Anya Levitov, Managing Partner, Evans Property Services
In today's uncertain environment, where economists and financial advisors have lost fortunes and credibility, many are afraid to make any decisions. Still, however complex, we should try to analyze the situation in order to protect assets and make investment decisions, as any crisis is also an exciting investment opportunity.
Why real estate prices are certain to fall: demand will dramatically decrease.
Disappearing Buyers
Lay offs are not yet at their highest, but many large companies have already announced plans to shed 30 to 50 percent of their employees. As purchasing power decreases, more firms, such as large retailers, will join the increasing number of companies downsizing. Currently, the number of candidates looking for jobs on major Internet portals is doubling almost every week. Large industries, such as finance, construction and development, and other large borrowers will suffer the most. Anyone without a job is unlikely to make large and expensive purchases, so they will all withdraw from the real estate market. Nowadays, most salaries are denominated in rubles, which are rapidly losing value. Although many government officials are claiming that the ruble will maintain its value, it is unlikely that the cushion that the government has accumulated will be spent on supporting the currency. This will further affect the spending power of those who keep their jobs.
Scarcity of Mortgages
The growing availability of mortgages in recent years coupled with a limited supply of housing was partially responsible for the rapid appreciation in residential real estate. Now we are facing the reverse process. Many banks have terminated their mortgage programs completely. Those that have not have introduced high rates, in some cases increasing them to 12 percent and over, and low loan-to-value ratios to make sure the borrowers have little incentive to turn assets over to the banks. Borrowing has become more difficult as lenders have increased the application review time and the value of down payments they require, which can now stand at as much as 30 percent. Gray, or unofficial, income can no longer be used to help secure a mortgage. BSGV, which previously had almost no limit on the amount it would lend for a mortgage and generous terms overall, has set a limit of $500,000 for some mortgage products. No stated income loans will be considered, which will further decrease the number of buyers. Only those, who have cash available, will be able to buy.
Most lenders are unlikely to call in loans, since this will cause most of their borrowers to default. Although RosEvroBank has reportedly begun asking borrowers for early repayments on their mortgages, its motivation is unclear. The bank could find itself party to multiple lawsuits claiming the assets, which lost value, incurring expenses in taking the properties over and selling them in a soft market. Most lenders would prefer to simply collect regular payments from borrowers and only deal with defaulting ones. In many cases owners have made significant investments in the properties they have purchased using a mortgage. This includes the down payment, renovation and the payments that have already been made. Therefore, they have a very high incentive to make the monthly mortgage payments. As a result, it makes much more sense for the banks to increase interest rates on existing mortgages to cover the increased risk caused by the decrease in the underlying asset's market price - provided that the mortgage terms allow for such adjustments.
Investment Buyers Leaving the Market
The universal trend is catching up with Moscow - investors are leaving the real estate markets to find safe havens in cash or gold. Facing high risks of decreasing real estate prices and rental yields will scare many well informed investors, including those who viewed real estate as a safer investment than stocks or bank deposits. The only reason to invest in real estate at the moment is to buy distressed assets, those offered by sellers facing financial difficulties, which could result in high rental yields and overall good performance in the long term. To do so, however, one has to have large cash reserves, as borrowing opportunities are extremely limited.
Why the fall is unlikely to be more than 30 percent: supply will remain limited.
Fire Sales and Distressed Assets
The short-term increase in supply will be limited to a relatively small number of recent mortgage buyers and assets of heavy borrowers. Indeed, massive lay offs will not only limit demand, but will contribute to an increase in supply: those who bought apartments on mortgage loans relied on high salaries to repay the mortgage. Now, it is less likely that they will be able to make their mortgage payments and so will have to sell. This only applies to those who bought at a very high price within the last 12 to 18 months. The same will happen to those who did not borrow against real estate but borrowed against stocks or business and have loans to repay. These types of borrowers will have to sell their real estate at almost any price to cover their loans. However, the number of such borrowers or mortgaged apartments is limited. Conservative estimates place the percentage of the population in any way involved in the stock market at up to five percent, while only up to 15 percent of real estate transactions involve a mortgage. Both of these categories are more often found in the luxury segments. A buyer of a one-room apartment at the last metro stop is unlikely to have played the stock market or be borrowing heavily. These budget buyers did not have access to credit lines or a brokerage account. Even if we imagine that 10 to 15 percent of owners are forced to sell, this will not force the price of real estate to decrease as dramatically as that of stocks. So the impact of fire sales will not last very long. We are already seeing more shoppers for distressed assets than there are sellers.
