MARKET KNOW-HOW: Investment Fair

Another source of financing is Western investors. Foreigners do not extend money at a certain rate of interest as banks do but claim a share in the future profits. Mixed schemes of financing involving both investors and creditors are also available. For a Russian firm, persuading a foreign investor to participate in a particular project is extremely difficult, but perseverance and willingness to sacrifice can make it possible.

“The best source of financing is the one who extends money for a long time, of over three years, at a low interest rate, of less than 10%,” is how Andrei Zakrevsky, vice president of Sistema-Gals, describes an ideal investor.

A company’s success in raising a loan on terms close to ‘ideal’ depends on how its business is organized. Overseas giants, such as IKEA, Auchan or Ramstore – a retail chain highly popular in Russia – usually borrow from international financial institutions. Russian firms approach domestic banks and investors for financing.

A respectable western organization will never agree to finance a project unless the borrower complies with international accounting standards. In Russia, however, few companies can brag about paying ‘white salaries’ and keeping books in accordance with GAAP. But, experience shows that even though it is hard, securing funds from a foreign financier is possible.

Persuading Investors

“Western investors arrive in Russia either through major consulting companies or through the top ten of Russia’s leading banks – Sberbank, Vneshekonombank, Alfa Bank, etc.,” says Igor Lavrik, general director of the Stabilnaya Liniya company.

Consulting companies have all the necessary data, marketing surveys and information on the borrower. Before signing a deal foreign investors often take out insurance with companies offering insurance plans against financial risks.

Stabilnaya Liniya has been working with foreign investors since the 1990s. “For example, we have been raising direct loans and using co-investment schemes to finance the development of our hotel chain,” Lavrik says. “Lately, our company has been considering establishing a credit line in Italy’s San Polo bank in favor of Vneshekonombank of Russia.” The loan will be guaranteed by an insurance policy issued by the Italian credit agency Sace.

To attract an investor a developer should be ready to assume at least 30% of the total costs. Investors usually bring their own funds into projects. “Sometimes, they employ more complicated instruments of financing providing, for example, an option to convert a loan into stock in the project at a later stage,” says Semyon Puzrin, managing director at Concordia Asset Management.

But the developer also needs to persuade the investor that the project will be profitable. “A competent analysis, marketing forecast and convincing presentation are the keys to success,” notes Puzrin.

The chances of attracting investment grow in direct proportion to the volume of documents submitted. Investment consultant at Noble Gibbons Valery Polyakov says that a developer is required to submit a set of documents to a foreign investor for consideration. When applying for a loan to a bank developers are simply obliged to do so by law.

Those documents include, to begin with, a detailed business plan and a feasibility study. Secondly, there is permission and approval from the authorities which represents a guarantee that the government has authorized the development.

Thirdly, a developer must have a long-term lease agreement signed with anchor tenants which constitutes the best proof of market viability for the future property. Finally, the developer is strongly advised to enter into an agreement with a well-known general contractor. That deal will provide a guarantee that the project is commissioned on time without exceeding the fixed budget.

“The composition of tenants is important and may even affect the terms and conditions of financing,” Polyakov adds. As an example he cites a project for the development of a shopping center where anchor tenants will be represented by international retail operators and the developer has already secured guarantees from their parent companies.

In such cases the investors’ attitude towards the project is likely to be more favorable as deals clinched with respectable anchors reflect the high quality of the project, its concept and its success for a period of at least seven to ten years to come. Besides, with retail market leaders involved, the project is likely to attract more respectable tenants who prefer tenancy in malls with strong anchors capable of attracting large numbers of customers.

Marina Mazur, deputy general director and head of marketing at Kulon, a company active in the warehouse real estate sector, insists that the decisive factor for attracting investments is a track record of successful project implementations. Kulon is involved in cooperation with many European investment funds operating in Central and Eastern Europe. “Most investors complain that in Russia it is hard to find reliable developers who meet their standard requirements,” Mazur.

Government Support

The International Finance Corporation (IFC) is one of the leading investment institutions with operations in Russia. The IFC is a member of the World Bank. The shareholders in the WB and the IFC are member states.

While the World Bank finances projects involving national governments and municipal authorities, the IFC promotes investment in the private sector. Established in 1957, the IFC has 140 member states. Russia joined the organization in 1993. Since then the IFC has invested $1.8 billion in over 90 private business projects in Russia.

Most of the funds arrived in the form of loans granted to domestic banks, financial institutions and leasing companies who then extended loans to private businesses in Russia. In particular, the IFC financed the projects of foreign retailers entering the Russian market. Cooperation with Turkey’s Ramenka has so far been the IFC’s largest project in Russian retail. Sweden’s IKEA was granted a relatively small loan by IFC.

But foreign retailers arriving in Russia to conquer the local market do have money in their pockets. For them an IFC loan is more of a political umbrella to safeguard them against possible bureaucratic hurdles.

After all, Russia itself is a shareholder in the IFC, and a government that has authorized lending is unlikely to put obstacles in the way of a borrower. That is why the IFC enjoys certain immunity against government regulations. For example, in August 1998 Russia was hit by a financial crisis and the government issued a decree freezing debt repayment to international financial institutions. That, however, did not apply to IFC loans.

The IFC is interested in extending long-term loans of 7-10 years and longer. Borrowers are usually granted a 2-year deferment on the repayment of a principal loan. The IFC interest rate is set at a margin over LIBOR.

Rates depend on the specifics of the project. At the earlier stages of a project loans are extended at higher rates. After the project is completed and the borrower is able to offer stronger guarantees the IFC may lower interest rates. Like other banks the IFC extends loans against the property to be developed with the help of IFC financing, the plot of land, shares in the project company, and long-term leases.

