Money-Growing: Collective Investment Farms

The new schemes are designed to lower the threshold at which it is possible to join large projects. The first investment funds specializing in non-residential commercial real estate have already been established in the city. Other methods of attracting funds from small investors, such as bonded debts and shareholding in construction are also being used.

St. Petersburg’s market of collective investment in commercial real estate is still embryonic (the same is true for housing construction). Over the past year only a handful of pilot projects were launched in the city. Further development of that market largely depends on how successful they prove.

“The middle class has already been largely formed and there are quite a few people in St. Petersburg who command savings of $10,000 to $50,000. A big problem for them is where to invest,” says Andrei Tetysh, board chairman of Bekar Group. “The range of financial instruments designed to suit that group of investors is very limited. That is why the development of unit investment funds is very attractive.

“It is quite another matter that years will elapse before they [investment funds] begin working at full capacity, and we cannot expect immediate results. Time is needed for ordinary citizens to obtain trust in investment funds, to get used to the scheme. The current situation on the collective investment market is similar to that we recently saw in the sphere of mortgage lending. The issue had been discussed for many years, but real work did not begin until major Western banks arrived on the scene. I believe that unit funds, too, need very serious players for real development to begin.”

Investment Morsels

The First St. Petersburg Real Estate Direct Investment Fund was formed in the city in spring of 2004. The closed-end unit investment fund, established by OOO Upravlyayushchaya Kompania Svinyin i Partnery (Svinyin and Partners Management Company), is a pioneer of the commercial real estate market.

Svinyin and Partners is a part of the St. Petersburg-based investment holding Okhta Group, whose assets are estimated to be worth $50 million. Okhta owns the business-class Karelia hotel and several office and industrial projects. Okhta is also involved in the large investment project Rayon 700 on the territory of the former Petrozavod plant.

The fund’s first project was the class C office center Narvsky (at 22, Narvsky Prospekt), previously owned by Okhta Group. The annual gross income of the center then stood at $445,000, with net profits at about $306,000. The real value of the property was estimated to be worth $3.63 million.

Svinyin and Partners floated securities entitling their holders to a stake in the fund and co-ownership in the office center. The property was thus sliced into 700 shares, each worth approximately 157,000 rubles.

Thus the funds were raised to finance the expansion of the office center and renovation of existing space. As the market value of the property increases the value of each share increases as well. A shareholder has the right to sell his share back to the management company at the actual market price.

The general director of Svinyin and Partners, Vladimir Svinyin, says: “Investing in funds like ours is less risky than investing in blue chips, bonds or shares. To begin with, a property is assigned not to the management company but to the group of unit holders themselves. This provision, included in the title deed, practically rules out any possibility of abuses like the stealing of assets without the holders’ knowledge. Secondly, each share is backed with concrete assets, i.e. square meters that are leased out and already bringing in revenues.

“The yield on shares is quite modest. However, it is paid regularly – on a quarterly basis – and share value grows as real estate prices constantly grow. Another advantage of the closed-end unit investment fund is the profit tax deferral. I think that in the near future such funds will become the main instrument of attracting the funds of medium and major investors to the office and retail real estate market. Incidentally, according to expert evaluations, about 90% of all office projects in Western Europe are owned by such structures.”

The pilot unit fund has been working for over a year already. Svinyin comments on its performance with cautious optimism: “There are still only a few shareholders. But there are companies, like the Progress-Neva insurance company for example, and private individuals, both Russian and foreign nationals. As of today, some 50% of all the units have been sold through the over-the-counter market. About $2 million was raised. The result is hardly ideal, of course, but not bad, considering that we are offering shares to conservative investors. In terms of current yields they can compete with deposit accounts. Dividends of 10 to 12% are distributed on a quarterly basis. We have started selling our shares on MICEX, but unfortunately, I cannot say they are being traded actively. But, the very fact our securities are being quoted on the stock exchange is very important for us and our partners.”

In late 2004 the fund took over one more property, a small industrial park built on the premises of a former bakery and confectionary plant in Ivan Chernykh Street.

