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Forget Everything You Think You Know About Mongolia

I've been wanting to interview my friend Chris DeGruben for the last 6 months.

Truth be told, I've spoken to him quite a few times and just never hit the "record" button - literally and figuratively speaking. That's a shame, because Chris is easily one of the sharpest guys in Mongolia, and definitely someone you need to pay attention to. I should have brought you this sooner.

Chris is a veteran of Mongolia, having first travelled there in 2005. Anyone that can hack out more than a few years in a frontier market is OK in my book. These are tough places…

Having learned from the master, Lee Cashell, Chris has gone on to make quite a mark of his own. Chris and his partner Joachim have participated in over 1,000 RE transactions, and multiplied their own capital 25 times over! Their firm, M.A.D. Investment Solutions has grown into a multi-faceted consultancy. Chris is qualified to comment!

I think you'll really enjoy this no-holds-barred interview with one of Mongolia's true "rising stars."


Mark: Chris, we talk about it a lot, but Mongolia is just coming onto the radar of most investors. The story started many years ago. You were there early. What attracted you to the opportunity?

Chris: My father was a diplomat specialising in the Soviet Union. I thus spent my entire childhood in Soviet economies where I truly saw the transition from centrally-planned economies to market economies.

The transition process always seems to follow the same path, with cars getting bigger and better, shops getting filled with foreign goods, clothes getting more colourful, skirts shorter, etc. The one constant I found in all those transition economies was that soon enough property would be privatised, which was then followed by an enormous boom in the real estate market for a period of 10 to 20 years. This would go on until it reached what I would call "normal" market conditions, like those that we find in Europe and in other developed economies.

We have seen this throughout Eastern Europe as well as all over those CIS countries that have successfully transited their economies to a market economy model. When I first travelled to Mongolia in 2005 this dynamic was just starting. This, coupled along with the incredible story of Mongolia, provided extremely strong fundamentals in which to invest. I knew that while it might take a few years to really develop into a serious market, the opportunities were absolutely worth the wait.

Mark: You know that is something Chris and I talk about a lot on this blog. Investors need to realise that "investing" is somewhat predictable. There are certain patterns that repeat time and time again. Chris recently spoke about front-running liquidity, that's a perfect example.

Chris: That's absolutely true, and it will be true in Mongolia as well.

Mark: You worked for Lee Cashell's APIP in the early days. Lee's had a lot of success, and he's one of the guys we like to chat with regularly. What did you learn from your experience with APIP?

Chris: I learned everything I know today from Lee; he is a true entrepreneur and I loved working with him. He has an incredible understanding of the market, and to this day I very much admire what he has achieved in so little time.

I have also been lucky enough to learn all the pitfalls that exist in operating in such a dynamic market as Mongolia, and this has allowed me to develop the strategy of M.A.D. into something that is more flexible, with few conflicts of interest. We allow investors to operate with transparency, and develop tailor-made strategies that are based on solid fundamentals.

Mark: We've had a lot of discussions about your business activities and the services you offer at M.A.D. With the background you developed on the ground in Mongolia, and your real-world experience as your foundation, what areas are you focusing on and why?

Chris: I am always on the look-out for the best possible opportunities for investment, and Mongolia truly is a place where anything and everything is possible. I am lucky enough to operate in a market where opportunities of all kinds exist.

Unlike more mature markets which have extremely high barriers to entry, Mongolia is a country with an incredible ease of doing business. It is a country which brings together a lot of of the ingredients needed to make it one of the most attractive in the world for investors right now.

Of course Mongolia is still an emerging, frontier economy, and this brings with it its own series of issues and problems. For instance, solid and formal due diligence is extremely hard to achieve, as so much of the economy is informal, and deals are made through connections and contacts "below board" rather than "above board."

Another enormous issue that still faces the country is the lack of scalability in its investments. While opportunities abound, they require small ticket sizes of between US$ 100k to US$ 1 million, this puts off the vast majority of institutional investors looking for US $30M plus ticket sizes.

There are three areas where we see the majority of foreign investments going into: Mining and the mining supply chain; the Mongolian Stock Exchange; and, real estate. I have looked closely at all three of those sectors, and only real estate makes sense for an investor such as myself. Let me explore this a little further.

The mining and mining supply chain sectors are certainly very interesting, and the entire growth in the Mongolian Economy is based on this sector, but I don't know the first thing about mining. To be fair, it is a sector where there is enormous amounts of corruption on the ground. It is a sector dominated by the big boys with large cheque books (Rio Tinto, Ivanhoe, Leighton etc…) who are able to make the most of those opportunities. Small investors such as myself will have absolutely no impact, and we are left with the crumbs that no one else wanted.

