Money-Growing: Moscow Does Not Believe in Asset Management

Trust, But Verify

Moscow has several thousand facilities owned by the state. They are the buildings of educational institutes, ministries, museums, concert and exhibition halls etc., run by state-owned unitary enterprises established for that purpose. State-owned properties are placed under their authority.

There are also several privately-owned firms that were set up to manage specific facilities. For example, OAO City runs the state-owned Bagration mall pedestrian bridge, and OAO Gostiny Dvor oversees an exhibition complex of the same name. Some of the state-owned properties in Moscow are placed under the authority of what is called “an internal apparatus”, i.e. employees of the entity in question such as museum staff.

“GUPs have proved inefficient as buildings placed under their authority fail to bring any tangible profits to the budget,” says Yelena Obolonnaya, president of the Gruppa Plaza management company. Perhaps a reason for that is poor motivation on the part of the GUPs themselves as municipally-owned buildings bring very little, if any, returns for the staff of those enterprises, while the quality of their services often stands in direct proportion to the remuneration, which is unlikely to inspire any incentives.

“Many entrepreneurs would join the civil service if it made the profit it is capable of making,” Obolonnaya says. “I quit the civil service after the office where I worked started growing bureaucratic.”

GUPs have a quiet existence, but municipally-owned facilities bring no revenues to the budget. Meanwhile, for their owners real estate properties can be a source of joy, as well as woes. Everything depends on attitude. If a property is neglected it brings losses, but if the landlord is diligent it may become an effective means of making money.

Privately-owned management companies know all the secrets of squeezing maximum profit out of real estate. Their clients are offered a whole range of property maintenance services – from cleaning to attracting tenants, and book-keeping. When a management company renders the widest range of services including the development of a property maintenance strategy, it is called trust management.

Ideally, a landlord need never visit his property at all and still receive income from its operations, which the trust manager is in charge of. Such an extreme may be very popular abroad, but not in Russia, where owners of commercial properties tend to take an active role in its operations, even if they delegate a considerable share to a third party.

When it comes to state-owned property, however, the situation is different. Over 200 state-owned facilities in Moscow have been transferred to trust, but most of them are residential buildings, according to a report by M+W Zander Facility Management.

The Fish Swam Away

Gruppa Plaza experimented with trust management of state-owned properties in 2000 when it entered into an agreement with the Moscow City Consumer Market Department and the Moscow Fish Industry Committee (MosRybKhoz) – the owners of the Pyatnitsky fish retail complex built on the site of the former Pyatnitsky market. Gruppa Plaza started running a 2-storied 40,000-sqm fish market before the newly-erected building was officially commissioned.

The management company’s task was to attract tenants, organize technical maintenance of the complex and promote the Pyatnitsky Fish Market Brand. The idea was good – the fish retail center was to become a replica of the fish market in Paris, offering a variety of fresh fish and sea foods. The success of the project largely depended on MosRybKhoz as it was the one responsible for supplying refrigerated fish, including valuable species, to the center.

The management company drew up a concept for the project, in line with which it hired experts and trained technical staff to maintaining the building, providing cleaning and security services. Then it filled the retail center with tenants, renting out all the retail areas, stores and refrigerators.

Remarkably, the list of tenants included both legal entities involved in the fishing industry and the like (shops for fishermen, seafood and sushi restaurants), and individual entrepreneurs with a license to sell fish. Then Gruppa Plaza organized a large-scale advertising campaign to inform potential buyers of the new fish retail outlet.

A year later, however, cooperation between the private management company and the city authorities ended. In 2001 the trust management agreement was cancelled at Gruppa Plaza’s initiative. Yelena Obolonnaya, president of the Gruppa Plaza management company, names several reasons for that.

“To begin with, one of the owners – MosRybKhoz – came up with a new concept of managing the complex. We disagreed with the new concept,” says Obolonnaya. “Secondly, the agreement had to be cancelled as it transpired that the [Consumer Market] Department had no right to act as a co-founder of a retail complex.”

