Studies & Data
The Prospects for Housing Finance in Romania
Prepared for: East European Regional Housing Sector Assistance Project, Project 180-0034, U.S. Agency for International Development, ENI/DG/LGUD, Contract No. EPE-C-00-95-001100-00, RFS No. 812
Prepared by: Sally Merrill, Harold Katsura, Carol Rabenhorst, The Urban Institute
This report updates selected information from a USAID-sponsored housing sector study conducted in late 1994. Although the main focus of the earlier study was not housing finance, it did conclude that the prospects for market-based housing finance were not good at that time. The present study identifies key developments in the sector with respect to housing demand and affordability, especially those that have occurred during the last five years, and discusses their importance for the future development of housing finance. In addition, it assess the readiness of the banking sector and associated institutions to focus on housing finance and provides suggestions for development of a safe, sound and more active market.
THE HOUSING MARKET
The Development of the Market
The housing market in Romania has continued to develop rapidly during the past five years. The extensive privatization of the housing stock has contributed to the development of a fluid real estate market that offers a wide range of prices and amenities to households seeking to improve or adjust their housing situation. The number of residential sales transactions went from about 39,000 in 1990 to a peak of about 226,000 in 1993, before dropping to an annual rate of less than 180,000 by the mid-1990s. Most transactions involved transfer of units through privatization, not newly constructed units. For example, only about 36,000 new units were built in 1995, yet there were approximately 170,000 transactions during that year (a figure representing about two percent of the total stock). The fact that there has been little new construction recently is not a reason for ignoring the role that housing finance can play in facilitating the market.
The economic downturn of the past few years has slowed the overall demand for housing. While this has hit the construction industry hard, it has helped to keep prices in line with incomes, which have not grown in real terms. The price difference between existing and newly constructed units has made newly constructed units unattractive to buyers. This is illustrated by the fact that nearly all of the 11,000 beneficiaries of a recent government-subsidized loan program chose to purchase existing units rather than new units. The decline in new housing construction has contributed to heavy job losses in the construction industry; the number of construction workers as of July 1999 (342,600) is only half of what it was a decade earlier.
Prices and Affordability
The price of housing is not likely to be a factor that hinders the development of housing finance. Conservative estimates of the ratio of the price of existing housing to income appear to fall within the range of a number of other industrialized countries, which range from 2.4 to 6.6. While the price of existing housing does not appear to be particularly high with respect to incomes, the price of new construction is prohibitive for most households. The price of a new minimum standard, two-room flat is about $18,000 to $21,000. This is well above the approximately $12,000 the newly-created National Housing Agency plans to charge for a comparable unit-a price that excludes charges for land, infrastructure, profit, taxes, and financing costs. In contrast, existing unit prices cater to a wide range of household budgets. A household can purchase an existing two-room flat in Bucharest for as little as $7,000 or as much as $60,000. In Oradea, the price of an existing two-room flat ranges from $4,500 to $17,000; in Slobozia, the price ranges from just $3,000 to $4,200. There is no general rule of thumb for the price of a single-family home (known locally as a villa). In urban areas, a relatively small number of villas have been built recently, and many of these were built by high income households. While prices for high-end units can easily exceed $100,000, it is nevertheless possible to obtain a modest villa with services on the edge of Bucharest for around $25,000 to $30,000.
The concept of housing affordability takes on a different meaning in a country with widespread free-and-clear ownership (over 94 percent of the stock is privately owned). In principle, any owner could trade his or her present home for another one of at least similar value, provided he or she could cover the transaction costs. Thus, there is a very high degree of affordability and potential effective demand among homeowners. For many , the issue of affordability revolves around the problem of being able to afford an incremental expenditure that would allow them to increase their consumption of housing services.
Housing needs are not being driven by population growth and overcrowding. The population has not been growing, even in Bucharest, and migrants from rural areas have not applied pressure on urban areas. Average household size has been falling and space consumption has increased throughout the decade. The average household size fell from 3.1 persons in 1992 to about 3.0 persons in 1998, and per capita living space went from 11.5 square meters in 1992 to 11.8 square meters in 1997. While it is true that many young adults experience difficulty acquiring housing outside of their parents' homes, this has not necessarily led to physical overcrowding. About 11 percent of households have at least one child between the ages of 25 to 35, and about half of these households contain a married child. The young adults have been the primary target of most recent government housing programs, and would be strong candidates for utilizing private sector housing finance.
