The sector has been moving from a state-owned and -controlled industry to one driven by for-profit firms for the past two decades. However, this transition has been complicated by the challenges of extreme climate, a shortage of trained workers and logistical obstacles preventing the establishment of a steady flow of low-cost and on-time materials in the supply chain.

In recent years, as the mining sector’s growth filters through the economy, domestic construction sector players have been focused on adding capacity to meet the huge future needs in housing, transportation, infrastructure and other areas.

NEED FOR INVESTMENT: Nearly everything is needed in Mongolia – migration patterns indicate that its capital city, Ulaanbaatar, could be short on domestic housing for the foreseeable future, for example. New power plants, roads, an airport, office towers, mall and more are on the agenda. Mongolia will remain reliant on foreign partners to an extent for major construction works, either on a for-profit basis or through development financing. Domestic builders are not likely to see a sudden leap in capabilities, an abrupt end to financing constraints, or a sudden boost to labour supply. The country is working to add capacity in the construction sector – the government’s high-profile effort to build 100,000 new homes was envisioned as a holistic approach in which money is to be spent on training Mongolians in the skills needed.

For foreign companies, however, the list of opportunities remains long, and the government has been improving its processes for tendering and its legal environment in order to win their participation. This has been done in part with a law to clarify how public-private partnerships (PPPs) are to work. In total, government plans call for MNT30.9trn ($21.6bn) in investments in infrastructure, construction, mining and energy by 2015.

EBB AND FLOW: A key challenge here is access to basic materials, such as cement, glass and brick. The country is landlocked and far from markets that can supply what it lacks in-country. Overland transportation options are swamped by existing demand, and building supplies compete with mining equipment and other imports on train wagons available. Building activity comes to a standstill during the frozen winter months, leaving a construction season of about six to eight months. During that period materials prices soar due to supply constraints. Whilst some groups may have the ability to acquire and store these materials over the course of a winter, most of the country’s builders resort to buying materials when the need arises, which means paying inflated prices. As demand is surging, procurement is already a regular concern for Mongolian builders, in particular for cement (see analysis).

As Mongolia builds itself up there are increasing concerns about a real estate bubble, and fresh in the minds of many are the results of the 2007-08 financial crisis.

The ensuing collapse in demand for Mongolian mineral exports and the cratering of commodity prices led to a bust in the construction and real estate sectors.

Several signature projects stalled and building skeletons remain from the period.

CAUTIOUS LENDING TO CONSTRUCTION: Those visual reminders help explain the current climate, in which banks are cautious to lend to builders. Around 450 developments of various sizes were unfinished as of 2011 due to a lack of financing, according to the Mongolian Construction Association.

The willingness of Mongolian banks to finance construction companies is likely to be different now. Cautious lenders and constrained access to capital will make cost management paramount for building to be profitable in Mongolia. Trade and Development Bank, the country’s largest lender, was as of October 2012 avoiding financing individuals looking to fund construction and mandating that successful loan applicants will have the means to finance a full project to its end, O.

Orkhon, its first deputy CEO, told OBG. During the 2008 crisis, he said, apartment sales halted for several months, and developers ended up selling for lower prices and saw most of their profits eaten up by financing costs.

Now, with symptoms of Dutch Disease evident across the economy and inflation a major concern, contractors are thinking of ways to go faster. “Now, if you can’t get your project done before the winter you’ve lost,’’ said D. Nurbol, the executive director of building materials provider M-Solid, a unit of the Mongolian Investment Holding Group conglomerate. “Interest rates will take all your profits. So it’s shifting now: we are pouring concrete in the summer and continuing to build in winter.’’ For most projects, the goal is to get a structure built to the point that it can be sealed from the elements before winter, in order to heat it and finish the interior during those cold months.

Financing is a constraint for consumers as well, which presents challenges for developers. A typical down-payment for a mortgage is at least 30% of the value of the purchased property, for example. The government has attempted several programmes to incentivise low-interest mortgages, such as a securitised-loans system, and set up institutions to work towards concessionary rates. It would like mortgages with interest as low as 6% made available to lower-income buyers; however, that is lower than that at which even the biggest and most capitalised entities can borrow, leaving the state unlikely to get help from the private sector in removing the financing roadblock for individuals.

TRANSITION PERIOD: The state gave up its monopoly control over construction in Mongolia once the socialist period ended in 1990, leading to a five-year period in which privatisation was under way but construction’s contribution to GDP fell by between 14% and 16% on an annual basis, according to research by R2 Research, an Ulaanbaatar-based team of foreign investors and data providers. Many of the largest builders currently are divisions of larger conglomerates, such as MCS Holding, or foreign companies, such as the Hong Kong-based Asia Pacific Investment Partners, whose principal is an US investor named Lee Cashell.

