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“There should be a distinction between housing price and developers’ costs in equity construction” – interview with Tatyana Polidi, Executive Director, Head of the Real Estate Market Department at the Institute for Urban Economics in an internet magazine “Stroitelstvo.ru”
Tatyana Polidi: “There should be a distinction between housing price and developers’ costs in equity construction”
Tatyana Polidi, Executive Director, Head of the Real Estate Market Department at the Institute for Urban Economics, a renowned Russia expert, answers the questions of the magazine
— Tatyana D., unlike developing economies, leading developed countries don’t rely on equity construction. In Russia, however, the practice became important as it supports developers, especially today, against the background of a falling market and well-known difficulties with fund raising. Then, why the scheme fails to work properly. Indeed, the number of cheated participants of equity construction makes up 43 thousand persons. What are main drawbacks of the existing scheme, in your opinion? What changes should be made in it?
— There exist various schemes of participation in equity construction in developing countries (Poland, China, India, Egypt, South Africa, etc). These are, by no means, countries with unsustainable banking systems, high loan rates.
Current version of the federal law (No. FZ-214) has two bottlenecks: supervision of intended use of co-investors’ money and non-existing limits to the amount of money that can be attracted from citizens at the stage of construction (as a share of housing value).
In every country the supervision of intended use of money takes place via a requirement necessitating the placement of the money on special controlled bank accounts. That is, banks carry out financial control. In recent years, in the countries with legislative opportunities for keeping special accounts, generally, an escrow account (a special account established to hold property, documents or money till the occurrence of certain circumstances, or fulfilment of certain obligations — editorial comment), a requirement for placing the citizens’ money, attracted for construction, on such accounts was introduced at once. That is a common international practice. Though the legislative opportunity appeared in Russia, it has not been used so far. The gap should be eliminated.
Another question is the amount of funds which a person risks. In Russia, currently, one may pay even full cost of an object. In developed countries, however, the schemes of presale normally envisage the amount of downpayment making up no more than 10—20%, and the money, as a rule, cannot be transferred directly for construction purposes. It, rather, serves as a guarantee of demand for a bank that extends a loan to a developer.
— Andrei Vorobyov, Governor of the Moscow Region, suggested that equity construction be canceled. Yet, it became known later that a complete repeal of the federal law (No. 214-FZ) appears not to be the case. Igor Shuvalov, Vice Prime Minister, assigned Natalia Antipina, Deputy Head of Minstroy Rossii with establishing a working group for preparing proposals on amending the law. At the first meeting of the working group it has been decided to introduce the new mechanism of equity construction which envisages the keeping of money of citizens-co-investors in banks and the use of it by developers under the supervision of a bank. However, the role of a bank as a third party to the agreement between equity construction participants and developers might result in a considerably increased cost of construction. “That is like choosing between Scylla and Charybdis: protect people and, at the same time, keep construction cost down”, —emphasized Mikhail Men, Head of Minstroy Rossii. Could that be technically achieved, in your opinion?
— For one thing, the proposals generally aim at better guarantees to citizens, which implies risk mitigation, rather than at reduced prices of housing. A risk could be mitigated in one of two ways: either by paying for risk management (e.g. insurance, banking supervision), or by eliminating the risk in full, which means excluding a systematic risk from the system. The latter method of risk mitigation also requires costs, though in some other manner.
We try to use the first method while seeking to include another one. The use of the second method would entail a better transparency of the market and its participants, and also the removal of crooks from the market while making everyone work in a legal way. This all would lead to elimination of the risk. I think that a wider engagement of banks as financial institutions would encourage the mentioned above changes.
For another thing, one should distinguish between the two notions: housing price and developers’ costs. Along with costs, housing price includes something else (and the share of it is considerable), for instance, profit margin. As costs grow, housing price doesn’t necessarily grow, profit margin simply declines. And that problem could be solved by way of increasing the mass of profit via expanding business volumes.
I have given only one example of how market participants could adjust themselves to regulation changes. By the way, in countries where the transition has already taken place the project volumes proved to be growing immediately, because of enhanced financing opportunities.
— The Government of the Moscow Region advocates the introduction of an obligatory banking guarantee. Moreover, those should not be guarantees issued by “trash” banks but by 20 largest ones, emphasized German Yelyanyushkin, Vice Chairman of the Government of the Moscow Region. But, according to developers, Russian banking system simply lacks the resources – more than one trillion rubles - to do that. In addition, banks would need to control each payment made by a developer. This necessitates employing numerous financial controllers. According to Kirill Kholopik, Head of NOZA Department, member of the work group, Sberbank alone should additionally employ 10—15 thousand persons. And indeed the banks appear to be reluctant to deal with balance sheets of developers…
— As far as I know, major banks mostly embrace the changes. They perceive the changes not as charity activity but as an opportunity for dramatically expanding their businesses. Banks, currently, participate in financing housing construction, including through extending their loans to co-investors. Yet banking lending to developers takes place on an extremely low scale. The proposed changes would enable the arrival of transparent and explicit borrowers such as developers, and, hence, the increase of their credit portfolios.
