Why Are Russian Houses So Expensive?

Recently my family and I were in Sestroretsk, a city near St. Petersburg. This lovely town is situated on the seashore and embedded in a northern forest decorated with birch trees.

Sestroretsk also happens to be a former favorite resort city for the who’s who of Russia's Communist Party. Because of this city's status during Soviet times, dachas* - typically modest houses and small plots of land - are transmogrified to enormous stately mansions on two or more acres of land.

Main Street on Sestroretsk:  Giant Communist Era Dachas

These mansions are beautiful; more accurately, these mansions were beautiful and some still are. Some older structures have been maintained and still have the glory they had some fifty years ago. Some have been razed and replaced by modern, very expensive buildings. Some are relics of yore and have been abandoned and, even in some cases, have fire damage.

New and Old in Sestroretsk:  Pricing Shock and Awe

The location of these mansions is idyllic. The maintained or new properties prove that there are a sufficient number of wealthy builders that are keeping Sestroretsk beautiful. The surprise is the high number of abandoned buildings. The question is why they are there; more precisely, the question is why are not more of them sold to would-be-buyers who could and would invest in them to maintain their soundness and beauty.

Clearly, one answer is that the price is too high, thereby limiting the pool of buyers to the ultra-wealthy. The "high-priced real estate" phenomenon, however, is not unique to Sestroretsk. Per my experience, all of Russia has surprisingly high real estate prices as measured by American standards. In the US (before the housing bubble where sanity prevailed), the rule of thumb was that houses should cost somewhere between three to four times the annual household income. As such, a family making $100,000 per year would be expected to live in a house that cost $300,000 - $400,000. My casual observation indicates that the house price to annual income ratio is far higher in Russia, and in some cases close to infinity (because income is nearly zero).

The question thus becomes "why are houses so expensive in Russia?"

While the complete answer is, like most things in life, complex, most of the answer, like most things in life, is simple. Basically, it comes down to property taxes, or the lack there of.

In the US, one pays the government for the privilege of owning a house. This property tax is different in different regions of the US, but tends to be 1% to 1.5% in most places. The family making $100,000 and living in the $300,000 house above would have to pay some at least $3,000 of annual taxes for living in the house. That is at least a 3% income loss, and a significant loss if there is the family has a small discretionary budget. Accordingly, the family living in the house has to generate enough cash annually to pay for all expenses and property taxes. Therefore, if rich Uncle Oswald bequeaths a mansion to poor Nephew Norman, and Norman does not have the income to support the property tax, you can be sure that Oswald's estate would be on the market and sold to the highest bidder that would show up within a reasonable amount of time.

Because there are effectively no property taxes in Russia**, there is no need to have the wherewithal to sustain a property after it has been acquired***. This makes housing prices at least inelastic in Russia (or it may even increase prices) as owners with no immediate need to sell and can hold on to the property indefinitely until the buyer with the "right" price - as defined by them - comes along. The more patient the owner is, the higher the price he can command.

Unfortunately for the average Russian, there are too many patient owners and too many ultra-wealthy Russians. Owners are patient because there is no property tax to motivate them to dump their properties on the market, thereby drive prices down. And because of the very uneven income distribution in Russia, there are those elite few who can buy what they want at very high prices. These factors conspire to pump up prices of new home purchases beyond the reach of the average Russian.

Patient owners, immune from foreclosure fears, are waiting for one of those rich Russians to come along and pay the "right" price. Thus, you have a checkerboard of beautifully-maintained or newly-constructed mansions next to dilapidated former estates in Sestroretsk.

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* Dachas are summer residences that are nearly universally owned by every Russian family. They are located out of the city in a nearby forest.

** There are some minimum property taxes but, compared to the US, those taxes are effectively zero.

*** Acquisition may come through a purchase, an inheritance, or otherwise. The point is that it does not matter how the house is acquired because property taxes should apply uniformly, regardless of the method of acquisition, to the owner.

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Addendum

Just for the fun of it, I have tried to model the interaction described above. The model is raw and needs more work; currently, it looks like this:

t is the time the owner is willing to wait to sell his property. The more patient the owner, the larger t is.

I is the owner's income in real terms.

T is the tax burden (not the tax rate) in real terms.

P is the owner's property value.

t is a function of T and I. In other words, t = F(T, I).

