Massive inflationary booms always end in tears induced by the resulting deflationary bust — Here's the case of Ukraine

One of my best friend expressed his intentions to buy a piece of land in Kiev, and it lead to me wander what was the state of affairs over there. After just a few minutes of Googling, I came across this Ukraine Real Estate Market post by a real professional, Sergey Kalinin, who is describing himself by the following statement: "I'm the Chief Operational Officer at ECO Tower BC. All you want to know about Ukrainian Real Estate you will find here!". Written in Jan 2007:
2006 for private investors, having free funds, was successful. Since 1998, when prices for residential real estate were twice dropped, there was possible to purchase one-room apartment for $5K. Now this apartment costs about $80K.

There is 1600% for 8 years and aprox. 60% for 2006 income for real estate deals. Secondly are power plant shares - 90% (and you should exclude 15% for taxes and traders commision). Third most profitable asset is gold brings 35% profit, but there is 10% spread for bank operations.

Talking about real estate pricing I have to say about enourmous growth - from $1350/sq.m at February to $2300 at December (at Kiev for sure). Make note, that is not only income from arbitrage. Most of them using for rent business. So potential income about 70% for 1 year

About stock exchange. Profitabily of mutual funds vary from 11 up to 57 %.

So, in short-term conditions, real estate investments are most profitable and reliable asset in Ukraine.
At about the same time, the BBC published this report (5th of Jan 2007):
Yet Kiev is now believed to be the most expensive city in Eastern Europe in which to buy a home.

Prices increased by 10-25% in just the final two months of 2006.
And although the flats remains a concrete shell - as with most flats in Kiev, it is up to the owners to fit floors and doors and finish the walls - a three-bedroom unit is valued at about $1m.

This kind of price is estimated to be about three times what it would have been two years ago - although, with no public register, no-one is entirely sure of the exact figures.
"Kiev has experienced such a property boom. I bought a flat three years ago for $30,000, and now its worth up to $200,000."
[Here comes the usual rationalization of a massive and totally irrational bubble]
"People simply want to move out of their old Soviet style housing, and move into something more comfortable," says Jaroslav Kinach from property developers XXI Century Investments.

In addition, many Ukrainians don't trust banks, preferring property as a way of securing their savings.
At the offices of agents Parker and Obolensky, prices start at $500,000.

"In my experience the most expensive places cost $25,000 per square metre," says Parker and Obolensky's Ruslan Suchkoe.

"That's not a joke. Apartments of this price are about 100 to 300 square meters in size."

Such a valuation would put the top of the market at around $7.5m.
The cheapest one-bedroom flat in Kiev costs in the region of $100,000- far beyond the reach of most people in a city where the average salary is about $200 a month.
[Given that the price to earning of the one-bed flat is about 50, it's laughable to see the conclusion of the report:]
But with so much speculation, and such an imbalance between prices and salaries, many fear that the residential property market in Kiev is in danger of overheating.

It could be a bubble - and if so, there is no way of knowing when it might burst.
Remember: When it seems to good to be true, it usually is! Proof? Here's a report published about 2 years later, in June 2010. Troubled Ukraine Real Estate Market Shows No Signs Of Recovery is full of economic nonsense and Keynesian misinformation, but some stunning hard facts come out of it nonetheless:
By March 2010 Kiev house prices had dropped 40.5% from their August 2008 peak
The housing boom saw four fast and furious years:
  • In 2005, prices of flats in Kiev, the capital, rose by an average of 60% y-o-y, according to Blagovest. 
  • In 2006, the average price of flats in Kiev rose 51%. 
  • In 2007, the average price of flats in Kiev rose 44%. 
  • In 2008, the Kiev flats price rise slowed to 17.6%. 
  • From 2002 to 2007, house prices skyrocketed 562%.
A significant number of buyers were British, with some Americans, Emiratis, Cypriots, Kiwis and Canadians. Ukraine’s wealthy elite also joined in the buying frenzy, pushing prices way beyond the means of the average Ukrainian.

In 2009, the number of individuals who were able to secure mortgage loans for apartments and houses plummeted by 94% to just 11,600 persons, from 180,000 persons in 2008.
The Ukrainian mortgage market amounted to 10.82% of GDP in 2009 (National Bank of Ukraine) - but the 117% rise in housing loan values in 2008 was simply due to the collapse of the dollar peg.
The substantial political and economic risks in the country mean banks are only willing to lend at a very high premium. Interest rates on US$-denominated housing loans averaged 12.7% in 2007, 13.5% in 2008, and 13.3% in 2009. By January 2010, interest rates had risen to 15.2%. Experts warn that the only borrowers willing to pay this high premium are property speculators.

The interest rate on real estate loans denominated in local currency (hryvnia) was even higher at 20.4% in February 2010. Euro-denominated loans have average interest rates of 13.6%.
Rental rates have fallen by as much as 50% since the onset of the global crisis.
Inflation slowed from 22.3% in 2008, to 12.3% in 2009, and is forecast to be below 10% in 2010.
Prices will have to decline by 82% from the 2007 top to reach the 2002 levels, after a 562% boom. As corrections are always overdone, I wouldn't be surprised to see a 90% decline. Remember: if you buy an asset after a 80% decline, but that the actual peak to trough is 90%, you loose 50% on your investment.

Ukraine is just another story of inflationary boom from a corrupt political class that allowed banks to push credit so much without any of the limits that a Free Market would impose. The resulting deflationary bust is going to be extremely hard, specially since the global economy is also falling into the abyss. There isn't going to be any exogenous support possible...

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