UKRAINE: KYIV'S BOOMING REAL ESTATE MARKET, A BUBBLE READY

UNCLAS SECTION 01 OF 04 KYIV 001391 SIPDIS SIPDIS SENSITIVE STATE FOR EUR/UMB USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYCK MUMBAI FOR WKLEIN E.O.: 12958: N/A TAGS: ECON PGOV UP SUBJECT: UKRAINE: KYIV'S BOOMING REAL ESTATE MARKET, A BUBBLE READY TO BURST? REF: A) KYIV 895 B) 2006 KYIV 4367 KYIV 00001391 001.2 OF 004 ¶1. (U) Summary: This report analyzes the real estate market in Kyiv, which has experienced a sizeable boom over the past 12 months as average citizens have rushed to throw their savings into the market. Mortgage lending has dramatically increased but has room to expand. Some bankers are concerned by the high rate of bad loans, and dollar-denominated mortgages constitute an exchange rate risk. Restrictions on land sale and unclear property laws continue to restrict supply. Inexperienced real estate brokers and an underdeveloped construction sector also produce upward pressure on prices. Some experts argue that speculative demand is mostly to blame, however, and claim that the real estate market is currently experiencing a bubble inconsistent with underlying fundamentals. Yet supply-side limitations and soaring demand appear sufficient to explain most of the accelerated growth in prices. End Summary. Real Estate Explosion -------------- ¶2. (U) Real estate is one of Ukraine's fastest developing sectors, particularly in Kyiv, which has begun to emerge as a major European capital. (Note: Although our investigation focused on Kyiv, Econoffs' discussions in several other major Ukrainian cities (e.g., Dnepropetrovsk, Odesa) revealed other parts of Ukraine are seeing similar spikes in the real estate market.) Kyiv is witnessing a continued, sizeable influx of people and businesses from all parts of the country and beyond. Official statistics list the city's current population at 2.72 million, up from 2.61 in 2001, although the real population is likely much higher. Using figures for bread consumption, the Kyiv-based City Institute estimated that the population as of January 1, 2007 had risen to 4.13 million. Housing construction has likewise grown, and in 2006 alone, the Kyiv housing supply grew by 8%, adding about 14 million sq. ft.. ¶3. (U) Despite booming housing construction, quality residential property remains scarce in Kyiv. According to local real estate agencies, Kyiv has an estimated 215 sq. ft. of housing available per resident, as opposed to 320-370 sq. ft on average in the European Union. [cy1] Even this low level represents an increase over space available in Soviet times, when extended families often squeezed into apartments. Today, the desire of young families to have their own apartments is a big factor in rising demand. Soviet-era statistics are unavailable, but since 1993, Kyiv's housing stock has risen about 15 sq. ft. per resident, despite the growth in population. The average price of residential property in Kyiv has increased more than sevenfold over the last four years. In 2002, buyers paid around USD 36 per sq. ft., but by early 2007 average prices had hit USD 260 per sq. ft. With Kyiv's residential housing stock at about 660 million sq. ft., the total value of Kyiv's housing stock stands at roughly USD 172 billion, or 1.64 times Ukraine's 2006 nominal GDP of USD 104.8 billion. By comparison, the total value of the U.S. housing stock (USD 19.8 trillion) is 1.5 times larger than U.S. GDP (USD 13 trillion). ¶4. (U) High-end rental housing is in particularly short supply. Rates for Embassy rental units, for example, have quadrupled over the past three years (ref B) and increased 50% or more between May and November 2006. The Embassy Housing Unit reports that monthly rent for apartments that meet minimal Department standards now stand at USD 4 per sq. ft., compared with USD 1.8 per sq. ft. a year ago. A newly-arrived business executive told Econoff in April that her USD 4000/month allowance was not enough to secure suitable housing in Kyiv. ¶5. (U) Kyiv also suffers from a lack of commercial property. The international real estate agency DTZ estimates commercial property supply to be about 5 million sq. ft less than demand, as of early ¶2007. A 2006 survey by Jones Lang LaSalle found that neighboring capitals like Moscow, Warsaw, and Prague have three to four times the office stock of Kyiv. Class A&B offices (1000-3000 sq. ft.) meeting international norms are in especially short supply. Mortgage Lending Boom Tapering Off? -------------- ¶6. (U) Investing in real estate in Ukraine has proven extremely profitable during the recent housing boom. According to the Oxford Business Group, investors have seen a 20% return on their investment, three