Price increase in construction business is still anticipated

Maka Ghaniashvili

Developers and experts are talking about revival of real estate market.

What are the reasons of such optimism, should we truly expect growth of activity at the housing market or this remains desirable. How the housing prices are going to change in Tbilisi?
The problems that construction field had to face recently in Georgia were anticipated even before August war and world financial crisis. As the financial mechanism of the construction business mainly depended on the income gained from preliminary sales. Increased competition at the market and specificity of the product (futures contracts) has compelled developers to use installment selling system. Initially, installments were limited to the project duration (2-3 years), but afterwards their term increased up to 10-15 years. In order to finance current expenses, developers were forced to sell at least 80% of overall project. Otherwise, installment schedules could not ensure funding of construction in a planned pace. In case of such intercorrelation of sales and construction pace, there always comes the time when scales of preliminary selling contracts exceed budget performance. This is a direct precondition for high level financial risks. To be more precise, in some specific project, 80% of incomes are predefined for future three years; while 80% of expenses are more or less predictable, but still indefinite. If in the course of the project, it appears that prognosticated cost-based part of the budget is increasing by 10%, the price of the rest of floor space should be increased at least by 50%, in order to gain the planned profit. This was the foundation of the financial pyramid that appeared in the construction field of Georgia. One percent inflation in cost-based part automatically caused two-five times increase of the prices. However, it was impossible to keep constant price growth in the pace that was needed for maintaining profitability of the construction projects. Therefore, many construction projects incurred losses and construction of the new developments has been started in order to cover expenses of the previous projects. Constant growth of competition and selling prices were resulted in outburst of land prices. Thus, the future of the sector became even more unpredictable and deplorable.
At the same time, it should be noted that majority of developers were unable not only to prognosticate financial situation for future years, but also to design construction budget based on the showings of the current period in writing. Many of the big optimists among developers did not even reckon it necessary. Banks weren’t immune to the charms of competition and thus they did not manage to properly evaluate existing situation and monitor crediting process. The situation became even more aggravated by the events developed in August and global financial recession. Construction sector suffered huge damages not only in Georgia, but also in whole world. There was a big plunge in sales of floor spaces and thus developers were unable to continue construction at their own expenses. Banks rejected credits to developers, as the last have lost confidence of the banks (construction companies remain the biggest debtors of the banks). The constructions were almost stopped. Many developers, including quite prestigious and powerful companies, were on the verge of bankruptcy. Association of the Developers has designed a new project for the support of the construction companies. Banks will assign credits to the developers under the warranty of Tbilisi Mayor’s Office. The developers will complete the constructions in the process with these funds and move in the newly constructed houses the residents of dangerous structures. Unoccupied old buildings will be conveyed to the Tbilisi Mayor’s Office that for its part will sell them to the investors. The plan is considered to be beneficial for every participating party. It has been approved in Mayor’s Office and the bidding has been announced for the financing of the project.
Mr. Irakli Rostomashvili, the president of the Association of Developers of Georgia: “This is a unique and very original project that is designed for our capitol and it reflects whole range of problems specific for Tbilisi. On the first point, it should be emphasized that concerns of the residents of the houses under the threat of collapse is considered in the project. This project wouldn’t have taken place without collaboration of the developers, banks and the mayor’s office. Every participant of the project benefits from it. GEL 53 million will be invested in the construction sector, ceased constructions will be restored, 20-25 thousand people return their jobs and 9 thousand square meters of floor space will be constructed. There are no budget expenses. On the contrary, budget will benefit from this. Additional taxes will enter state budget, including VAT. Banks are going to benefit either. They will revive old portfolios and gain additional profit of interest rates. Mayor’s Office derives benefit by this, as 35 thousand sq/m of the area in the most prestigious and expensive Tbilisi districts will be conveyed to it after the project accomplishment. All the above-mentioned is directly reflected on the country’s economy. Construction sector was a locomotive that drove many other fields also. Stagnation of housing sector had influenced furniture importers, construction material producers, importers and manufactures of sanitaryware and facing materials in a direct proportion. Numerous people became unemployed. This was a huge chain reaction that started in construction sector. Therefore, revival of construction sector is of essential importance. On average calculations, one well-appointed house utilizes 5 hundred various products, started from insulation materials and nails and ended with curtain rods.
