People in the Know: Looking a Couple of Years Ahead

Russian universities, too, furnish their students with profound knowledge of world economic processes and a deeper insight into the domestic real estate market which develops along its own lines and at its own pace.

Ivan Sitnikov, the head of RosEuroDevelopment, is in the habit of calling a spade a spade and seeks to get at the root of things and economic phenomena. In an interview with Vedomosti he dwells on the problems Russian development firms are faced with and the prospects for foreign companies operating in Russia.

-Rates of return in various commercial property sectors are changing all the time. Which sector is the most favorable today in terms of investment, and why?

I believe top quality properties to be the best investment. I know plenty of “wrong” projects in each property segment, which in some 2 or 3 years will prove disappointing for their owners. As to the situation in each segment in general, experts assume – and I agree with them – that nowadays we are experiencing a shortage of warehouse properties.

Yet, their reports should be regarded objectively, because all the analysts focus on the developments of today, and many projects go unnoticed. If we meet to discuss the issue again in a couple of years the situation on the market may have changed radically. It may well be that we shall see another dozen properties having entered the market, of which we know nothing today.

That is why my answer as to which property sector – offices, warehouses or retail centers – is the best to invest in today is simple: the best investment is top quality projects.

-What do you mean by a prime quality project?

This implies a favorable location, compliance with professional standards, involvement of western design studios in cooperation with the best Russian architects, cheap long-term loans, etc. Also, of great importance are such matters as a guaranteed agreement with a professional Russian or foreign building firm, which is able to meet deadlines and ensure quality of construction and spares the developer construction risks, leases with institutional tenants, etc.

-But quite often, the forecasts made by strong analysts, prove true…

Of course, there are certain statistical data produced on a quarterly basis by international consulting firms who evaluate rates of returns in each of the sectors. But it has to be kept in mind that those statistics deal with the developments of today.

When it is said that Moscow is short of approximately 1 million square meters of class A office space, some may think that investing in office development is likely to bring the highest returns, hence, it is worth spending cash on it forthwith.

But what skips their attention is the fact that the development of 0.5 million square meters of missing office space has already been launched. That is why, for investors, it is important to look some two or three years ahead and be aware that creating properties is an inertial process.

Finding yourself at the end of the cycle is painful and annoying. In this case, the risk of failure grows immensely. On the contrary, being at the beginning of the cycle you are likely to see financial results which are quite impressive, even if the project is not exactly successful.

As regards retail, the statistics on that sector should be treated with great caution. The same building plot can be used to build an outstanding project, or a very mediocre one. Returns on those projects will differ even if the amounts invested are approximately the same. That depends on the aforementioned conditions of success and on the quality of performance of the management company. This is one of the most painful and sensitive issues on the Russian market.

That is why, unlike the warehouses of office properties, retail centers require a very careful approach towards branding and marketing throughout its life.

In the office sector, by having provided for a very precise set of parameters, such as the depth, light field, height, bay spacing, and hiring of professional architects we will most likely come up with a successful property in a successful location. In retail development, developers and architects play a much bigger role. In that sector, each building site is unique, it is impossible to standardize and clearly describe all the details of the property.

Two projects in seemingly favorable locations may yield different financial results with one of them paying back while the other plunges into the red. Those are examples of different approaches towards development projects requiring the same amount of spending. That is why the professional skills of developers, architects as well as the entire team involved are crucial for success.

-What impedes developments backed by foreign investment in Russian commercial real estate?

There are two reasons why foreign investors shun Russia. They are a lack of transparency in land regulations and the specifics of the risks which they are reluctant to run. While in the United States it is possible to track down the history of a plot of land over the past 50 years and to secure guarantees that no claims will be made on it by any of its previous holders, in Russia doing so is impossible due to the reasons we all know of.

Quite often foreign firms arriving in Russia are guided by their corporate laws governing the U.S. and European markets. On the one hand, those companies are equipped with their know-how and a desire to work, on the other, they fail to understand that their laws will not work in Russia.

Foreigners need time to adjust to our conditions, or else, they will fail. I know quite a few large players who were willing to spend millions or even billions of dollars on the development or acquisition of commercial properties here, but they saw no projects here worthy of their attention.

-How well protected are the rights of investors in Russia? Which laws need to be passed?

The Russia of today has quite a sufficient number of laws, good laws that must be observed. Russia has adopted codes on land, town-planning, housing, the Civil Code, etc. Saying that Russia is still in dire need of more legislation is unfair.

But quite often officials in the regions, by raising all sorts of bureaucratic hurdles, prevent investors from exercising their rights, while investors do not insist on strict compliance with the law, although the law is on their side.

We waste a lot of time and effort on getting across our ideas to the governments in the regions. And we are thankful to the heads of many regions where we have succeeded in establishing a civilized dialogue and managed to explain the advantages of our projects, which have proved both commercially and socially effective.

