VZCZCXRO7102
PP RUEHDBU RUEHLN RUEHVK RUEHYG
DE RUEHKV #1391/01 1571118
ZNR UUUUU ZZH
P 061118Z JUN 07
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 2604
INFO RUCPDOC/DEPT OF COMMERCE WASHDC
RUCNCIS/CIS COLLECTIVE
RUEHBI/AMCONSUL MUMBAI 0045

UNCLAS SECTION 01 OF 04 KYIV 001391 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
STATE FOR EUR/UMB 
USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYCK 
MUMBAI FOR WKLEIN 
 
E.O.: 12958: N/A 
TAGS: ECON PGOV UP
SUBJECT: UKRAINE: KYIV'S BOOMING REAL ESTATE MARKET, A BUBBLE READY 
TO BURST? 
 
REF: A) KYIV 895 
 
     B) 2006 KYIV 4367 
 
KYIV 00001391  001.2 OF 004 
 
 
¶1. (U) Summary: This report analyzes the real estate market in Kyiv, 
which has experienced a sizeable boom over the past 12 months as 
average citizens have rushed to throw their savings into the market. 
 Mortgage lending has dramatically increased but has room to expand. 
 Some bankers are concerned by the high rate of bad loans, and 
dollar-denominated mortgages constitute an exchange rate risk. 
Restrictions on land sale and unclear property laws continue to 
restrict supply.  Inexperienced real estate brokers and an 
underdeveloped construction sector also produce upward pressure on 
prices.  Some experts argue that speculative demand is mostly to 
blame, however, and claim that the real estate market is currently 
experiencing a bubble inconsistent with underlying fundamentals. 
Yet supply-side limitations and soaring demand appear sufficient to 
explain most of the accelerated growth in prices.  End Summary. 
 
Real Estate Explosion 
--------------------- 
 
¶2. (U) Real estate is one of Ukraine's fastest developing sectors, 
particularly in Kyiv, which has begun to emerge  as a major European 
capital.  (Note:  Although our investigation focused on Kyiv, 
Econoffs' discussions in several other major Ukrainian cities (e.g., 
Dnepropetrovsk, Odesa) revealed other parts of Ukraine are seeing 
similar spikes in the real estate market.)  Kyiv is witnessing a 
continued, sizeable influx of people and businesses from all parts 
of the country and beyond.  Official statistics list the city's 
current population at 2.72 million, up from 2.61 in 2001, although 
the real population is likely much higher.  Using figures for bread 
consumption, the Kyiv-based City Institute estimated that the 
population as of January 1, 2007 had risen to 4.13 million.  Housing 
construction has likewise grown, and in 2006 alone, the Kyiv housing 
supply grew by 8%, adding about 14 million sq. ft.. 
 
¶3. (U) Despite booming housing construction, quality residential 
property remains scarce in Kyiv.  According to local real estate 
agencies, Kyiv has an estimated 215 sq. ft. of housing available per 
resident, as opposed to 320-370 sq. ft on average in the European 
Union. [cy1] Even this low level represents an increase over space 
available in Soviet times, when extended families often squeezed 
into apartments.  Today, the desire of young families to have their 
own apartments is a big factor in rising demand.  Soviet-era 
statistics are unavailable, but since 1993, Kyiv's housing stock has 
risen about 15 sq. ft. per resident, despite the growth in 
population.  The average price of residential property in Kyiv has 
increased more than sevenfold over the last four years.  In 2002, 
buyers paid around USD 36 per sq. ft., but by early 2007 average 
prices had hit USD 260 per sq. ft.  With Kyiv's residential housing 
stock at about 660 million sq. ft., the total value of Kyiv's 
housing stock stands at roughly USD 172 billion, or 1.64 times 
Ukraine's 2006 nominal GDP of USD 104.8 billion.  By comparison, the 
total value of the U.S. housing stock (USD 19.8 trillion) is 1.5 
times larger than U.S. GDP (USD 13 trillion). 
 
¶4. (U) High-end rental housing is in particularly short supply. 
Rates for Embassy rental units, for example, have quadrupled over 
the past three years (ref B) and increased 50% or more between May 
and November 2006.  The Embassy Housing Unit reports that monthly 
rent for apartments that meet minimal Department standards now stand 
at USD 4 per sq. ft., compared with USD 1.8 per sq. ft. a year ago. 
A newly-arrived business executive told Econoff in April that her 
USD 4000/month allowance was not enough to secure suitable housing 
in Kyiv. 
 
¶5. (U) Kyiv also suffers from a lack of commercial property. The 
international real estate agency DTZ estimates commercial property 
supply to be about 5 million sq. ft less than demand, as of early 
¶2007.  A 2006 survey by Jones Lang LaSalle found that neighboring 
capitals like Moscow, Warsaw, and Prague have three to four times 
the office stock of Kyiv.  Class A&B offices (1000-3000 sq. ft.) 
meeting international norms are in especially short supply. 
 