Developers' inventories are limited to completed or nearly completed projects, which are not large. Some developers have announced that they are freezing all of their projects or all new projects and are actively selling their existing inventory at discounts of up to 50 percent. Such sales will only go through for the projects that are nearing completion or have been actively marketed and are already partially sold. Newer projects will either never be realized or will face significant delays. Even if large developers are nationalized, it will limit construction, especially in the more expensive luxury segment. Consequently, the supply of new housing will remain limited and may even decrease further. Fire sales by developers will coincide with other sales of distressed assets and will only have a short-term effect. In the medium- and long-term outlook, the supply of newly constructed housing will decrease, which is likely to contribute to supporting prices.
Owner-Occupants and Investors
The majority of sellers who have bought with cash or who have small mortgages will most likely choose to tough it out. They are unlikely to sell at a perceived loss in a soft market. We are already seeing sellers take their properties off the market. Since real estate carrying costs, the outgoings required to hold on to an asset, are low, they are not motivation for owner-occupants to sell. Some owners who desperately need income or additional sources to cover mortgage payments are listing their properties for rent. Even though their lifestyle will suffer - they will have to move to budget rentals or move in with older family members - they will keep their properties. Therefore, these owners will not contribute to any increase in supply.
Investors not burdened with debt are unlikely to run, because after having sold their assets they will still need to find other safer, or more attractive, investments. Plummeting stocks and banks at risk of collapse are decreasing real estate prices worldwide and so making it very difficult to choose an alternative investment venue. Less savvy investors are terrified by the volatility in the currency markets not knowing which to choose: the dollar, which has been losing value over the last three years or the euro, which has recently suffered a loss against the dollar and the ruble, and could be in free fall if not supported by the interventions of central banks, both look equally uncertain. Such currency volatility serves as a deterrent against 'exiting into cash'. On the other hand, gold and diamonds often seem too extravagant for many and less useful than real estate. So investors are more likely to postpone their exit and instead rent out their properties.
Rental rates are likely to go down due to this increased supply of apartments that cannot be sold in a softer market, and a decreasing demand as many renters lose income or corporate packages. This will only benefit a small group of renters whose income levels remain intact. Others will face a similar decrease in their income and so rents will remain at the same levels, unattainable for many just in absolute terms at different figures.
What Have We Learnt From the Past?
Even though the Russian property market has a fairly short history, there are still some 18 years available for analysis. While markets do not have a memory and every situation is unique, it is often useful to look back and see how the real estate market has performed in similar circumstances. It took a little over three years for the real estate prices to reach their pre-crises level after the financial crisis of 1998. Only by December 2001 did the real average price per meter reach the levels of July 1998 in Moscow. The residential real estate market went through a much more subtle dip in prices and deal volume in late 2006 and early 2007, when high prices were scaring off buyers and there was little activity in the market. Some sellers negotiated and sold slightly below asking price, but the overwhelming majority waited around six months and were well compensated for their wait by further price increases.
The current situation in Russia is closest to that in many European countries, with the exception of Spain, Borrowing with low or no down-payment was virtually impossible in most European countries and having debt obligations, especially large ones, was viewed as a problem. Therefore, the number of defaults in Russia should be lower than in the US or the UK. However, there is not a strong culture of saving and prudent borrowing in Russia and many buyers who hold mortgages do not have 6 or 12 payments set aside to ensure they can continue loan repayments if they lose their job and the steady monthly income it brings with it.
Many recent buyers, especially those who have become real estate investors or buyers within the last eight years are used to real estate prices only going up, so the idea that they could be forced to sell at a loss is foreign to them. Psychologically, this new experience would be the most important impact of the current crisis. After the financial crisis of 1998, many business people became much more conservative and changed their spending habits. Something similar is likely to happen now. Another possible outcome might be that the concept of renting would gain more popularity. Currently, renting in general is looked down on by most Russians, while owning your residence is considered a norm. Now, when owning a residence could become a liability, renting might be viewed as a safer bet rather than just an unreasonable way of burning money.
Even though it is extremely hard to assess these somewhat contradictory tendencies and factors, it seems likely that a short-term dive in real estate prices is inevitable. It will be caused by a simultaneous demand decrease and short-term supply increase. Once the market absorbs the additional supply, current asking price levels will be restored. The deal volume, however, will be very low until the mortgage lending and employment rates are restored.
How to Take Advantage of the Current Market?
If you are going to buy, shop around and make low offers. Some owners who are desperate to sell will accept. You have to have a horizon of two to three years before you expect to exit. If you have cash or a stable income, it's a good time to make an investment or get better space. Renovated properties are a safer bet since you will be able to collect rental income straight away. As for the developers' discounts, however attractive they sound, such options are very risky. Unfinished projects may remain in that stage or incur very long delays. The ever-present risk of not getting proper ownership documents for several years will also increase dramatically. Therefore, hunting those bargains might backfire. Still, despite financial turmoil, a great many deals were made in the autumn of 1998. So, while the current situation requires a careful approach, the possible advantages for buyers and investors of acquiring a property could be great.
