Igor Tabakov

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Even the casual observer cannot have failed to see a major decline in Russian real estate development over the last year and a half in a whirlwind of credit draughts and asset seizures. Several Russian development companies have managed to stay alive and operational, albeit in a reduced form. AFI Development’s general director, Alexander Khaldei, explained to Alexander Teddy how his company has managed to survive this plague, while many others met their maker.

Why did you decide to set up AFI Development?

Alexander Khaldei: The company was not set up immediately. Initially it was Stroyincom-K, which was not a big company but had a few real estate development projects — in the beginning just in Moscow. As the market developed and the economy grew, our plans changed and we gradually developed our business. First of all we had to think up a strategy on how to grow. At that time there were several real estate developers producing cheaper housing and commercial construction — office and high-rise buildings. We went down a different channel — the development of large multifunctional complexes, that’s to say the construction of particular districts. We became one of the main developers of this type in Moscow. This was costly — much more costly than for other, smaller projects, but it allowed us to earn large amounts of money.

From here, the volume of projects began to increase. So the small company grew, acquired assets and  profits began to rise. The average revenue for the company was more than 50 percent year-on-year. This made us quickly realize that it was possible to develop a small company into a large one. Until then, it was a closed company, but six years after creating the company, we decided to list it on the London Stock Exchange. It was a very big listing for several reasons. First of all, we were appropriately structured for the listing: from day one our finances were well prepared for the listing because we had experience from the listing of another company within the Africa Israel Group. Secondly, we had interesting and attractive assets. Thirdly, we had good financial and administrative resources, and fourthly, we had a strong, professional team.

We have sold all of our completed projects for large revenue, our margins have been greater than 50 percent, and profitability has been 200 percent. When we listed, in 2007, our bankers said it was the most successful in 10 years. From the decision to the execution, it all went well. But unfortunately 18 months later, the crisis started. Economic conditions worsened, and many projects had to be frozen. But today we are one of only a few companies that is really working on development projects, that is really working in the real estate market, because out of all the public companies that there are today in Russia, we have a positive cash flow, money on our books and transactions that we complete.

Does this mean you think that there will be some form of polarization at the top of the development market in Russia? Will there be just several players that lead the market?

AK: I would say that after the crisis, when the difficulties come to an end, there will be different names and different companies, and the development business will be completely different. Today we feel that development, as a business, is practically dead. It does not exist. What is currently happening on the market is not business but some kind of fractured construction, so that people can keep their trousers up. Many people are trying to get piecemeal orders just to keep afloat.

For us today, the situation is somewhat different. The revenue that we get from our finished projects and rents fully covers our other expenses. We are allowing the profit we get from selling projects to accumulate so that we can assess how best to use it next. We could use it slowly to acquire more sites or use it to reinvest into our existing projects to put them in the best possible shape, for instance.

Do you think that companies that previously tried to reinvest continually probably overstretched themselves?

AK: I cannot cite any concrete facts, but in trying to increase their profits many companies slightly lost their heads and plunged all their profits into their new projects, continually running them all on bank credit. So, when the crisis began, banks wanted their money back and were forced to take over many of the development projects.

Our system was different. In our first six years before we listed the company, we had virtually no bank loans at all. We operated entirely on our own funds, simply letting the profit that we made accumulate. When we listed, we raised $1.4 billion, placing some cash into new projects, some into existing ones, while part of it remained on our books — about $400 million or so. Yet, of course, the crisis has affected us. We do not live on an island; we’re a part of the industry, and there are inevitable interlinking factors that impinge on us. But as a single company, we do not feel too badly off. And what’s more, we’re still getting our rental payments, which helps our cash flow.

How might unfinished — perhaps even unsuccessful — projects within Moskva-City affect your project, Mall of Russia?

AK: I think that Moskva-City will be a very successful project. Yes, unfortunately a lot of delayed construction projects there have become the property of banks. Why unfortunately? Because banks should be banking, while developers develop, just as all industries should be doing their own thing.

Moskva-City’s owners have changed: many developers have had to relinquish their assets there to banks, mainly Sberbank and VTB. But, with the banks as the principal owners of the projects there, I am certain that they will complete the projects, and that Moskva-City will be completed. It is in their interests.