There are certain omissions in some of the laws, but those omissions are gradually being eliminated. For example, the town-planning code stipulates that if the city has adopted the rules on land use and development, building plots can only be allotted through auctions. Where such rules have not yet been adopted plots are to be assigned under a procedure developed by the municipal entity itself. As soon as auctions become really common, Russia’s market will become more open and appealing to investors.

Another great advantage of the town-planning code is that this act obliges the government to inform a developer of the engineering specifications on a free-of-charge basis within a fortnight. What is important is that the specifications are provided not just in the form of instruction as to what must be done, but, say, in the form of a commitment undertaken by an energy supplier to plug the building into power lines within a certain period of time for a certain fee. That helps investors to prepare for future spending. Therefore, those charges are good, provided, of course, that they work.

-Do investment procedures in Russia follow the same scenario as in other former socialist countries, or are there any differences?

In terms of the general economic processes as a whole, the scenarios are the same as certain niches that remained vacant have begun to fill up eventually. The question is how they are being filled up. This is where the main differences between Russia and other Central and Eastern European countries lie. While in other countries foreign banks and firms took hold of local markets fairly quickly, in Russia the presence of domestic capital is very strong.

What has happened to the so-called socialist camp? Foreign banks have devoured local banks. Foreign companies have arrived and, owing to their close ties to the banks, secured full control of many industries, including entire property development sectors.

Incidentally, such things could have happened in Russia; foreigners could have succeeded in implementing that sort of scenario back in the early 1990s when Russians were too busy sharing the best bites of state-owned assets to consider investing in real estate. Foreigners, equipped with their expertise and money, had a great chance. But instead of using it they assumed a wait-and-see attitude, analyzing the market, writing reports instead of entering the Russian market.

It was namely due to this wait-and-see policy on the part of foreign firms that Russia has acquired sufficiently powerful domestic capital that has begun to pour into real estate properties. It is still hard for foreigners to compete with Russians, as they are not as versed in Russian realities and unable to settle many specific issues arising during the implementation of projects.

But this does not mean that the Russian market is closed to foreigners. Russian developers –RosEuroDevelopment is no exception – are willing to work with western, as well as Russian banks. What is important for us is the terms on which financing is extended, not where it comes from – whether from a Russian or a foreign bank.

Of course, there is a difference in approach by Russian and foreign investors. Foreign financial institutions have experience in project financing, but have never worked in Russia before and are afraid of making the first step. Russians, on the contrary, lack experience in project financing.

It is quite possible that we will resort to a joint model where Russian banks finance projects at the construction stage and assume certain construction risks for a higher interest, whereas foreigners refinance loans after the property is completed, commissioned and filled with tenants.

Thus, the project will have a guaranteed cash flow. Therefore, today we face a task of finding system partners as our project portfolio has already neared $1 billion and, undoubtedly, we are interested in several serious partners.

-What are the criteria for selecting a contractor, especially where there is the possibility of choosing between Russian and foreign firms?

Those criteria are based on a number of basic principles. To begin with, they are reliability and guarantees that contractual commitments will be honored. We seek to work with contractors who are able to meet deadlines, guarantee quality and assume financial obligations regarding the risks arising from those contracts.

That is why we are ready to hire more expensive contractors to ensure quality, meet deadlines and secure guarantees. Nationality is not a priority. We have been successfully cooperating with foreign, as well as Russian firms. We attach the utmost importance to their professionalism and ability to provide high quality performance.

-Do you build up reserve funds, for example, to secure the company against force majeure events such as, say, another financial crisis similar to the one in 1998?

We set up reserve funds for each particular project. In other words, we assess the risks not of the company as a whole but of a certain project. In each case, the company calculates and establishes the necessary reserve fund.

Ivan Sitnikov was born in Moscow on Nov. 7, 1972. He graduated from the Moscow Institute for Radio Technologies, Electronics and Automatics in 1995, and the Plekanov Academy of National Economy in 1997. In the same year he completed his post-graduated studies at the Institute of System Analysis and the Russian Academy of Sciences.

Sitnikov began his career in corporate and project financing in 1995. He worked for Rossiisky Kredit Bank, the S.A.&P investment company and RosEuroBank.

In 2003, Ivan Sitnikov was appointed general director at NLK Development. In 2004, he became the head of RosEuroDevelopment, established after NLK merged with Novoye Vremya Development.

RosEuroDevelopment was established by RosEuroGroup following the 2004 merger of NLK with Novoye Vremya Development. Novoye Vremya specialized in construction and management of out-of-town residential compounds while NLK Development was involved in turnkey construction of logistics parks in Russia.

The project portfolio of RosEuroDevelopment is estimated to be worth nearly $1 billion. The company is developing a class A business centre in Novosibirsk, a fashion-center in Rostov-on-Don, shopping and leisure facilities in Samara and Krasnoyarsk, and logistics parks in Rostov-on-Don and Krekshino, near Moscow.

By the end of 2005, RosEuroDevelopment’s investments will reach $100 million. Next year, the company plans to invest $300 million in real estate development.