Money-Growing: The Battle for Investment

Leningrad Region focuses chiefly on industrial development. The region’s trademarks are the Ford and Caterpillar factories, Philip Morris Izhora and Nokian Tyres.

St. Petersburg, too, can boast quite sophisticated production facilities such as Gillette or Coca-Cola, but takes more pride in its cultural, retail and hotel projects, such as the Second Stage of the Mariinsky Theater, the redevelopment of New Holland Island, a variety of shopping and leisure malls that include Swedish House, or business centers such as Atrium and Neptune.

In recent years, however, the situation has changed noticeably. The city government has succeeded in convincing Toyota Motor Corporation of the advantages of St. Petersburg as a venue for a factory. The city has focused on a number of major projects likely to attract billions of dollars in investments. The region is looking for major retail operators, while local authorities pledge to develop the tourism industry and actively put up funds for tourist facilities.

The city and the region are resorting to different methods to attract investment and are pursuing different priorities. Companies operating on the commercial property market have to remember that.

Siamese Partners

The administrative division of St. Petersburg and its countryside into two independent regions of the Russian Federation is seen by many as a geographical misunderstanding. “The situation where there are two constituent parts of the Russian Federation – St. Petersburg and Leningrad Region – is a vivid example of a contradiction in terms, as there are two regions, each having its government, establishment and all other attributes of an administrative unit, but economically they form a single region,” says Yuri Perelygin, head of department at the Ministry for Regional Development.

St. Petersburg’s Kurortny District is wedged deep in Leningrad Region along the bay coast; getting from the settlements of Koltushi or Yanino in Vsevolzhsky district outside St. Petersburg to the city center takes 15 minutes, and 60 minutes from Peterhof… What is especially strange is that the town of Lomonosov is a part of St. Petersburg, but Lomonosov District belongs to Leningrad Region. The countryside is indented with administrative barriers which obstructs market growth. Furthermore, each territory follows its own set of rules and has its own specifics. Initially, St. Petersburg enjoyed a higher status, the region being regarded as a sort of an appendix to the “great city with a fate of a province”.

“That difference is always implied, with a certain hue of snobbism at that; like, here is the capital and you are country folks over there,” says Yuri Borisov, managing director at IB Group.

Last year the total investment in St. Petersburg’s economy reached 103.7 billion rubles, in Leningrad Region it was 67 billion rubles. Foreign investment stood at $160.9 million in the region, and some $950 million in St. Petersburg.

However, on the whole, in 2004 Leningrad Region ranked 3rd among Russia’s regions in terms of total investment per capita (39,400 rubles), having left behind even Moscow with 25,700 rubles and St. Petersburg (24,300 rubles).

“We believe that, politics aside, the Leningrad Region is beyond comparison, in terms of investment appeal,” holds Grigory Dvas, deputy governor of the Leningrad Region.

But general figures fail to reflect all the details. The St. Petersburg government has waited far too long in the vain hope that investors, charmed by the beauty of the Northern Venice, would be queuing up to pour cash into the ruins placed on the world heritage list.

After those hopes proved futile, the city began to woo strategic investors, at times rather awkwardly. Developers like to recall anecdotes about representatives of an international corporation who were forced to wait for hours in the reception area of Smolny for a meeting with some high-ranking bureaucrat before smart regional officials snapped them up and took them on a helicopter ride to inspect available building plots.

The strong competition for cash badly needed for territorial development at times takes on a peculiar form. In the summer of this year Leningrad Region’s deputy governor, Grigory Dvas, told a news conference that the investment policies pursued by St. Petersburg should be of interest to prosecutors.

Obviously, Dvas was angered at city hall taking advantage of its stronger position in persuading Toyota to choose Shushary as a venue for its factory in Russia. Vladimir Putin himself had attended the cornerstone laying ceremony. Afterwards, the region’s governor Valery Serdyukov had to apologize to St. Petersburg mayor Valentina Matviyenko for his subordinate’s outburst.

Strategic Partners

The city government has approved a list for a number of major investment projects and established a committee to oversee their implementation.

