ARMENIA’S HOUSING BOOM-BUST CYCLE 1

I. BACKGROUND AND CROSS-COUNTRY PERSPECTIVES

During 2004-2008 Armenia experienced a large housing boom. Real estate construction

output increased four-fold between 2004 and 20082, with the share of the overall construction

sector in GDP increasing from 10 percent in 2000 to 25 percent in 2008.3 Other well-known

episodes of real estate booms pale in comparison: in Spain, the share of the construction

sector in GDP grew around 3 percentage points of GDP during this period. In the U.S., the

U.K., and Russia, the construction sector share in GDP was considerably smaller and barely

changed during the boom years.

During 2004-08, Armenia also experienced a house price boom, with prices increasing by

2.5 times over the four-year period. This increase was much larger than the house price

booms taking place during this period in some advanced countries (e.g., the U.S., the U.K.,

Spain)4, and also high compared to the very large increases in other former Soviet Union

1 Prepared by Armineh Manookian and Guillermo Tolosa, benefiting from comments from Mark Horton, Deniz

Igan, Mariana Colacelli, Edouard Martin and Gohar Minasyan.

2 There are no data for real estate investment in Armenia, but real estate construction output is an appropriate

proxy.

3 While this note makes references to the entire construction sector because of data availability; real estate

accounted for 60 percent of construction activity in 2008, largely concentrated in residential real estate.

4 The house price boom in advanced countries started in the early 2000, but given lack of data availability for

Armenia before 2004 it is impossible to compare the magnitude of the increases for the whole boom period.

- 2 -

countries.5 However, the increase in few countries, like Russia, Latvia and Georgia, was even

higher.6

During this period, house prices in Armenia seem to have clearly drifted away from

fundamentals, as shown by

marked increases in the house

price to income ratio and the

price to rent ratio.

The boom in Armenia turned

into a bust in the wake of the

global crisis. Real estate

construction output collapsed to

almost one third from its peak

in 2008, although to a level

5 Documented in Stepanyan et al (2010).

6 In Armenia and these countries, it is possible that part of the boom in house prices reflected a catch-up from

fall during Russian crisis years.

Russia

Armenia

Latvia

Spain

UK

USA50

100

150

200

250

300

350

400

450

House Prices(SA, 2004 Q1=100)

Russia 1/

Armenia 2/

Latvia 3/

SPAIN 4/

UK 5/

USA 6/

Germany 7/

Japan 8/

1/AVG house prices 5/Halifax HPI2/AVG apartment prices 6/ S&P/Case-Shiller home prices3/Standard type apartments 7/New houses price index,

4/Free housing prices 8/Tokyo AVG price per dwelling unit

12.6

22.2

10

15

20

25

30

12

13

14

15

16

17

2004 2005 2006 2007 2008 2009 2010

Price to Rent and Price to Income Ratios in Yerevan

Price to income

price to rent

- 3 -

similar to 2005.7 Against the backdrop of the large increases that had taken place, the fall in

prices was more moderate (15 percent, or back to 2007 levels). The volume of transactions

took a larger hit, falling more than 30 percent as the property market was on hold for some

time due to uncertainty on prices.

Two years after the bust, there are only limited signs of recovery in real estate

construction output and prices. Output remained flat during 2010 and experienced a slight

upward trend in the first half of

2011. After hitting a floor in the

middle of 2009, prices

experienced a mild recovery in

the first half of 2010, possibly

associated with a stimulus

package of the government

undertaken in the second half of

2009 and involving, among other

measures, the creation of a

mortgage fund and granting

government guarantees to

7 Based on NSS Statistical Yearbook.

0

2

4

6

8

10

2004 2005 2006 2007 2008 2009 2010 09-H1

10-H1

11-H1

9.5 9.2

10.4 10.3

7.97.4

8.6

2.83.8

4.4

Tho

usa

nd

s

Number of Transactions in Yerevan

Apartments Houses

200

250

300

350

400

450

500

400

500

600

700

800

900

1000

1100

1200

1300

08

-1

08

-5

08

-9

09

-1

09

-5

09

-9

10

-1

10

-5

10

-9

11

-1

11

-5

do

llar

pe

r sq

uar

e m

ete

r

SA House and Apartment Prices(2008-2011H1)

Yerevan-House

Yerevan-Apt.

