Almost as soon as the double whammy of the coronavirus (COVID-19) pandemic and a concurrent collapse in oil prices hit Russia’s economy last March, the government reacted by introducing a mortgage subsidy programme that cut the effective rate for would-be homeowners buying newly built residential housing to 6.5%. The programme has been a resounding success; in fact maybe a little too successful, as the Central Bank of Russia (CBR) is worried that a housing bubble may be forming as demand for new apartments has ballooned.  

The programme is due to end this summer and industry players think that it may be cancelled or at the very least trimmed down. What will happen then is not clear.

The goal of the programme was multiple. The increased demand for housing allowed construction companies to keep working and avoided layoffs in one of the key growth-driving sectors of the Russian economy.

The flow of loans also provided relief to the banking sector, where mortgage loans have become one of the main money earners for the sector.

The Kremlin’s long-term goal of increasing homeownership got a boost too, as it acts as “social cement” and improves the average quality of life. Owning property, so the argument goes, makes people less likely to protest, as well as more subordinate to the state thanks to the dependence on state services and their personal investment into bricks and mortar.

Russians jumped at the deal. Real estate developer says that each percentage point that rates are reduced by adds millions of new customers for whom a mortgage becomes affordable. And rates have been falling steadily for over six years, each year significantly expanding the pool of potential buyers.

The rate cuts stopped this March this year when surging inflation finally forced the central bank to bring its six-year-long easing cycle to an end, but economists believe that the current surge in inflation is the hangover from last year’s crisis and rates could start to fall again as soon as next year.  

Housing boom

Since the mortgage market appeared in about 2003 – the first mortgages were offered by Delta Bank, a USAID funded initiative, as growth of mortgage use is equated with promoting democracy by the US government for many of the same reasons that appeals to the Kremlin – the market really only took off in around 2008 and has been growing very strongly ever since.

Initially Russians used a mortgage credit as a bridge loan between buying a bigger place and being able to sell their old place to pay for it. Mortgages were often paid off in full within a few years or less. Few held their mortgages to term.

That has changed dramatically now. Developers report as much as half to three quarter of their sales are now paid for with a mortgage and that the borrower intends to keep the credit to term.

​The mortgage market has proved a boon for the four market leaders, PIK, Etalon, LSR and Samolet Group, which have seen steady growth and a steadily expanding pool of potential customers.

PIK is the stand-out front-runner in the business and an investors’ darling, putting in strong results quarter after quarter. Samolet is the new kid on the block, profiled by bne IntelliNews just before its IPO last year, having listed on Moscow Exchange (MOEX) in October with a valuation of $750mn, and has seen its share price soar by a third in the first quarter of trading this year. PIK was also profiled by bne IntelliNews in 2017 at the start of its run and has seen its share price go up by 60% in the same period.

All in all, Moscow housing sales were up a robust 22% last year, despite the coronacrisis, and residential sales soared across the country thanks to the government subsidy programme. The market leaders saw their profits rise even faster, with Samolet seeing revenues up by a third (36%) in the first quarter this year alone, its first financial results since going public.

“The sector results were mostly strong in 1Q21, potentially featuring one of the last periods of full support from subsidised mortgages and an outperformance by leading developers with wide market offers,” VTB Capital (VTBC) said in a note. “Quarterly mortgage origination was up 53% y/y to RUB1.2 trillion, while the [interest] rate hit a record low 7.0%.”

As a group the listed developers guide for a blended volume uplift of 25% y/y for this year, reports VTBC, ahead of analysts' expectations, although that result may come in lower if the government chooses to end the subsidy programme.

But even if the programme is ended the rates may come down anyway. The previous programme subsidised rates to bring them down to 10% when the market rate was 12% but following the CBR cuts they fell below 10% on their own and that programme was ended. While the CBR rates are anticipated to climb to 5.5% this year, crisis-induced inflation pressure is expected to fade as the year wears on and the CBR could go back to cutting rates next year that will bring them down again to the 6.5% level or lower.

Housing bubble?

The decision on ending the programme has not been made and the big increase in demand it has created has led to the increase in housing prices to the point where the CBR has said out loud that it is worried about the appearance of a housing bubble. The regulator is against extending the programme again.

“Primary market prices have been climbing in the last twelve months, driven by developers’ price over volume strategy, their desire to maximise returns for projects under pre-escrow regulation and elevated demand, particularly due to tailwinds from the subsidised mortgage programme. As primary deals added 30% y/y in 1Q21 in Moscow, prices climbed 20% y/y,” VTBC reports.

This supported the primary market, with prices in Moscow adding 21% y/y in 1Q21, according to Metrium, while in St Petersburg prices added 26% y/y in 1Q21, according to Real Estate Bulletin. Secondary markets in both cities saw a comparable advance in prices (up 18- 23% in 1Q21), according to R&D Centre ‘City Development’ and Real Estate Bulletin.  