The Marine Passenger Terminal is currently under construction in the western part of Vassilyevsky Island. The plan envisages the reconstruction of the navigation channel, development of five berths for ocean liners and ferries on reclaimed territory and a number of buildings and installations. The new terminal will serve 1.2 million passengers a year. The project is estimated to be worth $310 million.

The project for the construction of the Western Diameter Highway, or ZSD, envisages construction of a transit route. Once the motorway is commissioned the average amount of time spent driving around the city will drop by 24%. The total projected length is 46.4 kilometers. Construction is to be completed in 2011. The first stage – the southern stretch of the route – is to be completed before 2009. The project is estimated to be worth $2 billion.

Development of the Baltic Pearl residential estate began on a 208-hectare plot in southwest St. Petersburg in 2005. The project includes the reclaiming of land, the laying of engineering and communication lines, the development of apartment houses (over 1 million square meters of residential properties), four schools, five kindergartens, two health clinics, six libraries, four gyms, and a swimming pool. The project will take six to eight years to implement; the first phase is to be commissioned in 2008. The project, estimated to be worth $1.25 billion, is financed by Chinese investors – JSC Baltic Pearl was registered by five major Shanghai-based firms. The state also has a share in the project.

The city’s hotel development program for the years 2004-2009 includes a list of 150 sites recommended for hotel construction. The projected investment is estimated at $800 million.

The St. Petersburg government has held auctions to sell controlling stakes in a number of the city’s major hotels. 11 stakes have changed hands so far. The city budget revenues from sales are expected to reach 4.35 billion rubles. At the same time experts say that in 2005 alone tourist numbers visiting St. Petersburg dropped by about 30% due to the lack of accommodation facilities and exorbitant prices.

The new building of the Mariinsky Theater has been designed by Dominique Perrault. The state-of-the-art 40,000-square-meter opera house will be covered with a gilded cupola, described by the architect as a “golden shell”. The second stage is to open in early June of 2009, just as the ‘white nights’ season begins. The projected amount of investment stands at $200 million.

The government is about to launch the redevelopment of a 300-hectare area around the Moskovskaya-Tovarnaya train station; with the concept having already been prepared, the city is now working on the layout and land survey with a view to investment bids in the future.

In November, the city authorities began inviting bids for the redevelopment of New Holland Island from consortiums of investors, designers and developers. The project envisages the construction of hotels, offices, retail and leisure facilities, residential estates, and the Festival Palace on the island. A compulsory investment condition is the restoration of historic buildings in the area. Development, estimated to be worth $500 million, is to begin next year and to be completed by 2009.

Toyota Corp. has launched construction of its factory in Shushary; the 20-hectare building plot in Shushary-2 lies in immediate proximity to the city outer ring road. In August, Finnish company Quattro Gemini began earthwork on the site. Projected investment stands at some 4 billion rubles. The project operator is Toyota Motor Manufacturing Russia co-founded by Toyota (80%) and the European Bank for Reconstruction and Development (20%); the plant will produce the Toyota Camry.

Production is expected to begin in December 2007; a workforce of 500 will produce 25,000 cars per year though with time the projected annual output is likely to rise to 200,000 cars. Russia’s Minister for Economic Development and Trade German Gref has called the Toyota factory development project the most important investment project the city has ever known.

The city authorities usually place special emphasis on the amount of investment raised, well-known names of partners and the synergic effect of development of allied territories. Commercial developers complain about an unequal playing field – strategic investors are entitled to certain privileges and fight for contracts in the framework of huge projects.

In the Shadow of a Powerful Neighbor

The Leningrad Region is looking to develop industrial production, but not just that. The Philip Morris Izhora factory built in Lomonosov District near St. Petersburg is a subsidiary of Philip Morris USA. Production at Izhora was launched in February 2000. Since 1998, the company has spent $700 billion on the project.

Ford Motors poured nearly $150 million into an assembly plant in Vsevolzhsk. By the end of this year, Ford Vsevolzhsk will have turned out 32,000 Ford Focuses including 24,000 Ford Focus-2 cars, the production of which was launched in May. Ford Motors is set to double the plant’s production capacity by investing a further $30 million in the project.

