Free-falling property markets

Just a few years ago, a home purchased in the Ballsbridge section of Dublin could have appreciated at a double-digit yearly clip.

Not anymore.

Prices countrywide were down 9.1% in 2008. Since the country relied heavily on a booming real estate sector to support its economic growth, plunging property values have the Celtic Tiger suffocating, and now with a massive public-sector debt.

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Similar bubbles have popped all over Europe. In Norway, prices are down 7.5%. France saw a 9.9% dip. Even Germany, with debt-conscious consumers that helped it avoid a correction, saw its housing market contract by 2.2% last year.

But at the bottom of the heap lies the Baltic nation of Estonia. Once one of Europe's fastest-growing real estate markets, property prices there fell by a massive 23% in 2008 after growing by 18% in 2007.

Why the huge drop? Estonia is one of the many economies in Eastern Europe where property prices grew rapidly over the last few years as foreign-owned banks freely offered credit. This led to an oversupply of property in the Baltic state, which has now resulted in a correction.

Behind the Numbers

Our list is based off data from the European Housing Review, the Royal Institution of Chartered Surveyors' 2008 report of the region's property market. The RICS, an international property research organization, measured 2008 year-on-year house price inflation in 18 Western and Eastern European nations. Among the findings: Poland contracted 7%, Finland by 3.3%, and Iceland by 2.7%.

Eastern European property markets are some of the worst hit because of foreign-currency lending. The practice was widely popular in the region over the last few years because it allowed borrowers to pay a much lower rate of interest than they would otherwise pay on their local currencies -- they made up half the consumer loans in Hungary last year, for instance.

But the September collapse of Lehman Brothers led to a capital flight from Eastern Europe by foreign investors. And the subsequent drop in local currencies made it difficult for homeowners to pay for the array of mortgages they had taken out in foreign currencies like the Swiss franc and the euro. But as local incomes have fallen in value, mortgage payments have stayed largely at the same level, making them difficult to pay.

So-called "FX lending" is now being cited as one of the biggest threats to Eastern Europe's economies, and will also be hitting other Baltic states like Latvia and Lithuania, which weren't included in the RICS survey. "Foreign exchange has had a very negative effect on housing demand and will have an effect on house prices," says Michael Ball, author of the RICS' annual survey. "It has only happened in the last few months."

Second on the list of free-falling property markets is the U.K., a nation of consumers with twice the debt of the average European. Home prices in Britain fell by 16.2% in 2008, swinging from a 5.2% rise in 2007. The Brits are famously obsessed with their mortgages -- before the credit crunch, it was impossible to attend a British dinner party without someone gloating about the staggering rise in the value of his or her home -- but 2008 put a damper on such pretensions.

Why have the Brits been so hard-hit? The financial services sector is huge in the U.K., accounting for roughly one in 30 jobs and around 10.1% of gross domestic product in 2007. The recent turmoil in the banking sector has hit the British job market hard -- particularly in "the City," London's financial centre.

London's booming high-end property market has hinged on U.K. bankers' year-end bonuses, which have historically fed down payments. This year, a handful of now partly nationalized banks like Royal Bank of Scotland and Lloyds have stopped doling out big bonuses.

On top of that, many of the country's biggest mortgage institutions based their lending on wholesale-funding markets, which have all but dried up in the wake of the credit crisis. As a result, mortgage firm Northern Rock was nationalized while Bradford & Bingley and HBOS were swallowed up by larger players.

One might wonder why Iceland lands at No. 10 on our ranking after its economy came to the brink of bankruptcy last year and its banking system virtually imploded. Though there are several potential reasons, even Mr. Ball admits he's surprised Iceland didn't fare worse in 2008.

One factor: Inflation in Iceland is still eye-wateringly high (17.6% in February) which could be providing a cushion for home-price falls. And the shock to the country's banking system might not yet have fully affected property prices.

"First transactions really shrink, then sellers realize they can't get the prices they want," says Mr. Ball. It's a lagged process that's at different stages in different European nations, but declines are evident across the board, he adds.

And more are expected. In Ireland and Spain, an economic hangover is all the worse for the exceptionally heavy investment that was put into their property markets over the last few years.

Oddly, Greek property prices actually registered 3% growth in 2008, swinging from a 0.5% contraction in 2007. Mr. Ball reiterates that, apart from the challenges in getting standard statistics on real estate from different countries, the downturn has yet to fully hit Greek property prices.

(prepared by Parmy Olson/Forbes/National Post re Europe's free-falling property markets)