How long can the Ukraine property boom continue?

Last Updated: May 16, 2008

How long can the Ukraine

property boom continue?

Ukraine’s residential property prices continue to rise – against all likelihood, and perhaps against all reason.

But rise they do.

Prices in Kiev are now higher than Warsaw, higher than Prague, though not of course higher than either Moscow or St Petersburg. Yet the average monthly salary in Kiev is a fraction of that in either Warsaw or Prague.

Apartment prices in middle areas of Kiev reached US$3,136 per square metre (for 3 room apartments) in May 2008. In Lipsky, the central administrative district, 3-room apartments reached US$10,440 per square metre, according to house price statistics from Blagovest. The currency has been recently been appreciating against the US$, to which it was previously semi-pegged.

Ukraine is an interesting case. Like many of the countries experiencing substantial house price rises, it has no official house price statistics. The lack of official statistics mean that Ukraine’s house price increases rarely figure in those European house-price rise league tables, so loved by the press.

According to our numbers (January 2007) which of course are now very out of date, gross residential rental yields are healthy in Kiev, ranging from 7.50% to 10.23%. Smaller rental units produce better returns than large units, as is normal in most countries.

Inflationary pressure

Inflation for 2007 was 16.6%, the highest rate since 2000. This figure conceals larger price increases in food (up 23.7%) and fuel (up 36.2%).

Why such high inflation? The explanation is twofold. Partly global inflationary pressures – oil, food. But partly the US$ peg. The hryvnia was introduced in 1996 and initially steeply declined against the US$. But during the past five years the currency has been a tightly managed float at H5.5 to H5 to the US$. When currency stabilization first occured, the hryvnia was heavily undervalued in real terms against the US$ (IMF Country Report No 07/05, 2007, P14). Only since the beginning of 2008 have the authorities finally moved to allow the currency to move up.

The result has been a very strong current account surplus and generally strong economic growth, in the context of a fixed peg, which has led to substantial non-traded goods inflation.

Real interest rates are well below this non-traded goods inflation, adding fuel to the fire. This has led to a domestic credit boom. Real credit growth has been about 40% annually since 2001. At the same time, corporates and banks have borrowed heavily abroad. Household sector debt, mostly in foreign currency, has also surged over the past 18 months, albeit from a low level. The situation has been exacerbated by the liberalization of the financial sector and by an influx of foreign banks, eager to acquire customers.

Ukraine’s current account has now switched from large surpluses (10.5% of GDP in 2004) into mild deficit (1.1% of GDP in 2007). Capital inflows, FDI in particular, have however been buoyant, reflecting improved perceptions of Ukraine as an investment location. Thus foreign-exchange reserves have more than doubled since end-2004 to about 4½ months of imports, and are projected to exceed the level of short-term external debt at end-2006. This will mitigate external vulnerabilities.

The volumes of external investment have been enormous, with a record US$8 billion foreign direct investment (FDI) inveted in Ukraine in 2007 – a 40% increase on the previous year.

Trouble ahead?

Nevertheless the future is potentially troubling. Domestic demand is booming, while export volumes are slumping. Corporates' overall debts already exceed levels in more advanced economies. The majority of loans are denominated in foreign currency, thus raising banks' indirect foreign-exchange risk. While these are mitigated by the influx of foreign banks, these same banks could fuel even higher foreign borrowing.

Note that structural reform is only occurring at a snail’s pace in Ukraine. This is still a state-dominated economy, where permits, connections and bribes rule.

Nevertheless GDP increased 7.3% y-o-y in 2007, responding particularly to strong investment spending. This compares to the nose-dive to 4% GDP growth in 2006 and 5.2% in 2005 (the result of the tensions with Russia) after 11.8% growth in 2004.

Manufacturing and construction have been particularly strong sectors, and the economy weathered the 65% hike in the price of imported gas in early-2006 well, plus the long political wrangling which followed the parliamentary elections of March 2006. Central government deficits have been reasonable, and have now been reduced to near-zero.

Connections and bribes

There is clearly a speculative element in recent property price rises (see the discussion in Kiev Weekly), but there are other factors too.

Ukraine is still a semi-socialist country. The construction market in large cities is divided between two to three companies, whose management is directly linked with the local authorities. For example, nearly 70% of the new residential buildings in the capital are built by companies that belong to the KyivMiskBud holding company in which the Kyiv City State Administration has a large stake, and the same phenomenon is observed in other cities.

So those having direct ties to high ranking officials and who are prepared to pay large bribes come out as winners in land allocation, allowing construction companies to acquire land plots for construction. There are few builders, and at the moment, demand largely exceeds supply, and so there is a seller’s market. In the primary residential segment of the market in 2005 the volumes grew by only 7.5% and a amounted to 1130 million sq. m., according to In Real. In 2006 primary residential market volumes hardly increased.

Protection from inflation

The strong demand for real estate has been partly caused by people’s desire to protect their savings from inflation by investing them, and that the absence of alternative ways of saving and multiplying money in Ukraine. Another factor has been the development of the home mortgage lending, which has been growing very rapidly.

The rapid increase in prices of real estate in Kiev has stimulated the construction of houses surrounding Kiev. Starting from the year 2000 there were couple of “cottage towns” built near Kiev, mostly in the Koncha Zaspa area, which is close to the Dnepr River. More cottage towns around Kiev are being built).

It is hard to forecast what will happen next on the residential property market:

• GDP growth is strong – positive for the market
• Yields are strong – positive for the market
• BUT prices are very high by the standards of Ukraine – negative for the market