Caterpillar launched production in the town of Tosno, Leningrad Region, (construction of the factory began in 1998). Investment has exceeded $500 million. Caterpillar Tosno produces tractors, excavators, bulldozers, autoloaders and engine systems. Initially, Caterpillar had intended to set up a joint venture with the Kirov Plant, but the plans fell through.

In September 2005 Finland’s Nokian Tyres opened a $55 million production unit in Vsevolzhsk. By the year 2008 the total amount invested in the project will reach 140 million euros. Nokian Tyres plans to produce 1.9 million tires in Vsevolzhsk next year and 4 million tires in 2008. The unit employs 120 people, mostly Russian nationals.

In 2000 Kraft Foods opened a production line in the town of Gorelovo near St. Petersburg. The total investment in the project amounted to $29.4 million. In October 2005 the governor of Leningrad Region, Valery Serdyukov, met Kraft Foods’ president, Maurizio Calenti. The meeting was held behind close doors but it was reported that the parties discussed, among other things, additional investment.

The list of meetings and talks held by the regional government give a clear picture of the region’s investment priorities.

In the fall of this year, a delegation of Japanese businessmen representing some 40 firms, including Sumitomo, Mitsui, and Mitsubishi Estate Company, paid a visit to the region.

In October Valery Serdyukov held a working meeting with representatives of Germany’s ThyssenKrupp AG. Vice-governor Grigory Dvas discussed a plan to launch production of automobile spare parts at a meeting with representatives of Hammerstein GmbH.

But the regional government has not confined itself to just manufacturing, the timber and food-processing industries, or car assembly lines.

By the end of this year, a new alpine ski resort, Igora, will be opened in the Vsevolzhsky District of the region, at the 69th kilometer of Priozyorskoye Shosse; the project is estimated to be worth $50 million. Severstal and AKB Rossia are reportedly among the investors.

Grippi Finland plans to spend 13 million euros on the development of a 100-hectare golf club in Gatchino, featuring a hotel and country cottages, a restaurant, a car park and other amenities. The new golf club is to open by 2010.

In December 2003 IKEA opened its first outlet outside St. Petersburg, at the intersection of the outer ring road (KAD) and Murmanskoye Shosse. The chain has spent $40 million on the project. In 2004 IKEA-Kudrovo was renamed IKEA-Dybenko (the name of the nearest metro station). Thus, the property, although based in the countryside, has become closer to the city, so to speak.

By October 2006 IKEA plans to build a 145,000-square-meter Mega mall on a territory of 60 hectares in Kudrovo. Development of a second outlet – the 120,000-square-meter Mega Parnas – has been launched in the village of Bugry, and is slated to be commissioned in 2006.

The project will occupy a site of 30-35 hectares, to be secured by the company in the near future. IKEA plans to spend $500 million on both projects. At the same time, Swedwood, which is a part of IKEA, is holding talks on the launch of furniture production in Tikhvino. Outlets of the French supermarket chain Auchan will be the anchor tenants at both Mega malls.

Notably, when IKEA cut the ribbon to its first mall outside St. Petersburg the city officials who attended the ceremony expressed hope that the next mall would be built within the city boundaries.

But Lennart Dalgren, IKEA’s Russian CEO, said: “We did everything we could to come to an agreement with the authorities of St. Petersburg, but it proved impossible. So we focused on the Leningrad Region, instead, close to KAD (the outer ring road).” Those words were quoted widely in the local media.

Yuri Borisov believes that investors prefer rural locations for their projects due to the tax privileges they enjoy in the region. “The region has built up a reputation as an area with a favorable investment climate,” he notes.

Commenting on the regional regulations concerning tax exemptions for investors, Grigory Dvas notes that their main advantage is that they are precise and easy to understand. “We fully exempt all investors from property tax irrespective of the level of investment pending payback and for two years after the payback period is over,” he says. “In the course of the same period, investors enjoy the maximum possible benefit as stipulated in federal law – 4% of profit tax… We apply almost all the means the Russian regions have at their disposal to attract investors.”

Regional officials place special emphasis on new jobs and future tax revenues, when they speak of their efforts to attract investments.

A Hole in the Middle

St. Petersburg developers are convinced that while pursuing their strategic goals the city authorities tend to neglect the interests of small and medium-size businesses.

