Real Estate Prices in Tbilisi: No Bubble, no Trouble

Real Estate Prices in Tbilisi: No Bubble, no Trouble

The FINANCIAL -- Bubbles belong to the most fascinating phenomena in a market. Suddenly, people are willing to pay prices which are completely out of touch with the fundamental economic values of assets. In the stock market bubble of the 1920s, persons who had never before considered to become investors borrowed money and bought shares, so as not to miss out on the chance to become rich. Euphoria grew and grew, until even housewives, dock workers, and cleaning personnel had no other topic to talk about but the news from the stock markets. All this went on until in 1929 the bubble burst, triggering off the infamous World Economic Crisis.

In one of the most famous bubbles, the 17th century Tulipmania, market participants were willing to pay excessive amounts for tulip bulbs. In 1637, some rare kinds of tulips, like the Viceroy, achieved prices of almost 15 times the annual salaries of skilled workers. The story goes that a rich merchant had just bought such a tulip at an auction and left it unattended in the kitchen, when his servant came in hungrily. Seeing the yummy tulip on the kitchen table, he made himself a good sandwich with butter, lettuce, and a chopped tulip bulb – and then ate the most expensive meal of all times, corresponding to the price of a mansion at that time. Of course, in springtime 1638, all this had come to a sour end. 

Nowadays, bubbles are arguably most common in real estate markets. In the end of the 1980s, Tokyo experienced a real estate bubble when a square meter in central Tokyo sold at approximately 1.2 million dollars. Just the land on which the Imperial Palace was built had a higher value than all real estate in California taken together. When the bubble burst in 1990, this had severe consequences for the Japanese economy, as the wealth of many Japanese was drastically reduced overnight. 

One feature of bubbles is that everybody knows when they end, but nobody knows when they start. The uncertainty about the starting point of a bubble comes from the fact that it is often unclear what the fundamental “right” economic value of an asset is. In an influential paper from 2003, Dilip Abreu and Markus K. Brunnermeier show that even if all market participants are fully rational, a bubble can emerge just from this uncertainty about the fundamental value of the asset (“Bubbles and Crashes”, Econometrica 71, pp. 173-204). For this reason, when investing in real estate, one has always to watch out for the possibility that a bubble develops. Is there such a risk in Tbilisi? Before we can answer that question, we have to understand the mechanics of a bubble.


A bubble is similar to a Ponzi scheme, also known as a Financial Pyramid. People pay a price to enter such a system and through this payment obtain the right to participate in any payments that are made by people who enter subsequently. Person A starts the scheme, and person B enters and pays money to A. Then person C enters and pays money to A and B. Then the next entrant pays money to A, B, and C, and so on. Trivially, such a system must come to an end, at the latest when all people of the world have entered the system. When the pyramid collapses, all those who entered after a certain point of time incur losses, while those who started the system and entered early made gains. Funnily, a guy like Sergei Mavrodi, also known as the Great Builder of Pyramids, regularly starts new Ponzi schemes in Russia and always finds new people who are willing to enter. 

Like in a Financial Pyramid, if one buys the asset in a bubble at an excessive price (i.e. one enters the scheme), one hopes to find somebody else who is willing to pay even more (i.e. somebody else who enters the scheme later). And the guy who is buying at an even higher price also hopes to find yet another person who is willing to pay even more, and so on. Like the pyramid, the bubble comes to an end when there are no people anymore willing or able to enter, i.e. pay an even higher price for the asset. Then the bubble bursts. Those who entered the bubble early and left early enough will be well off, while those who are still invested in the asset when the market crashes are losing a lot of money. 


A new analytical product of ISET-PI, the Real Estate Price Index, tracks price change of houses and apartments in Tbilisi. According to this index, average sales prices for residential property increased by almost 11% in less than two years (from February 2013 until December 2014). This number provides the first reason why there is arguably not a bubble yet. 11% over the last two years is not an extraordinarily high return and falls short of what could have been achieved with ordinary savings accounts. A bubble, however, works by sucking in money from everywhere – otherwise it could not grow. If there was a huge movement of capital into real estate, the fact that in the short run the supply of real estate is fixed would have led to much more impressive price increases. In London, where the real estate market is arguably very bubblish, prices went up by 20% in one year, from mid-2013 to mid-2014, at a starting level which was already much higher than in Tbilisi.   

Yet this is not the only argument. In addition to the price change, a real estate investor also gets a return from rent payments. Making the rent return comparable with the returns of other investments is not trivial, as the changes of the real estate prices affect the amount of money which is “stuck” in a real estate investment. If an apartment sells for $10,000, then a yearly rent income of $1,000 translates into a return of 10%. Next year, when the price has gone up to $12,000, the return corresponding to the same rent payment is just a bit more than 8%. To take this into account, it is common practice to divide the average rent payments of each month by that month’s average price of the houses and apartments for which those payments were made. We have done this calculation for Tbilisi and the result is shown in the chart. The data for interest rates and mortgage returns come from the National Bank of Georgia.  

The graph shows that throughout 2014, the return on real estate is much higher than interest rate on deposits and mortgages. This means that with those real estate prices we had since February 2014, rent payments still generated a return between 10% and 14%. 

Were we in a bubble, the rent income would become negligible compared to the return made from price changes, which is the reason why a signal that are bubble has developed in a real estate market is a lot of idle space which is used neither for residing nor for other purposes. In such a situation, everyone is just interested in selling the estate at a higher price, and tenants make this more difficult, in particular if by law it is not possible to arbitrarily increase the rent payments for existing tenants. Thus, in a bubble many owners prefer not to rent out their apartments and buildings.

As we do not see lots of unused space in Tbilisi, and as the rent payments are still such an important component of the total real estate returns, it is extremely unlikely that there is already a bubble in the market. However, as one can also see in the chart, the returns generated by rents have a downward trend, indicating that real estate prices are increasing relatively fast since February.   


Real estate has the reputation to be among the most solid of all investment options, and Georgians are very keen to transform their savings into real estate. Indeed, there are good reasons to prefer dachas to derivatives. While the dacha will never lose its entire value, the same cannot be said about a financial security. Moreover, if times turn really rough, people move into their dachas, while in such catastrophic scenarios financial securities and savings books from the banks can just be used to feed bonfires (and even this is not possible anymore with stock portfolios and savings accounts being entirely electronic).

The inclination to buy real estate and not bring money to the bank aggravates the problems of high interest rates and capital shortage which plague the Georgian economy. Rightfully, this does not concern the individual Georgian who pursue their limited private goals. Yet also from the narrow perspective of an individual, investing in real estate has downsides and risks, which become paramount should a bubble occur in future. Therefore, go on but watch out for bubbles!