolio to have 80% loan-to-value at the maximum.

Therefore, it is significantly harder for households to get approved for a mortgage, resulting in a more diligent mortgage approval process. (Czech News Agency, 2017a)

6.4 Final Assessment

The housing market in Prague is experiencing a period of increasing prices due to the limitations facing the market on the side of supply. Real estate development companies need to accept increased costs and problems with operation mainly due to the lengthy approval process and the increased acquisition and construction costs. This pressures developers to increase prices in order to keep their margins and satisfy their shareholders.

The demand for housing is still quite high with no indication of reduced popularity of investment into real estate. From the perspective of theory of supply and demand, this relationship of decreased supply and increased demand logically results in higher prices for a lower quantity of a product. What might at the first glance seem like an inflating real estate bubble is very likely only a reaction of the market to tangible economic reasons.

If we compare the current situation to the past real estate crises explored in Chapter 4, we can see a similarity in the increase of credit due to easy access to mortgages. However, the increase is a result of good economic environment. While large amount of credit was at the heart of the crises that have been analyzed, Czech Republic very likely is not at the levels that would cause an imminent problem. The total indebtedness of Czech households is relatively low when compared to other European countries and the Czech

National Bank is proactive in its control of the financial sector. Unless new information

59 about massive problems with the ability of households to repay their debts arises, it can be safely assumed that the increase in credit has been a natural development during the era of economic prosperity.

A much larger issue is the problematic situation of supply on the residential market. Real estate developers have a very complicated position due to the lengthy building approval process. Their ability to bring new units to the market to satisfy the demand is significantly reduced by the excessive time a project takes to complete. If the government intends to tackle the increasing prices and make housing more affordable for the individual, it needs to create an environment in which developers could operate more easily. First of all, finalization of the Metropolitan plan and its approval by the Parliament should be given the highest priority. Access to new residential areas with lower acquisition costs would allow the developers to create cheaper projects at the outskirts of the city, providing the market with new units that it desperately needs. Secondly, the length of the approval process is a major issue, especially if compared to countries of the

EU. New regulation which would make the process more efficient would also help the market tremendously. In conclusion, the current situation is a result of poor governance rather than the greed of development companies or a market bubble. Providing the industry with an environment more suited for efficient operation would improve the current situation greatly.

60 7 Conclusion

The goal of this paper was to analyze the increase in prices of residential real estate in

Prague, the capital of the Czech Republic. Because of the public perception as the next bubble to burst, the focus was placed on the causes of the increase and how they affect the market. The goal was approached from the perspective of theory of supply and demand, with special focus being placed on the determinants of both, the increase of demand and the decrease of supply.

Firstly, the function of real estate and the aspects needed to consider in the development of new projects were introduced. Real estate serves an important function in everyday life of each individual and also provides a viable choice of relatively low-risk investment.

Therefore, new projects are essential in providing a wide variety of choice based on the personal preferences. These projects are affected directly by various determinants of supply which include land and its price and location, local regulation, infrastructure, costs of construction, and a wide variety of other aspects. Real estate is a fascinating and important topic due to its significance in both individual lives and business. Its purchase is very often the largest investment an individual makes. Therefore, aspects affecting demand like the economic situation, mortgage rates, income, and employment are all factors which influence one’s decision to buy real estate.

For the purpose of comparison to the current situation, past real estate crises have been examined. Crises and bubbles in Japan, the United States, and currently China all have one common characteristic – large amount of total credit. Irresponsible lending practices very often transpired into real estate crises, as the credit is largely used for the purpose of investment in the industry.

61 Current situation in Prague required to be put into historical context of the industry. The real estate market in the Czech Republic is fairly young because of the transition to free market economy in the early 1990s. After the transition the market developed extensively because of profitable opportunities which were present to national and international investors.

Recently the prices of housing increased by approximately 40% over a period of three years. This has given an incentive to stakeholder to discuss a possible market bubble. In order to analyze a viability of this assumption, the topic was approached from the perspective of both supply and demand. Demand is stimulated by current economic prosperity of the country allowing individuals to access credit relatively easily. Low interest rates made mortgages cheap, which increased the ability of an individual to purchase real estate. Recently, the Czech National Bank decided to tackle the issue by placing more regulation on commercial banks, forcing them to be more diligent during the mortgage approval process. In addition to regulation, the Czech National Bank also raised the interest rates, which should lower the demand and possibly slow down the increase in prices.

