| 26 September 2007 |
 
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The consequence of the mortgage crisis in the U.S.A. which started in spring 2007 is the shortage of free cash assets at the international financial markets. Many western banks floating building loans became more conservative in their views toward refinancing of projects, cut their lendings down expecting more favorable market situation.
LIBOR rate fluctuations, most evident in August 2007, show the instability at the American and European stock markets. Against this background some western banks operating in Russia have started revisions of the real estate sector credit conditions taking into account the increased risks and shortage of free cash assets, that may generally result in an appreciation of commercial and residential real estate building. Today about 70-75% percent of real estate buying transactions at the Russian market are subsequently refunded by banks.
In case of considerable cost increase in the of borrowed funds and consequent increase of building costs it will become unprofitable for developers to increase the volumes of construction. Many of them will leave the current projects, demand for which will decrease with the simultaneous increase of the market capitalization rates. The investors will be able to purchase such real estate units on more beneficial terms.
In such a situation the rent rates increase is not justified. Most probably, they will be corrected insignificantly, but there won’t be any considerable increase. It is primarily related to market buying capacity; the tenantry may not be ready for change in supply price in such a short period of time.
Due to reduction of construction speed and increase of capitalization rates, the quantity of investment transactions may lower at the market. At the same time, the investors` requirements to the quality of real estate units offered for sale will grow higher.
Jeremy Oates, Managing Director of Knight Frank Russia and the CIS:
“From the viewpoint of the real estate investments, the appeal of the Russian market is rather high, and, due to its growing potential and high profitability rates, the interest of the western investors towards this sector will only grow stronger. We are expecting certain correction of the Russian market, due to temporary instability at the European and American financial markets, but there won’t be serious changes in the proportion between demand and supply cost. The situation will remain stable, and the quantity of the real estate buying transactions, as well as capitalization rates, will increase in the midterm”.
Ekaterina Tain, Partner and Director of Residential Real Estate department of Knight Frank:
“During the recent several years the Russian market of the elite residential real estate wasquite comfortable. We are observing the increase of buying activity, notwithstanding fast growth of the market prices. For example, in 2006 the increase of prices in the elite residential real estate sector in Moscow reached about 92% and broke the absolute records of the previous years. With relatively stable demand for the premium real estate units, there is a shortage of high-quality supply at the market. At that, any significant increase in supply is not expected within the next few years.
The increase of mortgage crediting rates, which started in 2005 at the American market and the subsequent housing price fall, collapsed a number of mortgage banks and later led to a still larger-scale crisis in the U.S.A. financial sector. As a result, the international investors and the central banks of developing countries, that invested in the American securities, happened to be endangered.
There are very few mortgage transactions at the Russian market – about 5%, while in the other countries, especially in the U.S.A., the major part of housing is bought on credit. In such a situation no serious consequences of the financial crisis at the European and the American financial markets and their influence on the housing market are expected”.
Evgeny Semenov, Director of Capital Markets and Investments department of Knight Frank:
“The trends we have noted during the recent 2-3 years related to the commercial real estate market, indicate the positive dynamics of development of all sectors – office, trading and storage estate. We observe the increase in demand for such real estate units and the simultaneous rent rates increase, except for the storage real estate market. Of course, against this background, the increase of developers` expenses related to construction, power supply and other.
Against the background of the general growth observed in the sector of the commercial real estate in the recent years, the process of market correction is obligate on the next stage. In my opinion, the financial crisis in the U.S.A. and Europe have accelerated this process to some extent. Of course, this is a check of financial safety margin of companies. The crisis won’t affect the developers already known at the market, and it will be much easier for them to obtain borrowed funds, than for semi-professional stock market players”.
Heiko Davids, Director of Investment at Rutley Russia Property Fund:
“Making a decision on purchasing of the real estate units, the western funds working in Russia turn their attention to the internal rate of return. In the circumstances concerned, the value increase of the borrowed funds may be anticipated, mainlyl on the part of the western banks that will surely affect the cost of project financing. Some banks will either weaken the Russian market binding their time, or revise terms of units crediting.
With the development of the economy, the borrowed money become cheaper for the market, but the situation is absolutely different now. It is evident that in such conditions the investors` requirements to the quality of the purchased real estate units, contracts of tenancy and the structure of transactions, where the Russian partners participate, will be revised. If there’s no revision of terms on the sellers` part, some decrease in the number of investment transactions in the Russian real estate market may be expected”.
Maxim Sterlyagov, Associate Director (department of Real Estate Investment Management) Morgan Stanley:
“There’s still no single standpoint concerning the issue of how the financial crisis in the U.S.A. will influence the Russian economy. The question is, if the growth deceleration in the U.S.A. affects the markets of the developing countries (China, Russia, India). If we consider the worst-case scenario, the possible consequence will be power supply price fall at the world markets, and as a consequence – the growth deceleration in Russia.
The Russian economy remains one of the most dynamic in Europe, due to growing domestic consumption, so the possibility of such a scenario is very low. A significant part of free cash assets is invested in the most income-producing sectors, including the real estate market. Still, one of the main criteria is the supply shortage at all market sectors, that is why the situation at the Russian market will remain stable, and it is untimely to anticipate any negative consequences related to the financial crisis in Europe and the U.S.A.
It is possible, that in the short-run there will be less purchase and sale transactions with completed real estate units; capitalization rates increase is also anticipated. Investors will give preference to the premium real estate segment. The developers will solve the problem of financing by means of bringing in strategic investors”.
Alexander Olhovsky – Vice President (corporate department) of JSC “Vneshtorgbank”:
“Russia has rather strong market which will manage the crisis consequences in the whole. Of course, week market players following an unbalanced financial policy will be the first to leave the market. Developer’s companies having big percentage of borrowings in the liability structure will face difficulties. I think, in such a situation further market consolidation through takeover of marginal players, and the projects realized by them will be under way.
Taking into account relatively low volatility of commercial real estate market, the rent rate changes should not be anticipated during the nearest 6 months. Even in the worst-case scenario, some time is needed for the financial situation to affect the real estate market.
I think that the most risky is the market of economy class housing, notable for high degree of vagueness. In particular, in this sector there are the highest risks related to the project financing structure: low amount of equity and borrowed funds, and up to 85% - share participation. Under unstable market situation – this is the most risky variant of project financing. Some time the project implementation may be suspended due to the lack of the developer’s funds”.
Ivan Sitnikov, Director General of the "RosEuroDevelopment" LLC:
“The general state of euphoria present at the Russian real estate market during the last few years, had also an effect on the banks which operate in this sector. Many of them ceased to pay attention to the quality of their advances portfolio, following the policy of maximum availability of granted credits.
It is clear, that in the current situation insolvent borrowers, whose number can include small semi-professional developer’s companies, are identified by them as being in the risk group. If a small bank has a big number of such clients, it will hardly pass through the coming market crisis. The real estate market is more sensitive to various fluctuations in the financial sector. With the increase in the cost of borrowed funds the developers` margin will shrink, and the market consumption power will lower”.
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