G.E. – Is housing price growth anticipated?
I.R. – Price growth is already noticed. However, I reckon that prices will be stabilized at the market. Price growth boom characterized to pre-crisis period was illogical. $3 thousand per square meter of area is an impossible price in Tbilisi. When banks designed simplified mortgage loans, mass crediting was started in housing sector. Simplified mortgage loans caused increased client activity, as Tbilisi is one of the most damaged cities in Europe; it’s natural that 90% of the population desires to improve housing conditions. However, this does not necessarily imply that they can afford it, they just want this. In this case, naturally many people appealed to the banks for mortgage credits on these favourable terms. Those who had salary of $1000 took credits for buying apartment with the value of $100 000. Demand on real estate started and naturally it was resulted in the price growth. To my mind, in few years the prices will be stabilized and $1000-15000 becomes actual price. Average price of real estate in Tbilisi is $1200-1300.
The above mentioned project is known as “New life of old Tbilisi”. The committee assigned scores to competitors with quite complicated formula. It considers the bid price per sq/m, value of freed land, terms of accomplishing the construction and so on. The main, decisive criterion is the price. The companies offered $950-1100 per sq/m. as Mayor’s Office refused to pay higher price per square meter. About 30 construction companies were willing to participate in the project. However, many of them could not prepare necessary documentation on time. Some failed to reach agreement with the residents of dangerous structures, some were unable to come to an agreement with the banks, and others did not comply with the criteria set by the committee.
243 families will get new living space over two years. The budget of the project is $31 369 000 (approximately GEL 53 million). Seven out of eleven companies that applied for the project received financing. These are EUBE Georgia, Callas, Olympic Star, Axis, Bagebi City, LLC Nike and LLC ARSI. However, if the rest four companies manage to present complete documentation in 10 days, they will receive financing also. According to the company “Akademkalaki”, they did not present the original document of building permit. Tiflis Development and TEXX had problem with the agreement signed with one of the residents. The company Georgian House left the project. New competition will be announced in the nearest future. Those developers that did not manage to file an application will be able to participate in the second stage of the project. However, mayor of the capitol declared that the budget is limited and thus there is a necessity to establish some restrictions. Therefore, participation of private business in the project financing is not excluded.
TBC Bank, Bank of Georgia, Bank Republic and Kartu Bank will finance successful projects. Developers already started to designed construction schedule; they are planning to restore construction as soon as they receive corresponding funds. Banks will transfer credit to the companies gradually, by tranches. Construction companies received credit under annual 18% rate and they will cover it as a standard loan.
Bank of Georgia considers financing the following construction companies and projects on the basis of specific conditions: housing estate in Avlabari and project “Ortachalis Turfa” of the company “ARSI”; construction on Shartava Street of the company “Olympic Star”; housing estate of the company Callas – Vake Palace; and dwelling house of Bagebi City Group – Park Place”.
Funds assigned to the mentioned projects amount GEL 18 million (Source: www.sb24.ge). General Director of TBC Bank, Mr. Vakhtang Butskhrikidze declared in his interview with the data portal pressa.ge that the decision to support developers was mainly based on confidence expressed to the state and mayor’s office rather than to the developers. Bank will credit $10 million within the framework of the project.
Will this be resulted in price growth?
Interest toward apartments under construction increased from the very start of the old Tbilisi rehabilitation project. Information about this is spread by the part of the construction companies. Clients are interested in new constructions. Successful developers participating in the project are expecting increase of sales. It is forecasted that Tbilisi rehabilitation project encourages real estate market activity, the number of deals increased that would be a precondition for the prices to stop decreasing. Exhilaration at real estate market is seen since June. Sales of apartments, commercial areas and plots have increased. Partially, the banks have created incentives for this. Big banks increased mortgage credit portfolio within last three months and started to lend money for purchasing of the plots.