The increase in prices is mostly attributable to the supply side of the relationship. The amount of apartment units supplied had been steadily dropping in the 2015-2017 period.

Units are being sold out faster than the development companies are able to supply new ones. Additionally, development companies are facing increasing costs arising from land scarcity, higher construction costs and, most importantly, the constraints that the municipal offices and the government impose on the market. In order for the supply to catch up, the new metropolitan plan needs to be approved and the construction permit approval process sped up. An increase of the quantity of units supplied to the market

62 would force the developers to compete with one another and, consequently, lower the prices.

Nevertheless, it is important to state though that the current situation is nowhere near being resolved. Therefore, a clear statement of whether a market crash will or will not happen depends greatly on future development. Indicators point to the current situation being only a natural development of the market with no real reason for a bubble.

However, the situation will need to be resolved in the future or it could bring significant danger.

The research concentrated purely on the aspect of new housing development due to the career background of the writer. It is important to point out that on its own it is a fairly narrow scope of the residential real estate market, not to mention real estate industry as a whole. There are various ways this research could be built upon including analysis of second-hand housing market and the aspect of renting out real estate property. However, in order to analyze these areas in detail, additional research would have to be done on a wide scale. The market of new housing is carefully analyzed by various entities in the industry providing detailed data. However, the research in other areas of the market is insufficient. Therefore, it provides a clear opportunity for professionals to explore.

Additionally, the market overall is fairly unexplored in academia, with most authors focusing on the historical aspect of restructuring, or on commercial real estate. Therefore, a clear opportunity is presented for academic writers to explore the industry, especially, after the current situation is resolved.

63 8 List of figures

Figure 1. Price per square meter 2015-2017. The figure illustrates the progression of

the average offer price of a new apartment. ______52

Figure 2. Number of new apartments offered. The figure provides insight into the

decrease of supply of new apartments in the market. ______53

Figure 3. Sold v. new units. Figure shows the number of apartment units placed on the

market v. the number sold each period. ______54

Figure 4. Percentage of stock sold in period. The figure illustrates the percentage of

units sold out of the total stock of available units in the period. ______57

64 9 References

Aanstoos, C. M. (2013). Maslow’s hierarchy of needs. Salem Press Encyclopedia of

Health. Salem Press.

Alexio.cz. (2017). Property Tax Return, Rental Income Tax Return, Transfer Tax

Return. Retrieved March 7, 2018, from

https://www.alexio.cz/income_tax_return/property_tax_return.html

Auerbach, M. P. (2013a). Interest Rates. Research Starters: Business (Online Edition).

Salem Press. Retrieved from

http://library.esc.edu/login?url=http://search.ebscohost.com/login.aspx?direct=true

&db=ers&AN=89163774&site=eds-live

Auerbach, M. P. (2013b). Real Estate Bubble. Research Starters: Business (Online

Edition). Salem Press. Retrieved from

http://library.esc.edu/login?url=http://search.ebscohost.com/login.aspx?direct=true

&db=ers&AN=95607430&site=eds-live

Bean, C. R. (2004). Asset Prices, Financial Instability, and Monetary Policy. American

Economic Review, 94(2), 14–18.

Bilginsoy, C. (2015). The latest act: subprime mortgages and derivatives. In A history of

financial crises : dreams and follies of expectations. (pp. 370–396). New York:

Oxfordshire, England ; New York, New York : Routledge, 2015.

Bourassa, S. C., Hendershott, P. H., & Murphy, J. (2001). Further evidence on the

existence of housing market bubbles. Journal of Property Research, 18(1), 1.

Buchanan, B., & Choudhry, M. (2014). Back to the future: 900 years of securitization.

Journal of Risk Finance, 15(4), 316–334.

CEEC Research. (2018). Kvartální analýza českého stavebnictví Q4/2017 [Quarterly

analysis of Czech construction industry Q4/2017]. Prague. Retrieved from

65 http://www.ceec.eu/research/

Colander, D. C. (1998). Supply and Demand. In D. C. Colander (Ed.), Microeconomics

(3rd ed., pp. 59–83). New York: McGraw-Hill Education.

