Ukraine’s housing bubble bursts

Last Updated: Mar 21, 2009

Ukraine’s housing bubble bursts

From 2004 to 2007, while Ukraine was undergoing its worst political crisis since independence, residential property prices continued to rise – against all likelihood, and perhaps against all reason.

The house price bubble has seen four fast and furious years:

• In 2005, prices of flats in Kiev, the capital, rose by an average of 60% y-o-y, according to Blagovest.
• In 2006 the average price of flats in Kiev rose 51%
• In 2007 the average price of flats in Kiev rose 44%.
• In 2008 the Kiev flats price rise slowed to 17.6%.

Encouraged by pro-western President Victor Yushchenko’s victory in 2004, a significant amount of buyers were British, with some Americans, Emiratis, Cypriots, Kiwis and Canadians.

Ukraine’s wealthy elite also joined in the buying frenzy, pushing prices way beyond the means of the average Ukrainian.

Now everything has changed.

With the UK and US in recession, the property market is being swamped by properties sold by cash-strapped buyers. Transactions have dropped. Construction of new developments is on hold.

Property prices in Kiev dropped 23% to US$3,260 per sq. m. in February 2009, after peaking in August 2008 at US$4,227 per sq. m. Prices are still up on the year, however.

“It is not time to buy yet,” says Nickolay Omelchenko of KievApartment.com. “But I am shopping. I am recommending my clients to start the search, and to buy this late spring.”

“Remember - there are many real estate agencies, many offers on the market, and few of us – buyers. It was that way before the price rises - and it is like that again, now.”

With the massive size of the property bubble (a nominal price increase of 562% from 2002 to 2007), it will take a while for the housing market to correct itself.

Intentionally limiting supply

In other countries, developers responded to massive price increases by building new supply. This did not happen much in Ukraine.

New developments in major cities are typically dominated by two to three companies, whose management is directly linked to the local authorities. In Kiev, nearly 70% of the new residential buildings are built by companies that belong to the KyivMiskBud holding company, in which the Kyiv City State Administration has a large stake.

Despite the price increases from 2005 to 2007, the supply of new apartments has barely risen. In 2007 to 2008, only 95,000 new apartments were built. Although this was higher than the 63,500 units built annually from 2000 to 2003, these new units were barely enough to replace the crumbling units built during the communist era (almost 280,000 units were built in 1990).

So those having direct ties to high ranking officials, who are prepared to pay large bribes, come out as winners in land allocation. There are few builders, and during 2005-2007, demand largely exceeded supply, and so there was a seller’s market.

Betting against the hryvnia

Access to newly-built units implies huge amounts of money, not just any money, but US dollars. Transactions in the primary market are denominated in Ukrainian hryvnia (UAH) but paid in US dollars, while transactions in the secondary market are quoted and paid in US dollars.

The hryvnia was introduced in 1996 and initially steeply declined against the US$ (from UAH1.83 per dollar in January 1996 to UAH5.38 per dollar in January 2000).

The exchange rate somehow stabilised to around UAH5.35 per dollar before being pegged at UAH 5.05=US$1 (April 21, 2005 until May 21, 2008). But when the US dollar weakened against major currencies in mid-2008, the peg was eased. However Ukraine’s high inflation, and current account imbalance, caused the hryvnia to succumb to pressure. As of writing (March 19, 2009), the hryvnia was trading at UAH8.2 per dollar, although the official rate has been UAH7.7 since January 2008.

Hence, access to real estate in Ukraine means access to scarce and swiftly appreciating US dollars. It may even be argued that some of the property investors were simply betting on the eventual devaluation of the hryvnia.

Foreign currency risk

Despite high (and still rising) interest rates, the mortgage market has continued to grow at a breakneck pace in 2008. Although small compared to other countries in Europe, at 9.13% of GDP in 2008 outstanding housing loans are dramatically up on 2.37% of GDP in 2005.

Outstanding housing loans more than doubled from UAH40.78 billion (US$5.2 billion or €3.86 billion) in 2007, to UAG88.35 billion (US$11.3 billion or €8.36 billion) in 2008. (the large increase in housing loans during the last quarter of 2008 was simply due to the collapse of the dollar peg).

However, more than 86% of outstanding housing loans in Ukraine were denominated in US dollars in 2008, while 10% were in UAH. Monetary and fiscal authorities in Ukraine should be worried, because the exposure to foreign currency risk is very high.

Problem loans up

With the currency peg to the US dollar, interest rates in Ukraine should follow key rates by the US Fed. But with substantial political and economic risks in Ukraine, banks are only willing to lend at a very high premium.

Interest rates on US$-denominated housing loans averaged 12.1% in 2006, and 12.8% in 2007. By January 2009, interest rates were 16.7%. Experts warn that the only borrowers willing to pay this high premium are property speculators expecting massive capital gains when flipping properties.

Interest rates on housing loans in Ukraine are usually fixed for the entire loan term. In 2006, 98% of outstanding housing loans had a loan term between 1 to 5 years. In 2008, 92% of loans had a loan term of 5 years or more (75% at ten years or more).

However, housing loans are frequently prepaid before maturity, and it is typical that a 10-20 year loan is paid within 3 – 5 years. The situation is typical in a market dominated by speculators and property-flippers.

The National Bank of Ukraine noticed an increase in the number of problematic loans (past due and suspicious), as early as the first half of 2008. The number of problematic loans is expected to rise in 2009 as more investors and speculators default on their loans.

More troubles ahead

Ukraine’s future looks bleak. Political stability is still elusive. There is squabbling between pro-West groups. Unless President Yushchenko consolidates the pro-West vote, he is likely to lose to a Russia-friendly candidate in the January 2010 elections.

Ukraine’s strong economic growth for the past eight years (average annual GDP growth of 7.3% from 2000 to 2008) is unlikely to be sustained. The economy is expected to contract by up to 6% - 7% in 2009, the biggest economic contraction since 1996.

The main reason is a dramatic drop in steel prices and exports. Steel accounts for more than 50% of exports. Ukraine’s most important steel and machine-building equipment market is Russia, now heading into recession.

Despite the economic downturn, inflation is expected to remain high in 2009 at 16% - 18% - but an improvement on the 25% inflation in 2008.

Structural reform is occurring at a snail’s pace. This is still a state-dominated economy, where permits, connections and bribes rule. Industries are ruled by oligarchies.

With the economy in near collapse, and a ‘soft state’ often on the brink of civil war, the property bubble burst is unlikely to be near the top of government priorities.