times higher than the average return in western Europe. Middle-class Ukrainians use real estate holdings as their primary form of savings. Ukrainian official statistics show that investment in real estate grew by 30% in 2006, ballooning to 17% of total investment. KYIV 00001391 002.2 OF 004 ¶7. (U) According to the National Bank of Ukraine, the volume of mortgage loans grew 1.5 times in 2006 and more than tripled in 2005 and 2004. Despite this high growth rate, the absolute level of mortgage lending remains relatively low, at USD 5.5 billion or 5% of GDP (as of March 1, 2007). Volodymyr Lavrenchuk, Chairman of Raiffeisen Bank Aval, which has the second largest mortgage lending portfolio among Ukraine's banks, told Econoff he thought 10% of GDP would be an appropriate level. ¶8. (U) Lavrenchuk noted that Aval's share of bad loans, at 1.5%, was significantly higher than the standard target of 0.3%. Lavrenchuk added that only a few Ukrainian banks were competent to manage risk in loan portfolios appropriately. Once the share of bad loans exceeded 1.6%, banks would be forced to limit mortgage lending and the likely growth in mortgage lending would fall to 30-40% in 2007, he predicted, down from 125% growth in 2006 and 75% growth in 2005. At the same time, banks would also seek to unload foreclosed properties, compounding a downward pressure on prices. Aleksander Avramenko, Ukraine Country Manager for international real estate firm Ober Haus, told Econoff in April that the drop in mortgage lending was a sign that the real estate market was already cooling. Dollarization Risk -------------- ¶9. (U) The IMF recently expressed concern that growing dollar-denominated loans in Ukraine had created exchange rate risk for borrowers and banks (ref A). This risk is especially acute for mortgage lending, as over 80% of mortgage loans are issued in U.S. dollars. A devaluation of the hryvnia could, therefore, lead to widespread defaults on mortgage payments and send the real estate market reeling. The National Bank of Ukraine tried to address this concern through an April 10 regulation requiring higher provisioning by banks on overdue dollar-denominated loans issued to customers with incomes in local currency. Restrictions on Land Sale -------------- ¶10. (U) Government bureaucracy and a moratorium on the sale of agricultural land constrain Kyiv's real estate market. Ambiguities in land ownership laws have made property disputes common, creating risk for potential investors. An unclear, corrupt, and non-transparent process of land allocation for development, along with months-long periods needed for compiling the necessary documentation and permissions, further elevates real estate prices. One study estimated that the average commercial builder required 274 signatures for a project, adding about 18-24 months to the length of a project. ¶11. (SBU) In October 2006, the Rada (parliament) extended a moratorium on the sale of Ukraine's 33 million hectares of agricultural land, including the valuable land surrounding Kyiv and other major cities that many developers would like to convert into suburban housing. The moratorium blocks suburban development and keeps urban property values high. All major political parties except the Communists publicly support lifting the moratorium. As BYuT MP and former Minister for Agrarian Policy Ivan Kyrylenko recently told Emboffs, however, many MPs have personal real estate holdings whose value has been boosted by the moratorium and this may explain why the Rada keeps postponing that step. Underdeveloped Brokerage and Construction Sectors -------------- -------------- ¶12. (U) A 2006 assessment by the International Real Property Foundation concluded that many of Ukraine's 50,000 brokers and 3,000 individual appraisers either operated outside the law, or had little real expertise or experience. Remigijus Pleteras, responsible for expansion at Ober Haus, told Econoff that most foreign real estate agencies were wary of entering the Ukrainian market because of the complex and corrupt bureaucracy. The fact that so many real estate transactions were shady or improperly distorted prices, and made analysis of the market more difficult, he said. ¶13. (U) Foreign firms likewise have largely shunned the non-transparent Ukrainian construction sector, which is dominated by a few large companies controlled by local magnates with insider connections. According to the Oxford Business Group, a single Ukrainian firm, Kievmiskbud, which is controlled by influential MP Volodymyr Poliachenko, handles 60% of construction in Kyiv. ¶14. (U) The construction cranes dotting the Kyiv skyline show that KYIV 00001391 003.2 OF 004 domestic developers