Cox, H. (2017). Prague’s property prices outstrip Berlin. Retrieved March 29, 2018,

from https://www.ft.com/content/9dc992b6-ca28-11e7-8536-d321d0d897a3

Crowe, C., Dell’Ariccia, G., Igan, D., & Rabanal, P. (2013). How to deal with real

estate booms: Lessons from country experiences. Journal of Financial Stability,

9(Central banking 2.0), 300–319.

Czech National Bank. (2018). CNB increases interest rates. Retrieved March 31, 2018,

from

https://www.cnb.cz/en/public/media_service/press_releases_cnb/2018/20180201_

monetary_policy_decision.html

Czech News Agency. (2017a). ČNB opět zpřísnila podmínky pro poskytování hypoték

[CNB introduces further limits on mortgage approval process]. Retrieved

December 5, 2017, from http://www.ceskenoviny.cz/zpravy/cnb-opet-zprisnila-

podminky-pro-poskytovani-hypotek/1496316

Czech News Agency. (2017b). ČNB varuje před realitní bublinou: Ceny nemovitostí

rostou nejrychleji v EU a jsou nadhodnocené [CNB warns against a real estate

bubble: Prices of real estate are growing at a rate faster than the rest of EU and are

overpriced]. Retrieved December 5, 2017, from https://www.euro.cz/byznys/cnb-

varuje-pred-realitni-bublinou-ceny-nemovitosti-rostou-nejrychleji-v-eu-a-jsou-

nadhodnocene-1353876

Czech Point 101. (2009). Restrictions on Foreigners Purchasing Property in Czech

Republic - Lifted May 1st, 2009. Retrieved March 25, 2018, from

http://www.czechpoint101.com/restrictions-on-foreigners-purchasing-property-in-

66 czech-republic-lifted-may-1st-2009/

Czech Statistical Office. (2018a). Average prices of real estate - Prague. Retrieved

March 31, 2018, from https://vdb.czso.cz/vdbvo2/faces/index.jsf?page=vystup-

objekt&z=T&f=TABULKA&katalog=31782&pvo=CEN14&u=v7__VUZEMI__1

00__3018

Czech Statistical Office. (2018b). Latest economic data. Retrieved March 31, 2018,

from https://www.czso.cz/csu/czso/engaktualniinformace

Deloitte. (2015). Porovnání cen v Hlavním městě Praze TRANSAKČNÍ VS.

NABÍDKOVÉ CENY – byty v developerských projektech – rok 2014 [Comparison

of prices in Prague Transaction vs Offer Prices - flats in developer projects -

2014]. Prague.

Deloitte. (2017a). Analysis of Real Estate Development Market in Prague 09-10 2017.

Prague.

Deloitte. (2017b). Delloitte Develop Index: Offer prices of new apartments in Prague

July – August 2017. Prague.

Deloitte. (2018). Analysis of Real Estate Development Market in Prague 11-12 2017.

Prague.

Demyanyk, Y., & Van Hemert, O. (2011). Understanding the Subprime Mortgage

Crisis. Review of Financial Studies, 24(6), 1848–1880.

Dent, H. S. (2010). The Next Great Bubble Boom: How to Profit from the Greatest

Boom in History: 2. Simon & Schuster.

Dobre, C., & Răsăuţeanu, C. (2017). Greed and Global Financial Crisis: Reflections on

the Repeal of Glass-Steagall Act. Ovidius University Annals, Series Economic

Sciences, 17(1), 35–40.

Eldred, G. W. (2012). 22 Sources of Profit from Investment Property. In Investing in

67 Real Estate (pp. 1–20). New Jersey: John Wiley & Sons, Inc.

Federal Reserve Bank of St. Louis. (2018). Effective Federal Funds Rate. Retrieved

from https://fred.stlouisfed.org/series/FEDFUNDS

Frankel, J. (2015). The Plaza Accord, 30 Years Later. NBER Working Papers. National

Bureau of Economic Research, Inc. Retrieved from

https://ideas.repec.org/p/nbr/nberwo/21813.html

Ghanbari-Parsa, A., & Moatazed-Keivani, R. (1999). Development of real estate

markets in Central Europe: the case of Prague, Warsaw, and Budapest.

Environment and Planning A: Economy and Space, 31(8), 1383–1399.