We have a loan from VTB for the Mall of Russia, but they don’t own any part of it. It is a clean credit line — we own 75 percent of the project and the rest belongs to the City of Moscow. We already have tenants for over 55 percent of the building and we are going to continue to fill the building.

AK: Well, in principle, we haven’t changed our approach — big name stores, with some boutiques: mainly mid-range goods for the general public.

And how should today’s landlords conduct their business?

AK: They need to do all that they can to support their business and to make money. Also, they need to generate conditions that allow them to function properly and sustain business.

A number of the properties you are working on are multifunctional. What is the secret of this type of construction project?

AK: I’ll explain. For example, we completed an office complex on Ozerkovskaya Naberezhnaya, and when we sold it — which was before the crisis — we had three or four buyers interested in the property. Meanwhile, there was a high-rise office about 500 meters away, no worse than ours, which remained entirely empty. The difference lies in the fact that around that other office there were buildings that did not match the standards of the office complex. It had a communal apartment building nearby and no infrastructure. Whereas we built an entire complex, including residential apartments, as well as offices and commercial retail facilities. It was a large, multifunctional complex. And tenants look at it and think not just about the office, but what is available around it: where employees can eat and find key services, such as pharmacies and news agents, that might be necessary during the time one spends at the workplace. We provide the lot.

And in general we provide a different level of construction. We do not do Class B or C buildings, we try to build Class A offices, but for Class B or C prices. The sole difference between all our projects is the location. We do not make any less effort on the standard of the building because of differences in location.

How do you rate the prospects of the different branches of development activity in the current economic climate?

AK: Office real estate is in total decline; it is not likely to pick up soon, whether it is A-class offices, complexes, or big business centers. It is all linked to the drop in investment in Russia. When Western investment and credit from banks starts to reappear in Russia, then there will be demand for such large projects. While there is a lack of such investment, the need and demand will be lacking — it will be like that for the next four or five years.

Housing, however, is in a deficit; there is a lack of construction projects. Virtually nothing new is being built. Companies are coming and going the whole time, but there will be a need for housing regardless of whether there is a crisis or not. Prices might not be as they were prior to the crisis in the near future, but they will rally nonetheless; when there is a deficit, then there is going to be demand.

Does this depend to a large extent on mortgaging?

AK: Not if you are talking about elite housing, where there is also a deficit. But economy-class housing will, of course, largely depend on mortgaging.

We think things will probably move in the direction of the developer providing the mortgage. Currently we have a project in Odintsovo, where we are building economy-class housing and where we are going to offer mortgages to buyers of a property. Buyers will put up between 30 and 50 percent of the value of the transaction, and we will offer the rest as a mortgage. Because this is economy class, it is not such a lot of money. Our mortgages will only have rates as high as 10 percent so people can buy the properties — mortgages with rates above 10 percent are not fair.

We decided that when we offer housing it should be with a mortgage from 5 to 10 percent interest. To justify this decision, we just looked at the differences in rates between Western mortgages and those here prior to the crisis. Here people have been paying 15 percent or higher.

Do you think that banks really have the capacity to take over construction projects?

AK: Soon they will be the major owners of construction projects in this country. But banks’ main activity is not the development of real estate, so they will need to dedicate special resources to the maintenance and support of these projects, otherwise they will fall into decline. Moreover, many banks have taken over assets, but they are not ready just yet to reevaluate these assets or make write-downs. This will clearly be a big loss for many banks. The same banks now face the need to attract good and reliable professionals to manage and coordinate the ongoing development of these projects, otherwise they too will face the danger of falling by the wayside. In general those assets such as real estate and also industry that banks do not manage to sell, but rather that they continue to manage themselves could incur ongoing costs and create losses for the banks.

How did you yourselves reassess your position in the face of the crisis?

AK: We have 34 projects, out of which we established our priorities: which projects we would continue to develop and which we would freeze. And now we are again looking at which projects to revive, but not just simply revive, but which projects we could make good revenue on and not just have to spend out on.

Our last quarterly report, which reported a loss, reflects the reevaluation of projects and the general market situation. For instance, one example of a project we completed is the Kosinskaya Business Center, now valued at $40 million less than that we sold it for. Moreover, it is important to factor in the question of how a property that has not been built yet can be valued. It could either cost nothing, or $100 million — it entirely depends on who wants to buy it.

