Money-Growing: A Small Plant for a Foreigner

Production companies, on their part, face serious difficulties when looking for suitable building plots and registering title to them and problems arising at certain stages of construction. Foreigners complain about hard reality of Russia and intricate legislation. To bring their projects to completion many are forced to negotiate numerous legal and economic barriers.

Industrial development is rarely discussed in the media. Meanwhile, property consultants establish departments specializing not only in warehouses but also in production facilities. Viktor Afanasenko, deputy head of warehouse and industrial real estate at Knight Frank, says that industrial production in Russia has high potential. That sector will continue to develop at the expense of foreign investments, as workforce in Russia is much cheaper that in the West, he says. General director of the NZ1 Estate company, Yulia Nikitina, believes that as foreign investors’ interest in Russia as a large market is growing manufacturers are offered an incentive to develop industrial properties in this country.

Industrial property is the sector where gathering statistical data is especially difficult, holds Afanasenko. The sector lacks transparency and is largely ignored by the media; development projects are implemented without support from brokers or consultants. Owners of international brands usually negotiate their projects directly with local administrations and raise their properties in line with long accepted standards, tested in other countries.

Market Dynamics

At the outset of the 1990s foreign investments poured into various manufacturing projects. International experience shows that the development of production facilities makes sense in the areas where the commodity is sold. Such policy helps cut down transportation costs; besides, companies who have established their presence on local markets are able to respond promptly to the changing economic environment.

In the 1990s production facilities in Russia were launched by foreign companies, who earlier successfully operated in Europe and the U.S. World’s leading brands arrived in Russia during the first wave. For example, the Coca-Cola company, which has already launched 11 production facilities in Moscow, St. Petersburg, Samara, Volgograd, Krasnoyarsk, Novosibirsk, Vladivostok, Nizhny Novgorod, Oryol and Yekaterinburg (the total investment is estimated at $1 billion). Other companies have followed the example.

Bovis Lend Lease observes that the development of foreign production facilities in Russia covering the period since the 1990s up to the present may be divided into several stages. In line with the laws of the market the first to establish a foothold on any territory are the manufacturers of fast moving consumer goods, and only years later a place for luxury items producers appears in that sector. In the years 1994 to 2004 Russia saw the arrival of food and beverages producers. In Moscow Region, the company Mars launched a chocolate factory. The bakery Unilever opened a production facility in St. Petersburg. Cadbury Schweppes, a major international confectionery and beverages company, launched production of canned soft drinks in Veliky Novgorod.

Nestle opened production facilities in several regions across the country. World’s renowned brands Pepsi, Danone, Campina, Van Melle, Wrigley and Stimorol also established their presence in Russia.

Business development manager for Russia & CIS at Bovis Lend Lease, Konstantin Anashkin, says the first wave arrivals were the so-called FMCG companies; toothpaste and perfume giants P&G, Reckitt Benckiser and Gillette launched their production units in Novomoskovsk, Moscow Region and St Petersburg respectively in 1994 – 1998. Pet food manufacturers arrived in the late 1990s. The early 2000s were marked by emergence of construction materials and home appliances production facilities.

The second wave brought producers of gypsum cardboard and insulation materials; in the period of 2001 through 2006, Knauf launched facilities for production of building materials, first in Moscow Region, later on in St. Petersburg and Stupino. Beginning 2001 Russia witnessed arrivals of paints manufacturers Akzo Nobel and Tikkurila (Moscow Region). Construction materials manufacturers Saint-Gobain, Glaverbel and Pilkington launched their production units in 2002 to 2006. Facilities for manufacturing of aluminum panels were opened by Rehau and Veka. In the years 2003 to 2006 wooden panels producers Pfleiderer, Kronoshpan and Egger arrived. The same period saw the emergence of home appliances production units by Grundfoss, VTS Clima, Danfoss, Merloni Termosanitary and Electrolux. Tobacco companies BAT, Philip Morris, JTI launched production in Russia in 2004 to 2006; the packaging sector represented by leading packaging suppliers Tetra Pak, Van Leer, Huhtamaki is also on the rise.

The year 2006 marked the beginning of rapid development of home appliances and automotive manufacturing. Of late, home appliances manufacturing facilities were launched by Veko in St. Petersburg, LG Electronics (Moscow Region) and Bosch Siemens (St. Petersburg). In 2002 to 2006 car assembly lines were launched by General Motors in Tolyatti, BMW in Kaliningrad, Ford in St. Petersburg, Renault (Moscow), Toyota, GM and Nissan in St. Petersburg. Global car tyre producers present in Russia are Continental, Michelin and Nokian.

