People in the Know: A New Player with Old Opportunities

Why has the management of RZhD considered it necessary to begin the transformation of territories, and more precisely, enter the land market?

Last year RZhD presented to the government of Russia a program of development of railway transportation to 2030, which provides for significant investments in road infrastructure – mainly the construction of new roads - and in updating rolling stock. The concept has been approved, and the program is a significant component of the program of economic development of the country. For it to be realized, significant funds are necessary. They will come from: the profit of the company, various loans, funds from the realization of the companies’ subsidiary assets, allocated by the company as part of carried out reforms, funds from the Investment Funds of the Russian Federation, etc. One such source will become the income of RZhD from the sale or attraction of investment to the company’s non-profile projects, which are currently not always being used effectively.

For example, in the city centre there may be a cargo yard measuring tens of hectares for loading-unloading several wagons a day. Or, for example, uncompleted premises: during Soviet times they started building many premises when nobody thought about how much it would cost and didn’t complete them. And then this kind of Soviet monument is there, becoming dilapidated, and the company bears the expenses of its operation, and protects it from illegal occupiers, and moreover pays taxes. Understanding all this, RZhD is solving two problems simultaneously: avoiding paying expenditures on these premises and spending funds on their development.

According to information of the department of property management at RZhD disclosed at the Pro-Estate Forum, which took pace in St. Petersburg in September, the money from the sales alone of non-profile shares in 2007 totalled more than 2 billion rubles, and this year it expects to make 5 billion rubles. Moreover a number of premises are included in the financial turnover through the realization of investment projects and by concluding corresponding investment contracts.

RZhD invests in such projects, non-profile assets occupied by old railway infrastructure and that have a lot of defects. And receives new railway infrastructure premises and (or) a share in the results of projects in the form of real estate.

As an example I can give the project of moving the railway infrastructure of the St. Petersburg – Warsaw station from the territory of a freight yard. The land plot measures about 55 hectares and is located near to the central part of the city and does not just look like an ugly, abandoned industrial zone and is inefficiently used, but is also in such a condition preventing St.-Petersburg from developing this project (Izmailovsky prospekt), which it is part of. Attracting investments of almost 5 billion rubles (the investor is Zheldoripoteko), RZhD will not only get new infrastructure premises for industrial activity, but will also allow the city to construct a new micro-district.

Close work with the administration of St. Petersburg on the development and the approval of new town-planning documentation will allow us to build not only offices on the territories of the cargo yard, but also residential real estate. The concept of construction that we presented to the town-planning council of city in May, excluding commercial premises, provides for the construction of 350-400 sq.m of housing.

Abroad in large cities they don’t have such large territories occupied by railway tracks and railway premises.

Abroad it is easier and they understood everything much earlier. Germany, whose experience we have studied, as is known, is densely penetrated by a network of railways. German Railways (also a state company) is actively involved in non-profile assets in investment projects. Affiliated companies like ours, exist in Germany, Belgium, Japan, etc. The results of their activity are impressive. For example, superstructures above the central station in Tokyo are 60-70 floors high, and stations in Germany can compete with many modern shopping and entertainment centers. Or for example: in the center of Manhattan above the railway tracks a bridge has been constructed, on which parts of the city’s micro-districts have been harmoniously placed. Here there is both commercial and residential real estate.

Will you work independently on these territories or will you attract foreign investors?

Theoretically all the projects can be realized independently. But for any company, even the largest, financial and manpower resources are limited - we cannot borrow many billions of dollars at once and invite 2,000-3,000 more qualified experts to work. We plan to realize the projects as the leading partner (for example, moving of the freight yard at the St. Petersburg – Warsaw station or the Voitovich Factory in Moscow). But on a number of projects we will act in the role of field developer. In this case our work will involve the predevelopment and "packing" of the project to help RZhD sell the project or attract an investor. Such "packing", as a rule, requires financing (tens, and sometimes hundreds of millions of rubles) and time (2-3 years). But predevelopment of territories alone will allow us to correctly define the parameters of the future project, rather then selling a cat in a bag.

What will be the share of the investors?

In each case it will be different. It will depend on the market cost of each project or asset, which is defined on the basis of reports by independent appraisers accredited by the company, and also on market conditions.

Will there be the risk for your partners that RZhD’s land belongs to the state and RZhD is its tenant?

According to the law the managing subject cannot allocate a partner with greater rights than it possesses itself. So one of the primary goals is to find a legal scheme for each project that allows it to be realized. If such solutions are found, it is possible to sign a contract with an investor. It may be a contract of sub rent or occasionally a sale and purchase contract, etc.

With some potential partners we are starting to work exclusively on the basis of a statement of intentions, disclosing all the possible risks. At the earliest stage of predevelopment we invest the most risky money. Another topic is that at this stage a lot of money is not needed. RZhD will never conclude an investment contract and allow someone to invest money, without understanding how they can make a return on their investment.

