print 11.04.2007

Development of Residential Construction in Eastern Ukraine in 2004-2006

The volumes of residential real estate ready for occupation in Eastern Ukraine, namely Donetsk, Lugansk and Kharkiv oblasts, seem to be insufficient to meet demand.  This is clearly shown in both supply and demand analysis and in the comparison of per capita nominal residential space in the above mentioned regions to of the rest of the country. 

According to the social development programs of the above mentioned regions from 5 to 6 million square meters are to be ready for occupancy in order to meet demand, with only 0.9 million square meters currently ready for occupation. (See diagram 1).

Diagram 1. Construction Rates during 2004-2006

As it seen from the above diagram, the Kharkiv oblast holds the lead in terms of construction volumes with almost 40 percent of all residential premises constructed in this region. The construction is conducted predominantly in the city of Kharkiv and its suburbs (in a 50 kilometer zone). 2005 saw 192 000 square meters constructed in this territory, or 55 percent of all residences built in Kharkiv oblast (according to provisional data, 2006 saw 230 000 square meters constructed in the city, or 55 percent of the entire-volume of the oblast).

In our opinion, such significant construction volumes may be accounted for by the following factors: successful development of this region and the presence of an experienced construction industry in the city (the history of some of the companies dates back 50-60 years), attractive terms for living and working in this region (the 2006 weighted average salary amounted to UAH 974, with the annual growth rate being 119.4 percent), which, in its turn, boosts the demand for newly-built residences.

The second place is taken by Donetsk oblast, in fact 2005 saw c. 35 percent of the residences constructed in the Eastern region. It is necessary to note that though the Donetsk oblast shows higher growth rates of social and economic development, (the weighted average salary amounted to UAH 1,201 with an annual growth rate of 113.4 percent), and it is a less popular place as a residence than Kharkiv oblast. The volumes of residential construction are much below the average level. A living space of 21.3 square meters accounts for one person, which is lower than the average for the country (21.8 square meters). Moreover, there are c. 650 unfinished residential buildings of 1.4m square meters in the oblast. Construction of the majority of them (88 percent) is suspended or laid up. The peculiarities of this residential construction market lies in the fact that three fourths of the residences are being built by individual builders, which mainly erect low level buildings).

Unlike those of the Kharkiv oblast, large scale builders are less active in this region. The city of Donetsk has c. 35 percent of the total of residential premises built in 2005 and 46 percent in 2006.

Lugansk oblast in 2005 saw 25 percent of the total volume of residences constructed in Eastern Ukraine. A slowdown in construction rates, particularly in the centre of the oblast is being observed. This is unlike Kharkiv and Donetsk oblasts, where the oblast centers account for 35 to 55 percent of newly-built residences. The majority of new residences built in Lugansk oblast are built in large towns of the oblast (Alchevsk, Severodonetsk and others), the present volumes of construction, though, are insufficient.

This boosts the price rebound due to high demand. In fact prices have grown more than 3 times in Lugansk over the past 3 years. The main reason for this is the absence of the primary market. Despite the fact that several buildings are currently under construction, in the past 2 past years none of them have been completed.

It is necessary to note that the volumes of construction and prices correlate with the key indicators of social and economic development of the above regions (see Appendix 1).

The growth in the populations incomes bolstered the growth in demand for residential real estate, and an increase in the volumes of residential construction caused a growth in gross regional product. There is also a reverse dynamic situation in the Lugansk oblast, where real estate prices are rapidly growing in line with exceptionally low levels of construction activity.

In summary we may note the following tendencies of the residential construction development in Eastern Ukraine for 2004-2005:

• except for Lugansk oblast, construction work is conducted mainly in oblast centres and their suburbs;
• growth rates of real estate prices outpace those of the populations incomes, which may witness its unofficial character and speculative interest;
• the demand is greater than the supply;
• the dynamics of the construction industry, as well as its character in both oblasts differ from each other. The Kharkiv oblast features the presence of large construction companies facilities, which allows for an increase in the number of residences being built and for the reduction of per unit costs. The construction industry of the Donetsk oblast is characterized by the prevalence of individual builders.   

Different types of customers, investors and builders stipulate the need for different instruments for the attraction of cash. Let us analyze the housing bonds market.

Peculiarities of the Utilization of Housing Bonds in Eastern Ukraine

The total size of housing bonds issues rated by Credit-Rating agency in 2004-2005, the cash raised from which are to be used for the financing of residential construction in Ukraine, amounts to c. UAH 400m (4 percent of the total volume of housing bond issues in Ukraine). That is 16 issues, with 14 of them aimed at construction funding in Kharkiv oblast. In future years c. 300K sq.m. or one third of all residences constructed in 2005 in Eastern Ukraine are to built using cash raised from placing housing bonds. 