Major producers seek to secure a foothold in the vicinity of big cities. Understandably, many of them are operating in Leningrad Region and Moscow Region.

One of the first international producers to launch a manufacturing facility in the Moscow Region was the leading maker of chocolate Nestle, Knight Frank reports. That happened in 1996, in Ramensky District. From then on, in the years from 1996 to 2006 the region saw the launch of over 10 major production facilities. Several major projects are currently under construction. For example, in 1999 British packaging company Rexam opened a production unit in Naro-Fominsk; the project is worth $145 million.

Dutch dairy foods company Campina arrived in 2000 ($50 million). In 2002, a production facility worth $40 million by Dutch foods company Nutricia was launched. Saint-Gobain’s construction materials production unit opened in 2003 ($104 million). International companies Knauf, with a project estimated to be worth $26 million, Hochland ($40 million) and Avon ($40 million) built their production units in 2004. Those companies produce construction materials, dairy foods and cosmetics, respectively. Pilkington Glass arrived in 2005. This year Oriflame, LG and Tetra Pak began construction of their facilities, estimated to be worth $45 million, $150 million and $130 million respectively.

In 2006 Russia’s industrial sector was structured as follows (source: NZ1 Estate): energy and fuel production accounted for 30.5%, ferrous and non-ferrous metallurgy – 7.21%, chemical and petrochemical industry 5.5%, machine-building and metals processing 19.9%, defense industry 5.76%, timber industry 4.2%, construction materials 3.1%, light industry 1.4%, food industry 14.1%, other branches account for 4.1%.

Building From Scratch is Safer

Foreign producers have always preferred acquisition of existing installations, with a view to redevelop them and then launch production on their premises. Harald Purainer, chief executive at the Russian unit of the international office furniture and decorations maker Schattdecor, says that the company has already opened manufacturing facilities in Shatura and Penza. The workshops operate in refurbished buildings acquired by Schattdecor from previous owners.

After the company failed to find a suitable property to house what would become its third production facility in Russia, the manufacturer decided to secure a freehold in Chekhov, the Moscow Region, and build the third factory from scratch. “But a property built from scratch is rather an exception than a rule for us,” Purainer admits.

But as the region is running out of Soviet-built installations suitable for redevelopment, manufacturing companies are forced to undertake construction projects increasingly often, Russian experts report. Konstantin Anashkin notes that there have been practically no plots of land with buildings meeting all requirements left.

In the early 1990s many Russian production enterprises went broke and their properties were easy to buy, for example, through buying stakes in them, and to rebuild. Today, the word combination “construction from scratch” is more often heard on the market. Although, seeking to minimize costs investors prefer redevelopment to new construction. An alternative is the acquisition of an operating business. But, in the opinion of Yulia Nikitina, such deals are rare as foreigners are warded off by lack of transparency in many post-Soviet enterprises.

Vladimir Kravtsov, public relations expert at Coca-Cola, says that the company focuses on new construction but does not rule out redevelopment, which is the case for example in Coca-Cola’s project in Samara.

Cosmetics concern Oriflame opts for building production units from scratch in accordance with the established standards, taking into account the specifics of manufacturing itself. “The company opted for development of new properties on Novorizhskoye Shosse [highway] in the Moscow Region, as no buildings suitable for redevelopment were available,” Sergei Kanashin, deputy general director at Oriflame Russia, has reported. “The requirements for such production facilities as ours are high. The building must have special properties in terms of water treatment and air cleansing. That is why cosmetics producers prefer to build their production units on their own. Much depends on quality standards adopted for production facilities. Although, on the face of it, the country abounds in old industrial developments, but suitable properties are unavailable.”

Viktor Afanasenko says that foreigners either rent or buy industrial properties. Leased properties usually house small-sized low-end production facilities (assembly of prefabricated parts, for example). Major producers who make up 80 to 90% of all operators opt for construction of buildings for own use. Leaseholds are seen as quite risky and not always economically viable, especially where major industrial high-end productions are concerned.

In case of a conflict with the landlord, which may occur for example if he moves to push up the rental rates – the tenant may face difficulties in relocating production facilities. The cost of relocation and losses resulting from suspension of operations are quite high. As an acceptable alternative producers may consider long-term leases. There are cases where manufacturers enter into a long-term lease agreement with a view to secure a freehold to the property in the plot of land beneath afterwards.