Indeed, by law the only government agency entitled to act as a co-founder of a legal entity is Moscow’s Property Management Committee. Besides, governmental agencies – the owners of the retail center – were involved in a legal dispute over the deeds to the property. The owners’ rights were stated in the documents but were never confirmed or officially registered.

Действительно, по закону в состав учредителей может входить только орган, распоряжающийся имуществом, – Комитет по управлению имуществом г. Москвы. Кроме того, возникли юридические разногласия между государственными собственниками торгового центра и проблемы с правами собственности на объект. Права собственников были определены на бумаге, но фактического подтверждения и регистрации в органах регистрации они не получили.

Manageable Bridge

Municipally-owned property in the capital is committed to the trust of the company OAO City, owned by over 15,000 shareholders. OAO City runs the Bagration mall pedestrian bridge at Krasnopresnenskaya Naberezhnaya [Embankment]; in the future the company plans to take over other facilities to be built within the Moskva-City International Business Center project.

The Bagration mall bridge comprises a two-level indoor pedestrian zone and a five-floor building featuring numerous restaurants. The total space of the bridge is 13,000sqm, with retail outlets accounting for approximately 880sqm, and restaurants, bars and cafes for over 2,500sqm.

“Bagration was transferred to the trust of OAO City under the 1997 trust management agreement with the Moscow city government,” says Natalia Orekhova, a spokesperson for OAO City. “In line with the agreement – and as per existing practice – all management and maintenance costs, including maintenance of the bridge as an engineering structure, are covered from the funds earned by the trust manager through leasing the commercial properties.”

OAO City itself leases retail properties and hires the contractors responsible for maintenance, cleaning, security and the development of complex. Technical maintenance of the bridge is particularly expensive. With commercial properties accounting for less than 25% of the total space the management company has to apply enormous efforts to maintain the facility at a due level, taking into account the interests of the landlord and tenants.

Problems

Those are rare examples of state-owned facilities under trust management. Why do the city authorities take so little interest in the services of private management companies? The answer to the question can be found in a variety of problems ranging from gaps in legislation to mutual mistrust between private firms and city officials.

Although over the past ten years Russian lawmakers in the State Duma have worked to draw up legislation on trust management, certain questions remain unanswered. In particular, there are gaps in the law governing legal and accounting procedures. To establish a legal basis for property management in Moscow City Hall is to adopt two fundamentally important laws: “On the fundamentals of property management of the city of Moscow” and “On the city treasury”.

The amount of remuneration is another issue that remains unclear. “I cannot name a company that has an objective and clear procedure for making such a valuation,” says Konstantin Baranov, marketing director at M+W Zander. “On the other hand, I am convinced that the initiative should emanate from the state-owned enterprises themselves as the valuation can only be successful and effective as long as they are willing to provide the maximum available data.”

Evaluating the costs incurred by the state when managing its facilities is possible with the help of special procedures, though, for the time being no such procedure has been adopted in Moscow. Baranov assumes that in the course of time Moscow will see the emergence of companies that specialize in evaluating successful management services.

Another problem that is likely to arise is the securing of budget financing, which is often delayed. “As long as government officials fail to accurately allocate budget finds, private management companies will not engage in business with the state,” claims Obolonnaya. For their part, private managers are unlikely to risk investing their funds in a state-owned real estate property, especially in the long-term. But world practice shows that quite often only those kind of investments help to reveal the full potential of a building in terms of profitability.”

The size of investment depends on the cost of reconstruction. According to Baranov’s evaluation, in many cases a municipally-owned square meter requires additional investment. Thus, upgrading office space – at least to the class B level – may require spending over 300 euros per square meter.

In other words, even if the matter concerns a small building of 3,000sqm it may require 1-3.5 million euros. “That is why management companies holding real estate properties in trust will be faced with a real challenge when it comes to substantially increasing their profitability, which is possible only with the help of modern technologies and know-how,” notes Konstantin Baranov.

