Money-Growing: Smolny Launches Sale of Freeholds

Buy or Lose!

Real estate owners entitled by federal law to target-oriented acquisition of plots beneath their properties have decided to play safe. Even the companies hitherto quite satisfied with leaseholds moved to purchase their plots The law adopted by the St. Petersburg legislative assembly in late 2004, whereby the cost of developed plots of land dropped considerably, only added to the buyers’ enthusiasm. While earlier the sale price equaled 30 land-use tax rates, running as high as 7,158 rubles per 1sqm on Nevsky Prospekt, beginning 2005 the price fell to the equivalent of 9 tax rates. In the upshot, the Property Fund registered 470 deals last year.

The number of bids for acquisition skyrocketed in the weeks remaining till the year end. In November, the fund registered 62 deals, 230 freeholds were sold in December. As a result, numerous valuable properties have changed hands. For example, Metro Cash & Carry has obtained a title to two hypermarkets of the chain. The deal had cost the retail giant 47.8 million rubles (or $14 per 1sqm). Adamant acquired plots beneath its shopping centers Baltiisky, Akademichesky, Nevsky and Balkansky. The investment company Makromir secured a freehold to 1.43 hectares of land beneath the operating shopping center Frantsuzsky Bulvar (at the Leninsky Prospekt metro station), and a 7-hectare site beneath a shopping and leisure center under construction on Ispytatelei Prospekt (Pionerskaya metro station).

JSC Solomon has secured title to 10 hectares of land beneath the Grand Canyon shopping center launched in February 2008 on Engels Prospekt. Maksidom acquired a plot beneath a home goods hypermarket of the same name on Moskovsky Prospekt, at 14 million rubles ($32 per sqm). Shareholders in the city hotels Radisson SAS, Ambassador, Oktyabrskaya, Pulkovskaya, Vyborgskaya, Business Hotel Karelia, Andersen Hotel and Severnaya Korona (under construction) registered freeholds to their plots. Owners of movie theaters Mirazh Cinema and Rubezh also purchased their plots.

Ruric AB, the development firm established by Swedish investment companies to oversee their commercial property projects in Russia and St. Petersburg, has purchased freeholds beneath new class A business centers to be launched this year on Fontanka Embankment and Sredny Prospekt of Vassilyevsky Island. Plots of land occupied by Konstanta and Troitskoye Pole business center, too, have been privatized.

Sberbank, Russia’s leading savings bank, has been especially active in acquiring plots beneath 11 branches across the city. Neste St. Petersburg has bought land beneath its 16 service stations – measuring a total of 4.9 hectares at 26.5 million rubles (less than $20 per 1sqm). Freeholds to vast territories along city exit freeways where active development has long been underway passed into private ownership in 2005. OAO Tsvety purchased 468 hectares along Pulkovskoye Shosse and 104.5 ha on Kiyevskoye. The Shushary farm bought 58 ha on the site of the industrial and logistic zone of the same name.

The city budget revenues from the sale of municipally-owned land last year stood at about 2 billion rubles, the city government has reported. Thus, the cadastral valuation, without being actually applied, considerably replenished the St. Petersburg budget.

New Countdown

The cadastre value of land in St. Petersburg has been set for each of approximately 5,500 base districts, into which the city is divided. Before 2005, tax rates, and, correspondingly, sale prices varied only in 19 areas of special urban value. Land-use tax rate is based on a percentage from the cadastre value of land and differs not only from one base district to another, but also depends on the type of land-use. So far there are only three such types: agricultural use, with tax charged at 0.004% of the cadastre value, residential (0.042%) and all other types (1.5%).

“A more detailed classification was not possible as at the moment tax rates were set St. Petersburg still had no general plan for urban development adopted. As a result, a bank and a production facility situated in the same neighborhood are charged the same. Although, of course, their earnings per 1 sqm are different. Now that the general plan has already taken effect I hope that in 2007 we will be able to set the rate proceeding from the functional zoning of territories, as is the case with calculation of rental rate, charged for plots,” says Dmitry Gordo, head of the St. Petersburg real estate management directorate.