Glaeser, E., Huang, W., Ma, Y., & Shleifer, A. (2017). A Real Estate Boom with

Chinese Characteristics†. Journal of Economic Perspectives, 31(1), 93–116.

Global Property Guide. (2017). Robust house prices rise in Czech Republic. Retrieved

March 25, 2018, from http://www.globalpropertyguide.com/Europe/Czech-

Republic/Price-History

Heller, J. (2017). Poslanci posunuli platnost územního plánu, Praha nestíha schválit

nový [MPs postponed the introduction of a new zoning plan, unable to approve the

new in time]. Retrieved March 30, 2018, from https://praha.idnes.cz/metropolitni-

plan-praha-nestiha-schvalit-uzemni-plan-pds-/praha-

zpravy.aspx?c=A170412_2318876_praha-zpravy_rsr

Henderson, C. (2013). Real estate industry. Salem Press Encyclopedia. Salem Press.

Hines, M. A. (2001). Japan real estate investment. [electronic resource]. Westport,

CT : Quorum Books, 2001.

International Monetary Fund. (2017). Czech Republic: Economy So Far So Good.

Retrieved March 31, 2018, from

http://www.imf.org/en/News/Articles/2017/10/02/na100317-czech-republic-

68 economy-so-far-so-good

Iyoda, M. (2010). Postwar Japanese Economy. [electronic resource] : Lessons of

Economic Growth and the Bubble Economy. Springer eBooks. New York, NY :

Springer New York : Imprint: Springer, 2010.

Jacqui, F., & Chin, K. (2017). Economist Jim Rickards on gold versus bitcoin —

intrinsic value is meaningless for both but the bitcoin prices aren’t real. Retrieved

December 16, 2017, from http://www.businessinsider.com/economist-jim-rickards-

bitcoin-versus-gold-price-manipulation-2017-12

Jilemnická, L., Berka, V., & Hromada, E. (2008). Development of Real Estate Market

in the Czech Republic. Acta Polytechnica, 48(5).

Johnston, R. (2017). Czech Republic among worst countries for building permits.

Retrieved March 30, 2018, from https://prague.tv/en/s72/Real-Estate/c141-Real-

Estate-Articles-FAQs/n11414-Czech-Republic-among-worst-countries-for-

building-permits

Jones Lang LaSalle. (2018). JLL Prague Residential Report H2 2017. Prague. Retrieved

from http://www.jll.cz/czech-republic/en-gb/research

Lewis, M. (2010). Chapter 1: A Secret Origin Story. In The Big Short: Inside the

Doomsday Machine. New York: W. W. Norton & Company.

Mari, C. (2013). Subprime mortgage crisis. Salem Press Encyclopedia. Salem Press.

Merriam, D. (2004a). The Importance of Zoning in Creating and Protecting the Value of

Real Estate. In The Complete Guide to Zoning: How to Navigate the Complex and

Expensive Maze of Zoning, Planning, Environmental, and Land-Use Law (1st ed.,

pp. 1–16). New York: McGraw-Hill Education.

Merriam, D. (2004b). Zoning as Part of the Larger Regulatory Environment. In The

Complete Guide to Zoning: How to Navigate the Complex and Expensive Maze of

69 Zoning, Planning, Environmental, and Land-Use Law (pp. 17–36). New York:

McGraw-Hill Education.

Nemoto, H. (2017). Credit availability and asset price: Empirical analysis of the

Japanese bubbles in 1980s. Journal of The Japanese and International Economies,

44, 90–98.

Noguchi, Y. (1994). The `Bubble’ and economic policies in the 1980s. Journal of

Japanese Studies, 20(2), 291–328.

Peicuti, C. (2013). Securitization and the subprime mortgage crisis. Journal of Post

Keynesian Economics VO - 35, (3), 443.

Pirounakis, N. G. (2013a). RE as an investment decision. In Real estate economics.

[electronic resource] : a point-to-point handbook. (pp. 124–161). New York:

Routledge.

Pirounakis, N. G. (2013b). Real estate (RE): an overview of the sector. In Real estate

economics. [electronic resource] : a point-to-point handbook. (pp. 1–11). New

York: Routledge.

