Russia's Bold Real Estate Investors

Alexander Levchenko bought a small building a year ago and turned it into a Western-style office space. Then he bought a bigger building that he is turning into offices and apartments. Now he wants a whole street.


With self-confidence and excitement, Levchenko shows the empty lots and derelict buildings that he will turn into apartment blocks and office space.


But to get the job done, he had to mortgage the offices he already built, promise to give up half of the new office space to the city government and hire foreign construction workers.


Levchenko's construction business, Inzhenyer, is an example of the mix of daring and cunning required for success in the private construction industry in Moscow.


Profits can be high, up to 100 percent on capital invested. But the problems of finding materials and labor, obtaining clear title to land, borrowing money and then winning government approval mean that the risks for both Russian and foreign companies are almost as great.


Take the case of Perestroika JV, which established a reputation as Moscow's most successful developer over the last three years. It was recently forced to suspend work on two buildings because of a conflict over who owns the land and doubts over how to finance the projects, according to Timothy Head, Perestrotka's director of marketing and leasing.


Now the city prosecutor's office has sued the Russian partner in Perestroika, Mosinzhstroy. It argues that Mosinzhstroy lost the rights to the government buildings which were to be used by Perestroika after it went private.


Perestroika has also had trouble financing the projects. It used to raise money by selling leases five to six years in advance, but as more and more office space comes on the market, tenants prefer to lease space that has already been completed. According to Head, "The days of pre-payment are over".


Taking out a mortgage on the property is difficult because Russia still does not have a mortgage law.


According to Michael Oster, managing director of the Oster & Co. real estate firm, investors could get around the lack of a mortgage law using other legal forms of security. But because the whole concept of a mortgage is so untested, few banks are offering loans and even fewer landlords are willing to put up their property for collateral.


Even though Levchenko, like most developers, does not own the land he builds on, he said he got a two-year mortgage covering part of his costs. He hopes to fund the rest from a furniture import business.


Haka Oy, a Finnish building firm very active in Russia, developed a special form of financing for a St. Petersburg office construction project that is designed to bypass legal restrictions on subletting office space in a building leased from the city.


Haka sold shares to tenants in the company that leased the building. These shares give each shareholder rights to office space in the building, according to representative Kyosti Laitinen.


Laitinen has been trying to sell this financing plan, used widely in Scandinavia, to both foreigners looking for an office in Moscow and to the city government, but he said that many city officials and potential Western clients were suspicious of the uncommon use of shares.


Another major risk for builders is the difficulty of obtaining city approval for projects. The Inzhenyer firm, for example, has received permits for the construction of four apartment blocks and renovation of two smaller buildings on Trubnaya Street the city center.


But Levchenko said that in order to receive that permission, he had been obliged to promise to give half of the space free of charge to the city.


"This means that the space will cost twice as much", said Levchenko, who hopes the rules will be changed before completion.


According to Ian Whiston, Moscow director of the real estate consultancy Ferguson Hollis, it is common practice for European city councils to demand a share of property in exchange for a cheap lease agreement, but 50 percent is unusually high.


"They feel they are entitled to a share of the returns", Whiston said, "but it kills the development before it starts".


Vladimir Resin, deputy mayor in charge of construction, said in an interview that the 50 percent cut for the city was justified by the high demand for such arrangements, particularly from a growing number of Russian developers.


But be admitted that many companies cannot get financing for projects with this 50 percent requirement and have to return the property to the city. Developers complain that, in the old Soviet style, the city ignores realistic office construction in favor of grand projects that may never get done.


At the Build '93 conference on construction last month, Resin invited Western investors to help fund a project to create a business center on Krasnopresnenskaya Naberezhnaya and a shopping mall on Manezh Square. The project on Krasnopresnenskaya, to be named City, was valued at $8 to 9 billion at last year's prices.


According to Whiston, Moscow has little chance of financing two such superprojects.


"It would be nice to see some realism in the real estate market", he said, "rather than the grand projects now offered to foreign investors".