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

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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.

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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

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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

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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.