What advantages can a company wanting to participate in one of your projects expect?

Land is an asset which will never grow. There are practically no land plots without defects that are large and in a good location remaining. This is especially true for Moscow and St. Petersburg. And plots under construction at times in not the best of places are forced to look for investors. We are honest with our potential investors: our projects are difficult. Developers carrying out projects in usual city territories, deal with the usual structures – architectural bodies, inspectorates.

We also come across problems concerning railway regulations and the observance of technological requirements that guarantee uninterrupted work activity on the road. We also work with large land plots. Not 20-30 sotkas, but tens of hectares. As a rule, these have a good location. But small companies cannot afford to work with us. This is because our projects are long, and demand experience and qualified personnel, and the volume of investments is estimated in the hundreds of millions of US dollars. But if we have found a legal scheme, and the project in terms of where and what needs to be done has been approved with the railway people and we have worked well on the project then the risks will be lower than in projects connected with mass eviction.

Is the construction of housing on former railway premises ecologically wise?

Problems do not arise if the former premises is completely removed, because the rails, the sleepers, the goods yard are not nuclear or chemical premises. If the land needs to be recultivated it is not really expensive. The problem is in what remains on the land. For example, if part of the railway was moved and another part remains and is functioning, then there will be a sanitary zone (around the remaining objects). It is prohibited to build housing closer than 100 metres from railways.

Is it because of this that the redevelopment projects you have started in Moscow, St. Petersburg, and Kaliningrad involve commercial real estate?

Partly. Another reason is town-planning restrictions. If a territory from the point of view of functional zoning is a recreational, business or industrial zone then, in theory, it can be changed. But only in theory. In practice it is a long process which requires inspection of the land and a reasonable explanation, development of new town-planning documentation, and modification of the general plan.

Do you have to do this?

Sometimes yes. But if the restrictions are connected with requirements of sanitary regulations then it is impossible to bypass them. And this is one of the main reasons why in a number of projects only non-residential construction is possible.

With regards to changing the function, an example may be reorganization of the territory of the freight yard at the St. Petersburg-Warsaw station. After we move all the rails from it, there will be less sanitary restrictions and the changes we will suggest to the general plan will be logical and reasonable. We have started development of a project in Kazan which involves the reorganization of territories near the Kazan Railway Station and the embankment. The concept of the project is to move part of the railways and build residential and commercial real estate on this land.

And in Moscow?

If we entirely move the Voitovich Factory to Ploshchad Ilyicha Station (where a new large station is planned to be constructed in the long term) and all manufacturers, then it will be possible to build housing. Although the first 3 hectares (the first stage of development) while the factory has not been moved, will be built up with office real estate only. We are participating in the development of the whole territory of the factory covering an area of 18 hectares.

At the Pro-Estate investment exhibition in St. Petersburg the head of the property department of RZhD announced that the company intends to include the land plots into the assets of the company. How will this be reflected in your projects?

It is better to address this question to the property department of the company. The removal of some federal restrictions on some of RZhD’s land plots is extremely important to work more effectively with them and will make it easier to attract investors. Projects will become simpler from a legal point of view and will be more attractive to investors.

How will the reduction of RZhD’s investment program affect you?

Reduction of the investment program may directly or indirectly affect many divisions and affiliated companies of RZhD, but it is too early to talk about. In turn, management of Joint-Stock Company Zheldoripoteko is preparing its own anti-recessionary program.

Zheldoripoteko is an active developer in the regional markets. What are you guided by when making a decision in favour of this or that region?

We assess many different factors. When analysing the possible input of housing in a specific city we carry out a test on "many/few". In the last three years new housing in an average Russian city did not exceed average Russian figures but now it is no more than 0.5 sq.m per person and that is "not enough". And, accordingly, this parameter in a given region is attractive for us. If more than 0.7-0.8 sq.m per person per year is put into operation, then this is "a lot". If it’s around 1 sq.m of housing per person this is "a lot". It will be hard to sell housing in such a city. This point should be considered seriously, including by the local authorities.

Why? In most cases the markets of medium and large cities from the point of view of buying ability do not digest supply at a rate of 1 sq.m per person a year. It is possible that in the next few years everything will change and everything will be fine with the economy, salaries will grow, interest rates for credit will fall (though at the moment everything is the opposite to this) and then consumer demand will easily "eat up" more than a meter of housing per person built in a year. But at the moment everything is the opposite. For example, in Tyumen they build about a meter per person. And there is a problem with selling. In Kazan large volumes of housing are also being delivered, and there too there are big problems with selling them.