Overcoming Barriers

What attracts foreign plants and factories in Russia, among other things, is the fact that many regions really look forward to their arrival. Suffice it to download an official website of any Russian province – all of them proudly announce the launch of new production facilities by international companies in the area. “Major producers usually receive a go-ahead for their projects from district officials, most of which help foreign entrepreneurs in registering titles to building plots,” Afanasenko says. “The benefit is mutual. Districts or regions receive new jobs and extra tax revenues; foreigners’ presence improves their image, especially where leading international brands are involved. Producers get tax benefits, leniency on the part of controlling authorities and permissions for construction are issued faster.”

That is how the things are on the whole. But manufacturers, on their part, admit that at times they have to tackle problems, faced by all companies who have to deal with land and industrial real estate. The construction of Schattdecor’s production facility near Cheekhov will be completed in a year and observers expect the project to succeed, but Harald Purainer says the main problem he is now trying to solve is to connect electricity to the property. “When you meet Russian officials in Europe they actively welcome [foreigners] to build on Russian soil. But when it comes to real work they, for some reason, refuse to connect the building to communication lines,” he complains.

It is no secret that working in Russia has always been harder for foreigners than for local businessmen. The proof of that are numerous examples of complicated and failed projects (suffice it to recall Prologis’ move to abandon its plans to build warehouses in Moscow countryside) discussed by market operators themselves at seminars and conferences. Harold Purainer reports that 90% of developers begin building works before obtaining a full set of permissions from government bodies. But the developer’s failure to produce some document does not always end in the official ban on construction. As a rule, the government orders suspension of building for a couple of months during which the developer is obliged to obtain lacking papers, says Yekaterina Gudina, lawyer at Pepeliaev, Goltsblat & Partners.

Quite often properties are raised before the developer acquires all necessary permissions, which are obtained in the course of construction. If this is the case, the company should always be ready for officials to call on the site and try to use the situation to own benefit. Konstantin Anashkin says that almost all developers and investors take the risk and launch construction before obtaining all necessary papers from controlling agencies. If Russia had a different legal procedure for obtaining permissions from government agencies the laws would be observed, he is convinced. But each stage of the process takes several months, while investors cannot afford to wait that long. “Nevertheless, each operator seeks to ensure top quality of his product, that is why the lack of some licenses from controlling bodies does not necessarily mean the product in question is of poor quality,” Anashkin says.

The process of project negotiation in Russia is far more time-consuming than in other countries, especially during the stage of design and approval of the architectural project. Strictly speaking the government’s main task is to ensure observance of environmental, fire safety and labor regulations during construction. The rest is the developer’s business. In European countries, for example, it is the designer who is responsible for the architectural project. But he enjoys real legal protection. Russia, on its part, is yet to introduce insurance for building designers. That is why, for the time being it is the government’s task to exercise control over design stages.

A seminar on the problems faced by companies establishing production facilities in Russia, hosted in early October by Pepeliaev, Goltsblat & Partners and the American Chamber of Commerce and Industry in Russia, examined several international projects, which encountered grave problems at various stages. One of those cases, which will go down in history of the Russian market, is the litigation involving Coca-Cola’s buildings in Samara. Military prosecutors had asked the court to return to the state the Soviet-built property, which houses soft drink manufacturing production. The prosecutor’s office urged the court to invalidate the sale of the building that previously housed a ball bearing plant. The claim was filed after the new owner pulled down an air-raid shelter, situated on the territory of the former plant. The military said their claim was based on the government’s decree “On delimitation of state property in the Russian Federation” and the presidential privatization plan adopted on Dec. 24, 1993.

Coca-Cola’s example shows what kind of problems may arise at the stage of the deal, says Vitaly Mozharovsky, partner with Pepeliaev, Goltsblat & Partners. What made things even more complicated is that the Russian law bans the sale of civil defense installations. A spokesperson for Coca-Cola has reported that the hearing into the case continues; the Defense Ministry, indeed, has complaints against the Samara project and so far no ruling has been passed on the issue. In the meantime, the soft drinks production unit has already begun operations.

Quite indicative is the widely-covered case of Oriflame, who decided to build a production unit on a 13-ha plot of land on Novorizhskoye Shosse. The company had no problems with securing the site and registering title, Sergei Kanashin said. “Problems began after the plan became known to the public. At first residents of local communities voiced protests; but such complaints are quite frequent when construction of manufacturing facilities in the Moscow Region is planned.” The company managed to prove that production would be environmentally friendly its only waste being purified water. Building works continued. The complex is to be completed by late 2006, according to Oriflame. For the time being the company does not plan any other manufacturing facilities in Russia.

