Market Know-How: Lands and Factories to the Builders

In the near future that act is to be updated, or, rather replaced with a new program, covering the period till 2030. It is expected that one of the novelties will be a decrease in number of industrial territories. As a result, more sites for housing and commercial construction will be vacated in the city that suffers an acute shortage of building plots.

Of course, developers undertake projects to reorganize industrial estates simply because they see no alternative, however on the whole such projects are seen as quite rewarding. The projects envisaging redevelopment of residential areas occupied with rundown apartment blocks that are not subject for dismantling are even less appealing. Therefore, the government has moved to offer developers who are ready to undertake redevelopment of such residential areas a bonus in the form of the right to adjoining industrial lands.

Planned Adjustment

Rapid urban development forces the authorities to adjust the tenets of the general plan to the changing situation. The program itself undergoes changes as time goes. For example, Soviet-era urban development plans took almost everything in consideration and each new development required approval at the very top. Today, the general plan is based on different principles. It contains no orders, only recommendations.

The key point of the program is the three schemes of zoning of territories. Functional zoning designates permitted uses of land and sets the rules of placement of residential spaces, greenery, production facilities and common use areas. Landscape zoning reflects correlation of built-up spaces, green areas and pavements within each given area. Finally, construction zoning sets restrictions as to height and density of buildings.

The city is divided into 1,800 units, with zoning parameters set for each of them. Each developer has a free hand as long as he does not go beyond those parameters. For example, sites vacated after Soviet-built five-storied apartment houses are pulled down may be used for developments of varying sizes. For example, it may be possible to increase the floor area or the number of stories.

As a rule, investors insist on increasing volumes of construction. The city hall usually heeds their requests by amending town-planning regulations. Thus, decisions are taken authorizing more dense built-up or construction in the areas, earlier designated for greenery.

The Central Administrative District of Moscow, experts at Moscow’s research institute for the general plan of the city’s development (NIiPI Genplana) admit, has long reached the targets set in the city hall’s plan for development of apartments and offices. At the same time the city center is far behind the schedule set for construction of infrastructure facilities and refurbishment projects.

The “outdated” version of the general plan provided for annual increase in volumes of construction of housing space alone by 3 to 3.5 million square meters. These days, the housing stock grows by 5 million square meters annually. The question where new homes are to be raised will soon become rhetorical. Homes need road access, power capacity and public amenities, i.e. parking areas, shops, kindergartens, schools, hospitals, etc. Industrial estates are one of the last territorial reserves the capital has, the city hall’s construction department admits.

The Last Reserve

“Moscow has 84 industrial zones, 30 of which are currently being looked into,” Konstantin Korolevsky, first deputy head of the department for town-planning and urban development, says. “In some of them the survey of territories has already been completed and town-planning documents are currently being drawn up. By late 2006 those documents are to be adopted for 15 industrial zones and work is to begin on 15 more projects, which are to be prepared in 2007. As a result, in the years 2006 and 2007 alone sites for development of over 2.5 million square meters of housing will be vacated.”

By 2008, Korolevsky says, the plans for redevelopment will have been adopted for at least 44 industrial estates, which is more than half of all production areas in the city.

“New construction projects on the sites of reorganized industrial zones is a normal pattern of development of all world capitals who are past the stage of industrial development, such as London, Paris, and, finally, of Moscow,” says Alexander Krutov, deputy head of valuation and consulting department at Colliers International. “Other large Russian cities such as Novosibirsk and Krasnoyask, too, have entered that stage these days.”

Preserving industrial facilities in the city center is fraught with losses given the high cost of land. “Historically, Moscow has a high concentration of production facilities namely in the center or in the areas suitable for housing and commercial property development. For example, many business centers around Paveletskaya [metro station], including Aurora Business Park, which houses Colliers International offices, are built on the sites formerly occupied by industrial facilities. Other examples are Akvamarin II (by Stroiinkom-K) on Ozerkovskaya Embankment; on Kozhevnicheskaya Street the development company Vedis Development is raising an office and hotel complex on the site of the Moscow fittings plant; a large number of production facilities on Yauzskaya Embankment are waiting for their time to come. There are plenty of other examples of such reorganization,” the analyst concludes.

“Moscow is catastrophically short of free building plots, while the shortage of residential estates and commercial properties is still acute,” Roman Sokov, head of consulting at Becar. Commercial Property concludes. “On the other hand, the capital still has a large number of industrial zones and obsolete enterprises many of which are deep in the red. All of them are situated mainly in the central belt of the city, between the Garden Ring and Third Ring Road. It is evident that such use of municipal lands is ineffective, considering the existing demand for residential, office, retail and warehouse properties. Many of the enterprises operating in the city were built using outdated know-how. Today they may be redeveloped to save space, lower noise, etc.”

“The main reason why developers take up redevelopment of industrial zones is the lack of appropriate construction sites,” Sergei Voronin, head of finance and investment at Forum Properties, agrees. “A large number of enterprises, including those operating within the historic center of the city make low profits, which, compared to profits from development projects, makes it unreasonable to preserve those businesses. The situation cannot be remedied even through benefits granted by the Moscow city hall to such enterprises, the most important of those being low rent for their plots. Their withdrawal to the outskirts or even full closure ensures higher returns for investors and increases tax revenues to the city budget. Unfortunately, the city government is slow in approving investment contracts involving relocation and reorganization of production facilities.”