Housing needs are driven more by the need to replace and upgrade existing units than they are by demographic factors. Homes in rural areas are more likely to suffer from a lack of access to basic services, while homes in urban areas are more likely to require physical upgrading of existing services and structures. Over 90 percent of the urban housing stock is made up of flats. Much of this multifamily construction was of poor quality initially and has suffered subsequently from poor maintenance. Deterioration of the multifamily stock is likely to continue as most resident owners still lack an effective means to maintain and improve their units and the common areas of the buildings. Major opportunities exist for financing rehabilitation work in the privatized stock.
THE DEVELOPMENT OF THE HOUSING FINANCE SECTOR
Housing Finance Under Current Macroeconomic Conditions
Under the current macroeconomic circumstances, demand for housing finance will be very constrained: economic growth is negative, growth in real wages in essentially zero, and unemployment has risen annually since 1996.Interest rates are not only high, butequally damagingthey have been volatile. Very high levels of uncertainty further disrupt economic activity, especially for credit. In general, but especially in the case of housing finance, even if banks are somewhat protected from interest rate risk through variable rate products, borrower ability to pay suffers in the face of abrupt changes in scheduled amounts due.
Also, there is an extremely large gap between bank lending rates and deposit rates, which can signify a number of problems, including, of course, inefficiencies in bank operations. However, the excessive risk inherent in very volatile conditions is disruptive. Finally, although a new mortgage law is now under discussion in Parliament, at present banks apparently cannot use the property being purchased as collateral, and must rely on other assets, particularly other properties owned by the would-be borrower. Clearly, this limits an already small potential market.
The Changing Situation
On the other hand, there is better news on the horizon. The positive features of the emerging economic and legal situation include the following:
- Improved Macroeconomic Environment. Inflation is again falling and is expected to continue to fall. Growth in real GDP is expected to become positive during the year 2000 (or at least by 2001). The Central Bank is well aware of the necessity to decrease the volatility of the inflation rate as well as the level.
- Restructuring the Banking Sector. The process of privatization, consolidation, mergers, and foreign investment in the banking sector is well advanced. The restructuring process is now nearly complete for the banks that currently have an interest in housing finance.
- Lending for Housing Finance. There are at least five major banks that already have a small portfolio of market-based housing loans. These include the Romanian Commercial Bank, the Romanian Bank for Development, BancPost, Transylvania Bank, and the Savings Bank (CEC). Each of these has stated aggressive plans to expand consumer lending in the near future, including housing finance. In addition, the Ian Tiriac Commercial Bank plans to introduce housing finance in 2000. The financial position of most of these banks is adequate or good. This will have a very positive impact on the ability of mortgage lending to go forward in the next stage of development in a competitive environment.
- The Mortgage Law. The new mortgage law, although it certainly needs additions and clarifications, is a positive step forward in the legal structure for housing finance. Real estate transactionsnew purchase, trading-up, and rehabilitationwill be greatly facilitated by effective mortgage and collateral laws. Similarly, building an effective market will be greatly facilitated by a foreclosure process which is readily implementable and is actually implemented when necessary.
- The Home as an Asset for Romanian Households. Finally, as noted above, the very high homeownership rate in Romania provides numerous households with a valuable asset that can be used as collateral for purchasing an alternative unit as well as for consumer or business loans.
Affordability and Effective Demand in the Medium Term
There is an immense diversity of circumstances in Romania with regard to ability to purchase a home. While Romania's situation is not unique among the transition nations, it offers a different profile from the housing situations in the U.S. and much of Europe. The rental sector is much smaller than in most nations. Many of the poorer households would be renters if they were living outside Romania. Even among transition countries, Romania's housing privatization was both massive in scale and accomplished very rapidly.
This situation offers both advantages and disadvantages. On one hand, most homeowners now hold a valuable asset that can be used as collateral for a loan for rehabilitation or in order to move and purchase an alternative unit. On the other hand, some owners are too poor to afford even a modest rehabilitation loan. Also, many of those who do not own are likely to be "liquidity constrained" (lack an adequate downpayment) and/or would not be able to service a large loan.
Illustrative calculations are presented in the charts below regarding the proportion of households that can afford housing finance loans under different circumstances. The charts indicate relative magnitudes of affordability for existing units, new construction, and rehabilitation loans in Bucharest and other areas of the country. Calculations are based on income distribution and house prices discussed in Section 2.0; the loan assumptions (a dual index mortgage product, or DIM, is utilized to assist affordability for purchase loans, while a conventional mortgage product is used for rehabilitation loans) are found in Section 3.0, which provides the full analysis of affordability. In summary:
- Households with equivalent incomes face very different affordability circumstances depending on two key factors: (1) location and (2) whether or not they are currently homeowners.
