The Lessons from Kazakhstan’s Real Estate Crisis

analysis

The Lessons from Kazakhstan’s Real Estate Crisis

By SRI ⋅ January 28, 2008 ⋅

Kazakhstan has been hit hard by the recent banking and real estate crisis. Will the lessons from this crisis lead to a more developed, resilient and just economy in the future?

Background:

Kazakhstan’s GDP grew by 10.6 percent in 2006 but slowed to 8.7 percent in 2007, and according to the forecasts of local analysts, will slow even further to 6 percent in 2008. Inflation, at the same time, grew from 8.6 percent in 2006 to 18.8 percent in 2007. The main factor that led to worsened economic conditions was the local credit crisis triggered by this summer’s subprime woes in the United States and the subsequent global liquidity crunch. This crisis has hit hard Kazakhstan’s praised banking sector and exposed its reliance on cheap foreign credit and overexposure to the speculative construction and real estate sectors.

A shake-up of such magnitude was a first for Kazakhstan. Until this summer, the market has been increasing steadily, and Kazakh real estate was among the most attractive investment plays in Central Asia. The growth came after nearly a decade of stunted development following the collapse of the Soviet Union in 1992 and the Asian financial crisis in 1998.

With the introduction of mortgages in the early 2000’s, the real estate industry began expanding quickly, especially in the more affluent urban areas. Residents of Almaty, the largest city in Kazakhstan, have been particularly active and have held almost half of all outstanding mortgages in Kazakhstan. In the last two years, however, the market has clearly been showing signs of troubles lying beneath. The unprecedented pace of growth in real estate prices has started to crowd out potential middle-class homebuyers and gave way to unregulated speculation.

As the market boomed on and reached its peak in the summer of 2007, the presence of the bubble was obvious and widely discussed. But only the global credit crisis triggered by the uncertainties about the U.S. mortgage sector has finally brought the exuberant growth to a stop. The crisis and the lack of global liquidity have forced banks to make credit standards more stringent and raise interest rates. This has virtually overnight turned Kazakhstan’s speculative demand-driven real estate market into a state of near-panic, and the years of double- and triple-digit growth in real estate prices in metropolitan have come to an end. So far, the price of one square meter on Almaty’s real estate market has fallen almost a quarter from a June peak of nearly $4,000.

Analysis:

There are several causes for the abrupt fall in prices. One is that the remaining middle class homebuyers and amateur speculators playing the market have suddenly been cut off from a source of funds. Mortgage rates have doubled, even tripled, virtually overnight, and many banks simply stopped issuing loans after the severity of the banking crisis in Kazakhstan was exposed. This resulted not only in a dramatic fall in demand for new construction but also a supply glut as many speculators (who came to dominate the market) were forced to sell their properties to meet mortgage payments.

This has been further exacerbated by the construction sector’s dependence on bank credit for its operations. The sudden lack of financing for the construction sector has left the companies without resources to finish projects in early stages of construction or start new ones. That has left a significant number of hopeful home-owners and would-be investors — who have frequently bought their properties before foundations were laid — without a home and often with little hope to receive what they paid for.

Furthermore, the majority of construction companies have saturated the market with luxury housing developments. This segment was initially extremely profitable both for the builders and the speculators in an environment of fast-rising prices. The sudden stop of speculative fever, however, has left the speculators and builders with properties that the vast majority of the population was unable to afford.

Conclusion:

While the Kazakh construction and real estate sectors have been hit hard by the crisis, its long-term effects can be positive. The global credit crisis ended the irrational exuberance of the Kazakh property market before it could further escalate and inflict more damage on Kazakhstan’s developing financial system.

The Kazakh government is able and willing to support the financial system. It has quickly agreed to allocate funds to the largest builders and banks affected by the crisis to ensure delivery of paid for but unfinished properties. This has helped to stabilize the market and calm investors.

There are several lessons that should be drawn from this experience: Kazakhstan needs to further develop its financial system to offer its domestic investors alternatives to investing in real estate. While there is a small but growing mutual fund industry in Kazakhstan today, it is virtually inaccessible to the average Kazakh. Furthermore, Kazakh banks, construction companies and real estate developers need to take a longer-term view of the industry. There is significant demand for housing in Kazakhstan that is set to grow as the country’s hydrocarbon wealth finds its way into wider strata of the society. However, the luxury housing market is saturated and has been for long kept afloat mainly by speculators hoping for further price increases. Also, more stringent oversight of the construction and banking sectors is necessary. People hurt the most by the crisis were middle-class homebuyers: those who were crowded out of the market by the ever increasing speculation, and those who are waiting in vain for the condo that they bought before the market turned.

It remains to be seen whether Kazakhstan will heed these lessons. The fundamental disbalances that led to the crisis have been laid open. The question is whether the government decides to tackle the problems head on or settles on half-measures and rhetorics.