Written by Dr. Sebastian Sipos-Gug – Ebuild srl, EECFA Romania
Revisiting the Romanian residential construction market
We previously looked at the stability of the Romanian residential construction market and the likelihood of a correction even in the scale of the 2008 one. A lot has happened in the year since our previous post and we see ourselves faced with a similar question regarding the future of the residential construction, albeit now of a substantially different one. Previously, the main threat to market equilibrium used to be the oversupply due to speculative development. Now, we are faced with the distinct probability of a drop in demand.
Emergency Government Ordinance no. 114/2018 (EGO 114)
Residential construction was quite active in 2018, and our previous analysis indicated that despite significant growth in the past years, the market could be considered relatively stable. This has changed dramatically due to government intervention at the end of the year through Emergency Government Ordinance no. 114/2018 (EGO 114).
There are a number of features of this legislative paper directly and indirectly impacting residential construction: changing the minimum wage for construction workers, tax breaks for construction companies, changing the taxation of telecom and energy companies, and a new tax on bank assets.
Starting with 1st January 2019, the minimum wage for construction workers has been raised to RON 3000, up from RON 1900 previously, and higher than the RON 2080 value for the rest of the economy. The government also included in the Ordinance a tax break for these wages, exempt from income and health taxes, yielding a much better net to gross ratio for employees. However, the total impact on salary costs for companies remains significant. According to the Employers’ Federation of Building Companies, around 60% of all employees in the construction segment are paid the minimum wage, and thus this would lead to an increase in operating costs of 12% to 15% for construction companies with more than 50 employees (according to Cromwell Evan Global). This rise would be, naturally, passed onto the market and buyers.
After increasing steadily since 2015, residential prices started to show signs of stalling in late 2018, reaching a growth rate comparable to the one in consumer prices, leading many to conclude that we are approaching the end of the current economic cycle. Due to the impact of EGO 114 on construction costs, we can expect this balance to shift once more and prices to continue rising in 2019.
Energy companies would pay a 2% tax on their fiscal value. This would normally drive the price up, but the Romanian Energy Regulatory Authority (ANRE) claimed that prices on the regulated (household) market would not change in 2019. This will impact, however, energy intensive activities which include many construction materials manufacturers such as steel, cement, bricks, and so on.
The combined effect of higher labor and material costs should drive final residential prices for new construction even higher, and thus the current market equilibrium should switch to a higher price point, resulting in lower demand.
Banking and finance
Another major legal change with a large impact on the market is the new tax on bank assets. The tax is set as a function of the ROBOR index, and, as of the publishing of this article, the total amount owned would be 0.3% of bank assets per quarter. With an average return on assets (ROA) of 0.44% over the last 10 years, a tax of 1.2% of assets per year would have a major effect. According to the analysis conducted by the National Bank, the assets of banks operating in Romania totaled RON 377 Billion (as of October 2018). The new tax would lead to RON 4.5 Billion paid out per year by the banking segment. The stress test done by the National Bank concluded that this tax would lead, in the best-case scenario, to all banks having no profit in 2019.
Since it is unlikely that banks would take kindly to losing money on the Romanian market, one can expect them to move to reduce their assets and/or try to recover their profit margins by making loans more expensive. Either way, getting a loan would be more difficult for individuals, especially when talking about mortgage loans that tend to have a high asset value, but a lower interest rate than consumer loans.
Combined with limiting the monthly installment to 40% of income for mortgage loans and delays in implementing public subsidies for home purchasing in the ‘Prima Casa’ Program (both detailed in our EECFA Romania Construction Forecast Report Winter 2018 that can be purchased here), the impact on the market would be amplified.
Currently there are heated debates among various political parties, the government, private and public companies, mainly in the fields of banking and energy over the effects of order 114, mitigating its negative effects and perhaps even partly, or completely, repealing it. There were also concerns voiced from international forums like the European Bank for Reconstruction and Development regarding this piece of legislature. However, as of the writing of this article, the government stands behind it, at least in the short term.
The measures have a strong pro-cyclical effect and they arrive late enough in the economical cycle to have a potential powerful negative impact. With new homes more expensive and loans harder to procure, demand would take a hit. Despite consistent increases in income (real wages grew and estimated at 9.7% in 2018 – source NCSP), this has been barely enough to offset the increase in residential prices.
A factor that cannot be easily captured with market indicators is public sentiment. Starting with January 2019, one can notice the real estate market to seem to slightly freeze. Home buyers are more timid and, expecting a correction in the near future, delay purchases.
The fate of residential construction and real estate markets
In conclusion, we find the Romanian residential market in a stalemate. Due to the market being at a sensitive point, it might all come down to the result of the negotiations between the government and companies on the implementation of EGO 114. With sentiment playing a strong factor in the real estate stability as well, the current mixed feelings on the market also sustain the current unstable equilibrium.
Despite the negative factors previously discussed, we maintain our previous opinion that a major correction event on the scale of the 2008 one remains unlikely (<10% odds). Demand in major cities could sustain the market in the short run, even with higher prices and more difficult access to credit. We do expect the residential market to underperform in 2019 and 2020 and find likely (>75% odds) the risk of a small or even moderate correction as the market adapts to the new context.
More information can be found in the EECFA Romania Construction Forecast Report Winter 2018. Sample report