Please see Kazakhstan Part I if you missed it.
You cannot have a real estate bust without debt — lots of it. When looking at real estate busts, very few American cities can even come close to the epic collapse that Almaty, Kazakhstan’s largest city, experienced. Of course, to have a bust, you also need a boom, and here again, Almaty’s ascent from Communism is the stuff of legends. American investors salivated over making 10% a year on their condos. In Almaty, that was a mundane month. I will admit that the data is very anecdotal, but as best as I can tell, Almaty property prices roughly doubled each year for almost a decade leading up to the collapse. Here is that story.
When communism ended in 1991, all property was owned by the state. As happened in so many other former Soviet countries, there was a multi-year period of general chaos. Most individuals were unaware of property rights, and the laws didn’t help clarify things. Essentially, whatever apartment you lived in when the music stopped, was yours. Then again, the apartments were drab and it seemed as though there were few winners — especially as it was cumbersome to get property into your name. For almost a decade after communism, a nice 2-bedroom Soviet apartment in downtown could be had for around $10,000. Anecdotally, we heard that in the first few years after communism ended, an apartment could be had for as little as $1,500-$2,000.
Eventually, the Kazakh economy began to recover from the anarchy of privatization and it began to grow. Most of this awakening was caused by huge increases in oil revenues due to the twin boons of expanding production and rapidly rising prices. Starting in around 2000, property prices began to rise in a parabolic fashion and they didn’t stop for eight more years. By 2002, Western firms began to send professionals to Kazakhstan to oversee their oil projects. Of course, while most of the oil was in the west, the oil workers wanted to spend their weeks off in the relative tranquility of Almaty. These workers bought, or more likely rented their apartments, which slowly added energy to the ascent of property prices. Of course, Western firms bring with them all of the accoutrements of modern public companies — accountants, lawyers, auditors, consultants and well-heeled executives. As these people began to flood into Almaty, they also needed housing and by 2004, property prices began to increase at an even quicker pace. Of course, the gradual creation of a mortgage market didn’t hurt prices either. However, “buy now in order to sell later (at a higher price of course)” did not enter the borrowers lexicon for at least another year.
Locals were quick to notice that apartments had increased in price by a few times in just a few years. Their natural response was to buy extra units as investments. Of course, with the foreign population of downtown expanding, and no new supply of apartments, this only further pushed up prices. From the late 1990’s until roughly 2004, prices for a 2-bedroom Soviet apartment increased from $10,000 to about $50,000.
It’s difficult to really judge what ‘fair value’ of an apartment is. It’s essentially worth what someone is willing to pay for it and without a functioning banking sector, most property buyers were cash buyers. When you look around the world, one of the most common metrics to use when thinking of how to value dwellings is to compare them to after-tax income of the owner. I hate to generalize too much, but in the majority of countries, the average housing unit is valued at between five and ten times after-tax income of the owner. By that metric, apartments in Kazakhstan were expensive for locals, but quite cheap compared to the average foreigner living in one. This is where the fun began — how much could a foreigner be pushed to pay in rent?
By 2005, banks began to relax lending standards while simultaneously finding a whole lot of foreign capital — mainly wholesale deposits. After enduring a decade of high borrowing costs, Kazakh banks suddenly seduced Western financiers to lend them money at rates that were only slightly higher than LIBOR. Between 2005 and 2008, foreign banks lent $45.1 billion to a banking system that was only $8.6 billion in total equity in 2005. Of course, the Kazakh banks did what all banks do when faced with massive depositor inflows — they found absolutely asinine projects to lend stupefying sums to. We will return to some of these construction projects later on, but on a more retail level, the banks also lent huge sums to property speculators.
While I cannot confirm any of these stories and they are somewhat one-off in terms of situations, they’re simply too juicy not to relate;
With a massive shortage of available space in downtown, and Westerners desperate to rent in downtown, rental rates spiraled out of control. By 2007, an apartment that a few years earlier had cost $10,000, now rented for almost that much EACH MONTH. Of course, the renters were oil workers, embassy officials and the usual suspects that have someone else’s money to spend. As foreigners fought for the few leasable apartments, employees demanded ever higher monthly rental allowances from their employers — which only further pushed up prices. As demand overheated, apartment owners demanded one year of rent up-front, then two years of rent up-front. Suddenly, it cost over a hundred thousand dollars up-front to rent a 700 square foot apartment for two years. It made no sense. Meanwhile, the apartment owner took the deposits and used them for down payments on a few more apartments. The banks didn’t know or care where the money came from.