Among the recent tendencies are the onslaught against small vendors located near bus stops and metro stations, the so-called war on vending booths, and the city’s plans to push up rents for municipally-owned properties. After the new Housing Code came into force in March this year the procedure for reclassifying residential apartments as non-residential properties has changed.

But while the law requires the authorities in the districts to take over the task of reclassifying properties for non-residential use, the city government has still not adopted regulations governing the new procedure.

Each year 1,200 to 1,400 apartments – mostly in the city center – undergo reclassification, according to the estimates of the Peterburgskaya Nedvizhimost (St. Petersburg Real Estate) corporation.

Given the acute shortage of commercial properties, such deals are quite popular. Apartments are sold at $1,400 to $1,500 per square meter; the cost of renovation and redevelopment for commercial use stands at $500 to $700 per square meter; the average size of an apartment situated on the first or second floor is approximately 100sqm. Thus, the total investment required is estimated to be worth $200-250 million.

“And such investments have the least protection,” says Vyacheslav Semenenko, vice-president of St. Petersburg Real Estate. “Those are risky investments because people get loans, offering their own properties as security. The existing situation reflects the authorities’ attitude towards medium-size businesses.”

The general director at the company SKS-Padams, Boris Tomalak, agrees. Beginning this year, he says, there have been practically no orders for the redevelopment of residential properties while in previous years such projects were quite popular in the city.

It is hardly worth blaming the situation on someone else’s evil intent, dishonest competition or lobbying by large companies. Problems arise from the authorities’ omissions and failure to understand the needs of entrepreneurs and to establish control over the market. But this state of affairs reveals the government’s priorities.

“In the mid-90s it became clear that large businesses had bypassed us. And then there was a chance to stake on our own medium-size businesses, to simplify procedures for non-residential properties… We could have had hundreds of new cafes and shops now, small hotels, and then the government would not have had to complain about a shortage of hotel rooms,” says Vyacheslav Semenenko.

The deputy chairman of the Guild of Managers and Developers, Nikolai Vecher, notes that the border areas between Leningrad Region and the city where human and transport flows are provided by the city could be of special commercial interest, while the regional government offers favorable conditions for business growth.

“In general, there are fewer investors in the region, and that is why the local government is much more favorably disposed towards them,” Vecher says. He admits, however, that most properties are still being developed in the region by investors for their own use and not as commercial projects.

Another important issue, in Nikolai Vecher’s opinion, is the relocation of industrial enterprises from the city center: “The city is torn in two. It is trying to evict industrial facilities, for example, from the area between Obvodnoi Canal and Blagodatnaya Street. Companies are moving, chiefly to the countryside, vacating plots in the city center.”

Mikhail Zeldin, head of Avers Group, is certain that if that plan works – either at the expense of the city budget or external investors – sites in the countryside adjacent to the city will be in high demand. Such projects require close interaction between the governments of the two regions and an ability by investors to adapt to the rules of the game set by each party.

At the same time, the situation in the region should not be overestimated either. Some of the companies active on the local market believe that although the conditions in the city are extremely commercialized they are more convenient. While in the region, for example, the government enjoys a preferential right to purchase plots that are put up for sale.

In previous years, municipalities rarely exercised that right, but these days they’ve become very active in purchasing plots. But, as the law sets no deadlines for such purchases, the sites remain frozen. “The rules are such that often roundabout schemes have to be applied,” Nikolai Vecher notes. In this case, too, developers speak of a gap between declarations and the true state of affairs in the districts.

Resume

Competition has forced governments in both regions to improve regulations and take their neighbors’ interests into account. Regional authorities are actively developing the tourist sector in the hope that, among other things, St. Petersburg residents will visit countryside resorts instead of those abroad.

When coming to terms with investors on the price of land, the city government has to bear in mind that outside the city limits they are likely to find offers that are quite compatible because the region has more vacant plots.

Much has been said of the possible merger of St. Petersburg and Leningrad Region but this is not likely to happen anytime soon, whereas plans to build a single economic space where both regions would equally benefit from their geographic position, image and royalties have rather better prospects.