As the representatives of the company AXIS declare, consumer activity has increased in the recent period. AXIS Palace will receive $1.3 million credit and construct housing space of 1300 square meters. General Director of the company AXIS Mr. Giorgi Kapanazde talks about common tendencies of the field: “There is a huge demand on real estate in Georgia. There is 17 square meters of area per capita in Tbilisi, while this showing is 34 sq/m in Eastern Europe and even higher in Western Europe. It should be noted that the most dwellings in Tbilisi are under danger of collapse; there are so called “Khrushchev buildings” that are extremely uncomfortable with intercommunicating rooms, low ceiling and so on. Considering all the above-mentioned, demand on housing space is quite high. During the post-war period, sales were extremely decreased. However, sales have become more active in the recent months, but it is worth of noting that demand is mainly observed on completed products. People are still afraid to take risk and invest in constructing project. In pre-crisis period, this business was entirely built upon preliminary sales and nowadays, there is sharp deficit of completed projects. Therefore, it was necessary to design a mechanism that would enable client to purchase constructing area without taking high risks. AXIS is offering a new project to the consumers, so-called ESCROW. ESCROW means the special account on specific conditions. Consumer chooses desirable real estate, which will be completed with the term from three months to two years and signs trilateral agreement with the bank and the developer. Risks are brought down to minimum, as the consumer opens deposit in the bank and gets interest rate. Consumer places the sum corresponding to the price of chosen real estate on that account or part of it. Developer will be able to receive funds only after fulfillment of own obligations. Before that the sum remains on ESCROW account. In case if developer does not meet the time constraints and defaults on obligations, consumer is completely protected – he/she has the right to withdraw the money or continue the contract. Under any circumstances, consumer will receive accumulated yield of interest.
G.E. – Is price increase anticipated in the nearest future?
G.K. – Supposedly the prices this year will remain unchanged. When the crisis started, people were asking whether prices on real estate would decrease. Then we were saying that this was impossible, as the cost price of the construction was still high. However, at the same time, we were noting that if the cost price decreases then we would reduce the selling price either. This happened so and the prices decreased by 10-20%. Though, if the prime cost of the construction grows again we will respond adequately. The tendency of price growth is already noticed in construction materials business. The price of reinforcement has increased within last few months. If such trend continues, we will be induced to increase real estate prices. This is quite possible from the next year. However, right now, average price of housing space in our company varies from $850 to $900. After the start of rehabilitation program of Old Tbilisi, Developer Company ARSI also confirms growth of interest toward housing spaces under construction. The company admits that population’s interest has considerably increased. The company ARSI anticipates price growth for New Year. Company ARSI is the biggest player in Old Tbilisi Rehabilitation Program. It will provide 100 families with dwelling space.
Price of secondary apartment is growing either. According to the radio station Komersant, the part of independent brokers operating in Tbilisi is declaring that the price of secondary dwellings in the capitol has increased by 10-15%.
If the initial value of the dwelling for sale was 15 thousand USD a month ago, during recent weeks the price has increased up to $18-20 thousand. Independent brokers declare that the price of dwellings for rent has grown up to 200 GEL simultaneously.
Revival of real estate market is observed all over the world. Review of British edition “The Economist” covering real estate markets of 19 countries (mainly the most developed countries of the world), states that showings speak of minor increase of prices. This especially might be said of Apr-Jun 2009.
Housing prices have increased in Great Britain either. According to the Bankers Association of Great Britain, 38.095 applications on house purchase were filed in August of the current year. The showing is 81% more compared with the showing of August of the previous year. However, all in all, this number is 40% less than pre-crisis period showings. Despite first signs of revival of the British economy, this is only drop in a bucket. British experts reckon that activity of real estate market is not visible yet, thus price growth is rather surprising. They suppose that increased prices and activity is defined by lack of real estate rather than increased demand. Despite reduction of prices on Foggy Albion, within last two years, they still reach the historical peak. In comparison with 1997 year, the price of real estate in Britain increased by 170%, in the times when average income of the citizens has increased by 55%.