So is it hard for you to say if you will have further write-downs?

AK: No, it is not. I know that our assets are sufficiently liquid so that as time goes by we will be able to then reevaluate them in a positive way and be able to support ourselves more and more through the completion of projects.

Apart from not taking on loans, what might be the other reasons that AFI Development has been less damaged by the crisis than its rivals?

AK: I do not want to make any direct comparisons with competitors, but I can give several points. First of all, we did not overload ourselves with projects or take on credit to get more projects. Secondly, we correctly chose our strategy to select projects that turn a profit and, even if they are not immediately sold or do not make huge returns, they must not drag us downwards. The standards of the development business in Russia prior to the crisis were not always high. People would buy land and build all over the place, selling as soon as possible. Even a guy who just put up a single apartment block would call himself a major developer.

We have a strong and professional team that maintained its strategy throughout. We chose it and stuck to it, but remained flexible according to the conditions. We diminished our risks this way. But we did not change our strategy.

Your projects often involve complex technical conditions, for instance the underground construction at Tverskaya Zastava. How sensible — and difficult — is it to build underground in Moscow, where it can be very damp?

AK: The Tverskaya Zastava development by Belorussky Station is not a small topic. It really needs hours of discussion. But let me stress that I think Tverskaya is going to be a very successful project. It is a very big budget project, involving a lot of capital — but when we complete it, the project will bring in large profits. In terms of the technical side of things, we have brought in the world’s best technical experts. There will not be any unresolved technical issues.

And, of course, it makes sense to build underground — look at the advantages in an area like Tverskaya. We can create space in the middle of the city, where there are three metro station exits that converge, and a stream of underground passages that will lead straight into a shopping center. Added to this will be a car park, which will then afford all sorts of transport opportunities. People will be able to park their cars and continue on foot. And there is the recently opened terminal for the airport express to Sheremetyevo — a very important idea considering the constant traffic jams on Tverskaya.  

Where do your technical specialists come from?

AK: We have local specialists from Moscow, but also France, Turkey, Israel and Austria — generally international technicians.

What are the main differences between developing in the regions and in Moscow?

AK: In the regions approval and building is simpler and quicker, and the costs are lower. Let me give you an example. We built a hotel complex in the Caucasus, in Kislovodsk. This is a health resort that is fully operational with around 100-percent occupancy. It shows how one can get a very well-placed regional development, making the most of historical circumstances. Following the collapse of the Soviet Union, most health and relaxation resorts fell into disrepair because the profsoyuzy, the regional bodies and unions that looked after them, simply ceased to exist. Then private owners came in and a lot of them simply went into decline. Now you see big organizations moving in, developing their own health resorts, Gazprom or Rosneft, for instance. People need to go and relax somewhere and they cannot only go to Turkey!

We have put in a lot of money into the project, to connect it to the necessary utilities and put the right medical equipment in place. This requires a long stream of financing. Yet this is our most successful regional project.

However, we are only planning one other regional project at the moment — a project in the Moscow region, in Ruza. We also want to develop health resorts there and cottage settlements on over 150 hectares — a large complex, similar to that at Kislovodsk.

So, how do you look at the prospects of development in the regions?

AK: In terms of the projects we have chosen, we think that they will be profitable, but in general I cannot say that there is a lot on the horizon apart from housing needs.

You’ve also got a project in  Ukraine. What has happened to that?

AK: We have frozen it and currently don’t know when it will be revived.

What in your view will be the final effect of the crisis on the industry?

AK: Well, currently the development sector is dead. Will there be new projects? Of course, when there is a need from the industrial side, for instance. When? Well, when the economy picks up and people start to reinvest money. But in reality, why invest in real estate? Because real estate is a fundamental and tangible industry. Unlike a security it will always retain some kind of real value. In this respect, the development industry will be supported by rational investment in the real estate sector. As soon as people start to have freer, more liquid money, and invest in real estate, then the development sector will pick up.

Do you anticipate that when investment in real estate returns to Russia in the near future it will be direct or more via funds?

AK: I think generally direct. Funds will take off much later.