Another aspect is public accessibility of the land plots. We do not want to participate in "curve" schemes where a tenant who sub rents by way of targeted use after the introduction of the new town planning code, offers us to be an investor. Such "muddy" offers do not suit us. Here when the city carries out land auctions and they are regulated, it is a positive factor. We have participated in 11 such auctions and won 7 times.

There is another possible scenario: In a city there is a certain group of proprietors. Among them there may be enterprises that have privatized the land, or already new owners that have bought up these plots. There may be companies in a city that have been created for the realization of a project to which the authorities have legitimately given the land, and measures have not expired. We are prepared to buy under a cessionary contract the right of rent of the land from such companies with the consent of the city authorities.

Of course we assess the general economic and demographic situation in the city. For example, the presence of large working industrial enterprises whose economic growth will allow workers to get good salaries and to give birth to children, to provide an inflow of people, etc. Or the presence of federal programs: in Sochi – the Olympics, in Vladivostok - the Pacific Forum, programs concerning the organization of gambling zones, etc. All these attributes in a region will bring serious state investments, and after them private investors.

And finally, the price level. Last year prices did not grow or the rate of growth was slower in the country, then on average this means that there is potential for growth. And the opposite. One example is Yekaterinburg. After rapid growth there the prices have risen but have now stood still for about a year. But soon slow growth should begin again.

According to your observations, are regional authorities gravitating towards the formation of civilized relations more or it is just atypical?

Far from all promote normal development of the market. For example, in Samara from the moment the town planning code was introduced in autumn 2005 to summer 2008 no land auctions have taken place. It is clear that in this time there was a unhealthy rush around land plots, and the sale of rights to buildings through opaque schemes began to prosper.

Often authorities have tried to build a lot not thinking about the possible negative consequences of overstocking the market. But if the authorities have stimulated construction of volumes which cannot be sold as a result they will not increase, but reduce the accessibility of housing. Because companies-builders will loose out, other participants of the market will not have stimulus to come to these markets and banks and investors will cease to invest in this sector. In the medium term volumes will decrease, and following this the accessibility of housing will too.

What can you say about large companies from Moscow wanting to work in regional markets? What volumes of projects should be developed?

Experience shows that if for example, 500 000 sq.m. is put into operation and there are different builders working then it is impossible to sell at one address more than 20 000-25 000 sq.m. a year. Even because people will not buy one type of habitation from one builder, in one area – people need different offers. If an average company is ready to spend 6-7, maximum 8 years for a realization of one project, then in my example for this period of time it is possible to sell 150 000 sq.m., maximum 200 000 sq.m. of habitation. If to take over 1 million sq.m in a city where it is put into operation 500,000 sq.m a year, a sale of all the constructed housing will require 15 or more years. Is this period of time realistic for a builder who can borrow money from banks for a maximum for 3-4 years? And now even less. I think no. These factors also define the parameters of a project.

Do your competitors think about these things?

Of course, the majority of management teams are strong and are also guided by similar logic. Though there may be an element of politics.

In what?

Agreements with heads of Russian regions when there is an implicit profit. The logic is this: I become involved in a large project, I help a governor, and he also helps me with something. It is not always defined by economics alone.

The housing that is being built at the moment in the regions is generally outdated. But everyone keeps building it.

You are right, many companies are building using old technologies. The introduction of anything new is difficult. But it is impossible to accuse this of developers alone. The government also doesn’t stimulate them enough to make innovations. It is difficult to make changes to the regulations. For example: to approve the possibility of having a lift going to a lower ground floor is extremely difficult. There are fire regulations that forbid this. Or glassed facades and balconies. Because of fire-prevention safety regulations builders first hand over the building, and then glass the balconies, etc.

In your opinion why do you think constructors are unwilling to erect low-level housing?

Business follows profit. Our clients are not ready to buy low-level housing. If you buy an apartment in a high-rise building, you know what you are buying, but with a cottage or town house everything is different. There are a lot of questions: how much will it cost to maintain? Who will clean the snow in the area? Will the land be yours or will it be shared ownership? What will the ratio be between useful and total areas? And the main thing, of course is the social infrastructure. The risks in terms of sales will be higher for several-storeyed buildings, than apartment buildings. But this is where the future.

How much land does RZhD have in Moscow?

In Moscow RZhD has about 3,000 hectares. How much of it we will be able to use in economic circulation will become clear a bit later. For this purpose we are carrying out, according to an investment agreement with RZhD, work on inspecting some of the land plots. We consider it premature to list them now as their locations and area are not precise.

Why and how has RZhD chosen to be partners with Mirax? What other Moscow, St. Petersburg or western companies will cooperate with RZhD on the development of its territories?

I think this is a question you should ask to OAO RZhD and Mirax.

What can you say about selling your business and working as a manager for RZhD?

