Market Know-how: Construction from Pensions

Non state pension funds are non-commercial financial organizations providing the financial management of pensions accrued through voluntary investments. These funds deal with obligated pension insurance, and also non state, or additional, provision of pensions. Non state pension funds, which carry out effective investment of pension accumulation and reserves, allow citizens to considerably increase the size of their own pension after reaching pension age. In other words, the volume of accumulated funds increases due to the profitability of investments. Moreover, pensioners keep the majority of these funds, and the managing company through which an NPF usually works, takes only a small commission. "In general, from the point of view of the developer an investment in an NPF can be considered as a hidden credit. For example, such funds may purchase a share in a project, which will then be sold by the developer at a higher price, for example, with the use of option schemes. Thus the profitability of investments at a credit rate usually doesn’t suit funds - comparable figures can be received on the bond market. Therefore pension funds should be considered not as creditors, but as investors and more likely co-investors," says Danil Zarubin, head of investments in real estate at FinamManagement.

The mechanism of work

As is stated in clause 2 of Federal law 75-FZ dated 7.05.1998 "On non state pension funds," one of the exclusive kinds of activity of an NPF is as an insurer of obligatory pension insurance which includes the accumulation of pension payments and the organization of the investment of the given monetary resources. In other words, such funds not only pay pensions, but also increase their size due to their own investment. As a result they become rather effective players on the financial market, and moreover, unlike the majority of banks they possess long money. "The main status of an NPF is as an investor. First of all funds invest money through closed Pension Investment Funds of real estate, for example, NPF Khanty-Mansiisk invests in closed share investment fund Yugra-Nedvizhimost, and also has its own development company called YugraInvestStroiProekt, which has already realized several projects," says Zarubin.

"Now in the market, closed real estate investment funds as a tool of investment are

popular – they are a separate property portfolio transferred to the confidential management of a managing company by their founders, and can act both as physical and legal persons," says Nikolai Vopilovsky, head of the department of legal support at MIEL-Novostroika. According to him, such closed real estate investment funds are created for a certain period of time, 3-15 years, after which the founders can receive the market cost of the shares.

At the same time a significant share of Russian closed real estate investment funds are not intended for private shareholders, owing to the high threshold of investment into the fund – the cost of shares is too high. Also the legally stipulated 6-month period for the formation of a fund also doesn’t attract private clients. This creates conditions in which companies, organising closed real estate investment funds that are more convenient to work with large investors. "Therefore schemes that allow private investors to become shareholders of a real estate fund that is already operating has become popular, one such scheme is the investment of funds in a non-state pension fund by concluding a contract with an operating company. NPF’s so-called “long” money – the savings part of a pension that is formed over a long period - allows them to act as a source of financing for projects in the real estate market," he says.

However until recently, when banks actively financed builders, it was more profitable for development companies to work with credit establishments directly, than to involve co-investors. The situation changed after the world financial crisis hit. Non state pension funds has become one of the most perspective sources of financing for Russian developers. "At the same time the scheme that involves the participation of private investors in closed real estate investment funds and the investment of pension funds in non-state pension funds began to develop only recently and therefore there are some questions that remain open. Mainly it concerns the absence of precise regulation of procedural participation of non-state pension funds in real estate funds, and also the risks connected with closed real estate investment funds, which are the possibility of a reduction in the liquidity of a premises and also taxation issues connected with the fact that Pension Investment Funds are not legal entity," notes Vopilovsky. According to vice president of the Gazfond non-state pension fund Nikolai Semin, "the participation of non state pension funds in such projects increases the funds of the future pensioners, the clients of the fund." "Our main task is to develop perspective fields of investment with the purpose of receiving profit that significantly exceeds the rate of inflation," he says.

According to non-state pension fund UGMK-Perspektiva, which has 15.9 per cent of its pension reserves invested in the rights of real estate under construction, the positive features of investing in pension investment funds are strict control by the state: the daily estimation of assets, the obligatory publication of the price of pure assets, spending of funds only under the control of independent controllers - specialized depositaries, the division of the functions of management, control and also valuation. However according to the law the managing companies of share investment funds cannot guarantee not only profitability but also the safety of the invested funds. Pension Investment funds do not create insurance reserves or develop property, with which it would be possible to pay damages to the shareholders in case of an adverse situation in the market.

The first signs

According to experts, almost every fund that has reserves exceeding 1 billion rubles directly invests in real estate or purchases the shares of closed real estate investment funds. Khanty-Mansiisk Non-state Pension Fund, according to Zarubin, are quite active in this segment as are several others: Strategiya has created a closed pension real estate investment fund by the same name, UGMK-Perspektiva, and Parma. "Direct investment in real estate until recently did not enjoy special popularity as to meet the existing requirements made the possibility of using this tool limited. Actually, even now it is possible for only up to 10 per cent of reserves to be directly invested in real estate, and through Pension Investment Funds, the same again. Really this parameter now does not exceed 3-5 per cent," the expert says.