— What model for transition from financing at the expense of citizens to project financing at the expense of banks do you deem to be the most effective one? How could it be adjusted to Russian environment in such a way as to protect the interests of people?
— There are two financing options which could be referred to as “minimum” and “maximum” ones. The “minimum” option implies the introduction of banking supervision of intended use of money, but without imposing any limits to the amount of funds which continue to be used for the purposes of construction.
The “minimum” option (to be implemented in future after completion of the “minimum” program) envisages a transition to a presale scheme with a downpayment of not more than 10%. The downpayment, in that case, should be returned in full in the event that a developer defaults on its obligations. A developer and a bank use their own funds to finance the construction activities.
— Developer community, however, demonstrates its negative attitude towards the proposed revolutionary changes in equity construction. Top-managers of major developers told this magazine that the sector at issue doesn’t need any revolution to take place. They propose solely that supervision of intended use of co-investors’ money be tightened and the ensuing responsibility be imposed, and also that related auditing procedures and penalty schemes be introduced. They also advocate the removal from the federal law (No. 214-FZ) of an option of fund raising through housing construction cooperatives as well as of issuing housing certificates which could be regulated, as suggested, beyond the framework of the foregoing federal law. In other words, developers prefer an evolutionary option implying the transformation and improvement of the system rather than its destruction. According to developers, a revolutionary reform of equity construction, in present circumstances, may cause a collapse of the real estate market and push many developers to a “shadow” side of the economy. How would you comment that?
— This means that developers would rely on the “minimum” option because the use of auditing practices entails, in fact, the placement of money special controlled bank accounts. In my opinion, that is what we should begin with.
— Well, let’s, then, speak about the accounts. At one of recent meetings of the working group the representatives of Sberbank, Gazprom and VTB proposed that special accounts for supervision of intended use of funds in respect to each object under construction be maintained, just in the same manner as in the case of a federal law on state defense procurement (No. 275-FZ). Under the scheme the funds are kept “frozen”, and they could be used by neither bank nor developer until the commissioning of the real estate object takes place, and the construction activity is financed from loan funds. However, Alexander Khinshtein, a deputy of State Duma, Aleksander Khrustalyov, Head of “NDV-Group” and some other observers consider that in case of adoption of the bankers’ proposal the price of a square meter of housing would increase by 40—45%. In that regard, Minstroy Rossii, stated that the proposals previously presented by Russian banks, wouldn’t be supported. Nikita Stasishin, Director of Real Estate Department with Minstroy Rossii specified the underlying reason – a 23% increase in the price of a square meter. And what is your estimate of price changes under the scheme?
— I guess, the estimates don’t rely on economic calculation. These seem to be based entirely on the subjective opinion of the foregoing persons. Herein above, I have already explained the price setting process and the methods for improving the developers’ business, and have also highlighted the objectives of the proposed changes such as better guarantees, even though by way of increasing the price of housing. This, however, should not necessarily happen in that way.
I should draw your attention to the fact that, today, we also have to pay for cheated co-investors (indeed, the costs don’t vanish into thin air), but only do that implicitly. For instance, in the form of budget expenditures covered from our taxes. And, alternatively, in the form of infill construction permitted to the developers who agree to complete the construction of abandoned buildings in exchange for economic benefits. The country sees the surge of the ensuing town planning conflicts. Society suffers losses because we are unable to use the simplest instruments of control commonly used in countries which, by no means, appear to be developed (e.g. Egypt).
— What is your forecast: would it be possible to find the “golden mean” suiting everyone? That is, ensure that real estate market avoid a collapse, citizens get protected, while banks and developers be relatively content with the new rules of the game. Would there, necessarily, appear an injured party?
— I’m sure the market wouldn’t collapse. Just similar talks accompanied the adoption of the federal law (No. 214-FZ) ten years ago. But neither market collapse nor unforeseeably steep increase in housing price followed.
Market participants seem to be afraid of the novelties because of the uncertainty they feel. But I should note, however, that all developers, by no means, consider in that way. Their opinions have, normally, divided. The matter is that they simply need some time for adaptation, and I think that wouldn’t take long. But, in the end, we would rise to another level towards the streamlining of market relations in construction sector.