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Trump Made His Choice

December 2013

What are the prospects for Russian developers?

Fotobank www.lori.ru

The world famous American multi-billionaire Donald Trump declared his desire to build an office center in Russia. Moreover, and by analogy, on par with the well known Trump Tower, in New York City. A very revealing intention, which demonstrates the prospects for the construction business in Russia.

Meanwhile, the real estate market in Russia is currently stagnating. But this is not preventing construction companies from keeping the price of services at the same high level. This is especially true for premium class housing. Optimism in the housing market is in many respects connected with the high price of oil, due to the situation within the Middle East. The real estate market is also being supported by the low housing supply. For example, in Moscow, the average is 19 square meters per person.

Moreover, the average prices of real estate in Moscow, and in other cities of Russia, now largely react to currency fluctuations to the detriment of real trends in the cost of square meter. In other words, the ruble value of all segments of the housing is growing, though not by much. In part, it all comes down to an 'opening' of ruble prices and gaining momentum against the dollar.

Tatyana Kalyuzhnaya, the head of the analytical center department of research and consulting 'Real Estate Market Indicators', believes that there will be no essential changes to the real estate market in Russia for the near future, though it has obviously recovered after the crisis of the end of the last decade: 'The situation can only change if there are structural changes in the global economy, which has been observed, as of yet. While oil prices are more than 100 USD per barrel, the situation within the real estate market will remain stable. We should take into account, also, all the possible inflows of capital through the purchase of shares of Russian companies by foreign investors. The most possible scenario of development is moderate growth that is in line with inflation.'

Another opinion, held by Elena Balashova, an employee of the Development Centre of the Higher School of Economics says: 'Investors have already started leaving the construction segment, which will be followed by a decline in the Russian real economy. Old construction projects are completed, and in the meantime businesses are afraid to invest in new projects.'

The potential investor in the Russian construction business should consider trends in urban development in those regions in which he is interested. For example, in Moscow, the Soviet principle of building by residential neighborhoods has been abandoned and replaced with the construction of more comfortable quarters for people, following the European model with the closed courtyards. It is clear that construction is now possible only in territories where industrial zones have been vacated.

One of the conditions for the reorganization of industrial zones put forward by municipal authorities is their multipurpose utilization. Here, not only housing and social facilities should be built, but also jobs, retail stores, parks, and other zones for recreation. According to the project approved at the beginning of 2013, 69 industrial sites will be reconstructed in the near future. It should be noted, that not all industrial enterprises are subject to demolition – only inefficient and unprofitable ones, the others will be refurbished. Besides, some of them are architectural monuments, so that their appearance should remain the same, even if you change their purpose.

Dmitry Golev, the head of department of the Welhome company, is full of optimism concerning the prospect for the renovation of industrial zones: "It is the most satisfactory outcome for developers", – he said.

Meanwhile, the area of renewable territories in Moscow is significant. We are speaking of the eight pilot industrial zones, including the ZIL and 'Hammer and Sickle' factories, as well as the Tushino airfield. This is approximately seven and a half million square meters, while also taking into account, the development of new buildings. It is also important that all these areas are located in the heart of one of the most expensive cities in the world. The competition between developers for developing these locations promises to be extremely competitive.

In fact, competition is set to become even more intense, in view of the fact that, first of all, reconstruction of some industrial areas will come first, and then those 'bedroom suburbs' in Moscow, which will sooner or late become obsolete. It is clear that the companies proving their reliability practices will gain an edge to develop these areas. We are talking about decades of steady existence in the Russian capital market.

Frankly speaking, Russian integrated house-building factories, including in Moscow, are not ready to restructure their work yet. They have yet to significantly modernize production. It will also be necessary to develop a new series of finishing agents for facades, and a new format for the ground floors, and so on.

There are also other issues of 'mixed developments', required from developers by the Moscow authorities making the enticing to its citizens. Yet this approach it is not always attractive to developers. In some places, for example, in the southeast of Moscow, under the terms of development, office space is necessary to build to provide jobs to inhabitants living in the area. However, according to developers, the location of the site is such that the demand for office space is sure to be very low.