Regions-House-RHS

Regions-Apt.-RHS

- 4 -

construction companies. However, in the context of large unsold inventories, prices have

mildly fallen since then.8 Transactions in the property market have recovered, although they

are still less than the annual number of transactions during 2004-2007.

II. DEFINING FEATURES

Armenia’s housing boom-bust cycle featured a number of characteristics that set it

apart from other episodes of this nature. For example, it was largely concentrated around

the capital city, Yerevan. Construction outside Yerevan increased only at a relatively

moderate pace during the boom, and therefore an increasingly larger share of total

construction in Armenia took place in Yerevan (reaching close to 90 percent at the peak).

The real estate price boom was generalized, however, affecting the country as a whole.

The pace of the increase considerably differed between Yerevan and the regions, and also

between the center of Yerevan and non-center areas. Armenia average prices grew almost 3

times in dollar terms, with growth being considerably higher in the regions (about 5 times),

than in Yerevan (3 times) or in Yerevan center (less than 2.5 times). Yerevan center

apartment prices fell from 2.5 times of Armenia average price to 2 times. In contrast, average

prices in the regions relative to Armenia increased from 20 percent to 30 percent, probably

associated with the much higher supply response in Yerevan.

8 While there are no formal data on unsold inventories, anecdotal evidence suggests pervasive empty apartments

in Yerevan.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Share of Yerevan and Regions in the Output of Construction and Assembly

Work (in percent)

Regions

Yerevan

0

100

200

300

400

500

600

700

Real Output of Construction and Assembly Work in Yerevan and Regions

(in billions of drams)

Yerevan

Regions

- 5 -

The cycle was dominated mostly by activity in apartments rather than houses.

Apartments are the predominant housing style in Yerevan, where the boom was based.

Transactions of houses mostly took place in the regions (64 percent), where construction

activity was more subdued. The trend of prices for houses and apartments, however, was

very similar.

Yerevan

center

Yerevan

average

Regions

average

Armenia

average

2004 2.5 1.4 0.2 1.0

2008 2.0 1.4 0.3 1.0

2010 1.9 1.3 0.4 1.0

2004 4.6 2.7 0.5 1.0

2008 3.5 2.3 0.6 1.0

2010 3.3 2.1 0.6 1.0

1/Prices were put together by State Committee of the Real Estate Cadastre based on a

study of the contract price of transactions.

Relative Prices1 in Yerevan and Regions Compared to Armenia

Avearge

Apartment

Houses

0

200

400

600

800

1000

1200

1400

1600

1800

04

-1

04

-7

05

-1

05

-7

06

-1

06

-7

07

-1

07

-7

08

-1

08

-7

09

-1

09

-7

10

-1

10

-7

11

-1

House Price(USD per Sq. meter)

Yerevan center

Yerevan average

Armenia average

Regions average

0

200

400

600

800

1000

1200

1400

1600

1800

04

-1

04

-7

05

-1

05

-7

06

-1

06

-7

07

-1

07

-7

08

-1

08

-7

09

-1

09

-7

10

-1

10

-7

11

-1

Apartment Price (USD per Sq. meter)

- 6 -

The construction boom was undertaken by households to a larger extent than

developers. Households mostly tend to finance renovations of apartments rather than

building of new units, indicating

a very significant relative role of

renovations in the boom

episode.9 The increase in new

units was still large in absolute

terms (see chart).

The bust affected developers at

an earlier stage, but hit

households harder. Real estate

construction funded by

developers collapsed fell first, by 29 percent in 2008, while Armenian household-financed

construction continued to increase. During 2009, household-financed construction fell by 70

percent, while developer-financed construction had already stabilized. In 2010, household-

financed construction continued to decline by 40 percent and still there is no sign of increase

in the first half of 2011 (even though remittances increased by 12 percent compared to 2009,

the financial sources of households used in the construction sector decreased by 38 percent).

As a consequence, after the crisis there is a change in the structure of financial sources of

construction sector in favor of construction by developers, rather than by individuals.