Another closed-end investment fund, Nevo-Invest, was established in November. The fund is also run by Svinyin and Partners. So far the fund has only one shareholder, JSC Nevo Tabak, who has invested the real estate property of the tobacco factory at 25, Klinsky Prospekt in central St. Petersburg in the fund. The size of the fund is 50 million rubles.

The controlling interest in the factory belongs to the Muzei management company. It is considering moving the tobacco production facilities to the outskirts of the city, and redeveloping the site in Klinsky Prospekt into a class B/B+ business center. The investment fund was set up with the purpose of attracting an external investor who would invest in the withdrawal of the factory from the city center.

This method has certain advantages because by investing existing property assets in the fund the shareholders are not liable to VAT and profit tax; also, they are not liable to VAT and can reduce profit tax to zero by selling shares in the enterprise to an external investor. The risks are low due to the transparence of the investment fund, the strict legal regulations and additional control on the part of the Federal Service for Financial Markets. The shares can be redistributed between the investors and the enterprise at any stage of the project through simple agreements on the sale of shares (securities) without having to re-register the title deeds.

“Demand for new financial instruments is obvious. After all the organizational and legal issues regarding the establishment of closed-end investment funds are clarified, private investors’ interest in them will grow. Small investors will be able to choose between buying shares in several properties or investing all the funds they have in purchasing a 1-room apartment. However, those opting for a single property will have to be extremely cautious and seek professional advice,” says Maksim Maltsev, finance director at the Peterburgskaya Nedvizhimost (St. Petersburg Real Estate) corporation.

“We have signed a general cooperation agreement with the company AVK who will act as a management company for future funds, while we will assume the role of investment consultants who will assist in choosing interesting investment projects, and then implementing them,” Maltsev said.

A unit investment fund is not only a means of attracting investment but also a convenient form of property ownership due to the significant tax relief it enjoys.

“The choice of a financial instrument depends on the strategy of an investment market player,” believes Vladimir Vishnevsky, general director of OAO PSB – Invest Group. “We have a clear source of financing – the funds of the Promyshlenno-Stroitelny Bank (PSB - Bank for Industrial Construction).

“However, unit investment funds are also of interest to us, but mostly as a transparent and clear-cut form of real estate property ownership. Besides, this method is convenient when you want to withdraw from the project and sell to a large institutional investor. Our company has set up a special work group that mulls the nuances of forming funds like this.”

Funds for Gamblers

Russia’s first-ever joint stock investment fund, Redder, launched its operations in early 2005 in St. Petersburg, expanding the range of financial instruments used by commercial real estate investors.

The fund is an open-end joint stock company. However, it has certain differences from a conventional joint stock company. To begin with, it is aimed solely at investing shareholders’ funds in properties listed in the investment declaration. Redder has obtained a license from the FSFM. Secondly, all the shares in such funds are ordinary.

Thirdly, the fund has a special executive body – a management company in charge of its investment assets, acting under an agreement with the board of directors. Redder was brought on to the market by Svinyin and Partners who had until then worked with closed-end investment funds.

However, despite all the advantages such as profit tax exemption, and a transparent ownership structure enabling shareholders to control the assets, closed-end funds are not very convenient for complicated development projects where a property is often divided into several smaller ones, with some of them being sold and others undergoing reconstruction.

While a closed-end fund is a conservative vehicle designed for projects with stable but low profits, stock funds are of a more speculative nature. Investing in them is fraught with risks, but at the same time it is likely to bring higher returns.

Unlike closed-end funds that have fixed terms of operations, a stock fund is an ongoing operation and a legal entity, and its assets can be used as a guarantee. Shareholders in these kinds of funds receive income in the form of dividends set by the management company and endorsed by a general shareholders’ meeting.

Redder’s registered capital currently stands at 5.5 million rubles. It is divided into 550 shares at 10,000 rubles each. The founders of the fund are private individuals.

Redder’s first project is the Ulitsa Khimikov industrial park at 26, Ulitsa Khimikov [street]. It is being built on the premises of the Elektropult plant. The owner of the property is Okhta Group. The future industrial park will comprise 52,300sqm of production, office and warehouse facilities on a plot of 11.4 hectares. Some of the buildings will be put up for sale; others will undergo renovation and be leased out.

