Changes to Land Law May Help to Bring Life to a Slow Market
There has been a lot of press coverage and commentary on the impact of events on businesses and economic sectors and we are certainly seeing a lot of hype around real estate. Yet most of the press coverage tends to be negative or, at best, tight-lipped.
Indeed, Russia can hardly be called the most obvious or safest destination right now for the average foreign investor. However, from another angle, the real estate market is still demonstrating some activity. Here and there, new projects are being launched, deals are being closed and new players emerging (few though they be!).
This article sums up certain rather obvious factors affecting Russian real estate market players and describes the type of projects which, in my view, remain sought-after or promising, and perhaps gives an explanation as to why.
As a lawyer, I am bound to start with legal developments affecting real estate; particularly since there have been so many. There have been and will continue to be both large and massive reshuffles of laws and specific, targeted changes.
The altered Civil Code, with amendments already in place this autumn, and the planned changes to the land law coming next year are good examples of major change. The latter is the largest change since the Land Code was passed back in 2001. Proposed legal developments seek to govern public land allocation and use, more precisely and more strictly. It is an attempt on the part of legislators to prompt certain activity by developers and landowners in order to counteract land being deliberately put on hold in the hope of finding an attractive buyer. These amendments might, indeed, have a positive effect on the market, bringing more transparency to developers' operations. Yet there are questions that need asking, both about the draft law as it stands and the missing subordinate legislation.
Of specific interest are alterations to rules about the investment partnership that may now be used in real estate. In fact, a new format has emerged for making investments and establishing joint ventures in real estate. This is somewhat similar to a limited partnership in English law (distinguishing between a general partner in control of a business and a limited partner making an investment only). This is not, of course, a comparable substitute for classic tools, yet we can only rejoice at seeing the legislator's continued search for new types of joint venture.
There are also notable changes in tax law. First and foremost, the Tax Code is to be amended in line with the current deoffshorization policy. Most deals in real estate are, of course, effected at the corporate level, through transactions involving shares in foreign companies indirectly holding property in Russia. So it is no surprise that the news of the planned tightening of the screws related to the transfer of real estate rights with minimal tax implications (or none, depending on the jurisdiction) has promoted some market players to undertake such transactions this year.
Yet this coin has its flip side, as many market players have suspended their projects, mostly those involving a planned exit after 2015, since they cannot clearly see the future rules of the game. The projected amendments are thus certain to impact materially upon the level and nature of the investor and developer market behaviour next year.
The idle (and probably the overly wary!) are the only ones who have not commented on the negative impact of the sanctions and tensions in foreign affairs on the real estate market. Indeed, the adverse effects are obvious and many have already suffered from them directly. Yet the long-term implications are still a fog. Even if the sanctions were lifted immediately, this would not guarantee a sudden inflow of foreign capital. It might even be presumed that neither Russia nor the West should expect such a capital influx as we all would still need some time to understand the world's new paradigm.
Nevertheless, the immediate effect of sanctions on the real estate market should not be overstated. This market is, per se, inert and incapable of responding quickly. To illustrate, it is not completely true that shrinking bank liquidity, which followed the latest set of sanctions, has inhibited development projects, with the latter being largely dependent on project finance leveraged by the banks.
Certain projects have suffered set-backs, it's fair to say, but in terms of less favorable conditions rather than a lack of finance. Besides, this also means that developers and other market players must learn to perform better. Top, popular and one-of-a-kind projects are still very attractive for financing banks that are interested in their own business development. It might be more difficult now to balance borrowers' expectations and banks' requirements, yet this is the way towards quality property developments, which are universally more attractive to both future tenants and buyers and can potentially enjoy sufficient demand in the market.
Available banking liquidity is not the only lever for sustaining real estate market activity in the face of sanctions. There are other triggers impacting on banking. Just think of the slackening activity of foreign banks on the Russian market in recent years — well before the sanctions were imposed. Against this background, big Russian bank financing of real estate projects flourished. This was mostly due to the challenges in Europe and not in Russia. To corroborate, one of the most active German banks financing real estate projects had to get rid of most of the assets in its portfolio after 2008, even though it was virtually the most reliable region for credit returns.
Yet again today we are hearing news about another banking crisis in Europe. Now it is all about Italian banks. Given all this, it is hard to predict whether the liquidity dynamics in the Russian banking sector would have been any different, had no sanctions been imposed on Russia.
Moreover, there are other fundamental economic factors affecting the market beside the sanctions. Although all those sanctions have been imposed on Russia, some companies in the fast moving consumer goods sector, including U.S. ones, are still extensively developing their business here. Should the FMCG market growth slow down, which cannot be totally ruled out, this will surely affect real estate, too.
In this case what projects are still up-and-coming and what is driving market players? Some have good reason to see opportunities for business development in the current situation. Attractive platforms are emerging, upon which demand is not as excessive as it used to be. So there is time to consider solutions thoroughly and carefully.
Everyone now says that retail and warehouse property have the best prospects, noting that warehousing evolves largely due to development of trade. Yet we are seeing many new developments in the office sector, too, albeit that vacant space is reported to have surged to over 20 per cent. I believe the prospects for a real estate property depend on its quality rather than its type. If it is a quality facility that has been developed efficiently, it will be attractive to banks and investors and, ultimately, to tenants.
I do not, of course, expect a lot of new market players to appear on the Russian commercial real estate market, though I wish to be proven wrong! Even so, I believe that, with the squeeze still on, market players can reinvent themselves and understand their future development strategy. Profiteers and non-professional market players will have to exit the market or slow down. I see this situation giving rise, in the long term, to commercial real estate of better quality and a more mature market.
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