9 It is possible that the extent of this development is exaggerated in part by statistical shortcomings (e.g., some

developers may not have been registered as such, for example, for tax reasons).

60

65

70

75

80

85

90

95

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Total Space of Housing in Armenia(in millions of square meter)

- 7 -

Remarkably, the boom was unleveraged and consequently the bust spared the banking

system. Banks did not intermediate foreign flows into real estate construction, and in contrast

with most housing booms, lending was not at the center of financing in Armenia.10

By and

large, housholds did not use mortgages, which represented only 2.3 percent of GDP at the

peak, compared to 40 percent of GDP in Latvia or 94 of GDP in the U.S. Developers

accounted for 22 percent of total construction and financed themselves by the way of presales

with deferred payments). Therefore, the housing bust was not associated with major stress in

the banking system.11

However, several projects could not be brought to fruition as pre-

financing dried up, and developers went bust. Hence, some buyers who had pre-financed

construction took losses on their investments.12

10

Only 7 out of 30 real estate booms surveyed by Crowe et al. (2011) did not take place with a credit boom.

11 Interestingly, unleveraged booms do not usually tend to create such large recessions (Crowe et al, 2011) as

the one Armenia suffered.

12 It was common for investor to lose the entirety of their investments as contracts typically lacked provisions to

protect the right of investors in case of developers insolvency.

-120

-100

-80

-60

-40

-20

0

20

40

60

80

100

120

-60

-40

-20

0

20

40

60

2003 2004 2005 2006 2007 2008 2009 2010

State and local budgets International Loans

Humanitarian help Developers

Household sources remittances (annual % change)- Right scale

Contribution of Financial Sources in Construction Sector Growth

(in percent)

- 8 -

III. INTERPRETATION, DRIVERS AND OUTLOOK

By early 2000’s there were significant unmet needs of real estate in Armenia. Prior to

this period, the Armenian housing stock remained limited and poorly mantained. Amidst the

economic decline of final years of the Soviet Union and the important challenges of post-

independence, Armenia’s construction sector had not been particularly vibrant. Therefore,

resident Armenians experienced a clear need for an upgrade in quality and quantity of the

housing stock. At the same time, the large Armenian diaspora had been awaiting the

emergence of prime real estate to purchase housing units for vacations or as a base in their

home country.

Improved country and regional economic conditions in the early 2000’s triggered a

large increase in inflows associated with demand for prime real estate. The improved

economic situation in Russia allowed the diaspora and temporary guest workers to meet their

housing needs in Armenia.13

14

Also, it was becoming increasingly clear that the economic

situation in Armenia had stabilized, and prospects for growth had considerably improved

compared to the 1990s. In the absence of other attractive assets, a motivation to invest in real

estate was to gain portfolio exposure to the growing Armenian economy.15

The government

further encouraged the process by actively reaching out to wealthy Diasporans and local

businessmen to invest in the sector.16

Therefore, the increased demand was most marked for

prime real estate segment. Other segments of the market also improved. For example, newer

migrants also directed remittances to relatives, who in turn used these resources for real

estate (either renovations or acquisitions). Better economic conditions in Armenia also

contributed to increased demand from local Armenians.17

The sharp increase in demand triggered a large increase in prices and in construction

activity. Increased demand for real estate was not met by significant idle capacity, thereby

putting pressure on prices of existing dwellings and increased construction activity. The

13

While there were also inflows from other countries, Russia accounted for the largest share (Russia accounts

for 90% of total non-commercial inflows to Armenia).

14 Statistics are likely to have recorded in practice investments in real estate as remittances (while they should

actually be recorded in the capital account).

15 Empirically established by Stepanyan et al. (2010).

16 In some cases, the government contribution was engaged directly in real estate development projects.

17 Other fundamentals of house prices are not likely to have played a role. For example, there is a general sense

that demographics were particularly favorable, but very limited data on migrant flows render this conclusion

tentative. Also, domestic monetary/financial conditions were largely irrelevant given funding sources of the

boom.