Reconstruction on Credit

The city commercial real estate market has, for the first time, tested a new scheme involving the issue of bonds for the implementation of specific investment projects. In February 2005 the company Yeliseyev Palas Hotel offered bonds worth 300 million rubles on the St. Petersburg currency exchange. It was the second time that the company had issued securities.

The funds raised will be invested in redeveloping properties on the corner of Nevsky Prospekt and Bolshaya Morskaya Ulitsa [street] into a hotel and entertainment complex. OOO Yeliseyev Palas Hotel is a subsidiary development company of the OAO Center for Humanitarian and Business Cooperation (TsGDS). That holding owns the Taleon Club at 59, Moika Embankment.

The complex features a hotel of 29 rooms, a casino with several halls, restaurants, a fitness center, and other facilities. In 2004 TsGDS launched a new project to redevelop existing commercial properties of 10,500sqm by annexing two historic buildings neighboring the complex that were under federal protection.

The investor is set to increase the number of hotel rooms to 100, to transform the former Barrikada cinema hall into a modern conference center with 700 seats, and to build a 25-meter swimming pool under a glass roof on the top floor of the building. The amount of projected investments is impressive - $70-80 million.

In March 2004 Yeliseyev Palas Hotel floated its first bond issue on the stock exchange, brokered by Sberbank of Russia. Bonds with a 3-year term of maturity worth a total of 300 million rubles were issued at a nominal value of 1,000 rubles. The yield on the first coupon – from a total of six – was paid off in September and amounted to 15.7%, or about 78 rubles per bond.

According to a report by Sberbank, the securities are being traded quite actively on the market. Deals are registered almost daily. The actual quotation stands at 100.76% of the par value. The second loan, floated on the same terms, produced similar results. Admittedly, the first coupon rate was slightly lower – 14.7%. Like in March, the bonds were sold out immediately in small lots. Over 1,800 applications from investors were satisfied.

Keep Your Savings in a Shop

This was the slogan of a campaign launched by the Kaskad investment company in February 2005 to attract shareholders to finance the development of a hypermarket on Pulkovskoye Shosse [motorway]. Potential co-owners of the shopping center were promised a stable income from the lease of retail properties.

One of the future tenants of the complex is already known – a DIY store. In line with the plan, the first 8,900-sqm phase of the hypermarket will be commissioned by the summer of 2005; the second 5,600-sqm phase will be opened in 2006.

The project is being overseen and developed by ZAO (JSC) Megalit, the company that holds the titles to the building plot. Investments are estimated to be worth $10.5 million. For the time being Megalit is financing the project itself but hopes to get a return on its investment and fix its profits before construction is completed. To that end Megalit is ready to concede the property rights to the unit holders, while the developer will retain the title to the plot.

In February one square meter of the future hypermarket was offered for sale at 990 conventional currency units (based on dollar and euro rates). In March the price grew to 1,050 units. To join the project an investor must purchase at least five square meters.

Private investors’ funds are accrued by the OOO Kaskad investment company, established to manage the project. Kaskad enjoys the status of a general investor under an agreement with Megalit. To begin with, Kaskad enters into a share holding agreement with a private investor. Upon registration of the title to the building the shareholder becomes a co-owner.

The parties then enter into a trust management agreement for a term of five years where Kaskad assumes the role of the management company. The agreement guarantees an investor a fixed income from leasing of $10 per square meter per month. He bears no maintenance or renovation costs.

Five years later the parties can either extend the agreement or the private investor can pull out of the project. He can also sell his share earlier. If there are no buyers for his share the management company buys it for at least its initial value.

Approximately 30% of the property has been sold over the past month, says Yekaterina Kasenova, deputy director general of Kaskad.

Megalit plans to employ the same scheme for attracting investment in other projects, too. “Such partnerships are of benefit to the developer who releases funds for new construction projects, to the retail operator who, by securing a lease, does not have to withdraw considerable funds from operations to buy property, and to conservative investors who secure a guaranteed income,” says Yekaterina Kasenova.