In the last 17 years practically in all companies, the proprietor or the owner has been involved in management and was the general director. Therefore, at least psychologically, for me there was never a bias against work as a hired manager. Moreover there came a time when I understood that I can and want more: larger scales of business, solving new and bigger challenges. I wanted something new. As a matter of fact, I had quite a dilemma - remain the owner of some small or medium-sized business with an obviously known ceiling of development, or join a larger company with interesting problems as a manager.

It was almost a philosophical question: what it is better - to be the proprietor of a stall or to be a hired manager of a large company? I chose the second. The offer of the president of OAO RZhD, to come to Moscow and head its affiliated development company and solve an absolutely different level of problem to me was tempting. I have never regretted my decision. The problems that we solve now with the management team of Zheldoripoteko demand a certain response. They require the mobilization of the very best and strong qualities in each of us. Sometimes we deal with difficult problems, sometimes with routine ones, but in general it is interesting.

In 2007 the company has shown significant growth. For example, revenue doubled in comparison to 2006 to 4 billion rubles, and the profit of the company in 2007 totalled 118 million rubles (in 2006 it was 86.5 million rubles). The assets of the company at the end of 2007 totalled 21 billion rubles while in 2006 they stood at 14.5 billion rubles and in 2005 were worth about 7 billion rubles.

Do you like Moscow?

Yes, in general I like Moscow. St. Petersburg is my native city and I love it, here all my relatives and friends live, and from an aesthetic point of view I like it more. But I have never disliked Moscow. The climate here is better, the children are less ill. And, by the way, in the last few years I have a lot more friends here than in St. Petersburg as many of them moved here. The move was more difficult for my family: I have worked a lot in St. Petersburg, but I have worked even more here. When you live for many years in one place you build up an order of life: a house, a summerhouse, schools, doctors, etc. Here you have to build everything from zero.

Moscow has the best roads. In general, everything is better here. But the quality of services here, in my opinion, are worse than in St. Petersburg. Even in companies in the of sphere of services - shops, service stations, etc, customers are considered less. In St. Petersburg, we assume that good service will cost something but that it will be good quality, but in Moscow we pay one and a half times the amount and the quality will not be as high. In Moscow there are many clients who have the ability to pay, that sellers of goods and services sometimes forget about the concept of "serving the client." An exception is in restaurants. Here we should give them their due, they provide a very good service and there is a wide choice.

I think that the thing that pulls people to Moscow is that there is more interesting to do business here. The scales here are different, bigger - and, perhaps, this is the most important thing.

Vitaly Votolevsky was born in 1965 in Leningrad. In 1989 he graduated from the Leningrad Institute of Aviation Technology, and in 1991 he graduated from the faculty of retraining managerial personnel at the Vosnesensky Financial and Economic Institute in Leningrad. From 1991-1994, he was general director of VmB. In 1996-2000 he was the general director of OOO SberbankVmb-Invest. In 1997-2005 he was general director of ZAO Peterburgstroi-Skanska (until 2002 was OAO Peterburgstroi) and in 2003-2004 was general director of ZAO Skanska-Stroi. He was the first representative of the Russian guild of realtors at the congress of the national association of realtors in the USA (Miami, Washington). In 2004-2005 he was adviser to the governor of St. Petersburg concerning investments in construction. Since November 2005 until now he has been general director of ZAO Zheldoripoteko, and adviser to the president of RZhD on housing policy.

Investment-construction company Zheldoripoteko, an affiliate of Russian Railways, was created in 2001 to solve the housing problems of workers of national railway transportation. Now Zheldoripoteko works in three basic areas:

construction of residential and commercial real estate premises;

construction and realization of housing for employees of RZhD holding within the limits of the realization of the housing and mortgage program of RZhD;

performing the function of head of the operating company, being engaged in the realization of investment projects of residential and commercial real estate premises, which are not used for maintaining the transportation of cargo and passengers and are the property or use of RZhD.

The company’s portfolio of investment projects stands at 95 and are worth an estimated 45 billion rubles. The land bank of the company (excluding large projects connected with carrying out railway infrastructure) consists of land plots on which it is possible to build more than 1 million sq.m of real estate. At present the company participates in the construction of about 200 premises including residential and commercial real estate in more than 100 settlements of the Russian Federation. The company has branches in 16 large cities of the country including Voronezh, Yekaterinburg, Irkutsk, Kaliningrad, Krasnoyarsk, Nizhny Novgorod, Novosibirsk, Rostov-on-Don, Samara, St. Petersburg, Saratov, Khabarovsk, Chelyabinsk, Chita, Yuzhno-Sakhalinsk and Yaroslavl. In summer 2008 it opened its 17th branch for work in Moscow, the Moscow region and other cities covered by the Moscow railway.