Ben Aris in St Petersburg -
The world may be huffing and puffing and trying to blow Russia’s house down. But the house made of brick is proving to be a match for sanctions and falling oil prices, to the extent that Russia’s leading residential developer Etalon Group continues to see its business prosper as Russia’s emerging middle class have babies and aspire to own bigger homes.
“Despite the crisis people are still having families. They still need to move to bigger apartments and want to have nicer homes. Life goes on, irrespective of whatever else is happening,” says Aton Evdokimov, CEO of Etalon. “The demand for quality homes is a constant in Russia.”
Russia’s residential real estate business is surprisingly robust – at least for the well-established firms that are not dependent on debt to function. In December, real incomes started to fall for the first time since Russian President Vladimir Putin took over as president in 2000 because of the economic slowdown. There was a spike in purchases in December as Russians rushed to tie up their devaluing rubles in something concrete, but while sales have fallen off in the first quarter of this year, Evdokimov says demand remains “huge”, even if people are not buying as much as they once were.
Pre-sales were down 57% in the first quarter year on year, according to the developer, and contract values also fell as a result, leading Etalon to scale back on the pace of construction in an effort to match its spending with the money coming in. The upshot is that analysts expect Etalon's pre-sales to decline by a total of 30% this year. Etalon delivered 580,000 square metres (sqm) of housing in 2014, up 23.9%, but this year expects to deliver only 500,000 sqm. The company was planning to deliver 800,000 sqm next year before the recent string of problems appeared, but retains the capacity to ramp up construction should the market recover quicker than expected. “We have slightly decreased the pace of opening new projects, but by the end of this year we are still planning to break ground on a record number of new projects,” says Evdokimov. “It will take the economy about five to nine months to adjust [following the ruble devaluation] to a new level, but buying apartments is like buying bread – you buy it because you have to.”
Nation of homeowners
Russia’s primary residential market has several quirks as a legacy of the end of the Soviet Union. The first is the extremely high share of home ownership in Russia: when communism collapsed, the government took the radical step of simply gifting everyone the apartment where they were registered at the time. This was probably the biggest transfer of wealth in history, as trillions of dollars in property ended up in the hands of the population. Today, Russia still has one of the highest home ownership ratios in Europe of 84%, according to the European Mortgage Federation.
However, demand for new apartments remains on the same order, because one of the rewards for those who flourished under the communist system was a nice apartment, but most of these people were also the biggest victims of the collapse of the Soviet system. The upshot is that lots of now poor pensioners are living in nice apartments, whereas the new rich, many of whom were in their 20s in 1991, are forced to live in poor housing on the edge of the city: a high proportion of Russians want to move as a result. But until the advent of a mortgage market in about 2003, it was significantly more difficult to cash in their bricks and mortar or buy a bigger apartment.
Etalon’s success is based on its ability to cut banks out of the process of buying a new home. Customers need only to make a down payment of as little as 10% on a residential construction project that has yet to be built and pay the rest in instalments over the next three years to buy a brand new apartment, which makes it significantly easier to buy compared to the lump sum required for secondary market purchases. It is possible to wait until the building is completed, but then there are no discounts. Surprisingly, the average down payment on the company’s massive projects – almost exclusively in Moscow and St Petersburg – is a whopping 70%. “We are selling the future. When people sign the contract and pay the instalments during the construction, they are entering into a long-term deal. If they sign, they have to take a view of the future,” says Evdokimov.
The business has had a helping hand from the state, which is keen to promote home ownership because owning property acts as a social stabiliser. The Ministry of Finance has been subsidizing mortgages this year and on June 19 said it would double the size of the programme to subsidize RUB700bn ($13bn) of mortgages, but the scheme remains limited to newly built housing. “The fall in demand is a temporary phenomenon and not a fundamental change,” says Evdokimov. “Some 40% of the living area in Russia is old and needs modernisation or replacing.”
No rubble from ruble
In many ways the currency crisis at the end of last year that has left the ruble over 50% lower has worked to Etalon’s advantage. In the mad rush to buy apartments in December, consumers needed to be confident that the developer entrusted with their life savings would not go bust. And with 27 years on the market (the company was founded during Perestroika), listed in London after an IPO in April 2011, and transparent accounts, Etalon is one of the best-known, and importantly most trustworthy, brands on the market.
The downturn has also driven more badly needed consolidation in the real estate sector. Evdokimov says that in the UK there are a few more than a dozen residential developers that dominate the business, whereas in St Petersburg alone more than 1,000 companies have construction development licenses.
And because the company finances most of its work from the pre-selling of apartments before they are built, Etalon has been largely unaffected by the closure of the international capital markets to Russia or the freezing up of the domestic bank market.
Still, it’s been a hard time for shareholders. Since the IPO in 2011, the company has tripled in size – “and that growth came during not the best of times,” notes Evdokimov – yet the shares are down about 67% from the IPO price. However, the company has moved to quell dissatisfaction by introducing a dividend policy in 2013 to pay out 15-30% of net profits, equivalent to a 7% dividend yield.
“We have almost no debt; our net debt/Ebitda ratio is zero,” says Evdokimov. “We have a 40% margin on projects so what we have to do is manage the margin and not debt. We are very careful with the finances. We have a risk appetite, but we only bite as much as we can chew and swallow, then wait for the face to change colour. The trick is not to spend too much money. The uncertainty in Russia is high, but then so are the profits.”
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