For those who intend to work at the Moscow market, should become well-acquainted with a lot of aspects, well in advance. For example, following the model of development of the European or American metropolis, the places where suburbs should begin, multi-storey panel buildings stand instead, as a general rule. Only now, are developers thinking to master development of roofs. Their total area in Moscow apartment houses is about 1 billion square meters, but only 50 facilities have operating roofing. However, we can assume that this problem, more or less, can be solved in elite buildings only in the near future.

In general, Moscow now is very similar to Tokyo in mid-1980s with many of its problems. Monocentric development, huge traffic jams, poor environment. Even the population and the area can be compared. Therefore, governing bodies of the city seriously follow the way the capital of Japan succeeded in solving serious problems.

It must be kept in mind that the housing market in different parts of Russia periodically develops seasonally. Let's say, housing prices in Severodvinsk dropped significantly last summer, and rose again in the autumn. Basically, the situation in this city is relatively favorable due to huge amount of orders the ship-building wharf and ship repair yards receive. Hence, the reason why developers are so optimistic.

Developers market in Russia is mainly private. For example, in Moscow companies under city control are now erecting more than 4 million square meters. Though permits for the construction of 42 million square meters have been issued. However, the indisputable leader in the capital market is still the state-owned Management of Civil Construction in Moscow. It was established in 2011, when due to unscrupulous actions of contractors, the program for the construction of kindergartens was disrupted. Since then, they not only have built schools and orphanages, but also apartments, and also industrial and business real estate.

Olga Sergeyeva, the director of the Centre of Economic and Political Research and Development, is sure that the share of city contractors in the capital market is essential: "However, they have no real impact as of yet. Everything depends on the municipal authorities' future strategy.

Meanwhile, the practice shows that Russian banks are extremely careful and even reluctant to finance the developers. Exceptions are, perhaps, large and outstanding companies. It is evident that the banks' policy in this matter completely coincides with the approach taken by municipal authorities, be it Moscow or Tver.

The increasing attention of developers has moved from Moscow to the regions. Often they are estimated by experts to be zones free from competition with local colleagues. Sometimes this is true, but not always. Local developers are often supported and protected by municipal authorities and even regional authorities. Then confrontation begins, resulting in forcing out the Muscovites from local businesses.

It is worth noting, that the large Moscow construction companies approach with caution when working in the regions. There, they should have special connections, which is not always possible, regarding the level of operations that such developers have in the Moscow region. Nonetheless, large developers still eye the opportunity to work in the regions. They are attracted by the fact that level of purchasing power increases there, so good rental rates are expected, and developers will receive an adequate amount for facilities.

And while major development companies carefully study the regional market, the local authorities try to find investments themselves. Thus, the administration of the Omsk municipality declared its intention to involve not only developer companies for construction of affordable housing, but also local large industrial enterprises and banks. Negotiations with them are already underway. Thus, the industry enterprises will have the opportunity, through mortgages, to enable their employees to obtain housing in newly constructed buildings.

Construction work in Russia has a feature to fit to the characteristics of legislative law. Specificity of the latter is that the nuances prevail. As a result, it is better for the developer company to be private rather than public. It is not a custom to disclose prime cost of facilities, as the level of competition is very high. However, even joint stock companies prefer to disclose only part of their records. These are the rules of the game.

Since there is no access to companies’ financial records, expert circles often run with discussions about developers earnings – which are estimated between 10% or 100%. This dispute is currently insoluble. Although cases of colossal failures are well known to everyone, after which companies have had to leave the market forever.

Be that as it may, Trump's statement really is in many respects largely revealing, as he can hardly be called an irresponsible businessman. Perhaps, he, too, has run into same problematic features of the Russian construction business; he has over extended on bank loans, and is now faced with limited investment capital. But all these difficulties, Trump, can easily overcome.

Vladimir Kobzev
Exclusively for Russian Survey