Written by Andrey Vakulenko – MACON Realty Group, EECFA Russia
Housing construction remains one of the biggest segments of the Russian construction market, affecting both related industries and the overall macroeconomic situation, including GDP dynamics and labor market indicators. Because of the stagnating real income of the population over the past years, housing demand was stimulated by affordable mortgages. State programs that started back in 2018 targeted specific groups, but due to the pandemic in 2020 they became part of a comprehensive anti-crisis package to stimulate the economy, and unprecedented measures were launched to support construction. Thus, preferential mortgage became available to everyone. This excess demand caused record price increases in 2020-2021 and the rapid exhaustion of the positive effect of cheaper loans. As a result, housing has become even less affordable for buyers, and the market has become addicted to cheap mortgages whose issuance was supported exclusively by the state. Owing to the economic crisis caused by the events in early 2022, the central budget will experience a shortage of funds and spending on certain areas will be reduced. The mass subsidizing of mortgage rate is also likely to fall under sequestration, which may have negative consequences on the market in terms of demand.
Subsidized mortgage schemes then and now
Subsidized mortgage schemes to stimulate housing demand and support housing construction as a whole started in 2018. By then, the real income of the population had been declining for more than 3 years (from 2014 on). Subsidized mortgage rates (at the time about 10%) could stimulate demand and help those in need of buying a new home:
- ‘Family Mortgage’: launched in 2018, it was the first program to reduce mortgage rates to 6% for families with children.
- ‘Far Eastern Mortgage’: a targeted state program that started at end 2019 (a reduction to 2% for buying a home in the regions of the Far Eastern Federal District). Both programs are still in effect (with minor changes in conditions) and are valid until the end of 2023.
- ‘Rural Mortgage’: a targeted mortgage scheme, though geographically limited, started in 2020 (this year it was announced to become indefinite) for citizens intending to buy or build an own house in settlements with a population of less than 30,000. Participants can take up a loan for a new home or for a used home. The goal is to increase the number of people living in rural areas.
All three programs apply only to borrowers meeting certain conditions. All of them supported demand and stimulated buyer activity. But:
- The ‘Preferential Mortgage’ program (as part of anti-crisis measures to restore the economy at the onset of the pandemic in early 2020) had the biggest impact on the market. During this time quarantine restrictions caused a large-scale economic crisis and a major drop in the real income of the population, reducing the solvency of potential homebuyers and the number of transactions. It endangered housing construction, which is a critical segment for the economy. To aid the construction industry, the government implemented the scheme dubbed ‘Preferential Mortgage’. Unlike the other three schemes, it was available to everyone and citizens were able to take up a mortgage at 6.5%. Initially planned to be valid until November 2020, it was extended first until July 2021, and then until end 2022, but with tightened conditions: the maximum possible loan amount was greatly reduced, and the loan rate was raised to 7%. The events in early 2022 led to macroeconomic instability and a sharp increase in the key rate of the Central Bank. The rate under the Preferential Mortgage program also rose to 12%, although by June 2022 it was reduced to 7% again. It also became possible to combine soft loans with mortgages on market terms, which greatly increased the maximum loan amount.
- The latest state program to support the mortgage market has been the so-called ‘IT mortgage’ introduced in May 2022 for the employees of IT companies. It has become part of the large-scale measures to promote the development of IT industry in Russia and stop the brain drain.
The impact of subsidized mortgages on the housing market
In 2018-2019 the volumes of the mortgage market stagnated: the number of issued loans dropped (-8% in 2019 against 2018) and there was a minimal positive correction in the total number of transactions in the primary market (+1% in 2019).
The targeted schemes launched in 2018 helped certain categories of citizens to solve housing problems but did not have a huge impact on the whole primary market of multi-unit housing. But everything changed in 2020 with the Preferential Mortgage program available to everyone without exception. At end H1 2020, the number of transactions in the primary multi-unit housing market was 37% less than in 2019 due to quarantine measures and the general economic downturn after the start of the pandemic. However, the Preferential Mortgage program launched in Q2 2020 contributed to a sharp increase in demand, and in H2 2020 the number of transactions was already 33% higher than in H2 2019. In general, according to the results of 12 months of 2020, transactions slightly decreased, but the effect of the program in the second half of the year almost made up for the decline at the beginning of the year.
In Q3 2020 the share of transactions using mortgages shot up to 92%. The share of subsidized mortgage loans under government programs also began to rise; at end 2020 and during H1 2021 93%-96% of all mortgage loans issued for the primary market were under the subsidized programs, mostly the Preferential Mortgage one. This Preferential Mortgage ensured a pronounced increase in the number of general mortgage transactions, and the share of loans issued under this program exceeded 80% in the total volume of all types of subsidized loans issued in late 2020 and early 2021. The Preferential Mortgage program was popular because of its reduced rate relative to market value (at end Q2 2020 market mortgages were a rate of around 9%, while the Preferential one was 6.5%). With an average loan term of 215 months and an average loan amount of RUB 2.4 million (as of June 2020) savings from lower interest over-payments were around 30%. Also, a lower rate for the same down payment resulted in a lower monthly payment, making mortgages more accessible to a wide range of potential borrowers.
