MONEY-GROWING: KUGI’s 30 Pieces of Silver

Hitherto, Smolny (the city administration) has been auctioning off only vacant non-liquid properties that failed to attract tenants even after rental rates were lowed by 25%. They were, for the most part, basement facilities requiring major repairs. At auction, however, those properties have enjoyed a high demand.

Buyers are ready to spend large sums of money on premises in prime locations to secure a ownership in them. For example, in 2004 the St. Petersburg Property Fund sold 112 lots at auctions for a total of 136.2 million rubles.

Many of those properties were sold quite expensively despite their deplorable condition. For example, a 200sqm basement on Sennaya Square was snapped up for $810 per square meter; a 140sqm facility on Moskovsky Prospekt was sold at approximately the same price.

The 2005 city budget envisages a nearly 10-fold increase in overall revenues from privatization. The city government hopes to receive over 1 billion rubles for its non-residential properties. To meet that target KUGI has widened the range of properties to be privatized by including in the list unprofitable properties where paperwork costs are often comparable to the rental payments received.

New regulations were introduced by the KUGI order #576-r issued in November of 2004. In line with the order, municipally-owned non-residential properties with annual rental rates not exceeding 30 conventional currency units (c.c.u.) per square meter (where a currency unit equals 35 rubles) are all subject for sale.

Moment of Lawlessness

However, the city failed to launch the first auctions on time, as St. Petersburg did not have its own law on privatization.

Last year several members of the St. Petersburg Legislative Assembly addressed the Statute Court of St. Petersburg – the judicial body in charge of interpreting the city statutory documents – and expressed doubt that the city’s executive authorities had the right to decide the fate of certain properties while the city had no effective laws on privatization. Smolny claimed its decisions were in line with federal legislation.

The judges came up with a compromise decision. They did not cancel the earlier decrees, but pointed out that the city government could not go ahead and auction off its property before the city law on privatization was enacted, which was to take place within a reasonable period of time.

The most radically-minded deputies hoped to establish full parliamentary control over the sale of city property and to oblige the government to secure the approval of deputies before privatizing any property, however small or insignificant it may be.

After a lengthy period of bargaining with Smolny the Assembly passed a version of the law the city government was more or less satisfied with. The deputies will henceforth decide the fate of strategically important state-owned companies (GUP), and buildings and installations of more than 7,000 square meters, while Smolny is allowed to decide on the sale of all other properties.

The most important of those – with shares of a par value of 3 million rubles, buildings of over 3,000 square meters, etc. – are to be included in the city’s yearly privatization plan. The remaining properties, including non-residential ones – can be sold off by KUGI.

“Thanks to that law we will be finally be able to have municipally-owned properties privatized legitimately. Our opponents will no longer have reason to go to the Statute Court. That is why the process of the sale of property will be quicker,” holds Aleksei Chichkanov, first deputy head of the property management committee.

St. Petersburg’s law on privatization came into effect in March, whereupon the Property Fund immediately stepped up the preparations for auctions.

The Burden of Tenants

About 4,000 municipally-owned properties in the city are leased out at rates below 30 c.c.u. per square meter annually, according to KUGI’s reports. Such properties exist in nearly all the districts across St. Petersburg including the city center. For example, in Petrogradskaya Storona there are 116 such properties, 127 in the Admiralteisky District, and as many as 437 with a total space of nearly 70,000 square meters in the city center.

Those are for the most part so-called ‘built-ins' (non-residential properties for commercial use within residential buildings) and basement facilities situated in the backyards of St. Petersburg’s famous ‘wells’ and requiring major repairs.

However, that list also includes properties on the city’s main thoroughfare Nevsky Prospekt where the average rental rate is many times above the stated limit – i.e. the amount below which tenancy offers are not considered. But there are firms who entered into tenancy agreements with KUGI back in the early 1990s when rates were based in rubles and the government cannot unilaterally revise the terms and conditions.