- 9 -

pressure on prices continued unabated as supply persistently lagged the demand, even when

there were no obvious land constraints or regulatory restrictions for expansion of cities.

During the early years of the process, it was still not clear to economic agents the persistency

of the shock, and developers were wary of taking risks. Subsequently, a sharp increase

construction did take place but did not immediately translate into larger supply of units as it

was concentrated in construction of multi-unit buildings which take considerable time to

complete (compared to single-family homes). The eventual increase in supply was mostly

tailored to the increased demand for prime real estate, but drove construction costs up more

widely, significantly impacting real estate prices in all segments of the market.18

19

The increase in foreign demand for housing continued unabated until 2008. Economic

conditions in Russia continued

to improve with increases of

oil prices, making it possible

for an ever larger share of

diasporans and guest workers

to jump in to the market,20

Also, the steep increase in

prices created the prospect of

attractive short-term returns.

The investment was further

sweetened by price increases

that were even steeper when

measured in U.S. dollars.

Foreign purchases created an upward impact both on real estate prices and on the value of the

Armenian currency, which compounded the effect.21

In the wake of the global crisis, real estate demand was brought to a sudden halt. On the

basis of deteriorating conditions in Russia, together with suddenly negative prospects for

Armenian real estate prices, inflows associated with real estate purchases drastically

18

Also, given widespread renovation, in some cases price increases reflected housing upgrades.

19 Those cost-driven increases in prices appear to have dwarfed demand in regions outside Yerevan as suggested

by subdued construction in them.

20 Diaspora population is estimated to be more than 7 million, at least twice as large as population in Armenia.

21 The relative stability of real estate in dram terms raises a puzzle regarding saving behavior towards real estate

purchases, which usually takes place in USD.

0

50

100

150

200

250

300

350

400

450

500

04

-1

04

-6

04

-11

05

-4

05

-9

06

-2

06

-7

06

-12

07

-5

07

-10

08

-3

08

-8

09

-1

09

-6

09

-11

10

-4

10

-9

11

-2

Apartment Prices in Yerevan per Square Meter (Index, 2004 Q1=100)

dollar

dram

- 10 -

contracted and have barely recovered since. The early collapse in 2008 of demand for new

units (as suggested by data on developer-funded real estate), suggests that Armenians abroad

started to sense the upcoming fall in the real estate prices, while they were still able and

willing to help fund home renovations for a while until the crisis hit. With the uncertain

environment of the world economy, funding for this purpose has continued to fall.

The prospects for the sector are uncertain. The market for new units is likely to be

currently in excess supply. There seems to be a considerable unsold inventory (from

anecdotal evidence, as data are lacking). This would point to subdued real estate construction

of new units going forward. This notion is strengthened by the fact that cross country

comparison regarding overall construction share of GDP suggests that its level in Armenia

continues to be high (in part though also because of considerable foreign-financed energy

production and distribution and transport). However, as the economic recovery in both

Russia and Armenia strengthens, it would be reasonable for demand from households for

renovation to pick up from current depressed levels. The perceived excess supply would also

point to future reduction in real estate prices. However, the downside risks do not appear to

be large, given that prices against fundamentals do not appear particularly high by

international comparison. In addition, the recovery of transaction levels typically operates as

a leading indicator of a recovery of prices.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2001 2004 2008 2009

Share of Construction by Types of Economic Activity

others

transport

community, social and personal

communication

energy production and distribution

real estate

- 11 -

IV. LINKS TO THE WIDER ECONOMY

The construction boom was a

key driver behind double digit

growth of Armenia for seven

successive years. During 2001-

2007, Armenia recorded double-

digit growth rates each year, on

average by 12.5 percent. More

than 30 percent of this growth was

directly due to construction.22

In

addition, construction benefited

GDP through spillover effects into

other industries (e.g., quarrying).

The effects on consumption were limited by the fact that the increased collateral value of

homes was generally not used for increased consumer credit.23

It is likely, however, that

proceeds from sales to foreign-based investors at increasingly higher prices eased local

Armenians’ liquidity constraints and supported consumption. Against this background,

imports soared.

22

Calculated based on NSS published data on GDP.

23 It is possible that wealth effects supported consumption, but they could have been offset by the increase in

housing costs.