Then the government got in on the action. Drunk with petro-riches, the city of Almaty embarked on a massive infrastructure and beautification program. The government would routinely go out and pay two or three times market value for apartments in buildings that they intended to demolish. Almaty got wider streets and new highways. Government officials who were tipped off about which buildings would be purchased made fortunes. Meanwhile, speculators tried to guess about which buildings were next and would regularly bid apartment units up to prices that made no sense — only to learn that they were buying in the wrong building.
The sudden wealth boom (real money and pure bank leverage mix in strange ways) led to a boom in personal consumption. Per capita GDP in Kazakhstan went from $1,200 in 2000 to $8,400 in 2008. Meanwhile, the wealth increases in downtown Almaty were even more extreme. Luxury boutiques opened up all over the place. Unfortunately, there were no luxury malls — there was essentially no purpose-built shopping at all. No worries, just kick out the apartment wall facing the sidewalk, build up a few extra meters of space with cinder blocks, and you have a new store. Meanwhile, rents went to insane levels. I heard stories of landlords who would break leases and kick out international luxury retailers because they now wanted $200 a foot and the retailer had signed for $100 a foot just a few months earlier (those are Manhattan prices). Landlords would leave locations vacant rather than risk signing a multi-year lease at current market prices, as rents were increasing at 10% a month and doubling each year. It seemed as though as soon as you signed a lease, you were on the wrong side of the transaction because rents just continued to rise. Suddenly, store-fronts were vacant, not for lack of business, but because people refused to lock in leases — which only drove rental prices even higher for tenants that could find places to rent.
Of course, with such high prices, property developers rushed into the fray and offered new luxury condominiums and shopping malls. Naturally, almost all of this was funded with debt that was extended to those who were politically connected. (It’s not altogether ironic that when the BTA Bank failed, it was alleged that most of the bad loans were made to its chairman and his business interests).
Eventually, a combination of factors broke the bubble. To start with, prices had long ago stopped making sense. At its peak, a 2-bedroom Soviet apartment was worth more than $500,000 — if you could find anyone willing to sell it to you. We heard of a number of transactions that were priced at over $1,000,000. By then, speculators could no longer afford to make payments on their borrowings. The game only worked as long as Kazakhs could continue to borrow money against their rapidly increasing real estate. The Kazakh banks would have probably continued to lend against ever increasing prices, had overseas investors not forced their hand.
Starting with the March, 2008 collapse of Bear Stearns, financial institutions started asking questions — obvious questions, like why have we been lending so much money to Kazakh banks? The wholesale funding started flooding out, even more rapidly than it had flooded in. By the third quarter of 2008, banks in Kazakhstan were facing a liquidity crisis, which was suddenly accentuated by rapidly declining oil revenues as the price of crude began its descent from over $140 a barrel to $30. Without bank lending, property prices could no longer go up, instead, banks were calling in loans. What had taken nearly a decade to build up, came crumbling down in a weekend.
I know they’re a bit hyperbolic, but most property investors told me that prices essentially went no bid one day, and a few months later, when bids finally showed up, prices were down by over half. In the US, the government cushioned the fall in property prices. In Kazakhstan, the government was hard pressed to do much more than nationalize the two largest banks and take sizable stakes in a few others. Most Kazakhs were still in shock at just how quickly prices came apart.
Despite overshooting dramatically to the upside, and then collapsing even more dramatically, Almaty property has been a great investment over the past decade. After advancing from $10,000 to over $500,000, the average 2-bedroom apartment in downtown seems to have settled out at around $300,000. If you bought in at any time before the final two years, you are still up on your investment. A combination of expanding wealth, a rapidly growing middle class and the concentration of wealth in Almaty’s downtown has led to excellent upside. As the GDP of Kazakhstan continues to expand, and the banks slowly re-liquefy, I would expect to see interest rates continue to decline, leading to further price increases. I wouldn’t tell you to buy property in downtown Almaty, but it’s probably not a terrible investment either. In Part III, I’ll go over some of the other investments that I found to be much more interesting in Kazakhstan. For a growing economy, many assets seem unusually cheap.