The coronacrisis has hit the Russian construction business hard, but residential development is booming thanks to a generous 6.5% subsidised mortgage scheme the government introduced and has just extended for another year.

Construction is one of the three big economic drivers (consumption and investment are the other two). With the economy expected to contract by 4.1% this year, according to the latest International Monetary Fund (IMF) forecast, the government has been rolling out a number of measures to sooth the pain, and pumping money into mortgages appears to be one of the most effective.

The crisis has hurt Russia less than expected. That IMF forecast is a revision from its earlier prediction of a 6.6% contraction and that takes into account a 23% contraction in April alone in the midst of the double whammy of the collapse in oil prices and the start of the coronavirus (COVID-19) epidemic in Russia. That was the month the government rolled out the mortgage subsidies programme.

Real estate companies specialising in building apartments have all been putting in very strong numbers in the current reporting season as millions of Russians take advantage of cheap borrowing costs to buy a place to live. Things are going so well that the residential developer Samolet Group has just priced an IPO that values the company at circa $750mn and should be completed on October 29.

The issue of new mortgages contracts have been growing at a very fast pace. As reported by bne IntelliNews, the issuance of mortgages in Russia jumped by 38% year on year in absolute terms to 0.158mn loans, and by 59% y/y in monetary terms to RUB375bn ($5bn) in August 2020. Mortgages now account for up to two thirds of the purchases of new apartments amongst the leading developers. Indeed, the business is doing so well that Alexander Danilov, director of the banking oversight department at the Central Bank of Russia (CBR), warned on October 9 that a mortgage market bubble may be forming.

"There are no reasons for worry now. About RUB400bn ($5.2bn) of loans were given in the framework of the [mortgage subsidy] programme as of the beginning of September, while the total limit is RUB900bn. This is not much, because the entire mortgage portfolio of banks stands at about RUB8.5 trillion," Danilov said. But he warned the demand is so high that it is pushing prices up. Once the programme ends and if Russia is hit by another external shock then the people’s income will fall and credit risks will rise. Deputy Finance Minister Alexei Moisseev also said earlier in 2020 that the cut-rate mortgage programme subsidised by the government can cause a market bubble.

But for the moment the government deems it is more important to keep the economy running than it is to worry about hypothetical property bubbles.

Having said that, the government is still being cautious and has developed a monthly rating system for mortgage issuing banks. The Russian state housing agency Dom.RF and Frank RG agency are assessing the actual mortgage rates across various segments, as well as other indicators, to see which banks dominate which niches such as segments as new housing, refinancing, individual housing, Mikhail Goldberg of Dom.RF told Vedomosti.

Goldberg said that in August the number of mortgage applications through the top 20 Russian banks topped 0.6mn as compared with 0.45mn in March. Analysts surveyed by Vedomosti believe that even a rating of top 10 banks would suffice to give a clear market picture, as the concentration is high, with the top 20 banks accounting for 97% of the market.

After debating the issue for a month the Kremlin has just decided to extend the programme into the New Year and increase the funds available 2.4-fold to RUB1.9 trillion.

The Ministry of Finance has submitted a draft resolution to the government proposing an additional 354,000 mortgages for RUB1.1 trillion, on top of the existing subsidised programme. MinFin estimates that RUB800bn and 268,000 mortgages will have been issued by 1 November 2020 (the previous deadline).

“The previous draft resolution of the programme implied that it would be prolonged until the end of 2021, while the overall value was to be increased threefold, to RUB2.8 trillion. On October 14, the timing was shifted to 1H21, with a value of RUB1.9 trillion,” Marina Kolbina, an analyst with VTBC, said in a note.

The 6.5% rate is very cheap and half what the rate was only two years ago. And the rate is expected to continue to fall. The CBR’s prime rate has been cut consistently in the last years and currently stands at 4.5%.