“The city hall keeps an eye on developers involved in reorganization of industrial territories and sets terms and conditions of reorganization,” Korolevsky emphasizes. “Importantly, Moscow is to preserve its production potential. Admittedly, as new technologies are being phased in enterprises themselves downsize their facilities no longer need enormous territories.”

“Moscow has a great number of undeveloped sites, tens of thousands of hectares of land are currently occupied by industrial zones. All vacant sites have already been allotted, today the city government is involved in complicated work with owners of production facilities and the rapid process of withdrawal of production zones is underway,” says Daromir Obukhanich, general director at First Mortgage Company (PIK).

Addressing the September session of the Moscow government where, among other issues, measures to ensure effective use of industrial zones were discussed, Viktor Damurchiyev, head of land resources department, said that Moscow production facilities are concentrated chiefly in southern and eastern parts of the capital.

Moscow’s NIiPI Genplana institute is working on the inventory of industrial territories. Galina Mits, expert at NIiPI Genplana, has reported that each district of Moscow requires special approach. For example, the city hall has ruled against burdening the city center (CAO) with production facilities, whereas in the Southeast Okrug their number is likely to grow. The plan is not only to preserve existing faculties operating there today but also to reserve territories for plants and factories, which are to be withdrawn from other parts of Moscow.

According to Damurchiyev, 32 enterprises have been successfully relocated from the territory in Central Administrative Okrug where the development of Moskva City is currently underway. The authorities, it appears, have agreed that industrial facilities will retain only 7,000 to 7,500 ha of the total area of 20,000 ha of industrial territories. Earlier the general plan provided for reduction of industrial zones to 15,000 ha. But, Korolevsky says, even those figures are likely to be revised: “I am certain that by 2020 industrial territories in the city will be reduced to 11,000 – 12,000 ha.”

The volumes of new construction on the sites of former industrial estates, on the contrary, grow each year. “For example, in 2005 new construction amounted to 614,000sqm, the target for 2006 is 800,000sqm and this target will be reached; the projected volume for 2007 is 900,000. It also has to be remembered that those projects include commercial facilities, as well as garages,” he adds.

Everything Slated for Redevelopment

Not long ago Moscow city hall reached an agreement with the state-run Russian Railways Company (RZhD) on joint cooperation to reorganize the ineffectively used territories reserved for operation of federal railway transport network. 14 out of 30 projects currently examined by the government envisage – with approval from RZhD – elaboration of a thorough plan to overhaul the railway network, rail yards and adjacent territories.

Currently, the agencies involved discuss priority projects for development of the Moscow railway network and surrounding territories. For example, in the industrial zone No. 1 Paveletskaya alone it will be possible to develop 400,000sqm of housing, once the rail yards of Paveletskaya Tovarnaya station, measuring 50 hectares, undergo reorganization. Work on preparation of pre-project documentation is also underway on the section of Oktyabrskaya Railway, a section between Novaya Basmannaya Street and Syromyatnicheskaya Embankment; rail yards of Belorussky and Rizhsky train stations and Tsaritsyno station are also slated for reorganization.

Another project that has good prospects is aimed at merging industrial territories, which are being reorganized, with neighboring residential areas built-up with blocks that are not subject for dismantling and are designated for reconstruction, in order to provide developers with larger building sites and thus enabling them to cut costs, for example, by building underground parking facilities on former industrial territories.

“Builders are increasingly interested in industrial zones,” Korolevsky says. “Renovation of residential areas built up with houses which cannot be pulled down proceeds slower than expected. That is why the decision was adopted to work out new plans envisaging unification of industrial zones slated for reorganization with neighboring residential areas undergoing renovation.”

On Sept. 20, a special agency in charge of coordination of public infrastructure development was established by the town-planning policy department to oversee those efforts. The chairman of the new body is Igor Timoshkov, former first deputy to Vladimir Khaikin, head of the state-run company GUP Upravleniye Perskpektivnykh Zastroyek (Prospective Construction Mangement).

“The territory occupied by a residential area designated for reconstruction is squeezed in between other built-up areas and streets,” Vladimir Khaikin sais. “To achieve the volume targets set by housing property investors, huge efforts are required. Something has to be pulled down, residents are to be provided with new apartments, etc. Investors are not very interested in such projects. But if the given residential area is merged with a neighboring industrial zone, all sides will benefit from the arrangement, including investors, the city government and industrial estates themselves.” Khaikin says that nowadays about 80 such projects are being worked up.

Criteria of Choice

“A developer who has an alternative will not take up projects on the site of industrial territories,” says Oksana Basova, spokesperson for the corporation SKholding. “Only large companies with huge funds can afford such programs.” SKholding, she adds, once considered an opportunity to launch a project on the site of the Bogorodskoye industrial zone but was forced to give up the idea as economically unviable.