Viktor Afanasenko says the costliest stage of the industrial project is construction of the building. The second most complicated stage is the development of infrastructure and adjacent territory. Industrial installations need to have a good location, with good transport accessibility and, preferably, not very far from the city. Engineering systems play quite an important role in the project. Another factor of success is the workforce. “I remember a case where two units for production of thermal insulation were built in one countryside community,” Afanasenko says. “In addition to the problem of finding tea-total workers among local residents, both enterprises faced the problem of high workforce turnover as workers would move from one production to another seeking higher wages. As a result the companies were forced to increase wages constantly.”

Land-use Realities

Each industrial project begins with the search for a suitable plot and its preparation for building works. The developer registers a title to the plot, has it reclassified for industrial use, etc. Main problems for foreign producers usually arise namely during those early stages. A well-known example of a complicated project is the construction of four production units on a territory of 50 ha launched by Korean company LG in Ruza District of the Moscow Region. A year ago Rosprirodnadzor (the Surveillance Agency of Management of Natural Resources), led by [its deputy chairman] Oleg Mitvol raided the site and established that building works had been launched before the project was sanctioned by environmental authorities.

Experts close to the project said Rosprirodnadzor could have never paid attention to the project if LG’s plans had not angered a state official whose countryside dacha was situated in the vicinity. In the long run, LG received the approval and resumed construction works on the site. Experts warn that it is better to examine all possible pitfalls in advance. For example, land-use lawyers are convinced that problems arising in the earliest stages may damage the entire project. Enormous properties stand idle and projects never leave the drawing board only because they are not suitable for development.

When registering a right to the plot a lot depends on the legal status of land – whether it is government-owned or private, arable or industrial, acquired at a tender or under a conventional sale deal, built-up or free of any developments, how many owners it has, Vitaly Mozharovsky says. Undeveloped plots are ecologically clean, free of any encumbrances, and, most importantly, the developer is free to build exactly what he needs and does not have to adjust his plan to existing structures. Disadvantages are additional construction of communication lines, reclassification of land, and debts. Built-up plots enjoy access to communication lines and are already reclassified as commercial land. But on the other hand, quite often communication lines are worn-out, plots are polluted, obsolete structures need to be dismantled, the plot is heavily encumbered.

If the investor or developer launches a legal audit of the plot of land they are to pay special attention to several issues so as to avoid problems in the future. It is highly recommended to track the history of ownership, check the category of land and look into restrictions in effect on the plot. For example, the plot may be subject to environmental or sanitary restrictions, fall under government program for historical monuments protection or a special regime given its proximity to the state border. The developer should be aware of all encumbrances in place and determine whether the plot may be used as a site for a construction project or not (in line with the plan for prospective development of territories). It has to be remembered that local laws governing leaseholds to plots of land in Russia may vary from region to region.

New Russian Foreigner

Local operators note that a stratum of successful foreign developers of industrial facilities has already been formed in Russia. Those are foreign companies who have already accrued experience of working in Russia, says Konstantin Anashkin. “When they first arrive in Russia they still harbor certain illusions,” Anashkin says. “International companies, of course, have rich expertise in launching production across the globe. As they head to Russia they, perhaps, think that it is just another country where they will replicate schemes already operating in other parts of the world. They view this country as cheap, with plenty of gas and electricity. In practice, everything proves to be more expensive, and they do not always receive a warm welcome from the government at once. Having examined all that they learn to play by the local rules.”

Vitaly Mozharovsky agrees. Russia has seen the arrival of players truly versed in specifics of Russian mentality, which enables them to succeed in establishing relations with other operators and government officials, he says.

The seminar hosted in early October by Pepeliaev, Goltsblat & Partners and the American Chamber of Commerce and Industry in Russia, was attended by many international operators. Glass industry giant and leading producer of mineral wool insulation, French company Saint-Gobain launched operations in Russia in 1995. The company sells construction materials and builds production workshops on its own. One of the company’s production plants is operating in Yegorievsk. Francois Cariet, chief finance officer at Saint-Gobain, says the most difficult part of any project is finding a reliable partner. Sergei Kanashin agrees. But both companies succeeded in developing their projects in Russia.

Another company, glass producer Guardian Industries Europe, has been working in Russia for several years now. One of its plants is currently under construction in Ryazan. Legal counsel for Guardian Industries Europe, Vincent Pringiers, is a frequent guest at business seminars where he shares his experience of development in Russia. “First and foremost, you need to establish contacts with all people in town who may be useful to you,” he reiterates.