Recent reports about Moscow as the most expensive city in the world (24% more expensive for expat workers than New York), and stories about hundreds of new 24-hour casinos, boutiques, clubs and multi-million dollar condos bring Europeans and Americans to a simple conclusion -- Russians are getting rich only because of high oil and gas prices. This stereotype is wrong. As always, things are not quite as simple as they appear in Russia.
It is normal to assume a rising economy drives up prices for real estate and common goods; that's how it is in Western Europe and Northern America. However, consider the late 1990s in Russia: in 1998, oil prices bottomed out at $10 per barrel. Even so, castles in the Moscow suburbs and luxurious apartment complexes in the city were being built just as fast as they are today. The difference between Russian and American wealth creation is the fact that a rising economy in America means that almost everyone is a little bit better off; but this new wealth in Russia trickles down much more slowly, and the vast majority of the population sees no improvement.
Putin's economic reforms have indeed improved the situation of urban middle class Russians, but the question remains: can a middle class family pay cash for a five million dollar condo? Or a fifteen million dollar home in the Moscow suburbs or the Black Sea resort of Sochi? The answer is "No", so even if middle class Russians are doing better, the rising price of housing is pushing their American dream of home ownership out of reach.
The "riddle wrapped within an enigma" of Russian real estate consists of two related issues: good old supply and demand and the lack of other investment opportunities in Russia besides natural resources and real estate.
There are quite a few people in Moscow who have money and want to live in a nice place, but due to the physical Soviet legacy the demand for decent apartments far outstrips supply. The rising price of oil is "blamed" in the West for the outrageous real estate prices in Moscow, but if you look at the numbers, you'll find out that the oil prices increased almost by five times; roughly speaking, that means that someone who used to make 20 million dollars from their energy investments now makes a hundred. What's the difference in buying a two million dollar condo versus five million? None. Remember -- the oligarchs made their vast fortunes in the 1990s, when oil was still cheap. The accumulation of their fortunes had little to do with world oil prices.
Old-style Soviet bloc apartment buildings are still the norm in Moscow, and they are in huge demand, since the population of the city (including illegal immigrants from the former Soviet republics) has grown from nine million to nearly fifteen million people in less than ten years. As a result, apartments in Moscow have increased fivefold in average value (which can be viewed as an investment rate). A one bedroom condo which sold for $50,000 cash in mid-nineties goes for $250,000 today.
It makes little sense to talk about the skyrocketing prices for upscale housing today, because there were no mansions or luxury apartments to speak of in the Soviet Union. Even top party members dachas would be considered run-down by today's oligarchs and upwardly mobile New Russians.
Russia Blog's recent article about the Discovery Travel Channel show "Super Homes: Moscow" quotes real estate agent Phil Bogdanov saying that there are many people who want luxury and a view, but unlike in America or Western Europe, there are very few places for him to show his clients. It is not even a question of a temporary gap between supply and surging demand: there is huge demand and almost no supply. This is why Mr. Bogdanov said that "one can ask as much as he wants." in what the narrator calls the ultimate seller's market.
Recently the Federal Anti-Monopoly Bureau of Russia did some research, trying to find out if there is collusion in the real estate market to drive up prices. According to the common middle aged-Russian's Soviet-era logic, the price of one square meter (ten square feet) of an empty concrete space generously called a "new apartment" should value at $1,300. Instead it goes for $3,000 on average for a middle class housing, and the market, according to many real estate firms, is poised to reach $5,000 -- 6,000 per ten square feet. Luxurious condos or apartments with a view reach the tag of $25,000 per square meter (10 square feet!).
The results of the federal antitrust investigation revealed enormous corruption and kickbacks for local officials in charge of land administration, construction safety, local fire departments etc. However, the agency was unable to find any "conspiracy" or "monopoly" in the major cities. The number of construction companies in the market is astonishing, and so is the competition. The prices that sound ludicrous to Americans are quite real. An executive of the Moscow-based real estate company MIEL-Brokerage, Natalia Kirpichenko, said: "Considering the fact that it does cost $600 to build one square meter of housing in Moscow, $1,300 seems fair for a retail price. But we don't live in a central planning economy anymore, it is free market, and the free market is ready for the price tag of five to six thousand dollar per square meter".
There is a simple reason why prices will reach this point, and it is not oil money: if you are a newfangled Russian millionaire, there isn't anywhere else to put your money in Russia besides natural resources and real estate.
Imagine a successful small town gangster who saved up five million dollars or a member of parliament who collected ten million in bribes over four years. What can they do with their small fortunes?
The Russian banking system is still considered unstable and there are no mortgages to speak of or bonds that Russians can trust. Most Russian banks are used for international wire transfers and to safely store large sums of cash while families are traveling outside the city or country. After the 1990s run of bank failures, no Russian in his right mind trusts the banks enough to put his money in CDs. The only profitable Russian stocks are oil, gas and metals companies, most of them co-owned by the state. Buying significant shares requires connections, or hiring a law firm and reviewing a lot of bureaucratic paperwork before you get to risk your money. And if five million is all you have with no future income -- do you really want to play the Russian stock market?
Many would ask -- why not invest your money abroad? Let's imagine again that the small town gangster took his five million to America along with the former MP and his ten million dollars. How long will it last them here, if they have to pay property and sales taxes out of pocket, along with insurance, medical bills, etc? The answer: it wouldn't last as long as in Russia. I know a story about a lady who came to Florida from Moscow in the late Nineties with two million dollars. In her first year, she bought a house and a nice car. During her second year, her husband got into a car accident and they had to sell their house to pay the medical bills. Now she is homeless and begs outside a local McDonalds. With her poor English skills and arrogant attitude it really is hard for her to get a job. This story is true.
So what would wealthy Russians spend to live in security, comfort and respect? As much as it takes. And where else in Russia would a middle class family spend all of the few hundred thousand dollars they have managed to save? Because if you buy an apartment; and rent it to tenants, it will provide income for many years to come, and one day it can be sold to pay for retirement or be given to the children.
Even if the oil prices miraculously collapsed to $15 a barrel tomorrow, real estate prices in Russia will only continue to go up.