Bear with us?

The construction sector might be growing rapidly, but the Russians seem to have things under control. However, if it gets any more dynamic, developers and investors may start to have difficulties finding sites, engineers and materials. But one fact is indisputable: there will be no shortage of investment finance and Russian firms will be unable to cope with it by themselves. ‘Eurobuild CEE’ speaks to Vladimir Ponomariov, vice-president of the Association of Russian Constructors about the booming Russian scene

Emil Górecki, ‘Eurobuild CEE’: “Wow!” is the usual exclamation when people react to the scale of the new projects in Russia, especially in Moscow and the largest cities. You are building up the country at an impressive rate. What barriers – if any – exist for the growth of the construction industry?

Vladimir Ponomariov, vice-president of the Association of Russian Constructors: The greatest hindrance is definitely the absence of suitable building sites. There is a lot of land, but there is a lack of technically fitted plots or those where this can be easily installed. Heat, water, gas and electricity are needed for any project, while the installation of these systems is very expensive as well as time consuming. Taking out a loan to start the construction work is difficult and risky. A further problem is the absence of roads, and a private investor would be unwilling to cover the enormous cost of their construction.

There is much talk about insufficient building materials, labour and skilled specialists. Surely this is also an impediment to growth.

It is a fact that we do not have enough skilled personnel. Russia faces an unstoppable construction boom, while sufficient numbers of specialists are not yet available, which is why we employ migrants from former Soviet Asian republics, Ukraine and Belarus. The lack of engineering personnel is a continuing headache, but for the moment it is down the list of problems. General speaking, we cannot complain of a lack of building materials. Temporary, local shortages of cement do occur, even though Russian building materials factories are capable of meeting all requirements. Around 60-70 mln tonnes of cement are produced annually, although the largest cement factories are in Kazakhstan and Ukraine following the disintegration of the USSR. A shortfall in cement deliveries may happen at some point in the future if the construction industry continues to grow at the same rate. This is why the government has lifted duty on cement imports, which is to rise from today’s 2-3 pct to 10 pct. All our ports are presently inundated with cement, so there is still no problem here. Many large producers of building materials have already announced development plans, but should industrial construction, particularly in energy generation, start moving at the same rate as housing construction, then scarcities could arise.

Even so, when there is talk of Russian construction and real estate, what is highlighted is the enormous growth prospects of this sector of the national economy. Where does its main origin lie?

Annual construction performance grew between 12 and 15 pct in the last 3 years, in 2007 alone 700,000 new homes were completed. Prime minister Vladimir Putin wants to see 1 sqm of residential space per each statistical Russian delivered annually in 4-5 years from now, which amounts to around 1.5 mln large apartments. One emerging trend is an increase in the proportion of detached houses, which make up 40 pct of all homes today, but rising to around 50 pct in the future. The federal authorities have recently decreed that local government should review existing plans to identify large plots of more than 100-ha on which estates of single-family homes could be developed. There has been a very high return on residential investment in recent years – 25 to 26 pct last year – putting fears of high inflation into the background.

That means residential construction will grow at the fastest rate.

Infrastructure will also expand rapidly. Government plans earmark more than EUR 27 bln for infrastructure construction in the next few years. The power sector can also expect to experience growth. Plans exist for the construction of 42 nuclear power stations in the next 15 years and the modernization of existing plants. 80 pct of such projects will be carried out by engineering and construction companies. Current legislation allows 49 pct of the shares in power stations to be owned by foreign companies – giving stakes to the international players that build such plants may be a form of payment for services rendered.

Until recently, most construction activity was centred in Moscow and St Petersburg. Are the best days to make profits in those cities over?

You must remember that Russia is not Moscow. To get into the Moscow market is no easy task, with truly huge sums of money needed and no guarantee of success. The return rate on investment is not as high as in St Petersburg city and district, Novosibirsk and other cities with populations exceeding 1 mln. Profitability is much greater there and the entrance barriers are lower. 
It may seem a trivial question, since it is being asked by all the major operators in the world of real estate – but I’ll ask it nonetheless: how has the credit crunch affected Russia? It does not affect us at all. Russia is not closely integrated with the international financial system. The price of crude oil is rocketing, which is the principle source of our revenue. Our problem is rather how best to use the available finance inside the country.