Pavel Barbashev, marketing director at Horus Capital, believes that development of industrial territories is a normal business for a large city. “What is to be built on the site formerly occupied by a plant or a factor is for the owner to decide, unless, of course, the general plan explicitly states what is to be situated on that site,” Krutov says. “Of course, marketing surveys are conducted to determine which projects should better be launched there, homes, offices, a shopping center, or something else.”

“When taking a decision on the development of a site our company proceeds chiefly from location,” Barbashev says. “Office projects require proximity to transport routes and metro stations. Then, special technical characteristics are taken into account and environmental issues, as well as solutions to those. Special attention is being paid to legality of acquisition, the state of the property and the plot beneath it.”

“Arguments in favor of acquisition of the plot are successful location (proximity to the city center or to existing business districts and prime residential areas, transport accessibility and proximity to a metro station), the size of the plot (smaller spots are less interesting), legality of title (transparent ownership and sale deal), lack of tough restrictions as regards to development,” Voronin says. The site is of less value if it is heavily polluted, has complicated geology, poor access to utilities or installations operated by the ministry for civil defense and emergency situations, he adds.

One of the chief advantages of former industrial estates is their size. “Industrial zones, even those situated within the Third Ring Road, let alone areas along MKAD (Moscow outer ring road), are, as a rule, vast territories suitable for development,” Barbashev says. “While “conventional” sites available for development measure not more than 0.2 to 1 ha, industrial estates may take up 2 to 5 ha.”

A larger building site offers more opportunities. In addition to construction of real properties the developer is free to designate space for greenery, create some additional amenities, save costs on the development of parking areas by building an open-air parking area instead of costly underground facilities.

When mulling plans to launch a project a former industrial estate the developer should determine the optimal and most effective use of the plot and carry out an architectural and town-planning analysis of the site.

“While the former task should better be delegated to well-known brokers and consultants the latter is usually taken care of by professional architectural agencies, NIiPI Genplana or leading architectural workshops,” Voronin says. “The final decision should be made on the basis of calculation of economic effectiveness of various building projects.”

“Where an industrial zone is only partially being withdrawn beyond the city limits and some of the production facilities remain on the site, housing construction is banned there,” Sokov says. “For example, not long ago our company completed the survey of a plot of land on Zolotorozhskaya Street (not far from the Serp I Molot plant, where downsizing of production is planned). Production facilities will be preserved partially in immediate proximity to the plot, which makes housing construction impossible there. A shopping complex on the site would not pay back as the area has practically no human flow. So, we recommended the owner to build a class B office center there.”

As a rule professional developers rarely encounter serious difficulties during development of industrial territories. The gravest problems they are likely to face are toxic waste pollution, residential blocks operating on the site and civil defense installations, Voronin says. If, he continues, under an investment agreement an investor undertakes to move production facilities to a new location he is likely face difficulties with finding a new site for the plant or factory. Municipally-owned properties in place, too, may cause delays in registration of the developer’s title to the newly built project.

Reorganization Costs

“Developers involved in reorganization of industrial zones face two options, either to buy into companies who operate the sites in question (that is what Horus Capital does) or resort to assistance of intermediaries who restructure those companies,” Barbashev says. “In latter case one cannot be absolutely certain of legality of previous deals. The former option is not much more profitable but is more time-consuming and requires more efforts. Its undoubted advantage is that the developer keeps full control over the entire process from the very start.”

Given the uniqueness of each industrial site it is difficult for make any forecasts as regards the costs of its reorganization, most developers admit. “If the existing production facility has to be moved to another location within MKAD (the city limits) the cost may exceed $20 million per 1 ha. Each developer has his internal rate of return enabling him to join the project. The 15 percent rate of return on the project is considered acceptable, as it ensures a payback in 5 to 6 years,” Voronin says.

“It is quite difficult to determine the prime cost of construction on the site of some obsolete plant at once,” Barbashev says. “For example, bad floors will not be detected before the work begins. Usually developers are prepared for a 5 to 10 percent increase in costs. The average rate or return on Horus Capital’s projects is 23 to 25% per year, i.e. our projects even those that are not centrally located pay back in four years.”

“Industrial territories are more than just one of the last reserves of building plots. They are the hardest to develop,” Kirill Savitsky, deputy general director at Vash Finansovy Popechitel, admits. “Huge funds are spent on relocation of production units, restoration of land, obtaining all sorts of permissions from the government agencies, etc. On average, a project may take at least 5 years to be fulfilled and requires huge spending in the beginning – to purchase the city government’s share in the production facility, securing a new site to house the relocated production unit, moving equipment to a new address, addressing social issues, etc. Those costs may run as high as $6 to $7 million per 1 ha of land. But at the same time industrial zones have one undisputable advantage – they have access to engineering lines. The rate of return on redevelopment projects may amount to 20 percent.”

The Don-Stroi company believes such sites to be attractive as they offer room for development of large mixed-use projects within the boundaries of the city, which suffers an acute shortage of free spaces. “As to the difficulties that may arise during development, today in Moscow there are virtually no sites free of any encumbrances whatsoever,” a spokesperson for Don-Stroi explains.