 

 

Debating the programme

The mortgage lending programme is a large-scale subsidised primary market lending programme introduced in late April 2020: the current cumulative origination stands at RUB1.1 trillion ($14.8bn) versus total mortgage lending of RUB4.2 trillion ($56.7bn). This is about 1% of annual GDP and about a quarter of all mortgage lending during this period.

The first programme had the following conditions

• borrowing rate of 6.5% or less;
• only primary market borrowing is eligible, i.e. new housing;
• max borrowed amount of RUB8mn and RUB3mn for Moscow and St Petersburg versus other regions respectively;
• minimum down payment of 20%;
• total lending cap under programme at RUB740bn;
• the lender keeps full credit risk and is reimbursed monthly an amount equal to Central Bank of Russia's [key rate + 3pp max (6.5%, lending rate)] on the residual size of the loan;
• expiry date set at 1 November, 2020.

However, in November the programme was extended with the following changes:

• max borrowed amount increased to RUB12mn/RUB6mn for Moscow and St Petersburg/other regions;
• min down payment reduced to 15%;
• total lending cap lifted to RUB1.8 trillion;
• expiry date pushed to 1 July 2021.

The programme is due to expire in the summer but analyst say it may be extended, although they are expecting more adjustments to the conditions such as the possible exclusion of regions with the largest price rises.

VTBC says the current debate is mostly shaped by an attempt to reconcile three visions for the programme:

• A 'growth focused' vision of the programme assumes that it has been effective in supporting housing demand and suggests that it thus needs to be extended – preferably committing public support for another 34 years.
• A 'price stability focused' vision of the programme assumes that it has been key to the spike in real estate prices, and thus ultimately reduced affordability, so if housing inflation were to be allowed to run unchecked it could ultimately result in new financial vulnerabilities. Therefore, this argument goes, the programme must be either abandoned or constrained to a regional instrument.
• A 'public finance focused' vision of the programme is concerned with its efficiency, i.e. how much marginal demand the programme delivered per unit of funding and with accumulating floating rate liabilities at uncertain future cost for the tax payer.

What next?

The end of the CBR’s easing cycle will already put a brake on residential real estate growth. Interest rates are not expected to rise dramatically but the overnight rate has already been raised from 4.25% at the start of this year to 5% after the CBR hiked in March (25bp) and April (50bp). CBR Governor Elvira Nabiullina kept the door open to more hikes later this year and analysts say another 50bp could be added to the prime rates.  

Samolet told bne IntelliNews in a recent interview that it will not increase prices and that banks offering loans won’t raise rates as fast as the central bank to maintain their market share in what has become an ultra-competitive segment.  

In the first quarter the area under construction of residential real estate contracted by 13% y/y to 100mn sqm, the sixth consecutive quarter of contraction in Russia, as smaller and medium-sized players were unable to adjust their operations to the new escrow legislation requirements introduced last year after financing construction using pre-sales was banned. The smaller companies lack access to large-scale funding and are being pushed out of the market.

“Thus the sector consolidation continues, with the share of the ten largest companies increasing 1.5pp y/y to 19%. The implementation of escrow accounts is picking up, and 57% of the total portfolio (+27pp over the last 12 months) is being realised under this scheme as of March 2021, Dom.RF figures indicate,” VTBC reports. “According to the United Registry of Homebuilders, 1,978 homebuilders in Russia have portfolios of less than 100k sqm and account for 40% of the area under construction, which could trigger a further narrowing of the sector,” VTBC adds.

In the first quarter residential completions increased 15% y/y to 17.8mn sqm, reflecting a pick-up in the construction pipeline in the second half of this year.

The total amount of construction permits issued during the quarter reached 871 (+15% y/y) for a capacity of 7.2mn sqm vs. 4.7mn sqm as of the first quarter, as the overall project size has increased.

“The second quarter of this year will have a low comparison base, as last year construction sites were frozen from early April to mid-May in a number of regions, including the core Moscow Metropolitan Area,” VTBC reports. “It represented 30% of country completions in 1Q21 and 50-100% of sales for listed developers, while its higher prices (a more than twofold premium to Russia) brought favourable construction economics to local operators.”

The government estimates that completions will correct 5% y/y to 78mn sqm in 2021, according to Deputy Prime Minister Marat Khusnullin. The long-term target of 120mn sqm annual completions by 2030, a goal that is part of the 12 national projects, remains intact, implying a 2020-30 compound average growth rate (CAGR) of 4% versus the 3% observed over the last ten years.

“The programme could be prolonged further to YE21, but this initiative is opposed by the CBR, and is only going to be supported by the respective regulator if its conditions are modified. Potential updates could require the exclusion of those areas with the highest price growth (Moscow, St Petersburg and Krasnodar Region) and would target the social contribution of the programme,” VTBC concludes.