Market Know-how: The Chief Conductor

Vladimir Boguslavsky, the general director of Tandem Group, is convinced that the general contractor plays a key role in the construction business. Now the functions of general contractors have considerably widened, he says, for example, they also carry out technical duties. "Many customers want to construct something, even without having all the documentation. And I, as the manager, carry out the construction: I decide, with what to dig, how to dig, and who to dig," he summarizes. According to market participants, in practice the desire of the customer almost in 100% of cases varies during the course of construction, and additional charges may increase the final cost by 50%. Quite often the customer does not even own the land on which he wants to build, and has only a verbal agreement with the local administration. Everything else is a headache of the general contractor.

In most cases general contractors employ contractors. For some specialized work experts are required, Maxim Temnikov, a member of the board of directors of Mirax Group explains.

Almost 100 % general contractors don't have their own capacities. There are no special requirements for general contractors. They are in a literal sense a paper company. But the main contractor hired must meet certain requirements. For example, to have the equipment necessary for carrying out the construction work.

According to Alexander Ortenberg, general director of strata in Russia, general contractors must produce a high quality manufactured end product - buildings, solving all organizational questions, the coordination of documentation, etc. "The keyword here responsibility," emphasizes Ortenberg.

There are two models of development of this business, says Yaroslav Kozlov, director of development at Benefit Engineering. "Under the first model general contractors are engaged in everything, except for the financing of the premises. They are irreplaceable in this model. However, the expert marks, increasing popularity is for the other model. Under the second model the investor develops within its own structure a special department - client services. And then general contractors are not needed. "Abroad the services of a general contractor are refused," says Kozlov. The investor-builder does everything itself thinking it is more profitable because it doesn't have to pay a percentage to the general constructor for its work and if the premises are big, then the profit will be big. And so this is how he saves money. In other words the investor perceives the general contractor as an excessive intermediary. In Russia there is another method. The general contractor doesn't receive a percentage from the builder-investor. As a rule, his payment is the difference between the value of the contract and what he pays for the services of subcontractors. Under the Russian conditions, considers Kozlov, general contractors will developing and integrating. In Moscow the tendency to integrate the building business in general is observed, he says. Accordingly, for general contractors it’s a good thing. Competent managers, capable of carrying out large projects, are always valued. Though, apparently, general contractors just recently have suffered hard times, as a result not many professional firms remain on the market.

Those who are most successful re those that work on state orders, for example SU-155, Glavmosstroy etc and it is not impossible to say that these companies monopolize the market," assumes Kozlov.

Unusual profits

Market players In the capital's real estate share the opinion, that general contractors are more and more demanded, and this business on rise. Andrei Labas, general director of company Moszarubezhstroy (the general contractor of City - XXI Century), explains that qualified experts are necessary to actively develop the market. "Customers attempt to build on their own, but practice shows that It Is more profitable and reliable to use a professional," agrees Ortenberg. In Moscow there are many firms, which are engaged in only general contracting. This creates a competitive environment that is good for business. Maxim Temnikov, on the contrary, thinks that the level of competition is low. Ortenberg says that to find a good general contractor you have to hunt, the same opinion is widespread among market participants. Ortenberg thinks that there are currently not enough professional contractors in Moscow."

There are many companies specially created for Moscow. They call themselves European, but have no operational experience in Europe. Such companies are simply registered abroad. "Practice shows that in such nominally French or German companies on the building sites it is Tajikis that work, Boguslavsky says. Tandem Group has experienced cooperation with a foreign contractor. Workers in this firm were natives of the Caucasus and from Central Asia. And they hired them in Moscow. They are also foreigners," Boguslavsky ironically says. "If 5-10 foreign companies would come on our market or if there were domestic professionals, their cost of services, would probably, be acceptable for Russian developers" says Temnikov.

The profit genial contractors make, according to Ortenberg, is related to the cost of the project. Usually it is 5-7% of the value of the contract. 5% is the minimum of economic attraction. Ortenberg specifies that this figure is standard profit for foreign - really foreign - companies. Because they have got used to working in Europe under stricter constraints. And for Russian firms standard profit starts from 10-15%. Maxim Temnikov thinks that the profit of general contractors is 15-30%, as with the majority of other businesses connected with construction. Andrei Labas estimates the profitability of this business at 10-15%.

General constructors make profit mainly on the optimization of its own expenses, tells Labas. The ideal variant is to complete work on time or to finish before the deadline. Because if a premises stands idle, money is still being spent on servicing the building: paying security, clearing rubbish, renting equipment, etc. In Labas' opinion It Is really difficult to put a monetary price on the everyday damage, but it depends on the size of the premises. Other market participants estimate expenses on an average premises from $3,000 to $5,000 a day.

