Kazakh Residential Real Estate Sector Ripe for Consolidation

analysis

Kazakh Residential Real Estate Sector Ripe for Consolidation

By SRI ⋅ February 4, 2008 ⋅

Translated from the Kazakh weekly Business & Power - the original article in Russian can be found here.

Kazakhstan’s construction companies have been forced to search for new sources of capital. As local analysts suggest, now is the time for the builders to switch from relying on bank loans as a sole source of financing to partnering with strategic investors. This may result in increased mergers and acquisitions activity in local real estate and construction sector.

The mid- and long-term outlook of purchasing power among the Kazakh population will likely be lowered - not only as a result of the liquidity crisis, but also because of the of the deteriorating health of the entire economy. Accordingly, builders need to search for alternative sources of funds, and reexamine their strategies and financial models. “Today’s lack of liquidity affects big builders with excellent reputation just as much as small construction companies. The absence of acceptable bank financing shapes no longer only the market for real estate, but the whole consumer sector of the economy as well”, says Bakhytbek Katen, director of NAI Kazakhstan Aristan, a consultancy.

“Recent freeze of construction shook the reputation of the entire real estate market”, says Oleg Alferov, the vice president of National Association of Realtors. “As a consequence, buyers’ activity in the fourth quarter of 2007 was at its lowest level in the last three years.”

Present situation is favorable for those interested in entering the Kazakh real estate and construction sectors. The barriers to entry are low compared to the last few years, and interested parties may be able to acquire shares in new and unfinished projects relatively cheaply.

Alexander Kalinin, the chairman of Kazakhstan Estimators Association agrees: “The banks were focused excessively on the construction sector. Mortgage banking, construction and other real estate loans and similar financing deals accounted for 56-70 percent of the banks’ credit portfolios.” Under the current conditions, the sector is ripe for consolidation. According to Kalinin, the market will soon be dominated by large corporations characterized by high quality of their property portfolios, balanced price policies and additional sources of financing besides Kazakh banks. “One such institution could be, for example, corporation ‘Basis A’. I have no doubts that it is backed by serious shareholders with strong interest in Kazakhstan’s economy.” Other business models will have difficulties surviving in the new conditions, suggests Kalinin.

According to him, other construction companies like Vek, MAK or TS Engineering will state afloat as well. But the days of the most high-profile construction company in Kazakhstan, KUAT Corporation, are likely numbered. “Obscure policy and opaque management, and especially its murky dealings with land acquisition have apparently led to significant problems at KUAT.”

According to observers, the construction companies will need to share their risks and assets. “There are different ways to finance real estate development — starting with bank financing and ending with selling a stake in the project to a strategic investor. Today, construction companies are looking for any possible way to secure financing to ensure the completion of already started projects. Bank loans to construction companies look increasingly precarious and the builders cannot be confident that they will be able to finance their deals solely with bank credit, as was the case until the summer”, emphasizes Katen.

This is a situation when investors other than real estate developers can jump onto the market. Nowadays, only few existing construction companies have the financial capabilities to take over the unfinished objects of their competitors. Moreover, as a result of the stagnation of the market for residential real estate, this segment lost its recent attractiveness. “Commercial real estate developers with effective marketing methods are currently in a much more advantageous market position”, says Mr. Katen.

Alferov believes that foreign investors will become major providers of financing to struggling, yet potentially lucrative projects. “Notwithstanding the events of the second half of last year, European, American and Israeli investors are still expressing strong interest in our markets. Another potential source of emergency funds for halted projects are domestic development institutions”, he says. According to Alferov, European developers are interested in the projects of Kazakhstan’s biggest builder KUAT Corporation. SilkWay Construction, another major construction company, is likely to sell some of its projects to a new investor. “Projects like Tristar and Verniy.kz in Almaty are most likely to be taken over,” says Alferov.

There are two possible scenarios: the arrival of large development companies as co-investors in objects lacking financing, and 100-percent buyouts of the incomplete projects. “The question is only in how attractive will the troubled domestic companies make the proposal to new investors. But there will likely be abundance of tempting offers from construction companies that experience difficulties”, thinks Alferov. Most likely, he assumes, new investors will not acquire the construction companies themselves but rather individual projects, be it in the form of land, unfinished properties, designs, and building permits.

“For the current holders of these assets, these scenarios would mean that they could recover funds, at least partially, sunk in the projects. The cost should be sufficiently low and attractive, but only in the intermediate- and long-term outlook. Therefore, this absorption of construction sites will be profitable only to important strategic investors, not looking for quick profits”, thinks Alferov.

In Almaty, there are more than 900 licensed construction companies registered, but only 8-10 major ones, estimates Kalinin. “It is likely that within a year or two, 70 percent of the small- and medium-sized will not survive or will be taken over by larger ones.” Those emerging successfully from the real estate crisis will be those companies that have access to external financing and developing untypical projects like the Apple Town housing estate in Almaty, and the land owners who sold their land to construction companies at the height of the housing boom.

Meanwhile, the government has already allocated capital to aid construction companies, but thus far only in Astana, the capital city. In 2007, a state commission affirmed a list of 112 objects in Astana that would receive priority in state support for their completion. For this purpose, the government put aside $400 million from the budget that was channeled through the state development fund Kazyna. On the commission of Prime Minister Karim Masimov, the government has created two working groups to effectively take control over the construction projects and also to allocate funds from the state budget to support the ailing construction industry. The two working groups, headed by the Minister of Industry and Trade Galym Orazbakov and the akim (governor) of Astana Askar Mamin, include representatives of Kazyna and Kazakhstan’s banks.

Meanwhile another working group, headed by the akim of Almaty, has together with the banks and construction companies made a list of projects in Almaty that will require state support. There, 314 billion tenge ($2.6 billion) would be required to assure the completion of unfinished objects, and 167.2 billion tenge ($1.4 billion) will be necessary to finish projects with a high degree of progress, calculated akim Imangali Tasmagambetov. According to his data, there are 93 construction companies working in Almaty right now constructing 143 residential complexes. The total living area of those is 5.1 million. sq. m. This is more than 36 thousand apartments, and 12 thousand of those are paid for by would-be owners.

“Why would the state subsidize the building of 24 thousand apartments, not paid for by anyone?” - asks Meruert Makhmutova, director of the Public Policy Research Center. Moreover, she believes that the government should no longer allot budgetary money to construction companies. “In each specific case, it is necessary to investigate how the builders used the funds collected by owners who paid in advance. It is known that many construction companies worked as financial pyramids”, noted Makhmutova.