Reliance on foreign companies in particular for large projects has been common in the past two decades of market reforms as domestic companies learn the trade and build capacity. Help has come in some areas from the development community, such as a programme from the Millennium Challenge Corporation to train construction workers in adopting international standards for managing and disposing of hazardous waste materials, and another to help modernise relevant schools and training programmes.

RESIDENTIAL NEEDS: Precise estimates of housing demand are difficult to develop because of a lack of statistical data about the sector caused by reporting requirements. Developers are not required to provide sales or other data to any type of state or private agency that would then publish aggregate figures in order to provide transparency in the market. Based on migration trends and economic projections, R2’s research estimated that in the capital alone another 175,000 dwellings are needed at present. However, the construction sector’s aggregate building capacity is estimated at roughly 6500 flats a year. Were demand to remain constant, which few expect it to, that would imply 27 years before supply catches up, and few in Ulaanbaatar suggest that the city can wait that long.

Outside it, the populations of several small towns are set to double or triple as mining activity ramps up, creating several areas of the country in which the need for residential construction is acute. Informal or individually built houses are less likely to move that figure lower because of a trend for Mongolians to buy land on the outskirts of Ulaanbaatar (the state entitles each person to a small plot for a cost that amounts to slightly more than the transaction’s administrative fees) and live in gers (felt tents) as they build, over the course of several years, an immovable structure.

However there is little to no infrastructure in these ger districts, and so the government considers them a temporary phenomenon and not one that addresses its demand picture, regardless of whether their inhabitants are happy with their dwellings or not. The districts present long-term problems such as pollution, because residents have no heated buildings and therefore use low-grade (and therefore dirty-burning) coal for heat and cooking; and because without proper sewer lines there is a danger of polluting the city’s water supply. The Ulaanbaatar city government has pledged to extend infrastructure to the ger districts, however, sceptics believe that would be too costly, in large part because pipes would need to be buried at least three metres below ground to avoid them freezing in winter. “The ger district is just not dense enough for building infrastructure to it to be feasible,’’ said one foreign development agency executive.

POTENTIAL MODELS: One promising private sector response to the housing shortage has been MCS Properties Holding’s Viva City, which the company built in large part to meet the demand of its own employees. The development is a complex of apartment blocks of 40 sq metres or less and ground-floor retail space, and it is aimed at young professionals, first-time buyers and lower- to middle-income buyers. Margins are very thin, however, according to the company’s vice-president for finance and investment, Ya. Purevsuren. The units, which are now under construction, sold at about $1000 per sq metre, and costs were $900 per sq metre, he said.

MCS partnered with a Japanese architectural firm to create space-saving designs. The company’s collaborations with such foreign expertise have also resulted in landmark projects like Central Tower, the premium office space in Ulaanbaatar – it owns 49%, with the rest held by Shangri-La Hotels and Resorts. The two are also partners in building a Shangri-La hotel in Ulaanbaatar, which is under construction.

INFRASTRUCTURE PROJECTS: According to the World Bank, as few as 5% of licensed domestic road construction companies were considered capable of handling large construction projects. One of the problems is that often they are not following the construction blueprints provided, said B. Byambajav, the director of the Department of Strategic Policy and Planning at the Ministry of Roads and Transportation.

The ministry’s capacity to supervise road contractors is limited, according to Byambajav, and building roads that last in Mongolia is complicated because of extreme temperatures in the country.

Swings from 35°C to -35°C stress the roads and make it difficult to keep underground moisture away from them through conventional drainage techniques. In many cases, Byambajav said, potholes patched up on city roads in Ulaanbaatar need another fix as early as just one or two years later. Many Mongolian road-building companies are partnering with Chinese companies, which can help, he said.

PARTNERING UP: In the big picture, the considerable infrastructure needs will require significant participation from foreign firms, either on a for-profit or a concessional basis. The government, aware of this, has been working on providing a suitable legal environment. The World Bank and Asian Development Bank are among development organisations working with various Mongolian government agencies to improve tendering, for example. Another important change was the passage of the 2010 Concessions Law, which lays out a specific legal environment for PPPs. It addressed one of the longstanding complaints about Mongolian law, and sometimes public tenders: a lack of specifics. For a potential infrastructure builder on a PPP basis, this might have meant unclear responsibilities and obligations for the state and its partners, for example.