Most of the properties in question have leases in place. Also, there are properties burdened with debts, embroiled in litigation, or where unscrupulous tenants are in the course of being evicted – in other words, properties that are nothing but a nuisance to the city administration.

A new owner who buys a property encumbered with tenants automatically becomes the landlord under the tenancy agreement and is obliged to comply with its terms and conditions. If the tenant honors his obligations under the agreement the landlord has no right to sever it before the appointed time and rental rates cannot be revised unless the general method of calculating rental payments is altered.

“That is the conclusion we have reached upon thoroughly analyzing model tenancy agreements that KUGI has worked with over the years,” Andrei Stepanenko, head of the Property Fund, explains. Nonetheless, he is convinced that properties put up for auction will attract investors. The first lots will include properties with leases expiring no later than in two or three years.

However, lawyers representing private companies believe that, if need be, one can find loopholes in KUGI’s model agreements enabling new owners to evict unwanted occupants from the ‘built-ins’.

Immediately after the May holidays the Property Fund is set to auction off 56 properties; the list has already been compiled. Another 60 are to go on sale before June. The first list includes 12 addresses in Petrogradsky District, 7 in Moskovsky, and 6 each in the commuter areas of Vyborgsky and Kalininsky. Quite a few properties that will be sold are situated in satellite towns near the suburbs – Pushkin, Pavlovsk, Lomonosov, Petrodvorets (Peterhoff) and Kronshtadt.

When this issue went to print the market valuation of those lots had still not been completed. Officials only cited approximate figures.

Deputy head of the Property Fund Vladimir Zhukovsky says that properties on the outskirts that cannot be used for retail purposes given their location and technical characteristics would be offered at $300 per square meter.

‘Built-ins’ that can be used as shops will be sold at $400-600 and over per square meter. Premises in the city center will be examined separately. (Incidentally, it is possible to estimate the prices using the data from the sale of non-liquid space, as the qualitative characteristics of the properties are comparable. – Vedomosti).

But those prices are quoted without taking into account the existing encumbrances. Depending on the term of lease in place the initial price of a property could fall by anything from 10% to 50%.

Mikhail Zeldin, president of the Avers Group that takes part in valuing low-profit properties subject for sale, says: “What makes the valuation of such lots somewhat difficult is that the experts – quite often with no access to all the technical documentation of the property – have to make an adjustment for the renovation costs to be incurred by the future owner.

“Making an adjustment for encumbrances is not as difficult because we take into account the fact that in the course of a certain period of time the income the winner receives will not exceed the rental rate set by KUGI. The starting prices tend to be quite low. But what can you do? After all, barely more than 5% of the lots are of commercial interest. I believe the city government is doing the right thing by getting rid of such a dead weight.”

Igor Gorsky, head of Bekar Commercial Real Estate, believes that the low auction prices will not trigger further speculation in the properties.

“The auction is open,” he says. “Anyone can take part. The city officials, too, have already learnt to sell at prices comparable to those set by the market. Those properties are meant, first and foremost, for small businesses that cannot afford property at prices over $100,000. So, the numerous properties put up for sale will, undoubtedly, set that sector of the market in motion considering the meager supply that we see today.”

In addition to properties leased at rates below 30 c.c.u. per square meter the city also plans to get rid of vacant premises that have failed to attract any bids in the two weeks before the official list of lots was published. KUGI will no longer wait for a month before re-valuing those properties and putting them up for sale again. They will go on sale immediately, regardless of the rental rate.

The same will happen to ‘built-ins’ that were offered for lease by a city or a district property management commission but where the claimant refused to sign a deal and nobody else expressed an interest.

The KUGI order also includes a provision enabling the city commission to auction off any vacant non-residential property if it believes that selling it is more appropriate than leasing.