If I is much larger than T, t approaches infinity (the owner is very patient if his income dwarfs his tax burden, as I have witnessed for many owners in Russia). However, the closer in size I and T get, the smaller t gets. And if I is smaller than T - as was the case for nephew Norman above - the owner is operating on short time and we can expect a fire sale. So,

t = F(I, T) = (I / T) n where n > 0 and is descriptive of endogenous factors that may increase (n > 1), decrease (1 > n > 0), or have no impact (n = 1) on the owner's patience.

Now things get raw.

P is a function of t and x. In other words P = Q(t, x), where x is a catch-all for the time being that describes several exogenous market factors that determine market prices such as economic or political stability, expected inflation rate, foreign exchange rates, and so forth.

It is clear that the size of P (house price) and the size of t (owner's patience) are correlated. Hence, the larger t, the larger P tends to be and vice versa. It is still not clear whether the relationship of t and x with P is in terms of price elasticity or whether t and x actually determine the value of P. The answer largely depends on how x and Q are defined.

I have to noodle on this some more.  Comments welcome.

Got Into Hot Water

I never ceased to be amazed - or rather surprised - by building design in Moscow.  A tale of hot water will illustrate the story.

Surreal Building Design:  Keep Reading

I live in a decent apartment building in a decent neighborhood in downtown Moscow.  So, it came as a shock when my family and I discovered in June that the hot water to the building had been disconnected because a vacationing neighbor on the fifth floor had sprung a leak in his hot water line.  Because there were no per-apartment water valves, the hot water to the whole building had to be cut off.

Mind you, in June Moscow is still a cool place (the heatwave hit in late July).  The pipes in the ground were rather cold.  This made taking showers an endurance test of some sort.  The cold transformed the skin into an inverse golfball with all the goose bumps. I comforted myself by swearing that the cold water was somehow good for the soul and focused on that during the brief showers.

Cold Water:  Tough on Body, Good for Soul

After three weeks, the vacationer came home.  A plumber summarily fixed the leak.  Hot water was thus restored to the building ... for a short while.

Russian cities have a summer ritual.  Part of the Soviet design was to distribute heat centrally in cities.  Every house has a host of heat radiators powered by the hot water pumped throughout the city by municipal governments.  To service these mains, the city shuts off the hot water for about two weeks every summer.  Luckily, the second outage corresponded with the heatwave, thus making the cold showers (actually lukewarm as the ground burying the pipes had heated up to some degree) rather pleasant.

Given this history, you will understand my utter surprise when I returned home on Wednesday to find nothing but hot water running through the pipes - both cold and hot.  Washing hands became a speed challenge:  The question was just how clean hands could get before there were totally disinfected by the scalding water.  My daughters - to their delight - gave up brushing their teeth.  And showers had to be taken at the gym.

I could not figure out this mystery until a mysterious (and drunk) utility man came by last night, knocked on the door, and asked to inspect our pipes to resolve the new hot water problem.  He claimed that he had inspected every apartment in the building and had narrowed the problem to our quarters.  I was now sure that he was both drunk and insane, but I let him in anyway with a hope for solution.

He asked for the main water valve in our apartment.  I showed it to him and explained that I was sure that neither I nor my family had touched it because it was buried deep in a closet.  After a hiccup, he put on his thinking hat, traced a pipe to the nearest bathroom, and asked if anyone had taken a shower there.  I attested that I had.  He then adjusted the hot water valve in the shower, let the water flow, and disappeared for few minutes.

I presumed that he had gone away for another shot of vodka or perhaps something even more psychotropic given his bizarre behavior. I was proven wrong.  He returned with a "eureka" look on his face.  He said that the problem was solved and that he had verified it in other apartments.  Then he admonished me never to touch the hot water valve in my shower again because, somehow, that little valve controls the hot water for the entire apartment building.

Little Valve, Big Consequence

As I said, I never cease to be amazed by building design in Moscow.  And I still think that the drunk utility man is insane.

Perils of Passage, Part IV

Moving is a difficult proposition.  After getting married, I moved three times around the San Francisco Bay Area.  Each instance proved rather challenging.

My move to Russia is the fourth post-marriage move.  It is the most challenging of all.  To begin with, my wife and I moved the household internationally.  To put the icing on the cake, we moved to Russia, where customs regulations are known to be notoriously onerous.  To put the cherry on the icing, the Russian government decided to surprise everybody on 1 July through new legislation that levies a hefty "import" tax on the goods brought into the country by expats.