Beyond that, mining and the mining supply chain is the playground of the political class, a group I would rather not mix it up with. Even if you look past the fact that there is no due diligence, that all the good plays are being taken up by people with deeper pockets than myself, it is clear by being on the ground that the mining sector is extremely volatile. The politicians in search of votes (we have a new election in June) always find populist votes easy to get by making public declarations of nationalising mining assets, cancelling licenses or levying additional taxes on the mining industry.

The world is focused on the mining industry in Mongolia, and I don't have the resources to have a target painted on my back at all times. Mining is too capital intensive, it is a market in which you have a lot of country risk and no direct influence on returns. It's too risky for me and for my investors.

The Mongolian Stock Exchange saw enormous growth over the last year, but has stagnated over the last few months. Again, an interesting play, I have accounts there and so do most of our investors, but we recommend it as an additional strategy in addition to real estate, not instead of it.

The reasons for this are as follows: There is a certain lack of liquidity, with a total market cap of less than US $1.5B and a daily traded value of about US $50k, it is hard to put any money into play without impacting the markets. It's even harder to make a timely exit if you need to.

It is a place where I can and want to invest funds, but with so few stocks being traded actively beyond the top 10, it is nothing more than a waiting game where I have absolutely no added value as an investor, nor any way to differentiate myself from other investors.

We use Rescap (Eric Zurrin's firm) as our brokers for my own accounts as well as those of our clients, and hope that with the involvement of the LSE, and the growth in the Mongolian economy we will see a strong push in the summer of 2012, but we are not holding our breath too much in case it continues to stagnate.

Another thing to bear in mind is that practically none of the listed companies on the MSE pay dividends. So, this is a pure capital growth speculation. We see our investment in the MSE following this path: Invest in stocks by closing your eyes and throwing a dart (the financials of all the companies listed are a pure work of fiction, in my opinion), pray that the markets mature enough over the coming years so that other investors come in to buy your positions (instead of listing or investing in Mongolian assets on other exchanges), and hope that the management of the companies you invest in are not all certifiably insane.

Even then you have to rely on your broker to generate sufficient liquidity to allow you to exit from your positions whenever the time has come to do so, in a matter of days, and not months.

This leaves me with Real Estate, our chosen field of expertise. Real Estate ticks all the boxes for us, it is a market with no, or very little, government involvement. This cuts out corruption (if there is no need for licensing or special government permits, we don't rely on a mindless bureaucratic drone in search of a little envelope to carry out our business), it has no restrictions (apart from land) on foreign investments, ownership or repatriation of capital, it shows strong growth over the past few years and will continue appreciating over the coming years.

It is a market where our investors have great liquidity and can easily add value to their investments by renovating, renting, etc.

It is also important that our investors retain a certain independence with regards to their agents or brokers on the ground. All our investors own their assets outright, which means that should they wish to move the management of those assets to another agency they are free to do so at any time. This forces us to remain competitive and offer as good a level of service as possible. This is actually important to me, as it prevents us from becoming complacent.

I will go into further detail about real estate in a second, but essentially we are in a situation today where we have strong growth in demand from the expats, increasing numbers of high net worth Mongolians, foreign institutional investors and (mostly) the emerging Mongolian middle class.

Mark: That's a great point Chris, the demand is diverse and spread across several groups, it's not just speculation.

Chris: Exactly. Meanwhile we have dwindling supply due to the high cost of land (due to the lack of infrastructure development) the lack of talented construction workers, the lack of financing, the short duration of the summer construction months and the increasing difficulty of getting construction supplies into the country. This presents us with incredible opportunities to invest in undervalued assets with enormous growth potential.

We have come up with some very strong investment principles for real estate in Mongolia, and by following them we are fairly certain of being able to achieve above market returns. There are of course a number of risks associated with investing in the RE markets in Mongolia, but the balance is very much on the "pros" side, instead of the "cons" and makes the investment worth the risk, in particular when compared to other global markets where real estate seems to be in free-fall.

Mark: OK, you like Mongolian real estate, that's obvious. Real estate moves fast and furious in the beginning and most investors miss the initial bump. Where are we at in the cycle?

Chris: Real Estate in Mongolia is indeed an enormously dynamic market, which seems to change overnight. There is strong growth in nearly every sector with some sectors already heading towards an oversupply situation. You've got to remember that UB is a tiny, tiny, tiny market with excellent opportunities, but where it is also very easy to reach an oversupply situation before we even think about it.

A single building can completely change the markets, and the city is so filled with rumours that it is often hard to know what to believe in. Having said this, there are still strong opportunities available. I bought my first apartment in UB for US$ 26,000, today it is worth about US$ 140,000, and I am achieving a rental yield (based on my initial purchase price, of over 100%).

While it may seem to some investors that today's prices are already relatively high, I believe that we are still very far from a peak. Today we are seeing an average capital growth of about 20% per annum, and a net rental yield of about 10%. This is not bad at all when compared to other markets. I think that we still have 3 years of solid growth, as the fundamentals are still excellent. Let me explore what those fundamentals are a little bit.