Mortgage Lending Boom Tapering Off? 
----------------------------------- 
 
¶6. (U) Investing in real estate in Ukraine has proven extremely 
profitable during the recent housing boom.  According to the Oxford 
Business Group, investors have seen a 20% return on their 
investment, three times higher than the average return in western 
Europe.  Middle-class Ukrainians use real estate holdings as their 
primary form of savings.  Ukrainian official statistics show that 
investment in real estate grew by 30% in 2006, ballooning to 17% of 
total investment. 
 
KYIV 00001391  002.2 OF 004 
 
 
 
¶7. (U) According to the National Bank of Ukraine, the volume of 
mortgage loans grew 1.5 times in 2006 and more than tripled in 2005 
and 2004.  Despite this high growth rate, the absolute level of 
mortgage lending remains relatively low, at USD 5.5 billion or 5% of 
GDP (as of March 1, 2007).  Volodymyr Lavrenchuk, Chairman of 
Raiffeisen Bank Aval, which has the second largest mortgage lending 
portfolio among Ukraine's banks, told Econoff he thought 10% of GDP 
would be an appropriate level. 
 
¶8. (U) Lavrenchuk noted that Aval's share of bad loans, at 1.5%, was 
significantly higher than the standard target of 0.3%.  Lavrenchuk 
added that only a few Ukrainian banks were competent to manage risk 
in loan portfolios appropriately.  Once the share of bad loans 
exceeded 1.6%, banks would be forced to limit mortgage lending and 
the likely growth in mortgage lending would fall to 30-40% in 2007, 
he predicted, down from 125% growth in 2006 and 75% growth in 2005. 
At the same time, banks would also seek to unload foreclosed 
properties, compounding a downward pressure on prices.  Aleksander 
Avramenko, Ukraine Country Manager for international real estate 
firm Ober Haus, told Econoff in April that the drop in mortgage 
lending was a sign that the real estate market was already cooling. 
 
 
Dollarization Risk 
------------------ 
 
¶9. (U) The IMF recently expressed concern that growing 
dollar-denominated loans in Ukraine had created exchange rate risk 
for borrowers and banks (ref A).  This risk is especially acute for 
mortgage lending, as over 80% of mortgage loans are issued in U.S. 
dollars.  A devaluation of the hryvnia could, therefore, lead to 
widespread defaults on mortgage payments and send the real estate 
market reeling.  The National Bank of Ukraine tried to address this 
concern through an April 10 regulation requiring higher provisioning 
by banks on overdue dollar-denominated loans issued to customers 
with incomes in local currency. 
 
Restrictions on Land Sale 
------------------------- 
 
¶10. (U) Government bureaucracy and a moratorium on the sale of 
agricultural land constrain Kyiv's real estate market.  Ambiguities 
in land ownership laws have made property disputes common, creating 
risk for potential investors.  An unclear, corrupt, and 
non-transparent process of land allocation for development, along 
with months-long periods needed for compiling the necessary 
documentation and permissions, further elevates real estate prices. 
One study estimated that the average commercial builder required 274 
signatures for a project, adding about 18-24 months to the length of 
a project. 
 
¶11. (SBU) In October 2006, the Rada (parliament) extended a 
moratorium on the sale of Ukraine's 33 million hectares of 
agricultural land, including the valuable land surrounding Kyiv and 
other major cities that many developers would like to convert into 
suburban housing.  The moratorium blocks suburban development and 
keeps urban property values high.  All major political parties 
except the Communists publicly support lifting the moratorium.  As 
BYuT MP and former Minister for Agrarian Policy Ivan Kyrylenko 
recently told Emboffs, however, many MPs have personal real estate 
holdings whose value has been boosted by the moratorium and this may 
explain why the Rada keeps postponing that step. 
 
Underdeveloped Brokerage and Construction Sectors 
--------------------------------------------- ---- 
 
¶12. (U) A 2006 assessment by the International Real Property 
Foundation concluded that many of Ukraine's 50,000 brokers and 3,000 
individual appraisers either operated outside the law, or had little 
real expertise or experience.  Remigijus Pleteras, responsible for 
expansion at Ober Haus, told Econoff that most foreign real estate 
agencies were wary of entering the Ukrainian market because of the 
complex and corrupt bureaucracy.  The fact that so many real estate 
transactions were shady or improperly distorted prices, and made 
analysis of the market more difficult, he said. 
 
¶13. (U) Foreign firms likewise have largely shunned the 
non-transparent Ukrainian construction sector, which is dominated by 
a few large companies controlled by local magnates with insider 
connections.  According to the Oxford Business Group, a single 
Ukrainian firm, Kievmiskbud, which is controlled by influential MP 
Volodymyr Poliachenko, handles 60% of construction in Kyiv. 
 
