Money Growing: Mega-problems of Mega-projects

Two years ago at four large Russian developers announced plans at the same time to construct practically new towns. Within the limits of each project the construction of several million square meters of residential and commercial real estate were planned and such plans were christened mega-projects.

However in the last year the companies have collided with a lack of financial resources, and the absence of legislative mechanisms and real support from the government, which had promised to help developers within the limits of the national Affordable Housing project. As a result some companies could not find enough funds, one has sold its share in one of the projects to a foreign company, and one has escaped its "mini-town".

Everything big

Among the developers who have turned to mega projects are representatives of large Russian business. Masshtab, which belongs to the founder of Rusagro, Vadim Moshkovich, and his partner Sergei Kirilenko, are working on the construction of a mini city for 300,000 people on the territory of the Kommunarka state farm in the Kaluga area. Coalco, which belongs to Vasily Anisimov, planned to construct mini-city Bolshoye Domodedovo, measuring 12 million sq.m in the district with the same name in the Moscow region. The Rublevo-Arkhangelskoye project, announced by Nafta-Moscow which belongs to Suleiman Kerimov, assumed the construction of 3.2 million sq.m of real estate 3km from the MKAD on Novorizhskoye shosse. Outside the Moscow region, Renova-Stroigrup, which belongs to Victor Vekselberg, has announced the construction of satellite city in Yekaterinburg called Akademishesky. According to the company’s plans, on a site with an area of 1,300 hectares southwest of the capital of the Sverdlovsk region within the next 15-20 years about 9 million sq.m of housing should be constructed.

Later various developers also presented other large scale projects, for example, Solnechnaya Dolina by Renova-Stroigrup, Konstantinovo by Evrasia-Citi, and Novyi Gorod by VTB. However the majority of them are either of a much smaller format, or were announced much later and have not had time to start active work yet. The projects listed above, in the opinion of experts, have passed the necessary stages for construction to begin. Moreover, some of them are now included in the Affordable Housing national programme. However there are no mega-constructions yet.

"Big announcements made in 2006 have not borne results. The activity of developers has mostly been limited to organizational and design work, and the real embodiment of the announced projects has only been started by a few," says Dmitry Ivanov, head of the new construction department at Agent 002. "In actual fact, the speed of realization of some mega-projects is behind announced schedules," agrees Vladimir Kuznetsov, head of design, consulting and analytics at Welhome. Moreover, according to him, "plans have been changed even in the projects that have had support from the State within the limits of the Affordable Housing national project and construction of those located in the Moscow region have not begun yet".

Posing a problem

In the opinion of market participants, developers of mega-projects have faced several big problems. First of all, a lack of financial resources: to realize mega-projects, huge funds, including loans (which have become more difficult to obtain due to the crisis), are necessary. "A major problem in realizing such projects now is attracting finance. Everyone, including large companies, has experienced it. Banks give money, but at high rates of interest, which seriously influences the profitability of a project," notes Michael Zak, head of analytical management at Veles Kapital. In the opinion of Roman Kondrashov, the financial director of investment-development corporation City - XXI Century, “problems with receiving finance lead to timelines of projects being extended".

But builders of cities do not find such problems. "Companies realizing large projects come across other complexities that are mainly connected with the structuring of financing. Large projects, especially those with a population of more than a million people, are usually financed from more than one source. The structure should include banks, investors, and funds," says Natalia Chukayeva, director of the marketing analysis department at Masshtab. According to her, in such situations it is even necessary to involve broker companies. "They are interested in the optimum use of resources for both parties and work to achieve the greatest appeal of a project to financial institutions, and to develop schemes to enter a project," the expert approves. "Technical complexities can be limits and technical communication specifications," adds Gennady Teryayev, director of the business development department at Rodex Group.

"Complex development of large territories is a multi-plan process which demands huge labour and monetary expenses from the developer and longer times of recoupment and of earning profit. At the same time it is difficult at the initial stage of development of a project to precisely simulate the course of its future realization, and to consider all the risks that accompany such types of projects," says Maria Litinetskaya, executive director of Blackwood.