However, active demand and the stability of state support for home buyers prompted developers to intensively raise prices. At end 2020, the average cost per square meter jumped by 23.3%, reaching RUB 79,000 per sqm, although in 2014-2019 the average annual growth was only around 4.4%. Besides increased demand (supported by preferential mortgages), other factors influencing the price rise in 2020 were: the transition of the market to the project financing scheme and the use of escrow accounts (which increased the costs of developers); increased building material prices, and the outflow of labor due to the pandemic.
Dynamic home price rises in 2020 increased the investment attractiveness of homes and many nonprofessional private investors appeared on the market. And a large volume of transactions during this period aimed to capitalize on the intensive rise in prices. This attracted more and more new people to the housing market and the spiral of rising prices twisted even more. Similar trends were observed in 2021 and as a result, the average cost per square meter went up by another 25%, reaching about RUB 99,000 per sqm. Such price dynamics affected the overall level of housing affordability. The effect of reduced mortgage interest was quickly offset by the increased cost per square meter, and the benefit of cheaper mortgages was exhausted already in early 2021. Thus, the average saving period for buying a home rose by almost 1/3 compared to the similar indicator at end 2019.
There was a gradual decline in the share of transactions using subsidized mortgages in the total volume of demand in primary multi-unit housing, too: from 86% in Q3 2020 it declined to 42% in Q4 2021. Yet, despite some loss of popularity, the Preferential Mortgage program still remains key in supporting housing demand in Russia today.
What next
In H1 2022, about 315,000 transactions were concluded on the primary multi-unit housing market with 62% on mortgage loan and 52% under the subsidized state programs (the main program remaining the Preferential Mortgage one). The programs operate in a way that the state compensates banks for the lost profit (the difference between the market and the preferential credit rate). But the economic crisis stemming from the political events of early 2022 and the increasing sanctions on the Russian economy will reduce public funding in many areas. And obviously, one way or the other, this will affect subsidized mortgage schemes. The Preferential Mortgage one will most likely be impacted as this year there has been more and more official talk about the need to cancel it. But targeted mortgage programs (Family Mortgage, Far Eastern Mortgage, etc.) will operate at least until the end of 2023 with a possible extension.
The most likely abolition of the Preferential Mortgage program after the expiration of the current version on 1 January 2023 will certainly have a negative impact on demand. In 2020-2021 cheaper mortgage loans became the main driver and when the effect of savings from the reduced interest rate was exhausted due to the massive price growth, Preferential Mortgage, along with the other programs, became the only factor keeping demand from falling under the constant and intense rise in home prices.
Transaction numbers in the primary multi-unit housing market will most probably decrease once the Preferential Mortgage program ends. The combination of several factors will contribute to this:
- general rise in borrowing costs and a declining number of potential borrowers;
- expected decrease in the solvency of the population and in real income due to the ongoing economic crisis;
- inability to buy a similar or better home by selling the existing one. As per the results of Q2 2022, new homes are on average 27% more expensive than used ones, but this difference, depending on the city, can reach 50%–60% or more;
- unwillingness of developers in the primary market to reduce price. Many construction companies during the period of high demand in 2020-2021 made excess profits, accumulated certain reserves, but so far do not respond with direct discounts to the obvious deceleration of buying activity in 2022;
- strong competition from the secondary market. Price rises in the primary market have made the purchase of used homes much more profitable (yet there are no preferential mortgage programs in the secondary market). So, part of the demand from the primary segment flows to the secondary one.
The cancellation of the Preferential Mortgage scheme is not predicted to shock the housing market though, and is not expected to lead to a shrinkage in demand due to several factors acting at once:
- the key rate of the Central Bank of Russia is gradually decreasing. As of September 2022, it is around 7.5%, higher than the pre-crisis levels (4.25% in Q1 2021), but much lower than in March-May 2022 (14%-20%) when mortgage under general market conditions (without the subsidized rate), was practically impossible. Now, given the Central Bank’s course for further rate cuts, we can expect a gradual recovery in demand for mortgages outside the preferential programs;
- loan rates are often subsidized by developers themselves. Many construction companies, in partnership with banks, have their own subsidized mortgage programs at rates well below the market level (up to 0.1%). The developer compensates the bank for the difference between the subsidized and market rates at its own expense. The buyer receives an installment plan instead of a loan. However, as a rule, homes offered by developers under these programs have a higher cost (the difference is usually approximately equal to the amount of compensation paid by the developer to the bank).
Although the termination of the most massive state program to support the mortgage market will certainly contribute to a decrease in the number of transactions, the decrease will not be critical and will not have drastic repercussions on the industry. It seems also quite likely that after the end of subsidized mortgages, primary home prices will stop growing due to declining demand, and possibly start to go down.
Construction forecast for Russia is available in the latest EECFA Forecast Report up to 2024 which can be purchased on eecfa.com.