and builders are able to get projects started, but abandoned or delayed projects are not uncommon for several reasons: -- Lacking the deep pockets of large foreign builders, overextended local firms developers sometimes simply run out of capital before completing projects; -- There have been several cases in Kyiv of citizens opposed to new construction delaying or blocking projects on environmental or aesthetic grounds; -- Scams and business disputes have left buildings half-completed and middle-class investors penniless. The accepted practice of collecting payment for apartments before construction is finished makes it tempting for shady operators to take the money and run. ¶15. (U) The most notorious building scam was the Elite Center housing project, meant to erect four new residential buildings in central Kyiv. The architects of this scheme, Russian citizen Olexandr Volkonskiy and Ukrainian citizen Oleg Shostak, made off in February 2006 with nearly USD 100 million. Collecting payment in advance for unfinished apartments, the fraudsters sold the same properties to hundreds of buyers. Investors lost USD 45,000-60,000 on average in the scam. Housing Market Absorbs Looser Credit -------------- ¶16. (U) In order to offset the exchange rate risk of disproportionately dollar-denominated credit, the NBU lowered reserve requirements for hryvnia-denominated deposits from 8% to 0.5-1% in three steps in 2006, with the steepest reduction coming on August 1. As deposits in Ukrainian banks were rising rapidly at the same time, bankers responded with a rapid expansion of credit. Pavlo Prokopovych, an economist at the Kyiv School of Economics, identified this lowering of the reserve requirement as the driving force behind the explosion in housing prices, which indeed took off in August 2006. Market Forces or Speculation? -------------- ¶17. (U) Kyiv's skyrocketing housing prices have led some to question the market's fundamentals and to caution that what we are currently witnessing is a speculative bubble whose popping sound could reverberate throughout the Ukrainian economy. Much of the investment currently flowing into the real estate sector is indeed coming from private Ukrainians hoping to flip their property for a quick profit or who may simply trust property as an investment over bank deposits. Prokopovych, the Kyiv-based economist, used average real estate prices and Kyiv's monthly salary of USD 400 to determine that Kyiv's apartment price-to-income ratio exceeds 22. He noted that in 2006 the same ratio for Naples, Florida, often regarded as one of the most overpriced markets in the United States, was about 8, while that for the state of Illinois was 2.5. Prokopovych therefore argued that risky mortgage lending and speculative demand is creating a bubble inconsistent with underlying market fundamentals. ¶18. (U) There is anecdotal evidence that developers and individual speculators may be holding apartments--particularly in upscale buildings--empty in hopes of cashing in when prices peak. Some apparently completed large residential buildings can be seen in central Kyiv, but there are no hard figures on vacancy rates for residential property. Vacancy rates are easier to estimate for commercial property and are low: at about 2-5%. One realtor quoted in a recent press article worried that a number of the speculators may attempt to sell at the perceived peak, possibly creating a glut on the market and depressing prices sharply. In the mean time, holding property off the market restricts supply and helps keep prices rising. Comment: A Bubble Ready to Burst? -------------- ¶19. (SBU) At the same time, it is hard to determine whether investors' expectations of future prices are actually "irrationally exuberant," that is, not based on market fundamentals. Real estate development in Kyiv has clearly struggled to keep pace with the country's economic transition. Supply-side limitations and soaring demand clearly are part of the explanation for the accelerated growth in prices, and the easing of credit in 2006 only added fuel to the fire. While harder to quantify, there is some evidence speculation is amplifying the price rises caused by supply and demand. No one can predict if the Kyiv real estate market is a bubble about to burst, but the downside potential of speculation in this market would likely be somewhat mitigated by the underlying KYIV 00001391 004.2 OF 004 market factors (increased demand, restrictions on supply) we identified that are pushing prices higher. TAYLOR [cy1]I don't like this stat because we're comparing Kyiv to all of Europe (rather than a few selected capitals),but unfortunately thus far we haven't found anything better.