To add, "city authorities today strictly supervise the situation on the building market. Building sites are constantly checked, says Labas.

Also a part of the profit that general contractors receive is the delta between the sum of the concluded contract and the real expenses. In Boguslavsky's opinion, for a 5-6% profit no contractor currently works in Moscow. The minimum profit, he thinks, should start from 20-30% for the project to be interesting to general contractors. This can be explained by the large number of unforeseen expenses. "The customer defines the total cost of the project. And everything else remains the difficulties of the general contractor. And if something is not thought over and 100% accurate, then the expenses will affect the profitability. In that case profit essentially decreases, but within reasonable limits. .

General contractors rate commercial real estate highly, thinks Boguslavsky, because it approximately on 30 % more expensive. Everything is defined by the future use of the premises. An apartment in the center might cost thousands of dollars per sq.m, and the same premises but for a restaurant Ill cost lots more. There are difficulties with putting into operation residential buildings. It is much more attractive to build, for example, logistical center. The handed over premises adapt much more quickly, and start to make profit sooner. According to experts, among small companies there is a tendency to change the "building orientation." Everything is connected exclusively with the profit a premises will make, they unanimously agree.

Any skilled contractor, having looked at a building, can understand, how much he will put into it, he can even estimate the cost of the project to within $10 000, experts say. And then they throw in how much is necessary for them to be truly happy", Boguslavsky adds. But this does not mean, that the general contractor will get the price he offers. There are certain difficulties. And some absolutely unpredictable things sometimes happen. Therefore a skilled general contractor always includes unforeseen expenses in his profit.

But, adds Ortenberg, there are also unprofitable premises. This happens if a general contractor miscalculates the estimate. Or if there are sharp changes in the market of building materials. For example, In 1997-1998 in the construction of a residential building on Lanaya Street made a loss of $5 million; the reason was an incorrectly calculated cost of the contract.

Kozlov thinks that there are a lot of opportunities for general contractors to earn more than investors think. If the estimate suits the investor and the customer then they are not interested in how much the profit the general contractor makes and they do not interfere with its financial and economic activity.

A goal of the investor is to get a competitive product that corresponds to actual market demand. If quality is too low, it is necessary to reduce the price. If it is too high, the buyer will not pay all the expenses for object. In both cases the investor loses. So the Investor pays the general constructor to get it just right, concludes Kozlov.

There was a time, when a brick everywhere cost 1 ruble 20 kopecks. Now on the market it is possible to find a material more cheaply but the main thing is not for the quality to not fall below the fixed construction regulations specifications. The same with services. There is a minimum level and It Is important not to go lower. And to not break the law.

To force general contractors to use the best workers, instead of "their own," everything is stipulated to the letter in the contract between the investor and general contractor. For example, a brick of such and such a brand to buy at such a price from such a factory. The same with services, it's enough to stipulate everything in the contract.

Usual problems

It is necessary to work in complex conditions, says Labas. Practice shows that the design documentation comes in parts. "The completely developed project is not present, not only before they start, but even after work has begun on the premises," he stressed. Because of this it is very difficult to value everything and think of every difficulty that you might come across. Ortenberg considers that there are companies that underestimate the price of the offer to get the contract. Many of them build badly and poorly. "The barrier to get into this business is low, customers, unfortunately, are not very well guided," he says, "and all the nonprofessionals use this knowledge."

Serious difficulties in construction create not the most optimum design decisions. Professionals think that general contractors should be involved at the design stage when the cost of the whole construction is being considered and when technical decisions are being solved. Then it is possible to get a reasonable estimate. The organization of the financing of the project has become a common problem. For example, Boguslavsky says, a customer comes and says to me I have money and I want to construct a house. But after making an advance payment you find out, that he has money problems. The other story is getting the last tranche, which is usually 5-7 % of the full value of the contract. The customer always holds the last tranche as a guarantee that everything will be completed. And quite often he tries to not pay it at all, as 5-7% is big money if it’s a big project.

Once a premises has been constructed, customers look for defects and always find them if they want to. Of course, there are ways to beat money out of the customers. For example, stop construction or remove the workers and equipment from the premises. This has happened in the past, people have informed Vedomosti.

For the city's money

Besides commercial projects companies conduct construction under municipal orders using budgetary money. According to experts questioned by Vedomosti, there is a big difference in work between state housing and commercial housing. And though they don't give much profit, they create a good reputation for the general contractor that makes a solid client base.

However, in some companies they say that working with state money is more profitable. But the accounts department of the contractor should be in order and all the employees including unskilled workers must be employed officially. And the reporting is more complex at times.

