Why Real Estate is the Road to Riches in Mongolia

Harris Kupperman, Chariman and CEO of Mongolia Growth Group, talks about the updates on Mongolian economy, local real estate and developments in Mongolia Growth Group.

Emerging Frontiers: Harris, the Mongolian economy is still growing at an amazing pace. Expected to grow 11.6% in 2014, according to the IMF, what are you seeing on the ground that isn’t being translated through other media outlets?

Harris: The economy is much stronger than the headlines would suggest and I expect organizations like the IMF to begin raising their forecasts in the near future. Ever since the government passed the new foreign investor law, many mothballed projects are now moving forward again and we expect to see the growth rate accelerate in the spring as the capital spending starts up again.

At our business, we tend to have a pretty good handle on the direction of the economy as we manage leases on approximately 80 SME tenants between our office and retail space. I have to tell you that the economy hasn’t been this strong since we first started our business in 2011. We have only one vacancy in retail space and for the first time in our company’s history, we have no rent that is more than 30-days delinquent, which is a great indicator of our tenants’ ability to pay in a timely way. Even more tellingly, we have waiting lists on some of our high-demand properties as there is a severe shortage of well-located retail space and to a lesser extent, a shortage of well-maintained office space. This shortage is once again beginning to translate into increased pricing and in November, we reported a 23% year-over-year increase in rents for properties that were part of the core portfolio. This growth rate has a good chance of accelerating as more properties are renewed at currently prevailing rental rates.

In retrospect, it appears that many firms took a wait-and-see approach during 2013 due to the presidential elections and the expected change in the foreign investment law. Now those firms are flush with cash and looking to expand—unfortunately, there isn’t enough available space, even for well-respected Mongolian tenants that want to expand.

In summary, the economy is booming here in Mongolia, but too many overseas investors are reading stories that should have been written 12 months ago, by journalists who have never been to Mongolia. Ironically, right as things re-accelerate—you are seeing various Mongolian stock indices stagnate or even decline. Just look at the performance of the MSE which is down over 65.6% in US Dollar terms since the peak in 2011. It has recovered a bit from the absolute lows, but now is the time to be buying—instead; investors are scared—as they usually are right after the lows as they don’t have accurate data on how well the economy is doing here.

Emerging Frontiers: I can vouch for the vast discrepancy between what’s happening on the ground and that which is being broadcast overseas, having lived in UB for nine months. How will the revision of the investment law and implementation of the securities law impact investment in the country?

Harris: If Mongolia is going to continue growing at double digit rates, it needs for external capital to be invested in the economy as the domestic capital base is insufficient to support the current growth rates. The new foreign investment law allows a lot better clarity on what sorts of investments are allowed and it opens up a number of sectors to foreign investment that had previously been reserved only for Mongolians.

Meanwhile, the securities law will allow the growth of the domestic capital markets, which will ultimately be a captive source of future growth capital. Both of these changes are huge positives in terms of bringing capital into Mongolia and will be responsible for increasing the growth rate.

Emerging Frontiers: Through previous conversations you have said that MGG is receiving inquiries from many prospective retail tenants. Are you seeing increased interest from foreign companies? Who do you think is the next multinational retailer to open shop in UB?

Harris: We have had many inquiries from Mongolian and international tenants. Unfortunately, we cannot disclose who we are speaking with—however, I think the next growth driver in terms of the retail markets will be the entry of more foreign firms, often in partnership with professional Mongolian groups.

Emerging Frontiers: Now, onto government sponsored projects for a moment, how has the 8.0% mortgage program, which started last summer, helped property prices to rise? We have heard that prices on average in the city centre increased over 30.0% in 2013.

Harris: I’m not sure if 30% is the correct number, but clearly prices have increased at a healthy rate. In particular, there has been a noticeable increase in the value of well-located re-development sites in the downtown. It is hard to say how much of this growth in prices was from the 8% mortgage program and how much of the increase was simply from plain old economic growth that has fueled property price appreciation.

It is worth mentioning that in 2011, the economy overheated and this lead to an increase in inflation which the Central Bank ultimately had to fight. The risk is that the economy is once again really ramping up and this is starting to lead to an increase in inflation. The key is to make sure that the economy doesn’t overheat again, so that we have more stable growth going forwards.

Emerging Frontiers: On December 24 MGG announced the closing of the sale of Mandal Insurance. How has the elimination of insurance from your portfolio allowed you to streamline operations and cut costs?

Harris: Disposing of Mandal will simplify our business as MGG will be focused only on the property sector, and we will have less volatility in our reported numbers. Even more importantly, we will have very substantial savings at the corporate level. The unfortunate fact is that Mandal was simply too small to be part of a public company and going forward, I think they will also be more successful on their own.

Our hope is that by being a pure-play property company, with a lower cost structure, we will be much more understandable to the investor community, which should help us as we continue to grow our business.

Emerging Frontiers: What is your strategic focus for 2014 as the economy beings to heal itself and a higher degree of normalcy returns?

Harris: Since our listing, we always thought that our property portfolio was the key asset at MGG. We are increasingly realizing that our property management platform may be just as valuable—if not more valuable. What we have built over the past 3 years is a company that can do everything including acquisition, property management, leasing, value added renovations and development. Most importantly, we can do this in a way that is IFRS compliant, audited by Price Waterhouse and ideally suited for other institutional investors looking to invest in the growth of Mongolia. As investor attention has starting returning to Mongolia, we have received quite a few inbound inquiries from institutional property investors who realize that we are one of the only companies in Mongolia that can provide the sorts of services that they will need if they invest in Mongolia.

When we first started MGG, we faced the same dilemma that many of these institutional property investors now face, as there are only a handful of firms that provide professional property management services. Unfortunately, many of these firms aren’t set up for the added compliance needed to service the needs of a public company—hence we had to build out own team. Now that other overseas investors are entering the market, they have the same difficulty that we had—the only difference is that we have been here for three years now, have a dedicated staff and can understand their unique needs.

Over time, I think that our strategy will evolve from simply owning property assets to earning high margin fees for structuring deals and managing other people’s assets. We always knew that this was the direction that we wanted to go, but it took three years to get to the point where we had the extra bandwidth to really market these services and then perform on the mandates that we won.

Emerging Frontiers: That’s an interesting concept. I’ve spoken with several foreign funds seeking to build exposure, their problem however being what you just mentioned, a lack of structures and talent on the ground.

MGG owns multiple well located land packages ripe for redevelopment. What is the company’s strategy going forward to extract value from these parcels?

Harris: Previously, we did not have the team needed to properly develop these assets. Now that we have built up our team, we are actively exploring how to re-develop the assets. I think we have a lot of flexibility in how we maximize the value of the assets going forward and this will be a driver of growth in future years.

Emerging Frontiers: Harris, thank you for sharing your thoughts and insights.

Harris: Absolutely. Check back soon, given the growth rate in Mongolia, a few months is a long time.