The low level of activity in other oblasts (Lugansk) arises from low development rates of residential construction, as well as by the use of other schemes for the funding for construction projects, specifically via the funds raised for construction financing (Donetsk oblast). 2006 saw an increase in the use of housing bonds in Eastern Ukraine. 2005 saw housing bonds for UAH 120m rated (issued only within the Kharkiv oblast), with the 2006 figure having amounted to UAH 270m. The spread of such an instrument occurred at the expense of Lugansk and Donetsk oblasts. Though these regions saw only one issue each (with the ongoing registration of the bond issue for funding construction in Lugansk oblast).

As a rule, there are 2 types of Issuing companies. The first type is large regional builders, the majority of which have operated since the Soviet times. Such companies have a great deal of experience and can provide all the necessary processes including design, human and technical resources for supplying the construction process at all stages.

As a rule, such companies are assigned investment-grade ratings.

We may note the following Kharkiv-based companies:

1. Zhytlobud-1 Trust, PJSC (rated uaBBB).
The companys history dates back to 60 years, when the Kharkiv Union Trust of of the Ministry for Higher Education of the USSR was established. The trust was renamed Zhytlobud-1 in 1963. It is the largest construction company in Kharkiv, incorporating 11 subdivisions with over 800 employees. The specialization of each subdivision allows for the implementation of projects without outsourced resources, namely designing, construction and reconstruction of different levels of complexity. The company has constructed and made ready for occupation over 3m square meters of residential premises. In 2006 the company issued two housing bond issues for the total amount of UAH 80.1m for the construction of 9 residential buildings with a total area of 70K square meters. The hosing bonds holders are to be provided with almost a half of this space. The redemption of the housing bonds began in January 2007 (see Appendix 2).

Zhytlobud-2 JSC (rated uaBBB).
A company with almost a 65-year old history was founded on the basis of the Kharkiv district military construction department. The company is one of the largest companies in Kharkiv with over 600 specialists employed, and has strong production facilities. The companys subdivisions can support the construction process at almost all stages, namely design, construction and reconstruction of different levels of complexity. According to the companys data, the company has constructed over 4m square meters of residential premises over the past 62 years. In 2006 the company issued 1 housing bond issue for UAH 8.9m to construct a residential building with a total area of 8.9K square meters in Kharkiv, with almost 40 percent of the buildings space being financed by the funds raised from the bonds placement. The redemption of the housing bonds for the above project began in January 2007.

The second type of companies is Issuers incorporated with large construction holdings or connected with financial institutions, though they do not have experience in residential construction.

Credit ratings vary depending on the Issuers performance quality from the speculative grade (the lowest uaCCC , which denotes a default possibility in the countrys financial market environment) to investment grade (the highest uaBBB , which denotes adequate capacity to meet its obligation commitments in the countrys financial market environment).

Almost half of the volume of housing bonds issued is to be redeemed during 2007 according to data on issuances (50 percent of the issues are assigned investment-grade ratings). And, unlike in other regions of Ukraine, the time of bonds redemption almost correlate with that specified in documentation for the construction project. That may impose additional risks in the event of overdue redemptions caused by delays in the construction process. The Eastern regions of Ukraine do not have experience in the redemption of housing bonds unlike their peers from Central, Western and Southern Ukraine.

In our opinion, further utilization of such leverage will depend on the successful redemption of the to-be-matured issues.     

In summary we may denote the following tendencies for the use of housing bonds by regions in 2004-2006:

• high specific gravity of investment-grade rated issues, in fact 20 percent of all bonds issued in Eastern Ukraine, with 6% of them in Ukraine in general;
• high concentration of housing bonds issuers in the city of Kharkiv and its suburbs: almost 99 percent of the overall volume of housing bonds rated in 2004-2006;
• low activity of use of such leverage in other regions of Eastern Ukraine (Lugansk and Donetsk oblasts less than 1 percent of the overall volume);
• expectation of large volumes of issues to be redeemed in 2007-2008, in fact over 90 percent of the total volume of registered and rated housing bonds;
• active use of housing bonds by leading regional builders in the Kharkiv region;
• risks of non-fulfillment by some issuers their obligations, incurred by a short period between the term of the project being ready for occupancy and the bonds redemption;

Appendix 1

General Description of Residential Real Estate Market in Eastern Ukraine in 2004-2006

Appendix 2

General Description of Use of Housing Bonds in Eastern Ukraine in 2005-2006

Andrey Kulik, Head of Department for Rating Monitoring