Almost all work with budgetary money is related with delays in payments, specifies a source in one of general contracting company. Having passed all long-term procedures of registration of documents, the general contractor has to wait for the receipt of money for about six months. For huge holdings this is not a problem. But for smaller companies it is not.

One more minus is that deviating from the course of construction is almost impossible because the quantity of papers required for each new step is very high. A big plus is the guarantee of receipt of money, even with a delay. Besides a bank granting documents confirming the contract with the city and the future payments, the bank gives credit in the amount of a quarter of the expected profits and charges a 10-15% annual interest rate.

Strasbourg does not have lots of experience with state contracts. However in March the company won a tender that was held by the department for investment programs in construction and the Moscow tender committee. The contracts have already been signed. One of the premises is an apartment building on Ostozhenka, with an area of 100,000 sq.m. The company says that specific work on state contacts has its own price building process. Prices are different to market ones. But no matter what the differences are this is important and necessary experience, Strasbourg says. According to Ortenberg, state contracts have a big future. In Europe, for example, state contracts make up 40-50% of total construction. In his opinion, in this sector of the market there are greater prospects for development. In St. Petersburg the company will build an apartment building with an area of 100,000 sq.m at a place called Leontyevsky Myc. One more big project, according to Ortenberg is the reconstruction of a monument of architecture from the 18th century located near Isaakuevsky cathedral by Four Seasons.

In Ortenberg's opinion, the successful construction of the hotel Moskva was the reason for getting the contract. On this project the company has special conditions of profitability that are "below standard." But the project is important from the point of view of the location and the use of unique technical decisions.

Only companies with big funds can carry out image contracts because they can afford to spend on their image, says Labas.

Work on such objects helps to build relations with the city authorities. For example, construction of any big sports complex or kindergarten will almost certainly not bring profit, but will create reputation and a transparency to the company, which in Labas' opinion, is the basis of civilized business dealing. And when authorities come to approve it these facts will matter. This does not mean, that it is possible to rely on indulgences, Labas says. But in some cases it can give you time to correct any defects that are found.

Dividends from reputation

General contractors, as a rule, are selected by tenders. But reputation and recommendations have huge value, as do personal acquaintances. “Trust is important, because all projects demands considerable expenses. If people don't know each other where is the guarantee that the general contractor, having received from the customer's money, will not simply disappear?” argues one expert.

If it is a state contract, specifies Labas, there is only one way - a tender. But quite often with private business a general contractor is invited to participate in a tender. The customer and the contractor need each other, considers Labas. "A good customer is as good a thing as a good contractor," he says. In Moscow there is less land to develop, and that’s why much depends on the professionalism of the contractor, and how many contracts he has.

Kozlov describes the situation: The general contractor has been in business already for a long time. It has a generated a pool of subcontractors and experts in specialized areas, and takes them with him from project to project. So he doesn't need any tenders. But officially if an investor wants there will be a tender. Basically this is what happens.

On the other hand, there are no universal terms. One contractor cannot build various profile objects. Investors want experts to work on construction, not workers who have broad knowledge. That’s why tenders are necessary.

Professionals monitor all tenders taking place. "The general contractor doesn't advertise that he is available but looks for advertisements from those who need him, Kozlov explains. This business was not made for advertising," Kozlov says.

In some exhibitions they do participate, and they spend some money on advertising and on their own image of course. They list themselves in telephone directories. They all have a site on the Internet. And on the Internet you can come across lots of their advertising campaigns (banners). General contractors generally love the Internet, experts say. But it is not advertising in the full sense of the word.

According to Ortenberg, the contractor works within a narrow circle of consumers. And potential consumers "look not on billboards but at constructed premises." And on recommendations. Strasbourg, for example, tries to build partner relationships with clients for long-term cooperation. As, for example, do companies Renova and Severstaltrans.

A tender, in Boguslavsky's opinion, is a sly move from the customer, wanting to get information on the price of a premises so then he can bargain with the applicants. Unfair firms often lie and initially underestimate the price of work, and then after it has been completed recalculate. The reason they give is that they simply didn't count this, forgot that etc. In this sort of situation the customer who pursued the cheapest offer usually loses.

This happens if the company does not pay due attention to the drawing up of the contract, signing just a standard form with the standard rights and duties plus every possible force majeures. "It is necessary to write down technical tasks, but at the stage of signing the contract it usually doesn't happen, because there is no ready project and there are no approvals for construction. That’s why all participants of the building process are hostages to an infinite quantity of papers and procedures," says Boguslavsky.

