The Danger of Land Price Bubble in Ethiopia

Land price bubble (housing bubble) is a response to basic supply and demand. Bubbles generally occur when speculators enter a market where demand is already high and attempt to profit through short-term buying and selling, further driving up demand.

Speculative bubbles may also be defined as persistent, systematic and increasing deviations of actual prices from their fundamental values. Bubbles can often be hard to identify, even after the event, due to the difficulty in accurately estimating these fundamentals or intrinsic values.

In the real estate context, fundamentals can be estimated from rental yields (where real estate is considered in a similar vein to stocks and other financial assets) or based on a regression of actual prices on a set of supply and/or demand variables. In other words, property bubble is a type of economic bubble that occurs periodically in local or global real estate markets. It can be identified through rapid increases in valuations of real property, such as housing, until they reach unsustainable levels and then decline.

One side of the argument is that real estate bubbles cannot be identified as they occur and cannot or should not be prevented via policy instruments. Rather, cleaning up after the bubble bursts is the preferred remedy. As a matter of fact, they have broader macroeconomic impacts.

The pre-dominating economic perspective is that bubbles result in a temporary boost in wealth and redistribution of wealth. When prices increase, there is a positive wealth effect (property owners feel richer and spend more), and when they decline, there is a negative wealth effect (property owners feel poorer and spend less). These effects can be smoothed by counter-cyclical monetary and fiscal policies. The ultimate effect on owners who bought before the bubble but did not sell is zero. Those who bought when price was low and sold at a high price make profit, whereas those who bought at a high price and sold after the bubble or held off until the price fell would lose money. This redistribution of wealth is of little macroeconomic significance. Then again, the effects could turn out to be dire.

In some schools of heterodox economics, notably Post-Keynesian economics, real estate bubbles are seen as an example of credit bubbles (pejoratively, speculative bubbles), because property owners generally use borrowed money to purchase property in the form of mortgages. This is first argued empirically, for instance, numerous real estate bubbles have been followed by economic slumps. It is also argued that there is a cause-effect relationship between credit bubbles and financial and economic crises.

The Post-Keynesian theory of debt deflation takes a demand-side view, arguing that property owners not only feel richer, but also borrow to benefit against the increased value of their property. They take out a home equity line of credit and speculate by buying property with borrowed money and then expect that it will rise in value. When the bubble bursts, the value of the property decreases but not the level of debt. It is argued that the burden of repaying or defaulting on the loan depresses aggregate demand and constitutes the proximate cause of the subsequent economic slump.

The crash of the Japanese asset price bubble in the early 1990s had been very damaging to the Japanese economy. The crash in 2005 affected Shanghai, China’s largest city.

As of 2007, real estate bubbles are widely believed to still exist in many parts of the world, especially in Austria, the United States, Malta, Argentina, Great Britain, Jamaica, Micronesia, Ethiopia, the Netherlands, Italy, Equatorial Guinea, Monaco, Turkey, the Faroe Islands, Brazil, Denmark, the Philippines, Iceland, Canada, Germany, Portugal, New Zealand, the Democratic Republic of Congo, Ireland, Spain, Sri Lanka, Indonesia, Lebanon, Japan, Bahrain, Iran, France, Luxembourg, Tuvalu, Jordan, Oman, Venezuela, Mexico, South Africa, Israel, Mozambique, Botswana, Algeria, Norway, Singapore, South Korea, Thailand, Swaziland, India, Hong Kong, Romania, Vatican City, Ukraine, China and Croatia.

According to an article published in The Economist, the worldwide rise in house prices is the biggest bubble in history. Real estate bubbles are invariably followed by severe price decreases (also known as a house price crash) that can result in many owners holding mortgages that exceed the value of their homes. For example 11.1 million residential properties, or 23.1 percent of all US homes, were in negative equity by December 31, 2010. Commercial property values remained around 35 percent below their mid-2007 peak in the United Kingdom. As a result, banks have become less willing to hold large amounts of property-backed debt, likely a key issue affecting the worldwide recovery in the short term.

The negative effects in a given economy

Asset price bubbles and the speculative behavior associated with them tend to cause financial crises, which lead to lower growth rate, higher unemployment and higher government debt. High house prices also act as a mechanism for transferring wealth from the young to the old, from the poor to the rich, and from those that do not own their own homes to those that do. Even those who own houses do not benefit massively from higher house prices – after all, we all need somewhere to live, and anyone selling their home will find that, on average, other house prices will have risen by the same amount, leaving them no better off. In reality, only the banks and those with many properties benefit from high house prices because high prices mean that people will have to take out larger mortgages for longer periods of time, which, in turn, means more money in interest payments for the banks.