15.8

39.7

0 10 20 30 40

Baku, Azerbaijan

Tallinn, Estonia

Sofia, Bulgaria

Budapest, Hungary

Warsaw, Poland

Yerevan, Armenia

Tehran, Iran

Bucharest, Romania

Prague, Czech …

Kiev, Ukraine

Riga, Latvia

Paris, France

Vilnius, Lithuania

Minsk, Belarus

Beirut, Lebanon

Moscow, Russia

House Price to Income Ratio

Source: http://www.numbeo.com/property-investment/

43.74

8.07

-5 15 35 55

Paris, France

Prague, Czech …

Tallinn, Estonia

Vilnius, Lithuania

Warsaw, Poland

Moscow, Russia

Riga, Latvia

Bucharest, Romania

Beirut, Lebanon

Tehran, Iran

Kiev, Ukraine

Sofia, Bulgaria

Budapest, Hungary

Minsk, Belarus

Baku, Azerbaijan

Yerevan, Armenia

House Price to Rent Ratio

Source: http://www.numbeo.com/property-investment/

-60

-40

-20

0

20

40

60

-15

-10

-5

0

5

10

15

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Construction Sector Contribution in GDP

GDP growth construction contribution construction growth-right scale

- 12 -

The construction boom

hurt Armenia’s structural

external position. The

outsized growth of the

construction sector implied

an absorption of a larger

share of resources from other

sectors. Partly because the

boom was financed with

external flows that

appreciated the currency, the

tradable sector was

particularly affected. Exports

as a share of GDP and Armenia’s share in key world markets declined over the period with

various firms being permanently displaced from the international market. Despite this fact

and above-mentioned higher imports, the current account deficit remained moderate until

2008 in part because it is likely that foreign inflows associated with real estate transactions

were recorded as inflows in the current account.

Armenia’s double digit growth turned into double digit contraction in 2009. The

contribution of construction to the fall in GDP was about 70 percent. The spillovers to other

sectors of the economy were, however, rather limited, including because a larger share of

foreign citizens in the market at the end of the boom implied a considerable shift of the

negative wealth effects to outside Armenia.

While the construction

sector played an

important role in the

growth of the economy,

its contribution to tax

collections appears to

have been modest.

Informality in the sector

appears to have been

widespread. For instance,

formal employment in the

construction sector

reached at its peak only

46.541.2

36.1

37.2

33.3

34.6

29.7

31.1

60.4

49.5

0

10

20

30

40

50

60

70

Employed Population in Construction Sector (in thousand people)

10

15

20

25

30

35

90

95

100

105

110

115

120

125

130

135

140

REER and Export to GDP Ratio

REER (1997=100) Export/GDP-(RHS)

- 13 -

5.4 percent of total formal employment. Some estimates point to more than 50 percent of

employees in the informal sector.24

Also, as mentioned above, the construction during the

boom period was mainly financed and undertaken by households and individuals, a group

that was exempted from paying VAT and income tax up to 2007. Also, before 2007, the

valuation base of profit tax for legal entities was not clearly specified, although it was subject

to tax. In order to strengthen taxation of the construction sector, amendments to the laws on

VAT, income tax and profits tax became effective in January 2007.25

26

Profit tax collected from large construction companies increased in 2007-2008, but still

the share of large construction companies in total profit tax collections was small. Profit

tax paid by construction companies listed among the 1000 largest taxpayer increased by 86

and 154 percent in 2007 and

2008, respectively and reached

AMD 5.6 billion before the

crisis (2008).27

While the

breakdown of the total taxes by

industries is unavailable, taxes

paid by seven large companies

that covered most of the activity

in the sector was about 1 percent

in 2005, it increased to 3 percent

and 6.5 percent in 2007 and

2008, strikingly low compared

to the sector’s contribution to the

economy.28

24

See ADB, “The informal sector and informal employment in Armenia.”

