Үндэсний Стратегийн Хүрээлэн

Institute for National Strategy

Trends and Development of Real Estate Sector

For 1.4 million Mongolians living in Ulaanbaatar, the country’s economic progress has manifested itself most visibly in real estate. Ulaanbaatar has witnessed large-scale development and re-development, and the city is almost unrecognizable from 10 years ago. New residential areas, above all in and around Zaisan and the stadium area, have sprung up. New retail concepts, such as Hunnu Mall, have also entered the market.

3.8 million square metres of new living space come online since 2010,1 and this scale and pace of development, is unlikely to be repeated. However the real estate sector is now depressed with many problems evident and the future direction unclear to many. This article briefly explains some of the key trends affecting Ulaanbaatar real estate markets and the sector as a whole.

We have two realities to deal with, high levels of economic growth are unlikely in the short term and 60% of the city’s population (c. 200,000 households) are still living in ger areas that are often disconnected from formal urban infrastructure. A key question is whether there is room for growth, differentiation, and development within the sector?

It is critical to understand that real estate investing suffers from a time-lag, with developments only being completed some years after the initial investment decision was made. In Mongolia, where construction can only take place between May and September due to climactic conditions, this issue is particularly acute. New developments that enter the market are based on assumptions about supply, demand, and economic growth made between two and four years ago.

This time-lag explains why Ulaanbaatar has seen so much construction over the past 5 years. In early 20122 the World Bank predicted that Mongolia’s economic growth would be 17.2% in 2012, 11.8% in 2013, and 12.3% in 2014. The actual figures were 12.4%, 11.7%, and 7.8% respectively. Mongolia’s growth rates were much lower than expected, with the engine then being major mining and infrastructure projects.

During this period structural constraints impacted urban development, including a lack of available land connected to infrastructure, high financing rates, long construction periods, and the high expense of obtaining labor and materials. Together, these factors of optimism and constraint resulted in private sector focus being heavily skewed towards the upper-end of the real estate market.

The divergence between expectations and reality has resulted in a large over supply in upper market segments (residential, retail, and commercial) that will take time to be absorbed. The supply of good grade office space has doubled to almost 400,000 square meters since 2010.3 Absorption of this glut is one of the key trends that will define the office market over the next two years.

Market reality dictates that when there is an oversupply, then the price of the good being sold should drop if the buyer is well informed of the oversupply. This means that developers who are holding empty units will either have to sell at a discount or wait until economic conditions improve enough to stimulate demand for their units. The danger with the “wait and see” strategy is that the developer must bear the holding costs and suffers pressure for repayments from his creditors – which is not a sustainable long term survival strategy.

As for the rash of mid- and upper-end developments that are still being planned or are midway through construction, they will find it difficult to attract investment (or further finance) given current macroeconomic and market conditions. Although painful for many developers and investors, this market adjustment is unavoidable as development of the scale and pace witnessed over the last four years was unsustainable.

Of course, that is not to say that the entire Ulaanbaatar real estate market is consigned to purgatory until the glut has been absorbed. In fact, the market remains relatively undersupplied in certain critical segments, and there is considerable room for improvements in policy setting to stimulate activity in the areas where supply is urgently needed.

It is now essential to put Ulaanbaatar’s property development focus and its markets on a more sustainable footing. Several key trends require focus.

Focus 1- Affordable housing. Structural constraints have prevented private developers from providing large quantities of affordable units in Ulaanbaatar – despite the target market including almost 60% of the population that live in ger areas.

Efforts to address the challenge of providing decent and affordable units are now underway and successful will gradually and incrementally reshape Ulaanbaatar. These units are being provided in two distinct ways

  • Firstly through direct government intervention, and
  • Secondly through use of government financing and tools to incentivize development by the private sector.

The latter is being executed through government agencies and ministries, most notably the State Housing Corporation (TOSK), and its municipal counterpart NOSK. TOSK, for example, built the Buyant Ukhaa development by the international airport, which was sold at a discount. It is currently the process of bringing thousands of new units online through the Buyant Ukhaa II development and through projects in the 7th district of Ulaanbaatar.

In addition, the Ministry of Construction and Urban Development is taking direct action itself. Most recently, the Parliament approved its policy on rental housing, which aims to bring some 16,000 rental units online before 2021 – either through development or acquisition. With rental markets being relatively small in Ulaanbaatar, these units will help increase affordability and flexibility for city residents.

Focus 2 – Incentivising private developers. This is a central strategy and priority of the city’s Masterplan 2030 and is being carried out under the auspices of the Municipality.

  • Some 24 ger area sites have been selected citywide and tendered out to private sector developers.
  • The Municipality is responsible for extending and installing trunk infrastructure in the sites, while the private sector must meet certain conditions relating to planning and design.
  • By taking on some of the cost burden, this redevelopment plan hopes to attract large-scale private sector investment to the ger areas.
  • The first re-development – Khangai Town in the 7th District of Ulaanbaatar – was completed in 2014 and sold well.
  • The remaining sites will be developed gradually over the coming years, with the most challenging re-developments being those located furthest from the city centre.

Development and re-development of this nature will gradually reshape the city, as well as densifying it. If corresponding investments in urban services, such as public transport and utilities, are seen, then the dynamics of Ulaanbaatar could change considerably in the medium-term.

Focus 3 – Policy support for borrowers and better legal frameworks. A number of policy changes have taken place over the last year, with more being considered. Taken together these should help the market develop in a more sustainable manner.

  • The Ministry of Construction and Urban Development has gained approval for the linking of pension funds to mortgages, thereby allowing necessary deposit for property purchase to drop from 30% to 10%.
  • At the same time, the 8% mortgage programme, which offers subsidized real estate financing to first time buyers, has been extended.
  • The Government is in the process of approving a new affordable housing strategy which should provide further stimulus to the re-development efforts outlined above.
  • Donor-funded efforts to review and update the legal framework in the construction and urban development sectors are also underway.

Of course there are limits on policy reform due to domestic political issues and the electoral cycle. The Minister of Construction – who was instrumental in driving forward the above reforms – has lost his position due to the recent collapse of the DP-MPP coalition. Despite this, it is hoped that the good work carried out to date can be built upon by the new Minister and expanded upon by whoever takes office after the 2016 elections.

In summary, three focus areas will continue to define the real estate market in the coming years,

  • Markets will by necessity adjust and absorb the excesses of the boom years,
  • Developers will refocus in new directions through ger area re-development and large-scale provision of affordable housing, and
  • Legislators will improve policy that is affordable, positive and supportive of development in the areas most needed

INS commentary

While these focus areas are positive, it must be stressed that considerable risks remain.

  • The structural constraints that allowed demand and supply to diverge, for example, continue to affect investment decisions and there is a risk of further misallocation of financial resources within the real estate sector.
  • Similarly, large-scale affordable housing development, whether in the ger areas or elsehwere, risks facilitating socioeconomic stratification if these developments do not give sufficient attention to diversifying usage and income mixes and design.
  • Political risk remains a major issue in Mongolia and policy stability or positive progress can never be taken as a given, with populist policies that undermine long-term stability and growth prospects often being resorted to.

Affordable real estate is critical to us all. However, it is also important that the government does what is affordable in the context of its own debt and other budget prioritites. It is essential that it obtains value for every dollar spent and that the private sector is leveraged as much as possible.

The risks are known and will hopefully be avoided. Responsible government support and spending is essential. Attention to the above focus areas should help a more sustainable and mature market emerge.

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