Wile E. Coyote is a Looney Toons character famous for his tendency to injure and generally embarrass himself in pursuit of his quarry, the ever-elusive roadrunner. One of the show’s signature gags is for the coyote to run straight off of a cliff in pursuit of his nemesis, and then continue to run out into empty air until, after looking down, he promptly plummets back to earth.

When describing the Russian housing sector, very much the same image comes to mind. An entire part of the Russian economy appears to have proceeded as if it was business as usual, ignoring the enormous deterioration in the country’s macroeconomic environment in much the same way the coyote continued to run long after the clifftop had ended.

Now, a word of caution: there is no science to market timing. Plenty of otherwise excellent analysts have made fools of themselves trying to proffer predictions about exactly when a certain company or sector will come crashing down. The Russian economy has proven more resilient and adaptable than many of its Western critics expected, and so the process of a housing correction could be delayed – even delayed significantly.

But throughout the rest of this piece I will offer my rationale for why I believe that eventually there will have to be a sharp slowdown in residential development. And while I think it’s possible that this correction could happen in a neat and orderly fashion, I also think the longer the delay –and it has already been significant – the less likely the authorities will be able to keep a handle on the situation.

Cheek by jowl

First, a little bit of historical background. Pretty much throughout its history, the Soviet Union never built enough housing for its populace. Even the nostalgic New Year’s favourite, “The Irony of Fate”, a 1976 Soviet romantic comedy, quite openly shows how Muscovites (who had it far better than those out in the provinces!) were accustomed to living in physical proximity to parents and relatives in a way that Westerners would find extraordinarily stultifying. By any reckoning, then, Russia entered the post-communist era with significant pent-up demand for housing.

During the 1990s, the Russian housing sector performed just as badly as every other part of the economy. Total production of new housing fell by about 40% between 1991 and 2000, when a post-Soviet nadir was reached. Analysis of the sector is complicated by the enormous population decline of somewhere between 5mn and 6mn that took place over the similar timeframe, so it’s hard to figure out exactly how much of the Soviet-era overhang was eliminated during this period. Plausible narratives could be offered for either side.

What is not up for debate though is that, in the years since 2000, Russian housing construction has rebounded significantly, almost tripling in population-adjusted terms from 2000-14. 

On a per-capita basis, then, Russia is now building more housing than at any other point in its history. And unlike in, say, China, where writing about government subsidized “ghost cities” has become a closet industry in its own right, Russia’s modest housing boom isn’t taking place in far-flung and desolate corners of Siberia. Instead, the data show that most of the new construction is concentrated in regions (like Moscow, St Petersburg, Rostov and Krasnodar) that have a proven ability to attract migrants from the rest of the country.

So what’s wrong? Well, although Rosstat data show that the pace of construction actually increased by about 3.5% through the first 11 months of 2015, Russian consumers and the firms building all of this housing are increasingly running out of money. Consumers’ real wages have been hit hard by inflation and a gradual rise in unemployment, falling by somewhere around 10% on a year-on-year basis. As you might expect, they are increasingly running late on mortgages that they’ve already taken out.

If anything, the deterioration in the financial position of construction firms has been even more rapid, as evidenced by the growing pile of debt they are incapable of servicing. 

So, to summarize: Russia is currently in an environment in which 1) the output of housing is still increasing; while 2) consumers are increasingly unable to pay back their existing mortgages; and 3) construction companies are increasingly falling behind on servicing their bank loans. It shouldn’t be terribly controversial to argue that one of the three variables in that equation will eventually have to change.

Given the still-shaky economic situation and the poor odds of a significant improvement in the creditworthiness of Russian consumers or companies, I have to think that a correction is in order for the housing industry. As the delinquent loan data ought to indicate, Russia’s current economic fundamentals simply cannot support an ever-increasing amount of new housing construction. There’s no way for borrowers to finance a mortgage, and construction companies are either not being paid, or at least being paid far less than they expected to be paid when they took out their loans. 

The Central Bank of Russia has shown itself to be a reasonably adept bubble-popper, successfully heading off a looming crisis in consumer lending at almost exactly the right time. Their expertise, however, will be sorely tested by what looks increasing like a perfect storm in the housing sector. 

Follow @MarkAdomanis – Wharton MBA by day, Russia analyst by night.