- Many of those who currently own units hold a valuable asset and in many cases could easily "trade-up." Thus, the affordability analysis distinguishes four groups of households1:
Those who do not own a flat, but could provide a 10 percent downpayment;
Those who may or may not own a flat, but could provide a 25 percent downpayment;
Those who already own a flat and are assumed to have a 50 percent downpayment;
Those who already own a relatively highly valued unit, and can thus provide a 75 percent downpayment for another unit.
- Existing units are generally far more affordable than new units.
As noted, prices in Bucharest generally exceed those in smaller cities such as Slobozia and Oradea. In terms of affordability, households are far more able to move out of Bucharest than to move into it from elsewhere. Households currently owning a unit in Bucharest generally would be able to purchase larger and/or higher quality units outside Bucharest. Conversely, for those selling units located outside Bucharest in order to move into the city, the affordability scenario is less rosy.
Chart 1 indicates the proportion of households that can afford an existing, two room flat in a central area of Bucharest, an outlying area of Bucharest, and in Slobozia and Oradea. In the "expensive" zone of Bucharest (zone B on the chart), almost no households can afford to purchase an existing flat with a small downpayment; even with a large downpayment (75 percent), only 11 percent of households could buy in this type of district. The situation is greatly improved on the outskirts of Bucharest (zone D), where 70 percent of those with a large downpayment could buy/trade-up to another unit. Nearly 10 percent of those with only a small downpayment could also purchase. By contrast, in the other urban areas, affordability is far more favorable; those already owning (assumed to have a 75 percent downpayment), would be relatively free to choose their circumstances.
An even greater contrast is presented by those trying to purchase new homes (see chart 2). A modest flat in Bucharest-priced at $18,000-is affordable only to about one fourth of the income distribution. A smaller number can purchase modest villas, while high cost villas are beyond the reach of all but a handful of households. (In rural areas, where both land and labor are less expensive, the situation would, of course, be better; however, there is assumed to be less demand in these areas.)
Finally, as shown in chart 3, the picture is substantially more sanguine for rehabilitation loans, 10 year loans at an interest rate of 20 percent, which is assumed to be a feasible target in the medium term. Based on the specific income distribution for Bucharest, over half of the households there could afford a reasonably sized ($2000) rehabilitation loan; 13 percent could afford a loan of $5000. In other urban areas and rural portions of Romania, affordability is lower because income is lower, but it is still substantial for the $2000 loan.
Characteristics of a Successful Lending Environment in the Medium Term
In the medium term, it is likely that conditions will converge to offer Romania not only an improved economic picture, but also a more effective institutional and legal structure; These factors will encourage bank lending, including lending for housing finance. Thus, Romanian banks could see a fairly sizeable demand for market-based loans. The situation could be significantly improved with technical assistance to the sector. The key factors for a successful lending environment (in addition to macroeconomic improvement) would include the following:
- Adequate competition among banks (this has already begun in earnest).
- Appropriate loan products; as discussed below, considerable increase in affordability would result from special mortgage products now used elsewhere in the region.
- State subsidy policies consistent with market-based lending; that is, a level playing field across the banks and subsidy policies which do not compete with market-based lending to those who can afford it (this issue should be discussed with the Government).
- An adequate legal framework; this is underway and would benefit from further assistance.
- Appropriate supporting institutions, such as the Central Bank (NBR), the Romanian Banking Institute (RBI), and a credit bureau. The first two are in place and play active and important roles; plans are also being developed for the credit bureau. Technical assistance would help put training in place as well as the regulatory and supervisory framework needed for the special features of housing finance.
- Increased efficiency in bank operations, allowing a reduction in the interest rate margin; this should improve through competition, but could also be assisted with training, information systems, IT planning, and similar technical assistance.
Technical Assistance Recommendations
Technical assistance would assist Romanian banks, as well as the National Bank of Romania and the Banking Institute, to introduce a safe and sound system of mortgage finance. Alternative mortgage products can assist in a very substantial way with affordability if the macroeconomic environment continues to improve. A summary of the suggestions presented in section 4.0 is as follows:
(1) Staff Training Assistance to Banks via the Romanian Banking Institute
Bank staff training and training of trainers would best be conducted through assistance to the Romanian Banking Institute. Staff training in housing finance is probably one of the first steps, as there has been relatively little experience so far with market-based housing finance. The RBI could engage key bankers and staff of RBI to conduct training of trainers
Risk analysis was specifically requested by several banks as a component of training in housing finance, as the risk elements in housing finance are somewhat unique, and relate among other factors to the long-term funding discussed below.
