Clare Nuttall in Almaty -

Kazakhstan was the hardest hit in the region by the global credit crunch and residential real estate prices are still drifting downwards as pundits become increasingly pessimistic about the prospects for a recovery anytime soon. So investors and developers are instead turning to commercial real estate where significant unmet demand is keeping prices high.

Since the collapse of Kazakhstan's financial markets in August 2007, prices for office and retail space have continued to rise - albeit much more modestly than before the crash. By contrast, prices have plummeted in the residential sector. In Almaty, the country's most active real estate market, the price per square metre in the secondary residential market has dropped from just over $3,400 in July 2007 to below $2,200 today.

Given Kazakhstan's strong long-term macroeconomic prospects, no one expects the current doldrums to be permanent. However, this being the first downturn in the Kazakh housing market, forecasts for when and how it will recover are somewhat hazy.

In February, a survey by the National Association of Realtors found that 44.3% of real estate professionals in Kazakhstan expected the market to hit its low point in the first quarter of this year before starting to recover. Their forecasts proved to be over-optimistic. Three months later, there is still almost no buy-side activity as everyone waits for the market to bottom out. The turning point is now expected either in the fourth quarter of 2008 or - more likely - early next year.

As well as this uncertainty, difficulty in obtaining mortgages is also holding back potential buyers. "Interest rates for mortgages are now around 5-6% higher than in July 2007 and banks have toughened their conditions for people who want to get credit," says Gulnaz Aldibekova, an analyst at BTA Bank.

The number of claims filed by banks against mortgage debtors has also surged, a natural result of the credit crunch and consequential drop in residential real estate prices. According to figures from the Kazakh Supreme Court, over 50,000 debt claims were filed in 2007, totalling about $300m.

With Kazakh homebuyers stuck on the sidelines, the most likely trigger for a recovery in the market is the much-anticipated entry of major western investors. "There is a definite increase in interest. In the next few quarters we expect to see some major, reputable western players enter the market, and that will be crucial to its recovery," says Charles Raether, head of Jones Lang LaSalle Kazakhstan. "The first deal to take place will act as a benchmark transaction that will give an understanding of where the market is and where valuations are - and that will make other investors feel comfortable."

With most developers chasing the quick returns to be had in the residential sector, the commercial market, with its more complex and long-term business model, has achieved slower-paced and more sustainable growth. The collapse of the residential real estate sector has, to an extent, affected the commercial side of the market, but major Kazakh developers are continuing with their commercial projects, though at a slower pace than before.

Property business

The drivers for the commercial real estate market are strong. The unmet need for all types of commercial property - from office space to shops to hotels to warehouses - is even more immediately obvious than demand in the residential sector. "There is now a trend for the banks to redirect their attention from residential to office and retail real estate," says Aldibekova.

The attractiveness of this segment of the market has already put it on the radar of international investors. Jessica Buckley, investment manager at Scot Holland CBRE, says that while previously most interest was from Russia, Turkey, Korea and Middle East, her firm has, in the last two months, received several inquiries from Europe and other regions. "Investors across the world are looking for value and widening their usual search," she says. "People have now switched on to Kazakhstan, which has a great GDP growth story and strong economic fundamentals. Aside from the problems in the banking sector, the picture is very rosy."

Buckley points out that in terms of office property, there is generally growing net demand, not just churn in the market. In Kazakhstan's financial capital Almaty, around 1.5m square metres (sqm) of office space will need to be constructed by 2012 in order to keep pace with demand, according to research from developer Eurasia RED. At present, there is a deficit of around 220,000 sqm and this is expected to continue for several years - at least until the Almaty Financial District and other large-scale construction projects are completed.

"Supply is far below demand in Almaty, but there are a number of projects in the pipeline. According to most estimates, supply of Class-A office space will catch up with demand in three to four years, and then we will see a stabilization in lease rates," says Raether. "However, it is difficult to say exactly when the softening in prices will happen because so many developers' plans have changed since the crisis. Projects are still going ahead but on a longer timescale than originally planned."

Demand for modern retail space is equally strong in Almaty. According to Eurasia RED's director for finance and business development Dimitry Revin, "Demand for shopping space in 2008-2009 may exceed supply by 1.5 times. Taking into account current plans of developers up to 2010, potential deficit of shopping space in Almaty will potentially reach about 220,000 sqm."

Developers plan to build around 300,000 sqm of retail space in the next four years, with major projects in the works including the mixed-use Esentai Park development, TS Engineering's Sputnik shopping centre and residential complex, and the Prime Plaza Almaty being built by Oriental Real Estate.

Almaty is the only place with such an extreme imbalance of supply and demand. In Astana, at present supply exceeds demand, while in the regional capitals, economic growth and consumer spending power are lower, and as a result so is demand for commercial property

However, regional centres such as Aktobe, Aktau and Karaganda are all expected to experience a leap in demand within the next three to five years as the oil and gas and mining industries spread to the rest of their economies. And as Astana's population continues to increase, demand for both office and retail space is expected to overtake supply within the next two years. Demand for quality office real estate in Astana will increase eightfold from 2007 to 2012, says Revin.

To date, the commercial sector has evaded the speculative bubble that brought down Kazakhstan's residential sector. In Almaty at least, most commercial developments have been well thought out and tailored to demand. But while there are clear commercial drivers and prices are very much grounded in reality, there is still an element of fantasy in the commercial property market.

International developers, mainly from Turkey and the Middle East, are ploughing billions of dollars into mega-projects in Astana and the Caspian region that dwarf the developments going ahead in Almaty. Astana's massive Abu Dhabi Plaza, being built by Aldar Properties and Al Maabar, for example, will be completed by 2012, but it is as yet unclear whether by that time Astana will have attracted enough people with enough money to make it commercially viable. And the $20bn Aktau City project will see the construction of commercial real estate, infrastructure and accommodation for a million people next to a city that currently numbers just 200,000.

Unlike in Almaty, where there is a clear demand for the new office and retail space coming onto the market, the rationale for several of these massive prestige projects is less obvious. Just as residential developers had a sharp reality check last summer, the developers of some high-profile mega-projects may have to scale back their ambitions in line with demand.

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