Prague Institute of Planning and Development. (2015). IPR Prague. Prague. Retrieved

from

http://www.iprpraha.cz/uploads/assets/dokumenty/obecne/brozura_ipr_eng.pdf

Real Estate Monitor Worldwide. (2016). Bubble Watch: Experts Sound Alarm on

Chinese Real Estate. Real Estate Monitor Worldwide. Retrieved from

http://library.esc.edu/login?url=http://search.ebscohost.com/login.aspx?direct=true

&db=edsggo&AN=edsgcl.468132531&site=eds-live

Roberts, D., Liu, J., Forsythe, M., & Zhao, Y. (2010). How Do You Say Bubble

Trouble in Chinese? BusinessWeek, (4175), 18–20.

Roosevelt Institute. (2009). Looking Back at the Repeal of Glass-Steagall, or, How the

70 Banks Caught Casino Fever - Roosevelt Institute. Retrieved January 28, 2018,

from http://rooseveltinstitute.org/looking-back-repeal-glass-steagall-or-how-banks-

caught-casino-fever/

Safire, W. (2009, June). Location, Location, Location. The New York Times Magazine,

14.

Schwarcz, S. L. (2017). Changing law to address changing markets: A consequence-

based inquiry. Law & Contemporary Problems, 80(1), 163–191.

Škevin, P. (2011). Commercial real estate marketing - The importance of office location

on corporate image. Tržište, 23(2), 227–246.

Sýkora, L., & Šimoníčková, I. (1994). From totalitarian urban managerialism to a

liberalized real estate market: Prague’s transformations in the early 1990s. In M.

Barlow, P. Dostál, & M. Hampl (Eds.), Development and Administration of

Prague (pp. 47–72). Amsterdam: Universiteit van Amsterdam, Instituut voor

Sociale Geografie.

Sýkora, L., & Stanilov, K. (2014). The Challenge of Postsocialist Suburbanization. In

K. Stanilov & L. Sýkora (Eds.), Confronting Suburbanization: Urban

Decentralization in Postsocialist Central and Eastern Europe (1st ed., pp. 1–32).

New Jersey: John Wiley & Sons, Inc.

Szentesiová, K. (2010). Urbanistický vývoj Prahy za posledních 20 let [The urban

development of Prague in the last two decades]. Urbanismus a Územní Rozvoj,

XII(5), 129–147.

Tetteh, V. A. (2013). Real Estate Entrepreneurship. Research Starters: Business (Online

Edition). Salem Press.

The World Bank. (2018). Ease of Doing Business in Czech Republic. Retrieved March

30, 2018, from http://www.doingbusiness.org/data/exploreeconomies/czech-

71 republic#dealing-with-construction-permits

Trading Economics. (2017). Japan Government Budget | 1960-2017 | Data | Chart |

Calendar | Forecast. Retrieved December 21, 2017, from

https://tradingeconomics.com/japan/government-budget

Trigema, Central Group, & Skanska Reality. (2017). Ceny za nové bydlení se přehouply

přes hranici 80 tisíc korun za m2 [Prices of new homes have gone over the

threshold of 80 thousan CZK per square meter]. Prague. Retrieved from

https://www.trigema.cz/cs/o-nas/tisk-a-media/tiskova-zprava-analyzy-byty-

trigema-Q3

Ummelas, O., & Tomek, R. (2017). Europe’s Next Housing Boom Raises Red Flags in

Ex-Communist East. Retrieved March 29, 2018, from

https://www.bloomberg.com/news/articles/2017-06-21/europe-s-next-housing-

boom-raises-red-flags-in-ex-communist-east

UNESCO. (n.d.). Historic Centre of Prague. Retrieved March 24, 2018, from

http://whc.unesco.org/en/list/616

Whitehead, J. A. (2014a). Market Demand And Elasticity. In J. A. Whitehead (Ed.),

Microeconomics: A Global Text (1st ed., pp. 58–88). New York: Routledge.

Whitehead, J. A. (2014b). The Producer and Optimal Production Choices. In J. A.

Whitehead (Ed.), Microeconomics: A Global Text (1st ed., pp. 123–161). New

York: Routledge.

Wirth, G. (2013). Glass-Steagall Act of 1933. Salem Press Encyclopedia. Salem Press.

Zhao, S. X. B., Zhan, H., Jiang, Y., & Pan, W. (2017). How big is China’s real estate

bubble and why hasn’t it burst yet? Land Use Policy, 64, 153–162.