Over the past year and a half Russians could once again see that they should not write off residential real estate as a tool for saving money. Prices on the secondary market in Moscow and Moscow region from the beginning of 2020 increased by half. In new buildings the growth was even stronger and amounted to 58-60%. On a slightly smaller scale, a similar situation was observed in other megalopolises.
The key driver of price growth was a decline in mortgage rates amid a decline in current construction. In response to pandemic risks in 2020. The Bank of Russia sharply reduced its key rate to 4.25%. At the same time, the government launched a program of state support for developers, in which mortgages on primary housing could be arranged at rates around 6%. As a result, the weighted average mortgage rate went down, and the volume of mortgage transactions increased sharply.
At the same time, the industry’s transition to sales through escrow accounts contributed to the decline in the volume of current construction, which reached its minimum in February 2021. High demand on the background of declining supply became a stimulus for price growth. Additional pressure was exerted by the rising cost of construction due to a steep rise in prices for key building materials.
The market is expected to slow down in 2022. Due to the reduction of government support and the increase in the key rate, which could reach 8.5%, mortgage rates may rise in 2022. The chart above shows how the weighted average mortgage rate turned upward in August. We may see another spike at the end of November, as banks adjusted their programs this month after the Central Bank’s harsh rhetoric at its October 22 meeting.
Rising mortgage rates, high prices for square footage and the rapidly rising cost of the consumer basket may make housing less affordable for the population and cool demand in 2022. This will limit the ability of developers to further carry the rising cost of production into prices, putting pressure on margins.
There will be no decrease in prices for new buildings, at least not in the premium markets of Moscow, the Moscow region and St. Petersburg. Prices are more likely to plateau at the background of declining sales volumes. There may be a rise in all sorts of marketing and promotional events from developers who disguise a spot reduction in prices under the guise of discounts and installment plans. This might be more typical for developers who lack confident competitive advantages on the product level.
On the secondary market, the volume of supply and the number of transactions may also decline. Since homeowners have no price cap at the bottom in the form of cost, the most motivated sellers may agree to discounts, which could help drive prices down in the most overheated regions. However, no tangible decrease is expected in the average country.
Below we consider how a Russian investor in 2022 can make money on real estate and other assets related to it.
Investing directly in real estate
For investment property owners, December 2021-January 2022 could be the optimal tactical time to get good money for their property and place it in other assets. This is true for the speculative approach. Long-term investors have nothing to fear – there is no mortgage bubble or other prerequisites for a serious and lasting drop in prices. Over the long haul in Russia, real estate will long remain a reliable tool for saving capital.
For purchases for investment purposes now may not be the best time. More attractive opportunities may be available by the summer of 2022, although mortgage rates could remain high by then. However, for long-term investments of 10 years or more, the difference in price between buying today and six months from now may not be as significant.
LSR and Etalon were among the laggards in 2021, which could not fully benefit from the conjuncture due to the shortage of supply. The companies are now actively working to replenish the land bank so that they can achieve decent sales volumes in 2022-2023. In this respect, I think Etalon provides open communication with investors and gives a clear timetable for restoring sales volumes and current construction. Also, Etalon is now the cheapest in the sector in terms of multiples, which underscores the attractiveness of its stock.
PIK, the incumbent market leader, has posted record results in 2021, and its stock has renewed its historic highs. The outlook for the company remains positive, although performance could slow in 2022. An additional driver for PIK stock is its chances of being included in the MSCI Russia Index on rebalancing in May 2022.
Shares in the Samolet group have delivered outstanding returns for investors in 2021. Since the beginning of the year the securities grew in price by more than 5 times. Investors appreciated the growth potential of the business. On the horizon of 2022-2023 the company plans to hold an SPO, which will raise the free-float to 30-40%. This will significantly increase liquidity and make the paper attractive to large investors.
Bonds of developers
Yields in the bond market rose significantly in 2021. Given that the peak in inflation and the level of the key rate may not be far off, bonds with a maturity of 2-3 years look like an attractive tool for capital allocation.
Developers actively entered the debt market in 2020-2021, so there is supply in the sector. There are marketable bond issues by 25 issuers with the total issue size exceeding 300 billion rubles.
A peculiarity of the sector is that industry risks of developers are regarded as rather high. Despite the fact that the majority of bonds are rated from BBB- to A+ on the national scale, their yields are mostly above 10%.
On the one hand, investors can get high yields by investing into securities of high-quality companies. On the other hand, investors should carefully assess the risks of the companies, because even the most reliable issuers are not immune to market turbulence.
In the table below we have presented bond issues that look interesting on the 2022-2023 horizon.
Mortgage bonds – making money on other people’s mortgages
The boom in mortgage lending has had a positive impact not only on the sales of real estate developers, but also on the volume of the booming market for mortgage-backed bonds. A mortgage bond (mortgage-backed security, MSB) is a bond issued by a bank and secured by its customers’ payments on mortgages. At the heart of such a bond is a pool of mortgages, the payments on which are sent to investors in the form of coupons.
DOM.RF is the largest issuer of mortgage-backed securities in Russia. Its issues make up over 90% of the whole market of mortgage-backed securities. Mortgage bonds in Russia represent a good opportunity for investors to receive a long-term yield higher than federal loan bonds while ensuring high reliability of investments. However, a disadvantage will be low liquidity and a small list of securities available for purchase.
A list of exchange-traded securities can be found on the Moscow Exchange website. These securities are considered a complex financial instrument and are only available to qualified investors.
You can read more about mortgage bonds in a special article: Mortgage Bonds. What are they and how to make money on them
Investing big – Real Estate Investment Trusts
You can invest in square meters through closed unit investment funds (CUIF), in which funds of investors are gathered in a single pool and invested in residential and commercial real estate. Investors may become a co-owner of major shopping and business centers, production facilities or simply obtain a diversified portfolio and professional management with a relatively small amount of funds.
According to Investdunds.ru, there are more than 140 different funds in the Russian market that invest in real estate and are available to unqualified investors. But not all of them will be available for investment. As a rule, a fund collects funds from shareholders for a specific object, and when the necessary amount is collected, it closes the acceptance of funds until the next transaction.
When choosing a ZPIF, it is important to carefully study the fund’s strategy, conditions for investors and all fees to be paid for management. It is important to remember that the success of a fund in the past does not guarantee success in the future.
Investing Abroad – REITs
In the American market there is such an investment tool as REITs. Real Estate Investment Trust is a company that owns income-producing real estate or finances related operations.
An investment in a REIT is an opportunity to bet on the overseas real estate market. In a special feature on this tool, we have identified two of the most interesting funds that can bring a good return to the investor. They are Public Storage (PSA), which specializes in leasing storage space for household goods, and Realty Income (O), which specializes in real estate in the U.S. used by retailers.