St. Petersburg’s experts performed cadastral valuation of land on the basis of federally adopted calculation procedure based on the types of sanctioned use of land and a variety of other factors ranging from proximity to key motorways to environmental situation, Gordo says. The city government had hired real estate experts from property services agencies, consulted with industrial companies and examined over 5,000 property sale deals, seeking to determine the price of land proper. As a result, the maximum cadastre value of municipally-owned land was set at 24,000 rubles per 1sqm. The most expensive sites in St. Petersburg make up approximately 174 ha, concentrated in the first zone of urban value -- in prestigious historic center of the city. Plots of land within the second zone were valued much cheaper, at 14,608 to 16,256 rubles per 1sqm.

Zones adjacent to the city center were valued at 4,300 to 7,400 rubles/sqm. 250 base districts occupied chiefly with plants and factories were valued at only 750 rubles per square meter. The city government is willing to stimulate industrial development in these areas. Lower rates were set for plots within the industry belt of St. Petersburg and in the industrial zones on the city outskirts – Predportovaya, Shushary, Metallostroi, Konnaya Lakhta and, in part, also in the Parnas District. Not everything went off smoothly, though. “Our company holds two plots with cadastre value of one being 7 times higher than that of the other. The distance between the sites is 1.2 km. None of those territories has any special characteristics. It is unclear why there is such a difference,” says Marina Zvereva, deputy chief executive at LOMO.

The situation is similar at Arsenal, one of the city’s oldest defense production facilities. “To our regret, nobody consulted us before adopting the cadastre valuation procedure. Results of calculations are questionable. The cost of plots situated within a 60-meter distance one from another differs greatly. While one of the sites was valued at 737 rubles per 1sqm the value of another was set at as much as 5,375 rubles,” says Konstantin Loginov, head of real estate at Arsenal.

Nowadays, the St. Petersburg committee for land resources and land planning is working on a more detailed valuation procedure, also in connection with numerous inquiries from production companies. The new procedure will take effect in January of 2007.

Tax Therapy

In 2006, tax rates grew by 10 to 20 percent on average, says Dmitry Gordo. The increase has been especially felt in the city center where rates grew to 30%. “But there has been no sharp increase,” Gordo says. “Besides we sought to do what entrepreneurs had long insisted on – to prevent such situations where the land-use tax for production companies by many times exceeded the size of rent. Such an imbalance resulted from the fact that until recently land-use taxation policies were determined by the federal government and municipal authorities had to play by the rules set by the center. The average land-use tax rate was imposed at the top and nobody could explain the criteria it was based on. Each year that rate was adjusted for inflation. As a result, numerous enterprises who owned freeholds had to pay much higher taxes than leaseholders. In those circumstances, production companies showed no interest in acquisition of land. Today, at last, we are moving towards the sphere of economics. As soon as regional governments were given authority to regulate prices we did so immediately.”

City officials do not conceal their intent to stimulate privatization of land through introduction of the new procedure. However, in January 2006, sales came to a standstill, price of land being uncertain. The Land Code reads that the previously set price of land shall apply till cadastre value is set. But the federal government still has not provided any explanation as to how the sale price should be calculated proceeding from the cadastre value. The law to the effect is yet to be adopted. “We have debated the issue for quite a long time, but finally the city government ruled that the sale would continue on the same terms as last year. The price equals 9 land-use tax rates, the only difference being that the price would be calculated on the basis of cadastre value. In late January a decree to the effect was issued and today there are no obstacles for privatization,” Dmitry Gordo says.

Incidentally, the federal draft law suggests that in the cities with a population exceeding 3.5 million buyers of freeholds should not be charged over 20 percent of cadastre value. Calculations performed by St. Petersburg official show that, in order to keep the price at the 2006 level it should be set at 9.5 to 12% of cadastre value. So far, Smolny (the city government) does not plan to increase it to the upper level, i.e. in fact to double the price.