One of Mongolia’s current signature projects is a combined heat and power generation plant for which PPP negotiations were ongoing as of late 2012 between the government and a consortium of domestic and foreign firms. Authorities hope that this project will establish the country as a reliable environment for PPPs. The government first put the project out for tender in 2008, but only one company submitted a bid, said D. Gankhuyag, a business development manager for Newcom Group, one of the largest conglomerates and the domestic partner in the private consortium established to carry out the project.

Gankhuyag said that the current attempt, within the framework of the Concessions Law, made clear the obligations of various parties and provided a bankable government guarantee, and that explains why it has progressed past the tendering stage.

OTHER CHALLENGES: However, Mongolia remains in other ways a difficult place for builders. Building codes are vague and poorly enforced, and cannot be found in one single document but instead must be compiled from several. As of now, fines for failing to adhere to regulations are low, providing little incentive to construction companies to comply – in some cases as low as a common taxi fare, according to R2’s research.

Corruption is also, for most, a required part of the process. According to the World Bank’s “Doing regional average, but Mongolia is an easier country in which to get construction permits than, for example, Kazakhstan (147), which Mongolia benchmarks itself against, as well as its two neighbours Russia (178) and China (179). Countries in which building is easier include Japan (63) and South Korea (26).

As of late 2012 speculation in Ulaanbaatar held that a number of buildings under way without permits would be torn down by the city, perhaps in an attempt to clean up the process, and that as many as 250 buildings could be impacted. Though they are only speculation, these rumours serve as a reminder of the significant political risk that comes with building in Mongolia, and has encouraged market conditions whreby political connections are an important ingredient for success. The larger construction firms – there are about 10 with the size and influence needed, said Christopher De Gruben, real estate investment firm M.A.D. Mongolia’s managing partner – are considered far more bankable than the rest.

“We’re now only financing the 10 largest construction companies in the market,’’ said Trade and Development Bank’s Orkhon. He told OBG that the lender has been limiting its exposure to the construction sector since April 2012 on concern of a repeat of 2008.

Mongolia earlier in the 2000s agreed to have the Japan International Cooperation Agency (JICA) to review the long-term master plan for Ulaanbaatar, and the group concluded that legal obstacles to progress were significant. It recommended that Mongolia pass laws to govern the construction of new towns and for compulsory purchase rights in order to better specify regulations such as appropriate floor area ratios or height and setback limits, as well as improving existing laws by providing more definitions for terminology. The JICA report recommended specific changes to multiple laws.

COSTS RISING: For both materials and labour, costs are rising fast in Mongolia. This is in part a symptom of Dutch Disease, as Mongolia’s small cadre of skilled workers both blue- and white-collar are in demand by the mining companies arriving in the country, and that has pushed up salaries across several sectors. According to the Mongolian Building Association, there are some 28,000 trained indigenous construction workers. Chinese workers typically fill the gap. The official number of Chinese workers in the country during construction season in 2010 was 80,000, according to R2 research, however, companies have been known to bring them in illegally as well to avoid a head tax of MNT12,000 ($8.40) for each foreign worker brought in.

Laws limit the number of foreigners on any one construction site to 600, although in some cases such as large-scale mining projects, exceptions can be made. In general, the laws are not rigidly enforced. Estimates are that there are as many as 200,000 Chinese working in the country both legally and illegally during construction season. In some cases these workers are not paid but simply rounded up and deported at the end of a project, as the company that hired them will find it cheaper to report the workers as illegals and pay a fine to the government rather than paying the workers. In general, Chinese workers are paid more than Mongolian ones because they are considered more skilled, and more reliable. The standard wage for a domestic worker is $350 a month; for a foreign one $470, save for North Koreans, who are cheaper than Mongolians.

Materials costs have risen 26.5% since 2008, according to R2. There is some domestic production of cement, brick, concrete, window frames and doors, and wall materials, and a few local sources for water pipes and electric cable. However, imports make up the vast majority of supplies, and outside those few areas Mongolia is 100% reliant on imports. Some cement producers are ramping up capacity (see analysis), and seasonal solutions are emerging. Aizawa Corporation, which is based in northern Japan and produces frost-proof concrete, has opened a production facility in Ulaanbaatar. MIH Group, a local conglomerate, is making magnesium board and panel blocks that compete on quality with Chinese imports but cost more, said M-Solid’s Nurbol.

OUTLOOK: Mongolia’s construction industry is young and growing, and thus far has been unable to handle the demand that has arrived along with the mining boom. Foreign participation now is comprehensive, with non-profit projects as well as for-profit joint ventures in the residential, commercial and infrastructure sectors. Should Mongolia succeed in firming up its legal environment, and in particular if the electricity plant locally known as CHP5 (the Combined Heat and Power Plant Number 5) progresses as planned, it can expect a great deal more foreign interest and investment.