Global Economics

The Real Estate Crunch Comes to Russia


The global economic crisis has hit Russia with full force, and property prices, especially in Moscow, are tumbling

Shares of Russian companies have lost nearly three-quarters of their value in six months. The price of government bonds is down by almost a quarter. The ruble is sliding, losing 20% of its value against the U.S. dollar since August. The price of oil, Russia's chief export, has fallen by 70% since the summer. But for a long time, there was one asset in Russia—real estate—that somehow seemed capable of defying gravity.

Even as property market bubbles burst all over the world, the value of Russian real estate just seemed to go up and up. According to Moscow real estate agency IRN, residential property prices in Moscow did not peak until mid-October, rising by some 50% from a year earlier. With apartments in central Moscow selling for $6,000 per square meter ($557 a square foot), the city regularly tops lists of the world's most expensive cities. Elsewhere in Russia, too, property values have climbed dramatically over recent years.

It couldn't last, and it hasn't. Now that the global economic crisis has hit Russia with full force, real estate prices are finally tumbling. And if recent trends are any guide, the mother of all crashes may be in the offing. "The property market in Russia is on the brink of collapse," says Vasily Koltashov, head of economic research at the Institute for Globalization & Social Movements, a Moscow think tank. "Property prices are very severely inflated, and demand is obviously slumping."

Down 10% in Two Months

According to the widely cited IRN Index, the value of residential property in Moscow fell by 2% in the first week of December alone. That compares with a decline of 2.3% for the whole of November, and just 0.9% in October. Oleg Repchenko, IRN's head of research, says that real estate prices in Russia have fallen on average by around 10% in the last two months. He estimates they'll fall by a further 30% before next summer.

Others go further. Peter Aven, president of Alfa Bank, one of Russia's leading commercial banks, has predicted that Moscow property values will fall "several times over." In an October conference presentation, Aven pointed out that the value of Moscow property prices is some five times the European average. When it comes to choice property in the center of Moscow, the cost for a 100 square meter apartment is 155 times the income of the typical Russian. That compares with a multiple of just 5.9 in Germany.

Little wonder that Moscow property prices are now sinking rapidly. Indeed, some analysts say that the real market situation is way worse than the headline figures suggest. According to Inkom-Nedvizhimost, a Moscow real estate consultancy, the city's major development companies sold an average of five new apartments in the city in November. That compares with around 40 to 50 apartments per month in the summer, and 90 to 100 in the first half of the year. The collapse in demand means that many developers are already offering deep discounts on new apartments, typically ranging between 25% and 40%.

Nor is it just residential property, the most overheated segment of the Russian market, that is now crashing. Commercial property also has taken a dramatic hit. Irina Florova, an analyst at real estate consultancy CB Richard Ellis (CBG) in Moscow, says that average office rents have fallen by 20% since October and are expected to decline by 25% more by early next year. The take-up of new office space has fallen by 50% since a year ago, while the volume of vacant office space has doubled. "Now it's a tenant's market," says Florova. "Landlords were used to increasing prices, and now they are faced with a completely different situation. For them it was a bad surprise, which happened in the space of two or three weeks."

No Mortgage Overhang

The sudden slump is bad news not just for landlords, but also for the wider Russian economy. True, Russia can take some comfort from the fact that the mortgage market, a major component of the economic crisis in the West, is still in its infancy. The value of outstanding mortgage loans represents just 3% of Russia's gross domestic product, compared with shares of between 40% and 60% more typical in the West.

Nevertheless, mortgage lending has grown rapidly over recent years, doubling each year between 2002 and 2007. A collapse in apartment prices will spell misery for the most economically active part of the Russian population, young professionals who have recently taken out loans. Even for the majority of Russians who don't have mortgages, a dramatic fall in apartment prices is likely to have a major psychological impact, affecting their confidence and consumption.

For one thing, it will wipe out the largest share of many households' wealth. Unlike Westerners, few Russians invest in shares, pension plans, or mutual funds. Only a third have bank accounts. In contrast, most Russian families own at least one apartment, with many also owning country dachas. And over recent years, they have seen the value of this property rise dramatically—leading many to assume that the property market was a one-way bet.

As recently as October, a poll by Russia's National Financial Research Agency showed that 51% of Russians regarded real estate as the safest form of investment. The next most popular form of savings, an account at the state savings bank Sberbank (SBER.RTS), was trusted by just 23% of respondents. Only a tiny fraction of the population felt confident about other savings vehicles, such as mutual funds and pension plans.

Developers Facing Ruin

That's why, with property values now heading the same way as the Russian stock market, Russians will be in for a huge shock. The dismay will be greatest for the growing number of Russians who have acquired real estate not just as a place to live, but as an investment. "The real estate market in Russia was driven by investments by private individuals," says Natalia Orlova, chief economist at Alfa Bank, who estimates that around 20% to 25% of Russians' annual savings were put into real estate.

Spare a thought, too, for Russia's construction and development companies, many of which now face ruin. Over recent years they have collectively plowed tens of billions of dollars into new construction projects, typically financed with the help of short-term loans. But even before property prices began tumbling, the sector was in a crisis brought on by a complete halt in financing. In comments to the RIA-Novosti news agency in November, Vladimir Ponomarev, vice-president of the Association of Russian Builders, described the situation facing the industry as "practically a catastrophe."

As a result of the financial crunch, investment in the construction sector has already ground to a virtual standstill, with knock-on effects for other sectors of the Russian economy. "Of course, changes on the real estate market can significantly affect the rate of investment in the economy," says Evgeny Nadorshin, chief economist at Trust Bank in Moscow.

The real estate crunch also will affect the wider economy through its impact on the banking sector. When it comes to the banks' balance sheets, the fledgling mortgage market represents just the tip of iceberg. Alfa Bank's Orlova estimates that around 14% of corporate loans are to construction companies, while an additional 30% of loans use some form of real estate as collateral. That means that the volume of bad loans—already estimated at around 10% of banks' portfolios—is now set to rise sharply.

The combination of all these factors means that the wider economic impact of slumping real estate prices should not be underestimated. Little wonder economic forecasts for Russia are growing gloomier by the day, with signs that economic growth has already ground to a halt. "This is not just about 2009, but also about 2010 and 2011," says Orlova. "It's quite possible that GDP growth will stay around zero for this period."


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