The Duma passed in the second reading a package of bills designed to make the real estate market transparent. The new laws come at a moment when the market for the first time in the last four years has started to stagnate

Ilya Stupin

On July 10, the State Duma passed a package of bills in the second reading aimed at developing the housing market. Although the deputies postponed voting on the most debatable documents – draft Housing and Urban Planning Codes and the law on the single real estate tax – until autumn, this doesn’t minimize the importance of the event. The new laws will legislatively define the development of the real estate market, one of the most important markets in the economy. Regrettably, deputies and the government are noticeably lagging behind the times. The program documents did not contain a single word about the most pressing problem in construction, the short supply of credit. The lawmakers didn’t forget to establish an actual market for land, but they seem still afraid to say when this will take place and who will be responsible.

Don’t say we didn’t warn you

The debate about the so-called housing package took place in the context of official statements that the housing market (especially in Moscow) is overheated, the construction business is opaque, and officials are corrupt. Thus, for example, Economic Development Minister German Gref called the rise in prices for Moscow real estate unjustified and suggested that the price bubble would burst in 2005. He was followed by Igor Artemyev, Head of the Anti-Monopoly Service, who began to talk about signs of collusion between large construction companies dictating the level of prices and keeping close ties to local authorities. And shortly before turmoil began in the banking sector, Oleg Vyugin, Chair of the Federal Financial Markets Service, suspected some construction companies of creating financial pyramids. “If you keep insisting persistently that the market is just about to collapse, it will certainly do so sooner or later,” says Elvira Eremina, Deputy General Director of City-XXI Vek (City-21st century) Construction Company.
The market has more than just official doom and gloom to blame, however. Despite the seeming economic well-being, all Russian investment markets have been in the state of strain this year. And it’s absolutely normal that the real estate market should experience evident stagnation (local for the time being). At first, all these perturbations didn’t worry realtors and developers very much. However, the instability in the banking sector made them wake up and recall that prices had been rising for a very long time. “What is happening now can be called a crisis of anticipation. On one hand, there are no economic reasons for housing prices to go down and for the market to collapse: the economy is growing and construction materials are getting more expensive. But on the other hand, the rapid rise in prices over the last three years cannot last forever. Apparently, buyers have realized that there is a gap between price and the quality of goods available on the market. Meanwhile, most market players – buyers, banks, and construction organizations – have taken a wait-and-see stance,” one housing market specialist told Expert.

But back to loans

Naturally, market players will avoid talking about a market crisis until the very last moment but they are already taking note of one interesting detail. In their opinion, the market can be “biased” towards a drop in prices by large players putting investment contracts up for sale. According to Alexander Ziminsky, Director of Elite Real Estate Department at Penny Lane Realty, such offers are already appearing on the market. “Literally the other day, we held talks on one of the sites in the center of Moscow. It was offered for a quarter of the price quoted two weeks ago.” Getting rid of investment contracts is a sign of a shortage in funds on the construction market. Indeed, according to some expert information, many construction companies have already been confronted with a shortage of working capital because of stagnation on the real estate market.
Today, all market players anticipate serious changes in construction lending proper, provoked by market stagnation. So far, companies and banks in most cases co-finance construction projects, starting literally from the ground up. Experts believe that the percentage of such schemes will drastically decline. According to Maxim Sotnikov, Director of Komstrin Company, the housing that is almost complete will sell well.
“Bank loans will remain one way to get project financing but the process of obtaining them will become too lengthy, as lending institutions will seek to obtain maximum information about a developer,” notes Alexei Shepel, Chairman of the Board of SHolding Corporation. Only a small circle of large construction companies will be able to issue promissory notes or other securities. “The cost of borrowing on the securities market will still be higher than at the bank,” believes Alexei Pimenov, General Director of IFSK ARKS. In his view, constructors would have to resort more frequently to combining resources and forming pools of co-investors, although this approach has many shortcomings. Firstly, the borrowed resources come at a high price, as along with a share in a real estate development, co-investors would expect to get part of profits. Secondly, when selling interests under co-investment agreements, the schedule for receiving cash from investors might not match the construction funding schedule. “In any case, companies will have to look for alternative sources of finance,” notes Pimenov.
Closed unit real estate funds, including those established to attract small private investors, are already being considered as one such alternative source. City-XXI Vek and Region Development Management Company have very recently announced their intention to set up such a unit investment fund in the amount of $5 million. Shareholders’ funds ($1,000 is a minimum amount of investments to buy a unit) will be allocated to construction of a Moscow high-quality residential complex with a total space of around 250,000 m2. If this pilot project is successful, it will be replicated. Companies intend to set up similar unit investment funds to implement residential construction projects in several suburban Moscow towns. “Closed unit real estate funds are a promising form of finance. For the time being, however, attracting investments to residential construction is too costly a pleasure,” says Alexander Senatorov, Chairman of ZAO MIAN’s Board of Directors. “Unit funds owning, for example, a few office centers, which are occupied by tenants at the rate of 70-90 percent and bring in stable income, would be much more attractive for investors. You could really raise cheap money with those assets.”
The search for construction project money may be the main problem facing developers in the evolving situation on the housing market, and it will undoubtedly impede all the programs to construct affordable housing currently being considered by the government. Market players believe that the state could play a positive role in coming up with new mechanisms for organizing construction finance. For example, investment risks can be shared. “As far as residential construction is concerned, we need to establish a system of loan guarantees now,” says Senatorov. “The time has come to develop a mandatory system of insuring risks of incomplete housing construction. Private investors’ funds could be attracted by authorized lending or insurance organizations that would be entitled to manage these funds and finance construction. This financial or insurance institution would assume all risks or share them with the state. The only question is in the legislative elaboration of this approach.” However, as was mentioned before, the housing package debated in the Duma doesn’t deal with the critical issue of financing construction. As Leonid Chernyshev, Assistant to the Minister of Industry and Energy for Construction and Communal Utilities, explained to Expert, the main task facing authorities now is to make the construction market transparent – officials and deputies will deal with more delicate problems in 2008, at the earliest.  
 
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