In my case, this law made the "importation" of my household goods more expensive than the transportation across the North American continent and the Atlantic Ocean.

The Russian legal surprise coincided with two events.  New rules easing immigration for qualified professionals was to kick in on 1 July.  It was also the same day that Russia, Belorussia, and Kazakhstan unified their customs regimes.

Whether the imposition of the new taxes had more to do with either coincidence is besides the point; in either case, the coincidence is embarrassing for the Russian government.

One explanation of the new taxes, punishing any immigrant that has more than 80 kg of goods (basically anyone who is not poor or a student - which is precisely the type of immigrant that Russia is trying to attract with the 1 July "qualified professional" immigration act), is that governmental antibodies became activated in response to Mr. Medvedev's modernization agenda.  Under this explanation, those with a political axe to grind or yearning for the yesteryears of the Soviet Union, tried to muck up the cogs that move Russia forward.  This is an unlikely explanation and, surprisingly, the less embarrassing explanation because it suggests decentralization of power within the Russian government, hence some degree of checks and balances.

The more likely explanation, and the less fortunate one, is that inexperienced, inept, or inattentive bureaucrats did a marvelous cut-and-paste job with customs regulations from Russia, Belarus, and Kazakhstan, thereby creating a legal Frankenstein that was easy to create but had no correlation to Russian national policies or interest.  In other words, Russia unintentionally allowed one of the two much smaller nations, Belarus or Kazakhstan, set its national policy through new custom regulations.

This is a pity particularly because there is a clear object lesson from the United States that points to the cost of appointing a feckless  bureaucrat to a seemingly unimportant governmental position.  Michael Brown, a professional horse judge and an active political contributor, was appointed as the head of Federal Emergency Management Agency.  While Mr. Brown was highly qualified in judging a horses head from its backside, he had no qualification in managing any major emergency, like Hurricane Katrina.  Luckily, in the case of the 1 July Russian customs law debacle, the outcome - besides the embarrassment - is only the major inconvenience and expense of a few expatriates like me and not nearly as significant as what happened to New Orleans.

I am indeed lucky.  With significant efforts from my employer*, I am (hopefully) getting my household goods sometimes in the next month.  At some point in the near future - I hope - my children will finally have a suitable home and sufficient infrastructure where they can pursue their education and other childhood activities with some degree of comfort.  I look forward to that day.

Russia Today TV has more coverage of this issue here.

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* I am sincerely grateful to my colleagues who spent countless hours on my behalf to resolve this situation.

Apocalypse Later

The heat and smoke situation has improved significantly in Moscow, but things are not back to normal.  I arrived to Moscow early this morning to be greeted the by the lingering stench of ongoing forest fires around Moscow.  However, the visibility and air quality is much better than it was a week ago.

A Fine Day:  Things are Clearing Up in Moscow

I described the situation as "being in a pressure cooker" to someone in the US.  Basically, the temperature was hot and getting hotter, there was no breeze, and smoke concentration kept increasing, as if Moscow itself was cooking.  I also remarked to my wife that the ecological disaster that we were witnessing felt like a dress rehearsal for something far more apocalyptic in our lifetimes.

Moscow Circa August 2010

An article by the title of "Part of the main:  How the heatwave in Russia is connected to floods in Pakistan" in the latest issue of the Economist  does a good job of describing how the local weather system (around Moscow) feeds itself:

High pressure makes it hard for clouds to form, and thus for rain to fall. Under cloudless skies, the surface gives up its moisture, making the ground level hotter and drier while not increasing the chances of rain. As things get drier, fires start and spread. The still air keeps the smoke close to the surface, exacerbating its effects on health. The soot heats the air further. This is what has been happening in Russia for the past two months.

What this article does not mention is how people's habits can also exacerbate the heat problem.  As I strolled through forests around Moscow not long ago, I noticed freshly-burned firewood where someone had probably made shashlik.  At the local train station, I was behind a couple who flicked their still-lit cigarettes into the bush before getting on the train.  All this happened as the fires were raging.  Obviously, those who lit the firewood in the forest and the smokers saw no connection between actions like theirs and the stifling smoke everywhere.

