Moscow's Impending Real Estate Crash

It's been a while since I've written here. I hope my devoted readership doesn't mind all that much. I've gotten side tracked by a few things, like trips to the provinces and a weird and interesting encounter last night that may prove pretty promising, but more about that later. I hope my devoted readership doesn't mind. So since I live in Russia, you would think I would focus more on the motherland, but with the crisis in America and everything, which is just so much more interesting, I mean a once in a century event, my attention has been elsewhere.

In any case, as anyone living in Moscow may know, over the past few years, real estate prices have gotten to ridiculous levels, especially given the average income in the city and the quality of living space. For instance, I live in a pretty crappy 3 room apartment, far from the center and in a not particularly posh region to say the least. Apparently, this apartment would now fetch about $300,000. Doing a quick, back of the envelope calculation, that would mean that a mortgage this apartment would cost $42,000 a year, assuming a 17% interest rate (not too ridiculous in Russia), a 5 year term (again, pretty standard) and 52% down (a whopping $156,000, but once again standard in Russia). The first question I have to ask is how many Muscovites can afford $156,000 up front, especially when you consider that the median income is somewhere around $1200 a month. Secondly, we pay out 33,000 roubles a month, which translates into about $15,000 a year, roughly what the average Muscovite makes. Therefore in Moscow, annual mortgage payments cost roughly 3 times as much to buy as it does to rent, even with 52% down! By comparison in the US monthly mortgage payments generally cost about 1.4 times rent, and it's pretty easy to pay only 30% down for a prime mortgage, as opposed to the 52% required by Russian banks. I am not going to go into subprime here. In any case, Moscow is clearly ripe for a fall.

There have been a number of factors driving up Moscow real estate prices over the past few years. First and foremost, many wealthy Russians, who don't know how to or are just not comfortable investing in stocks, bonds, mutual funds, etc. chose to invest in real estate, because it is a more tangible asset. Nevertheless, this has naturally resorted in quite a bubbly market. Additionally, for anyone, who hasn't been to Moscow, for Russians and the former Soviet Union, more generally, Moscow is something like New York, DC and Los Angeles all combined into one, granted with some of the high culture aspects stripped out and left in Petersburg. As a result, anyone stuck in a village with no work, nothing to do and aspirations to something greater comes to Moscow, driving up the price of real estate. For instance, this weekend, I was out in a small village in the countryside 525 KM from Moscow, where there is absolutely no work and nothing to do. When I asked how people make a living, my friend Dima told me half of his classmates from school had come to Moscow to work construction and make a living.

Although many in Russia initially believed it would be immune to the current crisis in the West when it first appeared last fall, a year later, the RTS index is down about 70% and the country completely cut off from the world debt markets, it's clear that it has certainly taken its tole. Despite the fact that the Russian economy is not anywhere near as leveraged as the American economy, loose banking standards are certainly affecting the banking system here. Additionally, Russian banks are having trouble raising money abroad, resulting in a complete clamp down on long-term lending such as mortgages and commercial loans, as in the West. The first victims of the crisis after the banks will likely be the Moscow real estate developers, reliant on this funding, who have already halted a number of projects. This means that the provincial, Caucasian and Central Asian gasterbeiters (construction workers) will likely soon find themselves out of work and forced to search elsewhere. Typically, these gasterbeiters rent out small, run down apartments in the more run-down sections of town. However, when they are gone, demand will decrease and these apartments will become vacant. Many young residents of Moscow, like yours truly, may opt to sacrifice living standards for a cheaper rent, thus pushing down prices throughout the city.

Despite these headwinds, my friend Andrey assures me that he doesn't think a market crash is imminent, due to a lack of transparency in the Moscow real estate market and the relative unpopularity of mortgages in the country. While the Moscow real estate market lack of transparency in the real estate markets may retard the decline of prices, it will still eventually happen. Also, real estate is not a liquid investment. Even in America, where housing prices peaked over two years ago, they are still declining and showing no sign of stopping. By contrast, the Dow Jones has shed about 20% in this October alone. A drop in Moscow real estate prices won't happen over night, but the bubble still has to burst eventually. Secondly, although mortgages are only a recent invention in Russia, they still were still taken out for a lot of real estate purchases in Moscow over the past few years. The lack of availability of mortgages will certainly put another dent in demand for Moscow real estate.

Finally, Andrey maintains that not all regions are likely to be affected equally. While the regions on the outskirts of the city, home to migrant workers will likely see a drop in prices as a result of their departure, the Center might not. However, the center is generally home to Moscow's wealthier business class, the Muscovites most likely to be licking their wounds from this year's crash. Victims of Russia's stock market crash are far less likely to be making any kind of investments in the coming year as their capital base is depleted and worries about the crisis are in the front of their mind.

Before the financial crisis truly hit Russia, demand for apartments in Moscow had already reached an unsustainable level, given the massive discrepancy between earnings and the price of real estate. The price effectively left Moscow apartments off limits to everyone except for Moscow's rich, who while plentiful still have the majority of their assets tied up in real estate already. The crisis will merely serve as the catalyst for the bursting of the bubble. My main question now is how this is going to affect the Russian economy as a whole. Real estate and construction are huge parts of the Moscow economy. Additionally, wages earned at Moscow construction sites provide a living for many in the impoverished provinces. My only hope is that when the bubble bursts, some wealthy Russians will shift some of their assets into other classes. Russian stocks are an amazing buying opportunity right now. Maybe if there had been some more local money in the stock market, the fall wouldn't have been as severe when the fly-by-night, Western, hedge fund managers pulled their money.