Mark: Absolutely, let's dig into that a bit.

Chris: First is the strong GDP growth that will continue over the coming years.

It is no great secret that Mongolia is now one of the fastest growing economies in the world, and this trend will continue over the coming years regardless of the global situation. This is because the growth in Mongolia is spurred by already committed levels of foreign investments, such as the US$ 7 billion needed for the development of OT, and the US$ 5 billion expected for the Tavan Tolgoi deposit.

Remember that the GDP of Mongolia is only US$ 5 to 7 billion per year. This is in addition to the growth of the supply chain that will happen regardless of a global crisis, as mining activities are long-term investments and account for cyclical movements in world economies.

Next, Mongolia has a young, urban demographic.

Something like 60% of the Mongolian population is under the age of 26. On top of that, Mongolia still has a very highly educated and literate population with a strong ability to learn foreign languages. This will lead to two things: 1) A baby boom in the coming years, exponentially increasing the size of the population from 3 million to nearly 4 million within 7 years (and therefore the size of the market); and, 2) a population with an increasing disposable income that seeks in the first instance to purchase their own homes, and will eventually be looking towards investing in real estate as a product. This will start a "buy to let" frenzy, as has been seen in other similar markets.

We have already seen a strong impact on the demand side of the market, with a switch from multi-generational households (with grandparents, parents, siblings, kids and grand kids) all living in a single 2 bed or 1 bed apartment, to a more nuclear (parents and kids only) type of family housing. This growth will of course be dependent on the growth of a mortgage market over the coming years, something that will signal the real start of an active real estate market for the population as a whole, making real estate investments accessible to a much wider section of the population.

Mark: That's important to point out. This boom is cash-driven, there are really no mortgages to speak of in Mongolia.

Chris: Right, not yet, at least not in the sense that we're used to in the West.

The next point is that Mongolia is restricted in its infrastructure development.

Ulaanbaatar was built for 300,000 people by the Soviets. Today its ailing infrastructure is supporting 1.2 million people. Infrastructure is crumbling across the city and the government is doing no where near enough, not only to expand the infrastructure network (sewers, water, electricity, roads etc…), but it is not maintaining what currently exists.

This means that land outside of the current city infrastructure limits is essentially worthless. This in turn is driving up prices of land within the city limits and also the cost of construction. As long as we invest in the city centre or areas connected to infrastructure, demand on those areas will continue increasing exponentially.

Despite Ulaanbaatar being surrounded by thousands of miles of steppes, it is essentially an island like Hong Kong, and should be thought of as such. If you want to build on water (in UB's case on land with no access to infrastructure) fine, but the costs of doing so will be a multiple of building within city limits.

Then there are really low taxes and no restrictions.

With no capital growth tax, no stamp duty and only 2% income tax, Mongolia is essentially a tax heaven when it comes to Real Estate investments. Further to that, there is no restrictions on foreign ownership of real estate assets nationally (apart from land), this is unique in Asia, and a big growth factor as it allows foreign entities to invest without penalties in such a strong market.

Like I said a moment ago, Mongolia is still mostly cash purchases, with very little of the market mortgaged. With only 9% of the Real Estate market as a whole currently mortgaged, we still have a long way to go before we enter any sort of bubble territory.

This is possibly one of the strongest fundamentals that we are seeing in the market today, the math is simple: 1.2 million people in the capital, of which 700,000 live in the ger district, but are keen to upgrade their lifestyle (from outdoor toilet - painful when it is -40 outside - to indoor toilets and running hot water), and the remaining population are all crammed into barely 116,000 residential units, few of which are of good quality. Look at this alongside a national residential supply of barely 8,000 units a year, of which only 2 to 3 thousand are actually decent quality, and located within the city centre limits. This is nothing, and it will be pushing capital growth for years to come.

All of this to say that while we have seen amazing growth in the market over the past 5 years, bear in mind we started from absolute ZERO, and are now reaching a slightly more mature and normal market. It is still filled with opportunities in the right sectors.

A lot of the major risks that investors such as myself had in the early days are today gone, with enormous opportunities left for new investors. I think that we will see 3 to 5 years of strong growth pushed by the dynamics described above, with a potential for the markets to peak in 7 or so years and then stabilise at that point. So, overall it's a great time to enter the markets.


Mark again. We'll leave it there for today, that's a lot to digest. Tomorrow we'll run the rest of the interview.

Here's a side not for our readers… Up until this point we've been posting twice per week. The good news is that we're growing quickly, and there are so many fantastic opportunities in frontier markets that Chris and I are having to step it up a bit. That doesn't bother us, we're up for the task.

Going forward look for more posts and more actionable information, 3 or more times per week.

If you like what we're doing here please share it with a few of your friends. And, as always, please feel free to send us questions or leave comments below for the community.

- Mark

"There is no quote today - that interview was long enough" - Mark Wallace

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.