In any case, the article also does a fine job of connecting the raging fires in Russia for the disastrous floods in Pakistan and goes on to say

If you take into account the warming trend of the past half century, however, the extraordinary heatwave starts to look less improbable: a once-in-a-century event, perhaps. As the warming trend continues in future, the chances of such events being repeated yet more frequently will become higher still ...

Both heatwaves and heavy precipitation are more common everywhere than they were 50 years ago. Reflecting the latter trend, the Indian monsoon has been seeing more of its rainfall in extreme events than it did in the past. No single one of those events can be directly attributed to climate change; nor can Russia’s heatwave. The pattern of increases, though, fits expectations—and those expectations see things getting worse. 

Unfortunately, my off-the-cuff remarks of this ecological disaster being a dress rehearsal for something worse to come in our lifetimes seems prescient of an apocalypse, sometimes later.

 Bravely Riding into the Future

Bad Weather Forecasts

I have yet to see an accurate weather forecast for the Moscow region.  The forecasts are generally off by at least 5 degrees.

Winter days are forecasted to be much colder than they actually get; summer days are forecasted to be much hotter than they get.  The same pattern holds for night temperatures, where winter nights are forecasted to be warmer than they get and summer nights are forecasted to be cooler than they get.  It is as if some idiot talking-head stock analyst on CNBC took over Moscow's meteorological board after spewing hogwash over America's airwaves for years.

The only explanation that I see is that there is some sort of temperature dampening effect that the meteorological models do not take into account.  Basically, the weather models seem to have been built for a desert city when, in fact, Moscow behaves more like an ocean-side metropolis.

As it happens, greenhouse gasses have precisely that effect on the atmosphere.

Cops and Bad Boys

Police have a bad reputation in Russia.  Russians see their police as a corrupt force that is out to line its pockets instead of helping people.  I have been warned by good friends to eschew the police as much as possible, even when I am in trouble.

Russians' Advice:  Don't Call Our Cops

I have been been trivially stopped by the road police a few times, and I have had bribes extorted from me twice.  It may be surprising, then that I  do not agree with the Russian perpective on the police entirely.

Russian policemen are men after all.  They have families and mouths to feed.  Muscovite police - the ones I am familiar with - live in one of the most expensive cities in the world.  And, they are not well paid.  It is not a surprise then that the police would resort to unlawful measures of demanding bribes - knowing that at the end of every ruble there is a person - and that person is responsible for other people.*

Today I saw another example of good behavior by "bad"police - a behavior that I hope to see by police in major US cities someday.  Coming home, I noticed a grown man asleep in a stretch of grass on a private property.  As in the US, the police was called to resolve the situation.  Unlike the US, the situation was handled gracefully and with dignity.

In a major US city, the response would have been the arrival of two or more heavily armed police cruisers and rather aggressive stance towards the trespasser.  The trespasser would have been handcuffed, charged for trespassing and public intoxication, and hauled off to the jail somewhere.  With any sudden movements on the trespasser's part, the police would have taken preemptive restraining action, which basically means beaten the guy up to some degree.

American Police:  Every Clown is a Potentially Lethal Risk

Here, the police arrived, woke the man up, talked to him, gave him water to drink, further splashed him down to cool off, and had him walk away without any trouble.

The two cops, with no apparent bad boy amongst them, humbled the bad boy into good behavior.  This, I hope will be good and effective community-based policing in the US some day.

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* The Russian dynamics of extorting bribes are rather complex and shall be explored in future postings.


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Update

A friend told the following anecdote to me in response to this blog:

A [Russian] policeman stops a driver and demands that the driver produce his documents and 500 rubles.  In protest, the driver says "but officer, I have done nothing wrong."  In response, the policeman states "I have a wife and three children.  My wife, she cannot wait until you've done something wrong."

LA Has Excellent Air

Los Angeles is notorious for its smog problem.  This picture shows why.

LA's Skyline, Many Miles Away

Sure, the skyline is a pale shade of gray, but you can at least see the skyline!  Compared to Moscow these days, LA's smog problem is a breath of fresh air.

St. Basil's Cathedral, A Few Feet Away

Cough, cough.  With the scorching heat and ubiquitous, thick smoke, folks are starting to smell like smoked pigs around here.