¶14. (U) The construction cranes dotting the Kyiv skyline show that 
 
KYIV 00001391  003.2 OF 004 
 
 
domestic developers and builders are able to get projects started, 
but abandoned or delayed projects are not uncommon for several 
reasons: 
--  Lacking the deep pockets of large foreign builders, overextended 
local firms developers sometimes simply run out of capital before 
completing projects; 
--  There have been several cases in Kyiv of citizens opposed to new 
construction delaying or blocking projects on environmental or 
aesthetic grounds; 
--  Scams and business disputes have left buildings half-completed 
and middle-class investors penniless.  The accepted practice of 
collecting payment for apartments before construction is finished 
makes it tempting for shady operators to take the money and run. 
 
¶15. (U) The most notorious building scam was the Elite Center 
housing project, meant to erect four new residential buildings in 
central Kyiv.  The architects of this scheme, Russian citizen 
Olexandr Volkonskiy and Ukrainian citizen Oleg Shostak, made off in 
February 2006 with nearly USD 100 million. Collecting payment in 
advance for unfinished apartments, the fraudsters sold the same 
properties to hundreds of buyers.  Investors lost USD 45,000-60,000 
on average in the scam. 
 
Housing Market Absorbs Looser Credit 
------------------------------------ 
 
¶16. (U) In order to offset the exchange rate risk of 
disproportionately dollar-denominated credit, the NBU lowered 
reserve requirements for hryvnia-denominated deposits from 8% to 
0.5-1% in three steps in 2006, with the steepest reduction coming on 
August 1.  As deposits in Ukrainian banks were rising rapidly at the 
same time, bankers responded with a rapid expansion of credit. 
Pavlo Prokopovych, an economist at the Kyiv School of Economics, 
identified this lowering of the reserve requirement as the driving 
force behind the explosion in housing prices, which indeed took off 
in August 2006. 
 
Market Forces or Speculation? 
----------------------------- 
 
¶17. (U) Kyiv's skyrocketing housing prices have led some to question 
the market's fundamentals and to caution that what we are currently 
witnessing is a speculative bubble whose popping sound could 
reverberate throughout the Ukrainian economy.  Much of the 
investment currently flowing into the real estate sector is indeed 
coming from private Ukrainians hoping to flip their property for a 
quick profit or who may simply trust property as an investment over 
bank deposits.  Prokopovych, the Kyiv-based economist, used average 
real estate prices and Kyiv's monthly salary of USD 400 to determine 
that Kyiv's apartment price-to-income ratio exceeds 22.  He noted 
that in 2006 the same ratio for Naples, Florida, often regarded as 
one of the most overpriced markets in the United States, was about 
8, while that for the state of Illinois was 2.5.  Prokopovych 
therefore argued that risky mortgage lending and speculative demand 
is creating a bubble inconsistent with underlying market 
fundamentals. 
 
¶18. (U)  There is anecdotal evidence that developers and individual 
speculators may be holding apartments--particularly in upscale 
buildings--empty in hopes of cashing in when prices peak.  Some 
apparently completed large residential buildings can be seen in 
central Kyiv, but there are no hard figures on vacancy rates for 
residential property.  Vacancy rates are easier to estimate for 
commercial property and are low:  at about 2-5%.  One realtor quoted 
in a recent press article worried that a number of the speculators 
may attempt to sell at the perceived peak, possibly creating a glut 
on the market and depressing prices sharply.  In the mean time, 
holding property off the market restricts supply and helps keep 
prices rising. 
 
Comment: A Bubble Ready to Burst? 
--------------------------------- 
 
¶19. (SBU) At the same time, it is hard to determine whether 
investors' expectations of future prices are actually "irrationally 
exuberant," that is, not based on market fundamentals.  Real estate 
development in Kyiv has clearly struggled to keep pace with the 
country's economic transition.  Supply-side limitations and soaring 
demand clearly are part of the explanation for the accelerated 
growth in prices, and the easing of credit in 2006 only added fuel 
to the fire.  While harder to quantify, there is some evidence 
speculation is amplifying the price rises caused by supply and 
demand.  No one can predict if the Kyiv real estate market is a 
bubble about to burst, but the downside potential of speculation in 
this market would likely be somewhat mitigated by the underlying 
 
KYIV 00001391  004.2 OF 004 
 
 
market factors (increased demand, restrictions on supply) we 
identified that are pushing prices higher. 
 
TAYLOR 
[cy1]I don't like this stat because we're comparing Kyiv to all of 
Europe (rather than a few selected capitals), but unfortunately thus 
far we haven't found anything better.