Development of construction business in 2004-2008 years*
The share of construction business in Georgian economy has considerably increased within last years, especially in 2004-2007 years. The share of construction business in total production of economy was 4.9% in 2000Y and average growth was 0.3% up to 2005Y. From 2004Y to 2008Y, average share of construction was growing by 1.5% (Table 1) in total production of economy. This means that in the course of last four years, share of construction in total production of national economy almost doubled compared with 2004Y.
2007 can be entitled as the year of construction boom by the volume of construction works conducted. Construction works with the value of GEL 1717177 has been done to this period. The sum exceeded the showing of 2004Y by GEL 1340085. The volume of construction works 4.5 times increased in 2007Y compared with 2004Y and 7.1 times compared with 2001Y (Table 2). The number of builder and developer companies over last ten years almost doubled at Georgian construction market. 628 construction organizations were registered in 2001Y, but the number increased up to 1248 in 2007Y, 72 governmental companies and 1171 from private sector.
3815 building permits for construction of 3820178 sq/m area were issued by corresponding institutions in 2008Y. In overall volume of areas to be constructed, 63.1% is holding dwelling spaces. The volume of business and office areas is 13% and 7% correspondingly. It might be concluded that Georgian construction market provides three main types of construction areas: dwelling spaces, business and offices areas. However, there are some constructions of industrial destination. Together with the growth of the number of construction companies at Georgian market the volume of output was increasing either.
Output of construction companies produced in 2003Y made up GEL 302.2 million. This sum reache it highest value in 2007Y – GEL 1718.2 and then in III quarter of 2008 just before August hostility it downgraded to GEL 848.5 million (table 3).
World financial crisis and Russian-Georgian August war forced construction business into insolvency. Any type of sales was stopped at the Georgian construction market.
The price slump at the construction market of Georgia started in Nov-2008. Before the well-known war events, the price of one square meter area at the construction market was fluctuating from $600 to $3000 depending on the destination, category and location of the area for sale. The price sometimes was even reaching $5000. Nowadays, demand on commercial areas is extremely decreased as the processes developing in the country together with financial crisis impede business activities (Table 4). In the fourth quarter of 2008Y the pace of price reduction was rather slow than in the first quarter of 2009Y. The main reason of this can be considered the “standby mode” of sellers and buyers at the construction market. The price of housing spaces at the market was maintaining more or less stable rate in the first quarter of 2009Y. However, at the same time, it should be noted that supply of dwellings to the market was quite limited either.
2008 year started in Georgia with the boom of construction business. Correspondingly, commercial banks became active either. The volume of issued mortgage credits in Jan-2008 was GEL 455 809 000. In April of the same year,the highest showing of mortgage credits over last 16 months – GEL 549 316 000 was observed. However, the data of National Bank proves that overheating of the construction market started from this period, both by volume of mortgage credits, and by reduction of the construction output. In Apr-2009, commercial banks issued mortgage credits of GEL 304 335 00, that is only 55.4% of highest showing of 2008Y (Table 5).
It is obvious that events developed in construction sector were rather accelerated by Russian-Georgian war. However, one cannot make scapegoat out of this war as the majority of Georgian construction and developer companies took credits in too large amounts and in too many quantities so that the aftereffects were just a matter of time.
At present, the solutions for construction and banking sectors are actively sought by the government, banks and developer companies together with various non-governmental organizations. We have discussed one of such projects in detail. What benefits will this project bring to real estate market of Georgia? It is too early to speak about this. However, one can be said for sure, the ongoing processes in the country will change the state of construction market. Only those subjects that manage to produce output in accordance with existing reality and supply market with it would be able to stay at the market.
*Source: Kikutadze Vasil, “Dynamics of construction development and management organization in Georgia”, bulletin of Strategic Researches and Development Centre of Georgia, August, 2009.