Another problem is a discrepancy in the initially chosen concept of the project with the real needs of the market. "During the life of a long-term project the market will go through different cycles, therefore modelling in this case has a probalistic character. Any activities on the development of the project should be appropriate to the market, i.e. there may be changes to the structure of the project, its timelines, the process of construction and entrance to the market of separate parts, etc,” explains Elena Logvina, head of the consulting department of residential real estate at Miel.

For example, according to Yury Sinyayev, marketing director at Konti, the Rublevo-Arkhangelskoye project was initially announced as an elite city for millionaires, but "in due course it became clear that for the private investor to be able to realize such a project, the State’s support and cheap loans were necessary." "As a result the project has changed; it has been made cheaper as to sell such a volume of housing at high prices without mortgage schemes is practically impossible," the expert explains. In particular, it plans to construct 5.2 million sq.m of business class residential and commercial real estate instead of the initially planned 3.2 million sq.m. This information was confirmed by the PR-manager of Rublevo-Arkhangelskoye, Natalia Mikhaleva. According to her, construction of a channel that will become the center of the complex is currently being conducted, and the section of the project with housing is in at a design stage.

Developers of mega-projects prefer not to talk about financial difficulties and complexities in the development of the concept, but they do however designate two other significant problems. "The greatest difficulty which we had during realization of the А-101 project, was in design because in Russia such town-planning projects have never been created before. Old regulations and rules do not meet new ideas and approaches, which are not outlined in Russian construction rules and regulations," says Chukayeva. According to her, in USSR days "huge Soviet constructions, which were also conducted according to plans and programs of complex development, dominated, however in these projects the concept of minimalism prevailed: to give people only the most necessary for work and life." "If someone even really thought about comfort and the development of an environment, in reality it was not embodied. On one hand, we try to introduce new western ideas to a project, on the other, we cannot coordinate them because old regulations don’t correspond with the new ideas," the expert says. According to her, to solve this problem, the Public chamber commission for regional and local development plans to suggest to the State Duma to make changes to the norms and regulations of designing.

"The second problem is incompletely fulfilled legislation on state-private partnerships. On one hand, the State is ready to support large town-planning projects, to reserve funds in the budget, to help with roads and communications, and on the other, the mechanism describing how this should be done has not yet been created. Who makes an application for the construction of infrastructure – the local authority or a developer? Who accepts the application and considers it? Who makes the decision that the given project requires the State’s help in this particular area? The mechanism of answering these questions is not present, therefore the developer must solve each question separately with various officials and municipal, local and regional authorities," Chukayeva says. According to her, "imperfect legislation and under developed schemes make a project more difficult and slower to realize." "The success of town-planning projects abroad is possible only when the state really, systematically and seriously supports private developers and investors - not only at a conversational level, but is involved, for example, in the maintenance of engineering," she says.

Technical matters

Technical complexities for developers of mega-projects are the easiest to solve. "The legislative base continues to be improved, and large developers invite foreign experts with corresponding experience into the development of projects," Litinetskaya says.

Financial problems are not so easy to solve. One decision may be to sell part of the site to a foreign developer. In August 2007, in the real estate market there were rumours that Masshtab had sold 50 hectares of land under construction (building 500,000 sq.m of residential real estate) to St. Petersburg’s LSR group. This information has not been confirmed. But half a year later PIK group announced that it had bought a land plot of 127 hectares from Masshtab, which market participants estimated to be worth approximately $200 million.

This agreement became the first officially announced sale transaction for such a large share of an announced project, favourable to both parties. PIK always needs land for the development of capacities, and Masshtab has a lot of land demanding long design development and high financial expenditures," says Oleg Razin, deputy general director of Vesco Consulting. Masshtab approves that there won’t be any specific control over PIK’s activity.

