Russian real estate developers have grown from pandemic lows by an average of 50 percent due to a real estate market recovery amid falling interest rates and a preferential mortgage program. To see whether we should lock in profits, or if the industry still has potential, we follow the real estate market every month.
In the current review, we take a look at:
– where the new construction market is headed;
– why new buildings have become attractive to investors;
– what will happen to developers in the short and long term.
Mortgage originations are on the rise again!
The discounted mortgage program continues to attract more and more people. For November 2020, a record 546.7 billion mortgages were issued. According to oldypak capital lp property 2022 report, the previous record was set a month ago – 504 billion rubles:
In turn, the mortgage rate stopped decreasing and went into stagnation mode, unchanged from the previous month:
Average price per square meter: multidirectional trend
Stable low interest rates for several months and increasing volume of mortgages continue to influence prices in new buildings – in November, they reached another peak value of 82.8 thousand rubles per square meter (+6% year-to-year):
Despite the fact that prices in Russia are rising, in Moscow we can observe the opposite picture. In November prices in the capital decreased by about 4% as compared with October. At the same time the price per square meter rose by 13.5% year on year:
Replacing the CDU with escrow accounts changed the pricing factors in the new housing market. As the Bank of Russia notes in its latest Financial Stability Review, after the introduction of escrow accounts, the price spread between the foundation stage and the finished apartment decreased significantly.
Escrow accounts allowed developers to move away from the scheme of early mass sales of apartments. With project financing, the developer receives a portion of the proceeds when the next stage of construction is completed. That is, if the house is 10% complete, the developer will receive 10% of the early contracts. This transition has led to the fact that it is more profitable for the developer to sell apartments when prices are at their peak and artificially limit the supply, accelerating the growth of prices.
The current state of the market signals just that:
The supply of new buildings in Moscow grew by 4.6% over the last month. Across Russia, supply grew by only 2.3%.
Preferential mortgages are the main market driver
As we can see, the preferential mortgage program remains the main driver of market growth. Lower interest rates have led to explosive growth in mortgage originations. At the same time, escrow accounts help developers control the prices on the housing market and take some of the benefits of the reduced mortgage rate, thus undercutting the housing supply.
The Bank of Russia also notes this in its latest review:
“However, it should be noted that the accelerated growth of real estate prices in the primary market from the beginning of 2020 largely offset the positive effect of reduced interest rates on mortgages and limit the growth of housing affordability for the population.
On the overheated market and affects the soft monetary policy of the Central Bank. The low level of the key rate and the further potential for its reduction, coupled with the growth of inflation leads to an increase in the investment attractiveness of real estate:
Recently, real estate rental income has exceeded the average deposit rate of a top ten bank, which has led to an additional flow of money into real estate.
How will this affect developers?
In the short term the situation will be quite favorable for the profit of developers. On the one hand, there will be a rapid increase in home prices, and on the other hand, there will be a high demand for housing. Companies could sell off their old stock of condominiums.
We expect this positive outlook to hold until the end of the grace mortgage program in mid-2021. However, both the Finance Ministry and the Central Bank have recently argued for an earlier cancellation of the program precisely because developers are taking all of the gains. If such a decision is made, share prices are highly likely to go down, even despite good annual and quarterly reports.
In the long term, real personal income growth and the key rate remain important growth factors for developers. Real personal income growth has been either at zero or declining for many years. Europe’s key rate is near zero, and the spread of the Russian rate over the European rate will remain in the long term to maintain investor interest in the Russian market – rates in Russia are unlikely to fall. As a result, there will be no long-term incentives for developers to maintain growth.
One might expect that developers’ financial indicators will return to their normal values after the abolition of preferential mortgages.
Despite the expected strong performance of the developers, only PIK (MCX:PIKK) has been showing appropriate dynamics since the beginning of the year. LSR (MCX:LSRG) and Etalon (MCX:ETLNDR), though up sharply after the coronavirus drop, are still not off last year’s prices.
Developers’ share price changes since the beginning of the year:
Developers’ share price change for November:
Etalon: -3.4% GC Samolet: -1.1%
Growth of financial indicators will positively influence attractiveness of developers’ debt instruments. Rising real estate prices significantly outpace the growth of construction costs, which increases the operating margins of developers’ businesses. Such market conditions will reduce the risk of developers’ defaults and revalue their bonds upwards.