“But unlike many other financial institutions and banks who are either specialized in financing projects in a state of construction or refinancing finished projects, the IFC is ready to do both,” notes Sergei Kozhukhov, an IFC investment adviser.

The IFC offers debt financing and shared sponsorship, Kozhukhov says. In line with its regulations, the IFC cannot invest over 25% of the total estimated project costs. But in some cases an IFC share can reach 30-35% of the total project costs, if, for example, the corporation allocates extra funds to develop a brand.

The project must be financed by the developer himself. When the required loan exceeds 25-35% of the project costs, the IFC sets up a syndicate of several international banks who finance and oversee the project jointly. “We have a large list of international banks together with whom we arrange for syndicated loans,” says Kozhukhov. As for Russian banks, they are not involved in that partnership, but the IFC is ready to finance projects jointly with Russian banks.

The minimum amount the IFC is ready to invest in a project is $10 million. Firms willing to borrow from the IFC have to submit a brief description of their project, the estimated project costs, the sources of financing, information on key shareholders and the estimated size of the loan required.

“To qualify for an IFC loan the Russian team has to meet the requirements set by the IFC,” says Kozhukhov. “These include a certain level of financial training, knowledge of basic concepts of developing business plans and compliance with international accounting standards.”

Incidentally, quite often the latter requirement constitutes an insurmountable obstacle for Russian companies, few of whom are ready to adopt international accounting standards and pass examinations by international auditors.

Furthermore, they are likely to face problems of a legal nature as the IFC signs agreements in accordance with English law. Russian companies often lack knowledge of certain legal issues and have to enlist the services of legal firms and lawyers versed in English law.

When deciding whether to finance a project, the IFC studies its concept. Kozhukhov says that “of great importance are: the location of the property, transport accessibility, parking facilities, as well as preliminary agreements with tenants and the terms of the future tenancy agreements.”

The IFC seeks to become a long-term partner in a project and positions itself not only as a source of financing of development. The IFC combines a venture-like approach with conservatism.

Project financing is available at the initial stage, and after the project is implemented an investment deal is possible. “While financial investors are, for the most part, minority shareholders, we employ the same protection mechanisms as used by unit investment funds. Those include a preemptive right of purchase, protection against dilution of the share capital, preventing new shareholders from joining in,” says Kozhukhov.

The IFC is ready to invest in the development of any commercial properties, but has been especially active in the retail sector. Upon entering the Russian market in 1997 Turkey’s Ramenka applied for an IFC loan despite the availability of its own huge finances. The corporation extended a $36 million loan to the company and later granted several more loans totalling $100 million.

In 2000 IKEA – in contradiction of its corporate policy whereby the famous retailer finances all its projects itself – borrowed $15 million from the IFC to finance the development of a shopping mall in Khimki.

IKEA would not elaborate on the reasons for such a move. “We believe that our participation helped to settle certain problems IKEA had with Russian government bodies when it was launching its business in Russia,” says Sergei Kozhukhov.

In 2004 the IFC granted a $10 million loan to the Russian company Kulon for the development of two office and warehouse facilities, of 16,000 and 27,000 square meters.

“One of those loans was extended for a term of about seven years at a fixed annual interest rate of 8.5%,” says Marina Mazur. “Another loan – for a term of about nine years – was received at an increased rate and a smaller share of dividends pending expiry.”

Rates can be adjusted if the estimated rate of return is exceeded or if the borrower delays repayment. The loans are secured by land, developments, shares and future earnings.

“A deal with the IFC, as compared to European and Russian lenders, involves an enormous volume of paperwork and correspondingly high legal costs which we assume under the terms and conditions of the agreement,” says Mazur. Kulon’s agreement with Austria’s Raiffeisenbank to finance the same projects was much simpler and involved less formalities. The loan was extended at rate of LIBOR plus 5 points for a period of five years.

Russian Response

Undoubtedly, the growing economy, stable political situation and the fact that even Standard & Poor’s has finally upgraded the country’s investment rating contribute to the inflow of Western capital into the Russian development market. The growing number of successfully implemented developments, too, attracts Western investors. But still many factors remain that deter foreign investors and creditors.

“Vague laws and the legal restrictions of market players’ rights hamper development,” believes Marina Kislitskaya, managing partner at Concordia Asset Management. Obtaining permission from the authorities and registering the titles to property is very time-consuming, which has a negative impact on the entire project. Gaps in land use legislation are another obstacle. “Predictable laws and clarity in legal issues would help attract investments,” Kislitskaya is convinced.

The tradition of solving issues related to land use through connections in government bodies, the so-called “administrative resource”, also creates difficulties for investors. But that is likely to change. “The tendencies are such that soon Western capital will find a solution to the problem,” holds Stanislav Kapinos, general director of Russian Hotels. “Consequently, competition among investment companies will grow even stronger. The decisive factor will be the amount of financing and the correct choice of a Russian partner.”

A serious hindrance for Western financial institutions is that Russian companies often lack transparency and fail to present thoroughly developed business plans. “To address those issues we even arranged to train several employees at the Urban Land Institute,” says Marina Mazur.

But foreign investors are not the only source of financing. Domestic financiers are ready to put up funds in promising projects, both in Russia and other former Soviet republics – CIS member states, including Georgia, Ukraine and Armenia.

“But regardless of the location, the requirements for the projects set by the company remain the same,” says Stanislav Kapinos. The property and the building plot must be free from any encumbrances or claims. The size of the plot must be at least 0.25-0.35 hectares. The company considers options that offer tenancy for a period of up to 49 years, or tenancy with an option to purchase. Russian Hotels prefers to act as a majority investor. “We are not interested in projects where Russian Hotels’ share is below 51%,” says Kapinos.