Walking on letters

Under current Moscow laws, to construct a building, it is necessary to carry out a certain procedure: to collect a package of documents, receive approvals, make the project, generate a system of financing (including the attraction of extra funds) and construct and hand over the premises to the state commission.

Ortenberg notes that for foreign companies approval of documents necessary for the realization of the project is not an obligatory condition. But at Strasbourg they have a special "department of approvals." Experts in this division participate in the development of the project, and are engaged in receiving approvals, and the delivery of the premises to the commission. The company started to render these services about five years ago, as a result of colliding with certain features of the Russian construction market.

To simply start building work, according to Ortenberg, it is necessary to have more than 40 approvals. In Europe, he says, this process can also be long, but no more than 10 approvals are required.

Ideally the customer should prepare the land plot: order the design-budget documentation and receive approval for construction and Initially Allowing Documentation (IAD). Then the general contractor enters the game. As soon as estimates and other papers are ready, the general contractor arrives on site and leads the process of construction, Kozlov says. In reality, the investor assigns to the general contractor all the functions necessary for the realization of the full cycle of construction.

Market participants share the opinion, that the delivery of the premises is narrow work. It requires passing lots of authority channels, including local enforcement authorities, firemen, free economic zones, etc. If you take into account difficulties and the financing considerations, construction itself takes no more than 30% of the time spent on the project, experts say. "Market players complain about specially trained people who purposefully think up new examinations and ways of checking." If the experts working in the company have design, construction or architectural diplomas, why should they need some department to check their work?" Boguslavsky says surprised. In 1991-1992 the volume of papers required by the IAD was insignificant and was referred to as the GZ (town-planning agreement). After receiving this it was possible to implement the project. Now the IPD is made up of approximately 60-80 sheets, and every page costs "procedural money," say builders (officially paid). It is much more complex to generate a package of documents, than to build 15 floors of a monolithic house, Boguslavsky complains. Therefore approximately 85% of construction runs parallel to the gathering of documents, experts say. And although this is illegal, it saves time. And the quantity of papers continues to grow.

"Earlier there were technical sections in a project. They are necessary for builders, contractors and engineers to carry out building work. These sections used to take up a certain volume of the documents required. Now the volume of documents of non-profile sections makes up about 50%. The IAD itself makes up approximately 15%. There is, for example, a special section "The struggle against rodents." And though the war finished a long time ago, bombproof shelters are still being built now," Boguslavsky explains.

It is not a secret that builders frequently build "informal relationships" with related organizations and structures. But even with such relationships the customer should expect the receipt of the design documentation in about a year and a half. If you go the "correct" way then from the first administrative document to the approval to start construction it will take approximately 2.5 years. Then it is possible to start construction, which will last about one year, and then about the same time is needed to put the premises into operation.

Three in one

More and more companies are trying to combine the functions of developers, investors and general contractors. Maxim Temnikov thinks that the majority of development companies in Moscow today are becoming full-cycle companies including general contracting functions. This is caused first of all by a lack of professional general contractors. "By and large in Moscow today there are only three decent general contracting firms, and all of them are foreign," says Temnikov categorically. And the cost of these companies is high.

Besides the basic sum of the contract the customer-builder should pay for a set of additional agreements, which can cost from 50% up to 100% of the basic sum of the contract.

Additional agreements are required when there is any change to the original project. Even insignificant redesigning entails further agreements.

As a result of using a general contracting organization a builder will pay 1.5-2 times more than if the builder managed it itself.

An additional advantage in having a general contracting organization in the structure of a development company is that it is easier to supervise the general contractor. "In this case it's easier to finance the project because you put your money into it. And the chain of mutual relations is shorter," Labas adds.

A disadvantage of being a general contractor within a full cycle organization is that, of course, you won't want to fine yourself for something as it could cause lots of employees to leave the company. If a general contracting organization is part of a full cycle development company then its services are paid according to the established internal quotations plus a bonus for managing contractors.

Internal quotations can differ from the market and can be both greater, and smaller. It depends on the type of work and its complexity, explains Temnikov.

Tandem Group says that such a process of growth is characteristic for the business. First you are a contractor, then a general contractor, then a co investor, then an investor. And developers are the maximum step of evolution. In Moscow large contractors are engaged in development activity, say the company.

Ortenberg pays attention to the disadvantages of such overlapping roles. The investor is compelled to use "its own" general contractors, providing them with a necessary volume of work, even if it is not professional. "There is no market, no tender, no healthy competition," says Ortenberg. "Collecting all expenses in one place, the company can win as the developer, but will lose as the contractor. Such a format is not practiced in Europe at all because it does not possess market conditions."