At the beginning of summer 2008 at a St. Petersburg economic forum one of the largest agreements on the investment of funds of a non-state pension fund in Russian real estate was concluded. In particular, representatives of Renaissance Capital, Lider and M.I.R (representing the interests of several non-state pension funds including M.I.R Stroitelniye Investments and Gazfond) signed investment agreements for the sum of more than 9 billion rubles. The investments will be directed into the construction of premises of development company YugraInvestStroiProekt, which is realizing projects in the territory of the Khanty-Mansiisk autonomous district – in particular in Yugra. "World experience of the investment of pension funds in real estate is very successful. The investment of funds in such projects brings high income and ideally suits the investment of “long” pension money," says Igor Mustyats, deputy general director of Lider. In the near future it is expected that 7.5 billion rubles more of pension funds will be invested in projects in Surgut, Langepas, Ura and other cities in which YugraInvestStroiProekt conducts the construction of residential and commercial real estate. It is remarkable that previously this company preferred to use bank loans. In particular, in August 2007 YugraInvestStroiProekt signed an agreement with the West Siberian Savings Bank.

YugraInvestStroiProekt is not alone in its desire to attract pension funds in development projects. For example, the owner of non-state pension fund Strategiya Peter Pyankov intends to carry out the construction of bridges and roads in the Perm region together with Perm Financial-Industrial Group investment holding. The fact is that the pension money of the fund is partially already managed by "affiliate" of Perm Financial-Industrial Group - Parma-Management. According to Strategiya, at the end of 2007 about a quarter of all pension accumulation in the Strategiya fund (150 million rubles) were transferred for these purposes. It is intended that the investments will be directed on the construction of a bridge through Kama or on the Perm-Kukushtan highway.

Significant commercial real estate premises are among the premises belonging to non-state pension funds. For example the opening of the Aerobus children's shopping center measuring 32,600 sq.m located on Varshavskoye shosse took place in April 2008. The concept was chosen Becar and a pool of tenants has been generated, 85 per cent of which specialize in children's goods. In the complex are the Olant mother and child center, Ostrov children's entertainment club and Skazochnoye cafe. The proprietor of the complex is non-state pension fund Gazfond, one of the largest in Russia. This fund actively invests funds in real estate. It owns operating company Lider. In turn, the ex-president of St. Petersburg’s Baltika Taimuraz Bolloyev has created a closed real estate investment fund with 280 million rubles. One of the shareholders of this fund is Gazfond. It is planned that the attracted funds will be invested in tourist infrastructure premises and rest premises in cities in the Northwest, including in the development of boating. Moreover, Gazfond has been named the main candidate in the tender for the reconstruction and subsequent management of Pulkovo airport. The airport complex will be transferred to the management of a concessionaire for a period of 30 years on the basis of a private-state partnership. In accordance with this, the applicant should not operate or own an airport less than 800 km from St. Petersburg. In the opinion of experts, there are rather strict constraints in the tender, and possibly this proves that it is intended for a specific company or person. Some market participants name Gazfond as such a player as it completely meets the requirements. Anyway, the winner will be announced on April 6, 2009.

Meanwhile non-state pension fund Severstal and the administration of the Vologda region have created Stalfond. This non-state pension fund invests pension reserves in real estate using foreign developers. However Stalfond doesn’t invest a lot of money in real estate. In 2007, it invested 46 million rubles in real estate, i.e. 0.7 per cent of its total reserves.

The question of prospects

Market participants ambiguously assess the prospects of involving pension reserves in the real estate market. "In view of existing requirements, non-state pension funds can hardly pour several billions of dollars into this field, which by their scales is hardly considered a lot of money. However, pension reserves may quite possibly become a significant source of financing construction. It is not necessary to talk about big risks under conditions of sustained demand for real estate," notes Zarubin. Really, the main terminator of using pension reserves is Russian legislation.

According to a special order of the Russian government accepted in summer 2007, non-state pension funds can directly invest pension reserves in "non-residential buildings, premises, structures and constructions in the Russian Federation and also in land plots that will be used and occupied by the afore mentioned premises, structures and constructions". The maximum share of such investments cannot exceed 10 per cent. Before this governmental decree was accepted, NPFs could invest up to 50 per cent of reserves in real estate. And the real estate could be any, including residential. According to the National Association of Pension Funds, at the end of 2006 direct investments in real estate made up 5 per cent reserves. The volume of reserves of NPFs as of December 31, 2006, was 405.2 billion rubles, thus the volume of investments in real estate was about 20 billion rubles.

Funds can only buy buildings in their entirely. Otherwise NPFs should use management companies, which they should pay compensation at a rate of about 3-4 per cent. For this reason the majority of non state pension funds invest only through management companies. As a result some share of pension reserves in the near future will be directed on Russian construction, either directly or through management companies.

Previously American and European pension funds invested in Russian real estate most actively. According to the managing partner of Novoye Kachestvo Mikhail Gets, of the total amount of declared foreign investments in Russian real estate (almost $20 billion) 30 per cent made money for the future pensioners of the US and EU. The authorities in Kazakhstan have taken a similar route as a result of their pension reform in 1998. While Russian companies tried to recover from the crisis in that year, Kazakhstan companies set aside 10 per cent of wages into an accumulative fund. Thus, Kazakhstan banks and pension funds have received monetary resources, which the largest Russian credit establishments would envy. However after falling share indexes in 2007 and the following liquidity crisis, the profitability of the majority of pension funds appeared negative or at best at zero. Whether such consequences threaten Russian pension accumulation is not known. However in view of the stagnation in the market of residential real estate, investment in this segment is unattractive, but investments in commercial real estate remain capable of guaranteeing investors high profit. And consequently it is not ruled out that the funds of future Russian pensioners will soon actively compete against the funds of European, American and Kazakhstan pension funds.