On the other hand, when the bubble bursts, and especially if the speculators are buying property with borrowed money from the bank in the expectation that it will rise in value, the value of the property decreases but not the level of debt.

In the theory of rational bubbles, an increase in housing market activity may crowd out commercial and industrial lending through increased interest rates. As a result, one sector of the economy that is receiving liquidity and experiencing bubbles may overheat and crowd out other sectors of the economy. Speculators who bought homes (often with no money) simply walked away from the property when the home price fell. Many never made even the first monthly payment. Homeowners with adjustable rate mortgages found that they could not refinance because the decrease in home prices meant that they had negative equity in their homes.

Is there a bubble in Ethiopian property market?

The answer is quite simple. Yes there is! The sky rocketing land price in Ethiopia, especially in Addis Ababa, is no longer a front-page story. The maximum-recorded lease price for a plot per square meter in Addis Ababa is USD 15,500 (307,000 birr). Presently, the average lease price of land per square meter for plots in the center of the city is USD 3,636 (80,000 birr).

A recently released report by Global Property Guide that ranks the world’s most expensive cities in terms of buying price of properties (not land) puts Geneva as the fifth most expensive city to purchase a property (real estate) with an average price of USD 15,250 per square meter. With over 13 million people, Tokyo is the most densely populated city in the world and also one of the top ten most expensive cities. Real estate prices in Tokyo are close to USD 10,000 per square meter.

According to some researchers, the maximum land lease price per square meter in Ethiopia, especially in Addis Ababa, should by no means be greater than or equal to the price of land per square meter of the most developed and more economically active metropolises such as Geneva, Tokyo and London. Hence, they argue that the unjustifiable price increase of land and housing in Addis Ababa is the act of speculators.

This price hike is making Addis Ababa one of the most expensive cities in Sub-Saharan Africa.

Apartment price per square meter in some countries

No. Country Price

1 Sweden USD 8,389

2 Italy USD 7,116

3 Netherlands USD 5,888

4 Denmark USD 5,134

5 South Africa USD 4,214

6 Ethiopia USD 1, 500

7 Kenya USD 1,188

8 Tanzania USD 700

9 Madagascar USD 520

A person who lives in Addis Ababa with a monthly net salary of USD 1,500 (30,000 birr) and saves up to USD 1,000 USD (20,000 birr) every month to buy a mid-scale apartment in the city that is built on a 85 square meter plot and costs about 2.5 million birr will have to save the proposed amount for 10 years. Buying a two-bedroom condominium, which costs about one million birr and is being built by the Ethiopian government, will take the buyer four years. When we come to the reality, there are only a handful of citizens who earn this much salary per month. Currently the average monthly salary per month in Ethiopia on a relaxed estimate is USD 200 (4000 Birr).

This bubble has an impact on the increasing rent price in urban areas, especially Addis Ababa, making life difficult for urbanites. Indeed, the government’s condominium housing project makes a big contribution in solving the housing problem, but solving this big problem is just the tip of the iceberg.

As per the analyses based on a regression of actual prices on a set of supply and/or demand variables, this sky rocketing land and housing price in Ethiopia is not the normal response to basic supply and demand. Rather, it is the speculators that are creating artificial land prices to get high profit and further driving up demand.

Real estate, buildings and the government condominium project are built with money borrowed from the banks in the expectation that it will rise in value. Under this condition, when the bubble bursts, the value of the property decreases, but not the level of debt.

Some researchers argue that the main causes for the price increase include the government’s land policy (which is a lease system), poor government land administration and information system, and absence of a central and modern property market in Ethiopia. These loopholes create fertile ground for speculators.

If these problems are not resolved soon, the following subsequent macroeconomic slump could happen in Ethiopia as a result of the price bubbles bursting:

Episodes of financial instability that have damaging effects on the economy.
Financial crises, which lead to lower growth, higher unemployment and higher government debt.
Broadening of the gap between the rich and poor.
Finally, if the Ethiopian government is not going to find a solution for the land price bubble, the economic success that has been registered for the past decade will become a thing of the past.

Ed.’s Note: Dawit Tadesse is a graduate of Cranfield and Addis Ababa University, specializing in Accounting and Finance and Economics of Security Studies. He seeks to understand the impact of economics, politics and social issues on everyday life. The views expressed in this article do not necessarily reflect the views of The Reporter.

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Source: The Reporter

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