The outlook for property in Moscow

Following a fact finding trip in February, Charles Romney reports on the property outlook in Moscow

Russia

The Russian Federation has a population of 150 million and a total area of 17 million square kilometres. Even after the break-up of the old Soviet Union, it remains the largest country in the world.

During the years since the disintegration of the Soviet Union in 1989 - 1991 the country has reined in inflation (from as high as 410% in 1991-1995 to 20% in 1997, with 12% forecast for 1998). In 1997 the Russian rouble was re-based with a thousand old rouble to one new rouble. GDP was expected in 1997 to show positive growth at 1%. It is forecast to achieve year on year growth of 5% from 1998 to 2000.

Statistics for money supply, per capita income and spending are difficult because of the enormous grey market, reckoned to be 40% or more. For instance, the official statistics that the income into an average household is US$120 to US$130 per month translates to US$205 to US$225 per month in the figures produced by one research company if one includes the grey economy. These are figures for Russia as a whole with considerably greater spending power likely to be present in Moscow. Also, housing and transport are still heavily subsidised, making Russians bigger potential consumers than their incomes suggest.

The grey economy also makes unemployment levels hard to calculate. At the time of the Soviet Union it was officially less than 1%. Officially (that is ignoring the grey economy) it reached 9% in 1996, but was probably higher in 1997.

Foreign direct investment is still relatively small when compared with the size of the Russian economy and its potential for growth and the wealth of its natural resources (for instance oil, gas, diamonds, gold and coal). It is believed that the total amount of foreign direct investment since 1991 is about US$5 billion and although US$26 billion was forecast between 1996 to 2000 this may be optimistic.

Moscow

The city, which last year celebrated its 850th birthday, is the largest city in Europe with a population of 10 million (15 million in the Greater Moscow region) and an area of 384 square miles.

Traditionally Moscow has grown outwards from the Kremlin on the Moscow river. The greater part of central Moscow lies to the north of the river. All the main arterial avenues of the city radiate out from the Kremlin (such as the Leningradsky Prospect which connects the City centre to the airport) and are tied together by three ring roads circling the city, the Boulevard Ring, the Garden Ring and the MKAD.

There is no typical "down-town" area as such with prime offices, retail and residential areas dotted around within the Boulevard Ring and the Garden Ring. One reason for this is that new fibre optic telecommunica-tion cables have been run through the metro system and new development has therefore tended to be concentrated in areas of easy access to the metro, no-one wishing to be connected to the older analogue telephone lines laid elsewhere in Moscow.

Moscow is a city designed and executed on the grandest scale with the various avenues and prospects radiating from the Kremlin being largely straight, of considerable width (four or five lanes in each direction - sometimes more - often with long wooded parks in the central reservation) and substantial buildings on either side of the street. The architecture is often imposing and because one is able to stand back from the buildings one is able to gain a good impression of their substantial scale.

Moscow land ownership and development

Most land in Moscow is owned by the City, although some of the old state organisations, such as Aeroflot, claim ownership to land occupied by them. There was a partial liberalising of property law in 1991 as a result of which the City can and does issue 49 year development leases to a variety of developers from home and overseas. In many cases the development that results is in the form of a joint venture, either through a joint venture company or with the developer developing adjoining land for the City and giving the resulting buildings back to the City. The building which houses Cameron McKenna's Moscow office is the result of a joint venture between the City and Turkish developers, Enka.

In addition to reaching terms with the City of Moscow for the development and letting of a potential site, the developer must also obtain consents from the city architectural department and utilities and safety departments. All this can take a year or more, although it becomes easier as the developer gains a track record. It is generally acknowledged that mere compliance with the rules and regulations is not sufficient. It is very important whom you know in negotiating the lease and obtaining the necessary consents.

Once the developments are under way, occupational lettings are typically for five years, very often with the tenant receiving no rent free period and indeed paying the first year's rent in advance. To a greater or lesser extent service charges and insurance rents will be payable by the tenant in addition to basic yearly rent.

Most developments to date have been carried out by developers without site specific borrowings as there is no mortgage law yet in Russia. The typical developer will have general borrowings elsewhere which it is able to use to fund the Moscow development.

In addition, the banks themselves have been major developers using specially tailored subsidiaries to carry out development.

Where banks are involved in the provision of finance to developers this has tended to be through joint ventures with the banks having an equity entitlement.

Future investment market

As yet there is no investment market and no security market. However, there are a number of potential investors, particularly American backed, in the wings waiting for the first investment deal to be done or for the law to be reformed to enable the proper creation of an investment market. Some believe that the first investment deal will be done in 1998, whether or not the law is reformed. They believe that this will be followed by many others once the ice has been broken.

The Russian Duma proposed a law some years ago to reform property law. This was highly political and was vetoed by President Yeltsin. Much of the past freeing of the market has resulted from presidential decree which is at best only temporary. The president has arranged the preparation of a new draft law which, if passed, will further reform the market, although it is not clear at this stage whether it will free controls on ownership and help create an investment and security market. The draft law is being considered at the moment and if not passed by the Duma may be enacted by presidential decree. What happens in the near future will therefore be of considerable interest to potential developers and investors.

Note: This continues our series of occasional articles on other European property markets.