Welcome to Moscow

Trend Spotter: New Accessories

Moscow's fashionistas are known for their high styles and exquisite accessories.  Lonely Planet has even dedicated Moscow travel guide's introductory page to these fabulous creatures.

Recent nasty air quality changes, namely due to numerous forest fires, has forced the introduction of a new fashion accessory:  The face mask.

It's In:  What Every Modern Moscow Girl Must Wear!

Hey, Isn't That Moe?

No, it is actually Alexander Solzhenitsyn, one of Russia's intellectual giants. His photo is part of a theatre play poster plastered around Moscow's metro system.  But, at least in this picture, he has a remarkable resemblance to Moe Howard, one of America's idiotical giants.

Moe, of course, is il capo of the Three Stooges clan.

To women readers:  Please do not try to understand this.  For as long as I can remember, Three Stooges has been "a guy thing," much like Sex in the City is "a girl thing."

Apocalypse Now

Because of the raging and numerous forest fires around here, Mocow's sky these days resembles Apocalypse Now's movie poster.  Moscow's air smells like a chimney.

Screen shots from Fire Information for Resource Management System indicate the gravity of the situation. At first glance, it looks like all of Russia is burning.

A closeup of the Moscow region shows the nearby forest fires. Zooming in, suggests that the problem is not as grave is the large-scale photo above shows.

But, when your sky looks like this:

And burned out villages look like this:

It feels like the "Russia is on fire" picture above is rather accurate.

My heart is out to those who have lost their belonging, their homes, and their loved ones in this unprecedented natural disaster.

Constituents and Customers: Go Fly A Kite

When it comes to effective service provisioning, there are two worlds in today's Russia.  The first world is a post-perestroika world; the second is the legacy Soviet world.

I have discussed the quality fo customer service and customer orientation of Russian businesses.  Modern Russian businesses are very much American-like, in the sense that they understand that a customer has many choices and his business is not to be taken for granted.  The quality of customer service that these modern, post-perestroika business have is certainly above their Western European counterparts.  This is the modern, refreshing side of Russia.

Then, there is the legacy Russia.  By "legacy Russia" I mean the part of the current Russian apparatus that was created during the Soviet times, which persists to this day.  Modern Russian government is more or less an extension of what was in place some twenty years ago; the same is true for some government sponsored businesses, like Russia's principal airline, Aeroflot.  A personal experience with Aeroflot will demonstrate the attitude of legacy Russia to customers and constituents.

Customer Service from Legacy Russia?  Go Fly A Kite!

Some visitors were flying out of Moscow recently on Aeroflot.  Escorting them to the airport, I took them to the Aeroflot check-in queue, where passengers to four destinations were standing in line for three check-in agents.  The passengers self-selected the line according to the length of the queue.

With only one person ahead of us, the agent at my check-in counter very abruptly put up a "line closed" sign and quickly walked away.  I assumed, as I imagine that most people in my queue did, that she had a biological emergency of some sort, like an exploding bladder, and expected her to be back shortly after the emergency was abated.  We waited for about 15 minutes; she did not return and no substitute came in her place.  Getting impatient and worried about my visitors' flight, I hopped over the Aeroflot counter and found another employee.  With my broken Russian, I expressed to her that the check-in agent had abandoned her post and there were some fifty passengers stranded in the line waiting to check in.  The Aeroflot's employee's response was classically unfortunate and irresponsible:

This is not my problem.

Then, she quickly walked away as if nothing was wrong or, perhaps more accurately, to avoid having to fix a wrong because this is not part of her job as she sees it.  Time-pressed passengers, left to themselves and their own problem solving skills, quickly cut into the remaining two lines, creating contention and confusion in the process.

Please Bring the Erstwhile Aeroflot Logo Back

Dear passengers [Уважаемые пассажиры]:  Fly a kite.

Per my experience with modern Russian airlines, this situation would never occur.  The line would have been closed more predictably, customers would have been redirected orderly, and another employee surely would have taken ownership of the problem to ensure a better passenger experience with the airline.  As it happens, Aeroflot, a Soviet-era legacy, a semi-private entity, and the largest Russian airline, has little incentive to ensure that customers have a positive experience (or at least can board a flight on time).

If a semi-private entity treats its customers this badly, you can imagine how the government - with very little to check its behavior- is likely treats its constituents.  Dear Russian citizen: Fly a kite.