What sort of amounts are we talking about?

Enormous sums. When Russia’s national budget was being planned, crude cost an estimated USD 60-70 per barrel. Today it is twice that. We are simply saturated with money, which is why inflation is rising, reaching 12-15 pct in the last few months. In such a situation, money needs to be put to use, since otherwise it will lose value. Even when it is invested in real estate it creates new jobs and indirectly leads to greater consumption and inflation. This is why our funds, which amount to around RUB 1 tln, are being invested in the West to avoid giving our economy the jitters. Many specialists express the opinion that more should be spent on real estate in such a state of affairs. That is also my opinion; but crude oil production is valued in roubles and is being sold in dollars. To make that money return to Russia, the exchange rate has to be changed again – leading to a loss of income. This is why much of it remains to be traded abroad.

What is the scope of the Russian mortgage loans market?

Our model is based on that of the US, which consists in supporting the growth of the primary market to begin with and then refinancing through issuing mortgage securities. Around USD 35 bln in loans have been issued this year. In comparison, Poland has issued around USD 30 bln, spending the least among other European countries. On the other hand, only USD 2.5 bln of mortgage loans were refinanced, due to the US credit crunch and our commitments in the West. Credit costs around 13 pct in Russia today, while the cost of Western money for the Russian market is around 12.5 pct. That is why a greater rate of refinancing is less profitable. Russian banks are raising interest rates for such loans, which hampers the growth of the mortgage system. The government and market brokers wish to make greater use of such national sources of financing as pension funds, central bank reserves and insurance company reserves – the normal sources of ‘long-term’ money. The mortgage system will start moving again this year or in the first half of 2009, if possible.

The Association of Russian Constructors has a membership of almost 700 mainly Russian construction companies. Is access to the Russian market restricted in any kind of administrative manner?

I cannot entirely agree with the suggestion that question contains. The market consists of German, French, Turkish and other non-Russian companies. Access to it has never been closed, although the number of national operators is, indeed, substantial. Our association has issued around 300,000 licences permitting activities inside Russia. There are more companies today than there are technically fitted development plots available. A local Russian company makes a profit even when it is working on a single small project, while an outside company will have to do at least several of these to ensure a return on the original investment. This explains why foreign companies are not generally exhibiting any great desire to make a sudden entry here. Inflation is huge. Real estate prices have soared by an average of 25-27 pct annually since 2000, reaching as much as 100 pct in 2006 in cities with populations exceeding 1 mln. Last year saw a large price increase for raw and building materials. Such spiralling rates throughout the whole market are intolerable to Western companies, which cannot accept the risk involved. But no legal barriers exist.

But is the alarming level of bureaucracy and corruption not scaring away Western companies?

This is, indeed, a painful problem, which we prefer to call an ‘administration’ barrier. Western companies fare worse than we do, since Russians better understand the bureaucracy and corruption. Even so, I encourage foreign firms to take a Russian approach to these procedures and to behave as Russians. Every company, be it Russian or foreign, has to cope with such problems and has to spend a very large sum of money to gain official approval for any investment whatever. The Russian bureaucracy is nothing exceptional. I recently talked with a British company which complained that it has already been waiting two years to get one of its projects started. French bureaucracy is also notorious. But these nuisances are offset in Russia by the high rate of return. Foreign companies find it difficult to operate in such conditions, being accustomed to markets of much greater stability.

So ways must be found to encourage them to enter the Russian market?

German, Finnish, Chinese, Vietnamese and Hungarian business people can be found every day negotiating in our offices. Even Americans have a preferred spot. Interest in our market is clearly huge. Legislation exists which grants notable tax preferences to companies which reinvest here capital generated in Russia. It seems likely that VAT will soon be reduced for companies from 18 to 13-14 pct. Parliament passed an Act several weeks ago which regulates the construction market which, in effect, means that as of 1st January 2010 construction companies will not have to hold a licence for their activities. Such licences will be issued only until the end of the present year, after which every firm will have to be a member of a self-governing association which will accept joint financial liability for members which fail to discharge its contracts. The importance of insurance will increase as a result, making the market more transparent. ν