One of the most remarkable difference between this crisis and the previous big crises in the past in 1998, 2008 and 2014 is the CBR cut rates when the shock hit, rather than raising them. In the past it was more important to protect the collapsing ruble than to try to boost growth. This time the ruble did fall, but by nowhere as much as in previous shocks. By the summer oil prices were down by some 45% but the ruble had only fallen by 17%, largely thanks to the foreign investment that was still flowing into the domestic bond market. The CBR rate cuts are currently on pause due to the increased political tensions with the West, but economists expect them to restart towards the end of this year or the start of next, which will only drive mortgage origination further. Analysts estimate that for each 1% fall in interest rates mortgages become affordable to several million more Russians.

“The current rate is a record-low level and has become a key tailwind for residential sales. Since its inception, the programme has covered RUB630bn in mortgage origination, which is 70% of the total limit (RUB900bn). In 9M20, the total value of mortgages grew 38% year on year to RUB2.7 trillion (and the September figure was a record high). On the primary market, the programme has accounted for some 75% of total origination,” says Kolbina.

The difference between the residential business and the development of office and commercial real estate, which are not getting any government help, is very stark. Office space sales and lease deals in Moscow in 3Q20 dropped 2.5-fold y/y to 0.15mn square metres, Vedomosti daily reported on October 8 citing data from JLL. That is the lowest level its been since 2006. The third quarter of this year was one of the worst on record for the office segment since the last big crisis.

The government’s lifeline to residential construction has been a real boon, but has had different effects on different developers.

In the first nine months of this year the sector’s market leader PIK, which is five times larger in market capitalisation terms than its peers, reported very strong results last week.

In 3Q20 "total value of contracts rose 52% in ruble terms and 29.5% in [square] metres – impressive growth, amid lower mortgage rates and the mortgage support programme," BCS Global Markets commented on October 16. The share of mortgage sales stood at 77% for 9M20 for PIK," VTB Capital (VTBC) said in a note. 

The sales of Russia’s second biggest player, the LSR Group, did best of all, with sales growing by a 49% y/y rise in new contract sales to RUB29bn ($376mn) and 33% y/y in area terms to 0.24mn square metres.

"LSR has released a strong 3Q20 trading update, with volumes surging 33% y/y, reflecting the support from the subsidised mortgage programme (credit deals were 72% of the total versus 47% last year) and the low comparison base," VTBC wrote on October 21. 

The new kid on the building block, Samolet, reported flat revenue growth in the first half of this year at RUB23bn ($302mn) and Ebitda up by 5% y/y to RUB3.9bn, but saw profits up 44% y/y to RUB688mn under IFRS.

The odd man out was Etalon, which was the only one to see sales fall. Sales were down 19% in 9M20, but started to recover strongly in the third quarter: revenues were up by 10% y/y in 3Q20 alone in term of square metres. In monetary terms, the sales were down by 4% in 9M20 but jumped by 40% y/y in 3Q20. As reported by bne IntelliNews, Etalon previously saw weakness in 1H20 and the rebound in the 3Q20 quarter sales is welcomed by the analysts.

For Etalon, the company's mortgage contracts increased by 35% to 1,260 units in 3Q20, while the share of its mortgage sales reached 47% of total sales (64% for apartments).

Share price performance does not reflect the revenues 

The share price performance doesn't quite reflect the revenue growth. PIK has long been an investors’ darling and it became a bit of a “tourist stock” for international investors looking for exposure to Russia’s real estate market: foreign investors bought PIK and ignored the rest, leading it to outperform.

The share price performance charts shows very clearly the equity market boom in the first month of this year, where the RTS briefly topped 1,600 – somewhere it has not been for most than five years – before the perfect storm of oil price crash and the coronavirus (COVID-19) pandemic broke over the market.

During the short-lived enthusiasm for Russian stocks, traders had already started buying the second and third tier names as they already held the incumbent, and Etalon’s shares in particular did very well. It actually took another two months for the market to reach bottom on March 18 before staging a gradual recovery since.

Investors of course bought PIK first, which didn't fall as far during the February rout and had made back all its loses by July 28. Today PIK is the only one of the three listed majors to have actually returned investors a profit, up by 21.6% as of October 21. LSR is down by 4% and Etalon by 5.3% on the same date, against the RTS index, which is down by 26.2% on the same day.