Russia (a month old article, still relevant)

(reads like a nation of merchant builders)

 

The blame for London's eye-watering property prices is often laid at the door of wealthy Russians. But real estate in the motherland is hot, too. Prices are soaring and new developments are springing up all over Russia's big cities.

Apart from the country's dominant natural resources industry, Russia's real estate companies raised more new equity in 2006 than any other sector. Even so, it is debt that fuels the country's property development boom. Renaissance Capital reckons big mass-market developers typically operate with a ratio of book equity to total assets of just 10 per cent. Their rouble bonds are popular with investors, however. At yields of around 9-10 per cent, top-tier developers' paper trades at similar levels to that of mainstream issuers in Russia's consumer products sector.

Yet debt issued by Russia's real estate developers is arguably a riskier proposition. The sector's prevailing business model shapes the capital structure. Mass-market developers tend also to have construction businesses, encouraging a tendency to "build and sell" and move on to the next big project, rather than create a rental portfolio providing an annuity. That works in a booming real estate market where perhaps 40 per cent of properties are bought for investment purposes. It is facilitated by the role played by pre-payments – essentially free payment-in-kind financing – made by prospective homeowners. In their various forms, these can account for three quarters of the total financing in a typical development.

Besides encouraging constant building, this creates volatility – pre-payments dry up when house price growth moderates. In addition, it is unclear how pre-payments would be treated if the market turned sour and bankruptcies ensued. In theory, bondholders should rank ahead of many types of pre-payments. In reality, political considerations could mean they find their position in the pecking order of asset-recovery to be much lower than anticipated.