We all predicted the fall, but none of us were smart enough to say when and by how much. Now it is here, and developers look set to be jumping off their buildings at the same trajectories as the rental drops.
We’ve been here before.
In the wake of the Moscow debt crisis, top office rents dropped from $45 to $22 per square meter. It took 10 years for $45 per square meter prices to reappear. By the third quarter of 2008 they reached $73 per square meter levels. Now we are at $50 per square meter levels, a 35 percent fall from last year. Top residential rents have fallen by 20 percent during this period.
Feeling brave? Want to take advantage of the low prices? What to do?
Firstly, don’t go charging after anything as Mike Willard seemed to be suggesting in his piece on advertising last week in this column [Feb. 18, “One of the five new ‘old’ rules of advertising: Now is the time to advertise … charge as others retreat.”) Charging in when nobody else is around sounds good, but the charge of the Light Brigade (a disastrous charge of British cavalry led by Lord Cardigan against Russian forces during the Battle of Balaclava in Crimea on Oct. 25 1854) was a cockup dressed up as a heroic effort after the event. It achieved nothing save a poem and a gross insult to the Turkish soldiers who, in fact, fought well, but whom the British media trashed at the time.
There’s good reason for the real estate collapse and probably further reason for further collapse.
Now is the time for serious circumspection, certainly not a time for charging the guns.
Equally though, it is not a time to run. Rather, it is time to keep your head down and your eyes open. Sift and sift through the possibilities and be ready to act if the terms look very, very good. And then buy only if you can afford to lose your bet, for bet it surely will be. Prices will fall further but there should be an up side some time.
How long to wait for the upside? Who can say … but it could be ten years for a recovery in rents based on recent history.
Closer inspection of past rental trends show a 20 percent rise in rents between 2002 and 2003. Put another way: if you purchased in 2002 you were looking pretty smart in 2003, and this purchase would have been five years after the fall.
Of course this presumes a sensible relationship between purchase prices and yields. And such presumptions are tricky in Ukraine. Yields at 5 percent and less were not uncommon in asking prices as sales price rises outstripped rental increases.
The expectation of further price rises was a factor in the sale price rises. And for some time real estate looked like a one-way bet. According to local agent Planeta Obolon, the average sale price for apartments in Kyiv in 2001 was less than $300 per square meter. By mid-2008 it peaked at $3,400 per square meter, only to plummet 20 percent over the last six months or so. That’s an eleven fold increase over seven or so years.
If history is anything to go on, five or so years seems the time it takes for the market to turn.
What drove the spectacular residential sale price rises?
The short answer is: market distortions and most notably the problem of ‘where else to put your money other than real estate.’
What Ukrainian ever trusted company accounts and local currency placed in banks? The Ukrainian stock exchange has collapsed and this together with the currency gyrations and the banking crisis have served to confirm the suspicions.
So where to go now? Not real estate, for a while at least.
It seems those with money over the last months were so fearful of its value being slashed further that the old Soviet genes clicked in and a rush for the shops ensued. They rushed to buy anything physical: cars, televisions and washing machines. Given “The Punch and Judy show” put up by the politicians, who can blame them?
So, at what point does the drop in real estate prices look attractive to buy again?
My guess is: when 50 percent of peak prices kick in, but expect to wait at least a few years to get a return. And don’t come knocking on my door with a claim, this is negative speculation.
Many real estate owners are in denial. Some can afford denial. Others don’t have the luxury. Those with no choice but to sell, and those who can afford to lose, look to be the market makers.
Could there be a possible silver lining for Ukraine?
Essentially, the world crisis stems from a misallocation of capital. In the West, easy credit bred a slovenly attitude in the bankers. Instead of looking to new markets, they satisfied themselves with what was immediately at hand, and there followed disproportionate allocations of consumer credit and mortgage finance for the real estate sector.
All was well as real estate prices rose. ‘Hell … Get a new car,’ was a common attitude. ‘The equity gain on the house will cover the costs.’ Fees and bonuses flowed with each new professional wrap on the real estate dogs, and all prospered in la-la land.
In effect the pros fooled themselves into thinking that high-risk, low-return products made sense.
If there was a shortage of low-risk places to invest, why not at least have the prospect of high returns for the high risks. This is where countries such as Ukraine can fit in. But, Ukraine is a big ‘if.’ And the ‘if’ in Ukraine is getting bigger. Don’t forget that Ukraine had its home-grown misallocation of capital in real estate.
If Ukraine could get its regulatory and enforcement rules of the game in order, or at least keep abreast of its competitors, then it should get its share of inward investment.
After all, there is a lot to do and there should be high returns. Cut out the corruption and a liquid real estate market should develop and find a proper level.
One lesson that came out of the last crisis was a realization that in Kyiv real estate you have to be prepared for the economic winter. Compared to the West, winters can be long and severe in this part of the world. As a company, you need to be configured to survive the frosts. Shallow roots and early flowering may make for a fine flash of color. But one severe winter and you’re done for.
I suspect some of our recently arrived and flashy friends came on the hot winds of business plans from la-la land. Like ten years ago, many look set to wither in the winter. You have to be able to hold on through the winter and be ready for the balmy summer.
The economic winter has just arrived. And it looks set to be five years long.
Phil Hudson is an English architect whose has been doing business in Ukraine since 1993. He is the founder and head of Jones East 8, a real estate company offering property advice, design and construction activities.