To calculate a payback period on such an investment one should proceed from the average rental rate, which is 150-250 euros per square meter in a class C property. The payback period on an investment of 2.5 million euros is 4-6 years – quite a long time for Russia considering that the rules of the game on the market of municipal properties could change at any moment.

Another reason why commercial firms are not rushing to invest in state property is that there is still a high demand for professional management generated by privately-owned properties in Moscow. “Today we are much more interested in commercial real estate rather than municipally-owned properties,” says Baranov. “Today, Moscow’s commercial real estate market is much more predictable and understandable than the market of municipal real estate.”

On the other hand, in some cases government officials may decide that it would be much cheaper to run a certain facility with the help of a GUP, rather than enlisting the services of a private manager. Furthermore, the state also has reasons to mistrust management companies, as there have been cases where private companies took over state-owned facilities and used them solely for their own benefit, generating no proceeds for the budget.

The Other Side of the Coin

M+W Zander calculates the capacity of the municipally-owned non-residential property market in Moscow at approximately 25 million euros per year. A significant sum. Interestingly, property management companies receive from 2-98% of the income from annual rental charges. It all depends on the terms of the agreement between a trust manager and the state.

One of the reasons why municipal facilities attract private firms is that almost every property in Moscow is liquid and potentially profitable. However, while commercial retail and office buildings are operating at full capacity, what happens to the museums and concert halls? Clearly, museums do not make as much profit as they are capable of making.

To make a comparison: a ticket to the Tretyakov Gallery costs 60 rubles while an average European museum, far more modest in terms of its exhibits, charges 10 to 15 euros.

Art exhibitions could become another major source of revenue for museums, provided they are brought to Russia on the advice of experts equally versed in the arts and who know the tastes of the public. Such professionals have to ensure that an exhibition attracts ten of thousands, not just thousands of visitors, which, in the long run, shapes the museum’s profitability.

The same is true for concert halls, ice palaces and sports complexes. The real challenge is not just to fill the property with tenants for a year in advance but to select tenants with a view to earning the maximum profits possible. This requires an understanding of audiences and of events likely to make the largest profits.

Unfortunately, there are few analysts in the civil service working for a meager salary who are keen to devise the most profitable methods of leasing out state-owned properties. That is why today few people consider state property a source of high profits.

It cannot be ruled out that privately-owned management companies will start conquering the state property market by taking over the management of residential estates such as ‘profit houses’, hostels, etc. After all, residential estates are likely to bring profits faster than non-residential properties, as there will always be a demand for rooms and apartments in Moscow, while a small shop tucked away in an obsolete municipal building may fail to compete with a nearby Kopeika supermarket or some other retail chain outlet.

Thus, when we are talking about commercial real estate projects it is necessary to have a certain concept. Dealing with residential properties is much easier. Of course, managing a dilapidated ‘Khrushchyovka’ is unlikely to bring in much money. But then, operating dormitories and ‘profit houses’ is seen as quite profitable, though the novelty has not yet become very fashionable.

Today in Moscow there are buildings of 12-16 stories which are used as dormitories. Quite often companies rent several stories there for their offices. Of course, these kinds of projects are seen as far from ideal by property managers who are bent on making a profit.

Nevertheless, according to a market participant who asked not to be named, leasing two stories in such a dormitory as office space can bring in about $250,000 annually. Quite an income for a company with dozens of facilities in trust! It is possible to sign a corresponding trust management agreement with the state. Admittedly, it should be pointed out that the manager must be ready to deal with the burden of debts to communal services, leaking roofs and repairs.

Additional aggravating circumstances are individuals residing in the dormitory unlawfully, without proper registration with the city authorities. One private firm managing a dormitory in Moscow over the past seven years has won as many as 52 lawsuits against “illegal” residents, according to an executive of the firm who asked not to be named.