Global Crisis 2011/12 - The potential impact on the Mongolian Property Sector

Will we see a repeat of the 2009/10 crisis or is Mongolia now in a better position to weather the international storm?

The Mongolian Property Sector is currently under threat from two separate fronts, the first is increasingly similar to the 2009/2010 commodity crisis which impacted the Mongolian real estate market rather considerably. Not only did foreign investors reduce or completely halt their investments into Mongolia (on which the Mongolian economy was entirely reliant) but as the western world descended into recession, it reduced exports from China which in turn drove down China’s need for basic mineral commodities from Mongolia but also globally reduced commodity prices due to a sudden lack of demand, therefore drying up new mining investments. A serious financial crisis in China, which could lead to a weakening of its real estate market would create a pan-regional domino effect which would, in turn, severely impact Mongolia.

As if the concerns of an impending global recession were not enough to worry potential investors, the current levels of political bickering and nationalistic sentiments amongst the Mongolian population are setting a dreadful precedent (or maybe a reminder) of the constant underlying threat of political instability. As we approach the parliamentary elections (June 2012), it is likely that we will see an increasing number of anti-foreign public initiatives from parliament members desperately seeking marginal votes in a bid to clinch to power and the lucrative opportunities this presents. A clear and recent example of such a position was the sudden, and very public, declaration that the Mongolian state wished to renegotiate the OT agreement. While this was swiftly reversed, it has resulted in a serious blow to the international reputation of Mongolia.

Mongolia’s insistence to develop its railway infrastructure towards politically relevant Russia and its sea ports rather than business oriented China thus making Mongolian commodity export considerably less profitable, has been a disappointment to foreign mining investments. The Khan Resources uranium license case, the rejection of the Tavan Tolgoi bidders (previously publicly announced by the government as a done deal) in addition to the current nationalistic positions towards OT and foreign investments can only send negative signals to those investors who are becoming increasingly risk-averse and frustrated of Mongolian politics.

During the previous crisis, the property sector was impacted in various degrees. Practically all construction projects in the city halted and while prices only dropped by an average of 20% across the city, liquidity dropped dramatically with very few transactions taking place. This only changed after Oyu Tolgoi started significantly investing in Mongolia, thus signalling to the foreign investment community that Mongolia was once again a desirable global investment location.

Mongolia’s overall economic position today is only slightly improved from where it was in 2009. The country has had the chance to grow its economy over the last year (14% YoY GDP Growth), it has secured and started the Oyu Tolgoi development, improved fiscal policies as well as foreign reserves and has managed to marginally diversify its economy but the country has, on the other hand, become more reliant on foreign debt, increased its trade deficit and is burdened with high inflation as well as high (unofficial) unemployment rates.

Over the course of 2011, the Mongolian Property market not only recovered remarkably well but increased levels of foreign investments kept pushing up capital growth and rental prices as Mongolia became the media darling of the world; an attractive story in an otherwise gloomy world.

The current growth in the UB property market is very much linked to the burgeoning emerging middle class purchasing property on the back of the rapidly increasing wage levels across the capital. Should the global crisis take a considerable turn for the worst, foreign investment will most certainly slow down over the coming 8 months of winter, wage levels may thus drop as fewer companies hire aggressively and may in turn lead to a drop of consumer confidence in property. This is in contrast to the recent announcement from the Mongolian Government of a 53% rise in public servant wages and pensions, if this is followed through, it is inevitable that inflation will rise further and we may well start witnessing the onset stages of the infamous “Dutch Disease”.

However, the fundamentals of the real estate market are still extremely solid, the country is guaranteed a relatively safe future double digit GDP growth based on the existing levels of foreign investment through the commitments that mines such as OT have already made, therefore feeding the construction and mining supply chains.

The current levels of FDI enjoyed by the Mongolian government are not solely reliant on the exports of minerals but rather on the long-term development of those mega-mines that take generally a few years to bring to production and require enormous up-front capital and human investments. This thus means that even if there are no significant new numbers of expats relocating to Mongolia, the current residents are here to stay and will keep renting apartments.

Ulaanbaatar itself keeps witnessing considerable levels of urbanisation as nomads leave the countryside to seek their fortunes (or more often – survival) in the capital, adding to the already considerable demand pool for low-to-mid end residential properties in the city. Lets not forget that over half of the city inhabitants still reside in the traditional nomadic tents known as gers.

This demand, in addition to the increasing number of high-net-worth Mongolians investing in the property sector regardless of global economics, as well as those private investors that strongly believe in the future potential returns of Mongolia over those of more established western economies is most likely to keep fuelling demand across the city centre. In addition to which there is a very real “shadow FDI”, essentially private and very discreet foreign investment, mostly from China, that invests across the board in all types of assets regardless of economic logic.

It is also highly likely that large foreign institutional investors realise the opportunities afforded in a market with strong fundamentals and invest heavily in existing built properties to make the most of the situation without carrying construction risks, thus, while new developments may slow down, the prices of existing properties may keep rising.

In addition to growing demand, supply of new properties in the city keeps dwindling as scarce land becomes increasingly expensive and both skilled labour and construction materials are constantly diverted towards the Eldorado of the south Gobi and its enormous mining projects.

As mortgages in Mongolia are still too expensive to be attractive to a vast majority of the population (less than 10% of Real Estate purchases in Mongolia are mortgaged), there is little risk of a true collapse in the industry as widespread foreclosures are impossible in a cash driven market.

With the typical seasonal drop in demand over the winter months combined with the increasing uncertainty over politics and the state of the global economy, it is possible that general property prices may stagnate over the winter months with a potential small dip within some sectors of the capital but a price drop would only be short lived as the summer of 2012 will no-doubt bring renewed investment to the country’s mining sector (probably post-election) supported by, it is hoped, a more stable global economy. We furthermore expect to see a number of dedicated property funds launching their operations by mid-2012 who are, in turn, likely to single-handedly raise prices across the board.

Suburban areas such as Zaisan and the stadium areas are most likely to see a noticeable drop in prices while the Star Apartments area, the CBD and the State Department Store / Ulaanbaatar Department Store areas are most likely to see continued growth.

It is essentially clear to those on the ground, that, despite repeated setbacks, Mongolia has firmly set itself on a path towards extraordinary growth and, pending a catastrophe, shows no signs of slowing down in the near future.