According to director of the public relations department Evgeny Redkin, there is an understanding of what will be constructed by PIK because the development of this site is conducted according to the general plan of construction of the Leninsky area and consequently, control over construction will be carried out by the regional authorities. According to Zak, "in a situation when it becomes extremely difficult to attract money from banks or market funds, attracting partners into projects is actually the only option left.” "In this case developers get cheaper money than from other sources," he explains. "The sale of a share of assets at present is the only quick option of attracting money resources for the start of a project," agrees Nikolay Klimov, deputy general director of construction at Peresvet-Region.

If the developer doesn’t sell a share of the project, then it needs to find a strategic investor, which is not so easy. The experience of Coalco is an example. At the end of 2006 it became known that Arab company Limitless had become a strategic partner of the company in the construction of Bolshoye Domodedovo. It was supposed that the partners would act as co-investors. Moreover, it was expected that the Arab party would incur a share of the development interests. However in February 2008 Limitless came to an agreement with RDI Group on the construction of 734 800 sq.m of real estate on 113 hectares in the Khimki area of the Moscow region, so the development of the Domodedovsky area was no longer part of the Arabian company’s plans any more.

In the opinion of market participants, the difficulties inn finding financial resources has led to personnel rearrangements at Coalco. In March 2008 Alexei Tuzhilin, former corporate finance director, was appointed general director of the company. He replaced Alexei Kozlov who had held the position only for about half a year. Coalco did not explain the fast change of the heads, however a quick change of top-management simply says that the general directors simply could not find the necessary $4 billion to realize the Bolshoye Domodedovo project. Moreover, in autumn 2007, Coalco planned to sell 20 per cent of its shares on the LSE for $1 billion, but its former general director Kozlov postponed the placement for a year, having promised at that time to double the capitalization of the company, however this did not happen.

Another solution besides selling several sites and searching for a strategic investor is to sell the whole mega-project. In the Russian real estate market there is only one such example. In April 2008, Nafta-Moscow, which belongs to Suleiman Kerimov, sold the Rublevo-Arkhangelskoye project, which was included in the Affordable Housing program, to a company belonging to Mikhail Shishkhanov, the former owner of BinBank. The transaction was a record $5.3 billion. market participants have been saying that Nafta will sell the project since 2005, and have suggested that the buyer will be Base Element, owned by Oleg Deripaska, however, if such negotiations have taken place, there have been no results so far.

"The inclusion of the project in the Affordable Housing program does not influence the speed of its realization, but does make the settlement popular and increase its capitalization thanks to a positive influence on its image. This fact among others rendered a powerful influence on the successful sale transaction of the Rublevo-Arkhangelskoye project,” says Kuznetsov.

A question of the future

In general, market participants positively assess the potential of mega-projects. "But it is necessary to consider that every year their profitability decreases. All large projects that have been announced certainly have a chance of final realization. The only question is when?" notes Razin.

In the opinion of many experts, the start of mega-projects is a natural stage of development of the market. "Some time ago, the most liquid land on the primary market ran out, and large land plots belonging to several land owners is necessary to develop in a complex way. Therefore the number of announced mega-projects is constantly increasing, but the most effective ones will be those that have a competent and good quality concept, as the market is not capable of simultaneously absorbing such large volumes," Kuznetsov approves.

However, much depends on whether it will be possible for developers of mega-projects to solve the problems that arise before them. "In terms of the prospects of the format it’s worth noting that such big plans will be extremely difficult to carry out without the real support of local and national authorities (from the point of view of receiving approvals, the allocation of communications, the creation of external transport infrastructure)," says Kuznetsov. Therefore, according to him, the prospects of mega-projects in many respects will depend on the actions of authorities. "Meanwhile a situation is developing whereby the volume of large projects that have been announced is growing disproportionately to the number of those that have really started," the expert says.

However, in general, mega-projects can be profitable not only for developers, but also for the State. "The realization of mega-projects is one of the best ways to build affordable, mass and sufficient quality housing," says Klimov. The most important thing is that cities are built in the end.