This paper aims to use the user costs approach to identify the periods of over- and under-valuation in the Baltic residential real estate markets.
Three alternative estimates of the user costs of homeownership in the Baltics are computed: one that does not discriminate between the leveraged and unleveraged parts of a house and the other that takes loan-to-value ratios into account.
The approach successfully identifies the overheating that took place in the Baltic real estate markets prior to the crisis of 2009 and shows that there is significant upward pressure for the housing prices in the Baltics in the low interest rate environment that became prevalent ever since.
The paper uses only the current values of the fundamentals to compute the user costs. The framework could be augmented to account for the expected future developments of the fundamentals.
The macroprudential policy makers should monitor the developments in the Baltic residential real estate markets closely and be ready to act because an increase in the price-to-rent ratios might seem sustainable, given the current low interest rates, but could potentially bring harmful volatility when the monetary policy normalises.
This paper builds a novel data set on the real estate markets of the Baltic countries and is the first to derive the user costs of homeownership in the region. It is also among the first to identify periods of housing price misalignments from their fundamental values in the Baltic States.
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