The procedure itself of preparing properties for sale has been simplified. The set of documents will henceforth be prepared by the Property Fund, not by KUGI’s district agencies as it was before. Andrei Stepanenko hopes that such an approach will help reduce the presale preparation period to 1 or 2 months.

Paid up in Advance

Another category of properties to be put up for sale this summer is that of detached buildings and ‘built-ins’ whose tenants have paid their rent under tenancy agreements with KUGI in advance till December 31, 2009 and later.

Most of those properties are rented by banks, in particular, Sberbank and PSB. Both have paid their rent for 49 years ahead. Thus, there is nothing else the city budget can get from them. The banks, for their part, are interested in securing the titles to the properties.

With current laws on privatization stipulating no target sale of properties to their tenants, those properties will be auctioned off anyway. But the terms of sale of such premises are unlikely to attract outsiders who will not be able to make any profit from them within the next forty years or so.

KUGI plans to sell some 200 offices currently occupied by Sberbank branches across the city in one lot. Among the properties included in that list are 48, Maly Prospekt; 21, Prospekt Engelsa; 33, Ulitsa Gavanskaya; 36, Ulitsa Kuibysheva, etc. Albeit conveniently located, those ‘built-ins’ are offered at starting prices that are quite low. For example, one of the most expensive of them has been valued at $12,700.

“The tenant has virtually already paid the market value of those properties,” Stepanenko says.

Creative Approach

The city authorities have taken a special stance regarding studios occupied by artists and sculptors under tenancy agreements with KUGI. Controversy involving such properties flared up last summer. Then, the artists protested, threatening to set themselves on fire in their own studios and to renounce Russian citizenship should the authorities try to evict them.

They accused Smolny of planning to drive them out of their attics, basements and first-floor ‘built-ins’, i.e. premises previously included in the special fund of the so-called socially-important properties and allocated to artists on preferential terms. According to KUGI, St. Petersburg’s artists hold leases in over 1,800 properties with a total area of 116,000 square meters (most properties are under 100sqm).

The protests were staged after KUGI suggested that the creative workers pay rent in advance till December 31, 2009 and take part in the auctions for the sale of their studios.

Aleksei Chichkanov explains that the property management committee had merely acted upon the request of several artists who expressed an interest in buying their studios. As in the case with the banks, by law the authorities could not sell the properties in question to their occupants directly and suggested that the artists pay rent in advance to secure themselves against other potential bidders.

Chichkanov emphasizes that privatization would be solely on a voluntary basis with the tenants free to decide whether to buy or not. Those who cannot afford to buy or are not willing to secure the title will keep their status as tenants enjoying all the benefits that rental payments give. “Nobody will be forced to buy,” he says. “Although, we are interested in selling those properties, because revenues to the budget are minimal while the technical condition of the properties leaves much to be desired. Naturally, the artists, in their status as tenants, are not willing to spend large amounts of money on repairs.”

Representatives of the creative intelligentsia have been given 6 months to think it over. Within that period they can pay their rent in advance whereupon the properties will be put up for sale. Payments are to be made on the basis of the current preferential rate set at 13% by the Finance Committee.

A specific example is an artist occupying a 32sqm attic in a building on Ulitsa Pestelya, in the Central District, who pays 60 currency units per square meter per year. Without benefits the total amount would come to 2,000 currency units. It the tenant pays 280 units in advance, the property will be put up for auction at a starting price of 4,000-7,000 units.

What makes the buy-out scheme more complicated is that tenants in most agreements are represented not by the artists and architects themselves but by the artistic unions to which they belong. That is why before making a bid they are required to secure approval from the union leadership whose reaction is not always easy to predict.

The city authorities have also invited individuals who rent attached or detached garages to pay rent in advance and take part in auctions to buy those properties. They have also been given six months to mull the offer.

“Undoubtedly, we have seen a breakthrough in the privatization of non-residential properties. I think that in the year 2005 auctions will become a widespread practice and will affect prices on the secondary commercial real estate market,” says Andrei Stepanenko.