(2) Training and Development in Other Components of Housing Finance
New mortgage products. If Romania's inflation continues to fall, even somewhat slowly, and does not exhibit too much volatility, Romania's housing affordability problem could greatly benefit from dual indexed mortgage products, which have proved very successful under similar circumstances, especially in Poland (and also in Hungary, France, Turkey, and Mexico).
Improved information technology (IT) platforms for housing finance and their integration with other retail banking activities was mentioned by a number of banks as important to effective underwriting and servicing of housing loans. The U.S. is a world leader in this area.
Condominium owners associations and rehabilitation lending. A variety of problems face the operation of condominium associations, required by law to be established in each privatized building. In the context of housing finance, developing procedures for bank loans for building-level capital repairs is an important missing element for maintaining and improving the existing stock. Training would help banks understand the potential importance of this market and how to access it. In addition, USAID may wish to reconsider its decision to end assistance to the condominium sector, since owners will need assistance in organizing associations and planning and implementing renovation projects with bank financing.
(3) Legal Framework
Mortgage Law and Related Laws. Assistance with improvements to the Mortgage Law is important to solidify and improve the first steps taken by the draft legislation. Related assistance should be directed toward the Securities Law. As discussed below under capital market funding, the Mortgage Law and the Securities Law together do not provide an adequate framework for issuance of mortgage bonds or MBS.
Laws Relating to the Rental Sector. The Civil Code and other relevant documents need to be reviewed prior to providing suggestions regarding landlord tenant relations. It is important, however, to encourage and formalize the rental sector.
(4) Assistance to the National Bank of Romania
Regulation and Supervision. As discussed, regulation and supervision of housing finance entails some additional and unique features relative to the oversight of other loans; the NBR notes that this would be an effective type of support for their monitoring program in the medium term.
Credit Bureau. Establishment of a credit bureau is key to the banks' underwriting, as this is the facility which will ultimately provide the data for a bank to determine a household's gross debt ratio.
Indexes for variable rate mortgage products. The NBR requested special assistance with this technical topic. Both the inflation rate and the exchange rate are currently quite volatile, and thus do not provide an appropriate basis for indexation.
(5) Capital Market Funding and Access to Long-Term Funds
Access to Long-Term Funds. Beginning to plan for a mechanism to access long-term funds from the capital market will be crucial to achieving an adequate volume and to decreasing term risk, i.e., short-term liabilities funding long-term loans. The approach to secondary market funding might include a liquidity facility and/or securitization (MBS). The Federal Housing Finance Board, which is in essence a liquidity facility, might play a role in this development.
(6) Preparation of Industry-Wide Risk Analyses
Databases and Analysis. One of the unfortunate legacies of the socialist period is a tendency to withhold information. More data collection, information systems, and data analyses are required. The design of these could benefit from lessons learned elsewhere.
If current trends continue, and if Romania follows a path of economic recovery similar to that of other transition countries such as Poland, Hungary, and the Czech Republic, the development of an active housing finance sector should be possible within the next several years. Therefore, assistance in the further development of the technical and legal structure for housing finance, along with staff skills and appropriate mortgage products, would provide a valuable and solid foundation for the long-term.
Given the progress made to date in bank privatization and restructuring, the functions of the National Bank of Romania (the Central Bank), improvements to the legal structure for lending, and the desire of key Romanian banks to move forward aggressively with market-based housing finance, this is a propitious time to help Romania build a solid housing finance system. In this manner, a secure and effective structure will be in place when economic circumstances allow higher volume and broader based lending.
A well-functioning housing finance system can greatly facilitate economic improvement. A large majority of Romanian households have as asset against which to borrow-either for housing or as collateral for some other purpose. Rehabilitation loans will help maintain the existing stock. Loans to purchase new or existing housingin combination with further development of the rental sector-will support the labor mobility that is crucial to economic development. The relatively low level of new housing construction should not obscure the fact that housing finance can play an extremely important role in revitalizing Romania's housing sector, and thereby its economy. A major share of the demand will come from purchase of existing units, "trading-up" (or simply moving) by those who already own a unit, and rehabilitation of existing units.
Note: This report is available in its entirety in the Portable Document Format (PDF).
1. Please note that the analysis is illustrative only. The data on the income distribution and house prices are based on surveys and interview information respectively; however, the assumptions about downpayment, and the value of the unit are simply meant to be representative of probable situations.