Russian Reform of the Construction Market: Prices are on the Rise, Developers are Going Bankrupt

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Yuri-Konstantinovich-Chaplygyn-moscow
Russian reform of the construction market Russia

Reflecting on the results of introduction of project financing through escrow accounts

During the summer of 2019, a revolution broke out : the Law on Project Financing of the housing construction using escrow accounts came into effect. The authorities presented this innovation as a silver bullet against fraudulent developers. At the same time, industry experts note that along with shady and unethical construction companies, many good faith developers were driven out of business. In the regions, the new mechanism of financing of construction projects practically did not take off, and a market of new housing developments is alive thanks to the projects, launched in the past and during the first half of the outgoing year.

THE IDEAL PICTURE

“The market is crushed. Construction companies are going down,” comments real estate expert Yuri Konstantinovich Chaplygyn. “Even in Moscow, only a couple of dozens of developers can be considered as standing firmly on solid ground, as opposed to hundreds, a year earlier.” In Podmoskovye (Moscow outer area) and other regions of the country, the situation is significantly worse.

Let’s explain the nature of the reform. Prior to July 1 st , 2019 the construction companies had possibility to accumulate funds directly from the shared construction housing investors (homebuyers) and later invest funds as they chose. Including the external projects, which often led to the bankruptcy of the developer. As a result, the shared construction housing investors were left both without homes and without savings.

Currently, all the funds of the homebuyers are accumulated in special bank accounts (escrow accounts), the developers finance the construction either at their own expense or by bank loans. They can have access to the clients’ funds only after completion. If the developer didn’t complete the construction of the high-rise, the bank returns the funds to the homebuyers.

A worry-free, ideal picture? – No.

The Law on Project Financing was adopted as a special operation: hastily, by cavalry charge, without taking the opinion of the market participants into account. What will be the interest rate of the bank’s loans? The response was that the market would regulate it. The expectations were far from being cheerful - and later that was unfortunately confirmed.

“The cost of construction has soared, as well as the housing prices: in 2019, the prices on newly built housing of Moscow region went up by 30%. The financing schemes of hundreds of well-off developers were broken. As a result, the foundation for bankruptcies was developed, as well as nervous tensions on the market. Meanwhile, people purchasing newly built housing, finance it as a mortgage carrying interest, and later banks provide the same funds to the developers as a loan bearing interest. It’s just magnificent!” – protests Yuri Chaplygin.

THE RATES OF CONSTRUCTION ARE PLUMMETTING

Almost half a year passed since the inception of the construction reform. This time period should be sufficient to for an objective assessment. In reality, the experts and officials came to the most varying conclusions, which often contradict each other.

“Prices could jump 20-30% only in those boroughs of Moscow and its vicinity, which saw a major improvement in transport commute. For instances, when the new subway stations were opened," attests to the correspondent of «KP» the head of analytical center «Real Estate Indexes» Oleg Repchenko. “The developers in fact alerted that the move to escrow accounts would lead to astonishing raise in prices, but in fact, it did not happen. As an average, the price of newly built housing in the capital rose by 3-5% - commensurate with the inflation rate."

At the same time, on the website of the same analytical center IRN.RU, a report showing the situation on the market being far from bright was posted.

According to the data of ”Metrium”, in October of 2019, the average price of the apartment bought on CCI (contract for the construction equity co-investment - «KP») the price for the apartments in the в «old part» of Moscow reached 12,1 million rubles vs. 10.9 million rubles a year earlier.

In New Moscow, the average transaction check went up from 5,1 million to 6,2 million rubles in a year the report states. The prices soared especially hard in the comfort class: according to Bon Ton, by 43% in New Moscow and by 11,2% in the region.

In private conversations realtors and developers speak out even in more straightforward manner.

“Introduction of the escrow accounts had also impacted Moscow, but to the biggest degree in Moscow oblast and other regions. In many regions we saw significant decline in the financing volumes of the newly build housing,” notes Vice President of the Russian Guild of Realtors Konstantin Aprelev. “And this tendency will not only be maintained but will become worse. Because the scheme of attracting financial resources of the buyers in the co-financing construction, in my opinion, is not thought through to the end, and does not allow to maintain necessary construction volumes."

The reform diminishes the number of contractors and enlarges this business. In is not bad by itself as large companies are more reliable. But if the scheme of attracting financial resources will not be thought through to the end, expert believe that the volume of high rises construction will drop even in comparison to 2019.

In October (3 months after the launch of the project) the auditor of Supreme Chamber Svetlana Orlova during the Hour of the Government in State Duma made an announcement that the Nationwide project «Housing and urban setting» is on the edge of failure. According to the conclusions of the Supreme Chamber, the move of the construction industry to the escrow accounts can lead to bankruptcies and market exit of up to a third of all developers. This concerns mainly small, medium sized and regional companies, which leads to a risk of increasing the number of partially built housing and number of the defrauded homebuyers co financiers.

GREEDINESS AS IT IS IN MOSCOW

According to the Chairman of Central Bank Elvira Nabiullina, it was not a smooth transition to the new scheme of financing of the construction: neither finance organizations, nor developers had enough experience of working according to the new plan. The Banks showed little enthusiasm towards new development: from 95 authorized credit institutions, only 39 showed interest to financing the developers by escrow accounts. The Central Bank ruled that by beginning of the fall, out of 120 million sq. m of new housing under construction, about 57% will be finalized employing the old scheme, about 14%-is envisioned to transfer to escrow accounts and for about 30% the mechanism of financing was not yet decided on.

“In St. Petersburg and Leningrad oblast, the rates of construction didn’t drop. The switch to the project financing went quite smoothly, as we have established a good rapport between the business and authorities,” noted the Head of the Committee on Interaction of Developers with State officials under the Russian Union of Construction Workers Oleg Britov, “But in the other regions the situation is much more complicated”.

In the opinion of this famous St. Petersburg contractor, the problem of project financing lies in the fact, that the banks do not offer “green light” to the regional developers: the profit margin of the regional projects is minimal, but banks establish high interest rates on their loans, similar to the cities with million plus inhabitants. As a result, the authorities are trying to direct the market from the road of co-financing, but the mechanism of project financing is not being launched.

It looks like, the authorities are beginning to realize this as well. On December 17, the Deputy Head of the Ministry of Construction of Russian Federation Nikita Stasishin informed that in the year 2020 the Law on escrow accounts can be amended.

«Today, the disclosure of the escrow in Russia (transfer of the homebuyers funds to the developer - «KP») is prescribed after the initial registration of the property title. We have agreed that we will analyze the law enforcement, see how it will proceed, and next year we will revert to this matter. “The objective for the next year, is to understand how best to achieve this,” states the Deputy Minister. “These funds can be channeled to the same projects, to the same networks, towards the purchase of the new building lots.”

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