The “Ice Age” of construction

Until recently, the Ukrainian real estate market was among the most profitable and promising ones in Europe. The demand was boosted by a catastrophic lack of commercial properties and low-cost residential housing. With Euro-2012 approaching, developers were confident that they were in for two or three years of skyrocketing profits. However, their game was spoiled by the world financial crisis, which is threatening to freeze countless construction projects that were either scheduled or have already started.

In view of this, the Board of Directors of the Ukrainian Construction Association (UBA) has sent letters to the president and the prime minister listing measures that would pull the sector out of the current crisis. They are certain that if the government does not hammer out a stabilization plan, within two or three months the construction industry will enter an “Ice Age” from which it will take one to two years to extricate itself.

Developers cite three main sources of the construction financing business: clients’ money, banking resources, and – in the worst – case scenario-a company’s floating capital. Tightened requirements for mortgage loans in the banking sector have led to a reduction in the number of potential lendees. The second source of financing has also come under threat, as banks have raised interest rates on construction loans to an annual 25 percent.

At this steep rate, loans are not readily available to just anyone. They are most likely to be grabbed by large, high-profile construction companies that have completed projects in their portfolio to be offered as collateral. Medium and small market players are being forced either to freeze their construction sites-shutting them down – or dump them cheaply on their large rivals.

What is most distasteful is that buyers should seemingly have benefited from this situation. But just like before, they will not be seeing cheap apartments in the near future. Lev Partskhaladze, the head of the XXI Stolittia development company, says that after sorting out their financial difficulties, developers will raise the price per square meter because the demand for low-cost residential housing is constantly growing. Furthermore, there is a greater risk of fraud of which the Kyiv-based Elita-tsentr company has been a prime example. Many companies have launched construction projects, but owing to the lack of financing, will not be able to finish them and will simply shut them down.

“What is happening now is that the floating capital of developing companies is being washed away,” said Oleksandr Hlimbovsky, the general manager of the Altis-Holding construction corporation. He added that there is enough money to last for two to three months and then things will go down the drain.

In order to cut real-estate prices on the primary market, the UBA proposes to exempt individuals temporarily from paying the VAT on purchases of low-cost real estate homes from a developer. This will require amending the law on the value-added tax. Also, it would be advisable to institute a moratorium on increasing land lease rates and temporarily exempt developers from payments to local budgets, at least until a building is commissioned, allowing companies to focus on direct investments into the construction process.

In order to prevent stagnation in the construction sector, which-as some experts claim – has already made itself felt, they are calling on the government to consolidate the efforts of all branches of power and market players to adjust the monetary and currency policies of the National Bank of Ukraine (NBU) which should support mortgage financing.

They propose the following measures: raising the standard for construction loan risk coverage from 50 to 70 percent of the property’s cost, as is the case on the secondary market; scrapping the two-year property rights registration requirement that currently applies to residential property offered as security for a loan; introduction of mortgage loan refinancing with at least 50 percent of the property rights serving as a security; preventing the restriction of refinancing volumes for banks that finance construction with their regulatory capital,; and revising the NBU’s policy requiring commercial banks to form reserves on mortgage loans to individuals.

According to Hlimbovsky, a reduction in mortgage loans, which have become the key problem for developers, will not affect the inflation rate because this money is tied up for a long period of time, i.e., it is effectively taken out of real circulation and used to finance the development of brick, cement, and other satellite companies. People in the construction industry are convinced that the main way to beat the crisis in their sector is to stabilize the political situation in the country.

Above all, a coalition must be formed in the Verkhovna Rada. “If we don’t have a normal, civilized coalition, the situation will deteriorate,” Partskhaladze said. Hlimbovsky begs to differ: “We are talking about nothing else but the coalition, while we need to talk about the economy. If we don’t have an economy, the coalition will be totally useless.”

For a full week now developers have been waiting for a response to their proposal. There has only been one sign that may be viewed as a positive development for them. In a recent interview Oleksandr Savchenko, the deputy head of the NBU’s board of governors, said: “The NBU is ready to support banks and, above all, remove restrictions on the maximum rates for external loans. Soon banks will be able to take out loans at an annual rate of no higher than 11 percent. Limitations on the rate of long-term loans will be removed altogether. Even if these measures fail to relieve the tensions on the financial market and banks experience a lack of currency liquidity, the Central Bank will cut the required reserve volumes for short-term loans (right now, banks have to reserve 20 percent of the volume of loans issued for up to 180 days). Furthermore, we intend to support banks’ short-term liquidity at the necessary level in order to guarantee adequate financing for the growing economy.”