25 Also on simplified tax, before abolishing in 2009.

26 For the VAT law, the disposition of residential buildings owned by individuals had not been considered a

VAT-taxable transaction. The amendments specified that the constructor-individuals who are not individual

entrepreneurs should be taxed. For the profit tax law, the amendments specified the method of calculation of

taxable profit not less than the value specified in the property tax law. For the income tax, before the 2007

amendment, income received from the sale of buildings and construction works by constructor-individuals was

not subject to the income tax. With the amendments, this income became subject to taxation, with the valuation

not be less than the value specified in the property tax law.

27 This doesn’t include the related contractor companies.

28 This is consistent with a large share of the activity financed by households, some of them likely to have been

developers in disguise.

2004 2005 2006 2007 2008

Construction companies 0.7 0.8 1.2 2.2 5.6

Total profit tax 32.0 46.6 65.3 75.5 86.2

Construction companies 25.7 43.0 85.9 154.0

Total profit tax 45.4 40.3 15.6 14.2

Construction companies 2.1 1.8 1.8 2.9 6.5

Construction companies 1.2 1.9 10.0 31.6

Profit Tax Paid by Construction Companies Listed in the First 1000 Large

Taxpayer

(in bln. AMD)

Annual Growth rate (in percent)

Share in total (in percent)

Contribution in growth of profit tax (in percent)

- 14 -

V. CONCLUDING REMARKS

Armenia experienced a real estate boom-bust cycle with unique characteristics.

Armenia’s boom was the largest in the world in terms of the share of the economy that the

construction sector absorbed, with also very large house price increases by international

comparison. In contrast with other experiences, Armenia’s boom was un-leveraged (mostly

foreign financed), concentrated in the capital city and apartment buildings, focused to a large

extent on renovations and development of prime real estate, and developed by households or

by developers in the informal sector.

Its benefits for Armenia’s economy appear to have been rather limited, while its costs

were considerable. During 2004-08, the country made great strides towards upgrading and

expanding its housing stock. More generally, the real estate boom was at the core of very

successful macroeconomic performance during that time. However, the pace of the

expansion of housing supply, and more generally of economic growth, proved to be

unsustainable. Also, the benefits of the boom for the country’s long term prospects beyond

the improved living conditions of an upgraded housing stock are not evident. The impact on

government revenues, and therefore the capacity of the government to benefit from it to

attend to the country’s long-term development needs, appears to have been very limited.

Also, the disproportionate share of resources that this sector absorbed during the boom

crowded out other sectors and displaced firms from world markets permanently. On the other

hand, given the unleveraged nature of the boom, the bust did not represent a threat to

financial stability, thereby avoiding more severe dislocations to the Armenian economy.

The aftermath of the cycle is marked by uncertainties and challenges. The outlook for

the real estate sector appears difficult, as construction initiated during the boom comes to

completion, the already large unsold inventory of units continues to grow. Therefore, the

prospects for renewed strength of construction of new housing units are unclear (there are

however less obstacles for investment in housing renovation). In the meantime, a reallocation

of resources towards the tradable sector does not appear to be taking place, in part because of

the disappearance of some formerly successful tradable firms tend to make this process slow

and costly. In addition, the intersectoral allocation of resources has been prolonged by

strength of the nontradable sector on the back of relatively strong demand backed by new

external flows, this time more dangerously in the form of loans intermediated by the banking

system (and recovering remittances for consumption purposes). As the country progresses in

the structural reform agenda, growth is likely to become broader, more balanced and more

sustainable.

- 15 -

REFERENCES

Asian Development Bank, 2011 “The Informal Sector and Informal Employment in

Armenia” (Manila: Asian Development Bank)

Crowe, Christopher, and others, 2011a, “Policies for Macrofinancial Stability: Options to

Deal with Real Estate Booms,” IMF Staff Discussion Note 11/02 (Washington:

International Monetary Fund).

———, 2011b, “How to Deal with Real Estate Booms: Lessons from Country Experiences,”

IMF Working Paper 11/91 (Washington: International Monetary Fund.

International Monetary Fund, 2008, World Economic Outlook, April 2008 (Washington:

International Monetary Fund).

Stepanyan, V., Poghosyan, T. and Bibolov, A. (2010). House Price Determinants in Selected

Countries of the Former Soviet Union. IMF Working Paper 2010-104.