Relocation of Plants

“On the whole, for LOMO, as well as for many other companies, the transition to the cadastre valuation has resulted in lower land-use taxes,” says Marina Zvereva. “While in 2004 to 2005 the tax we were charged for our plots exceeded rental payments by 5 to 7 times, today the situation is reverse– the tax is three times lower. Being a company, focused on securing the freehold to our territories, we are happy about that.” But not all industrialists are as upbeat. “It appears we have found ourselves in the area where the city government would like to develop something other than industrial production,” says Svetlana Sadovnikova, head of real estate department at Silovyye Mashiny. “The rent we pay for our site on Sverdlov Embankment now stands at 12 million rubles per year, but if we purchase the land the tax will grow to 34 million rubles.”

“There are some 40 industrial territories in St. Petersburg,” says Dmitry Gordon. “They may be divided into three groups – operating production facilities, which are to continue operations in the next 25 to 50 years; sites designated for industrial use under the town-planning program and finally territories beneath production units, which are not supposed to be there (centrally located sites, sites within residential areas, etc). Higher tax rates are intentionally set for the latter category, so as to create extra incentives for those plants and factories to move out.” The city authorities have yet another fiscal argument in store, designed to stimulate the withdrawal of production facilities from valuable sites.

By adopting cadastre valuation of land, Smolny has developed a new procedure of calculating rent, which is to be adopted as early as this year. The key objective is to adjust the size of land-use tax and rental payments so as to make the position of freehold owners more favorable than that of leaseholders. On the whole, the idea conforms to the fair economic principle whereby the rent must always exceed the size of land-use tax. But with the cadastre valuation already introduced, bringing about a 10 to 20 percent increase in tax rates, an increase in rental rates is inevitable. First and foremost, the rise will hit industrial enterprises, for most of which leaseholds were less costly until recently. Besides, the city government plans to introduce higher rental rates for certain categories of leaseholders. For example, production units subject to withdrawal from the city center will be charged thrice as high.

The plan to evict production facilities from central St. Petersburg is hardly new. But so far only a handful of operating enterprises have been moved to new sites (Severnoye Siyaniye, First Furniture Factory, Vibrator, etc.) The problem lies not only in the companies’ reluctance to leave. “The policy aimed at encouraging enterprises to move to industrial zones is, of course, correct. But one has to understand that industrial complexes have been formed and quite often relocation of part of workshops from an economically convenient location at the embankment is likely to disrupt business operations. Until those costly assets exhaust their resources, for many companies relocation of their production units spells death,” Sergei Dmitriyev, general director at the company Perspektiva is convinced.

“LOMO is ready to abandon some of their leasehold sites. But is there any mechanism governing the procedure of returning that land to the city? Moreover, it is really difficult to do that given interconnected engineering networks, the single energy system in place, etc. We are ready to move to developing industrial zones, but where are the territories prepared for our arrival?” says Marina Zvereva. “The city is clearly seeking to encourage us to purchase and develop industrial territories. But we would rather that the interests of companies that shape urban areas also be taken into account.”

Igor Gorsky, development director at Becar Realty shares LOMO’s concerns as regards the lack of suitable alternative sites for relocation. “I have been working with four companies who have been bombarding the city administration with requests to allocate sites for them on the outskirts. But to no avail. The city openly names plants subject to withdrawal, as if offering developers to launch an offensive against them. The rest is for the production companies to decide. They can leave if they want to, or stay and pay high taxes and rents. Although, honestly speaking, not all production companies exercise a constructive approach. Directors of some companies are more interested in renting out space for nothing, pending their retirement, without paying any taxes. They squeeze out all the juices out of their companies and leave. Land-use charges are the only means of pressure on those executives.”

Becar, in its capacity of a real estate agency charged with territorial development has been specializing in Vyborgskaya Embankment since 2001. Over those years the cost of land in the area grew from $30 to $200 per 1sqm, and on some sites as high as $600. The zone houses 18 enterprises (Krasnaya Nit, Karl Marx Plant, Kompressor and others). All those companies agree that restructuring is necessary. A recent example: the Komsomolskaya Pravda plant has vacated eight workshops after new equipment had been purchased in Italy. “If the companies do not develop they, being non-competitive, will be swallowed up,” Igor Gorsky warns. “Developers are on the alert, as territories occupied by production facilities are, indeed, resplendent. A factory worker does not need a view of the Aurora Cruiser from his workshop. Buildings facing the street will bring much higher revenues to the company if they are sold or rented.”