Mechanisms of construction: in the USSR, in the West — and what is now in Russia?

Mechanisms of construction: in the USSR, in the West — and what is now in Russia?
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The October Revolution centennial is a moment to reflect on how the Soviet construction industry worked. What mechanisms, in the light of the current state of the construction sector, are considered to be the most effective. What Soviet experiences are close to modern foreign practices and how to use the lessons learned in solving our vital problems. We talked about all of this with the honorary builder of the Russian Federation, government award holder, Doctor of Technical Sciences and Professor at the Moscow State University of Civil Engineering (MGSU), Azary Abramovich Lapidus.

— Azary Abramovich, I came across a Soviet-era handbook entitled “Cooperative And Individual Housing Construction” dated 1989. I admit I was struck by the thoughtfulness and efficiency of the then mechanisms for construction financing. Tell me why is it impossible to imagine a problem, say, of hoodwinked investors being acute in the USSR?

— But there were no equity construction investors. One might join a cooperative, given that certificates from the place of work and social welfare institutions were collected and a permission to buy the apartment is granted. Then, the cooperative formed its own fund and opened an account — until Perestroika, all housing construction was carried out in conditions of Stroybank operations.

— Was such account to some extent an analog to escrow accounts, which are being promoted now?

— No, it was the Soviet Union, and the role of the state in controlling the funding of construction projects was altogether different at that time. Any construction was launched only when there were four basic papers: it had to be included in the plan, with a project brief, approved design estimate documentation, and allotted plot of land required — in that case, the account was opened for the customer. The developer submitted a work completion certificate to the customer, while the latter handed it over to the bank. A bank specialist checked the document with the estimate. As a result, the builder was checked twice, and only then funds were allotted and transferred to the builders.

— In light of the reality in which we live now, how is this experience perceived?

— Until recently, we had stayed in a state of continuous turmoil. I'm talking about the amount of permissiveness that was 8-10 years ago. After all, the 214th Federal Law was introduced in the early 2000s, before that everything had been built by a signal. There were not just hoodwinked investors, everybody was deceived. It seemed that the law made the situation more or less transparent. But you know, the same SU-155 almost did not work in accordance with the 214th.

— Yes, it worked in accordance with a housing construction co-operative.

— Also, the Federal Agency for State Registration could not control them, because the housing cooperative is a sheltered organization. If you look in depth, the consumer cooperation appeared in the Soviet Union almost simultaneously with the creation of our state. While housing cooperatives were one of the formats of this cooperation.

In the Soviet era, cooperation was a state within the state, they even had their own foreign trade. The cooperatives themselves were engaged in economic activity, while a person could become a member of the cooperative only under certain conditions. One could not just stop in the middle of the street, click the finger and say: “I want to expand” — it was impossible.

— If this was the only difference between the Soviet housing cooperatives and the present-day ones, why are they so defamed today?

— They are not transparent. Now, we are building a lot in Omsk, and our main competitors are housing construction cooperatives. What is going on inside them is impossible to figure out.

— As for interest rates. I read in a reference book the following: “Housing cooperatives received state loans through Tsekombank in amounts up to 90% of the estimated cost of the house for up to 60 years …”

— At 2% interest per annum, and if you returned in a timely manner, then the recalculation for 1% was made. In fact, the state financed this type of construction.

— Do not you get the impression that part of the Soviet experience needs to be revived?

— Look, all our experience was based on models close to capitalism — just within a special framework. What happens today when you go to a construction site in the USA? You do not buy the land directly, instead, you open an escrow account, transfer a certain amount and get complete documentation from the site owner. That is, the primary documentation was available to you initially, but here is the detailed ones, something for analysis and so on. You look it through and, if you are not satisfied, the agreed 5-10 thousand dollars disappear from the account. Then you go to the bank and get a loan against security of the land. Now, with money, land, and project, you head for the City Hall, where requirements for conditions of construction and security are specified. I know one construction site in the center of Los Angeles: the work of heavy equipment takes four hours a day. Moreover, they will also determine the hours when you can work.

And after that, when construction activities start, a contractor with his insurance comes and safely completes the building, and only then sales begin. For example, in Europe it is different: in Belgium, you can immediately sell apartments, provided that the construction is insured. And immediately an insurance company assumes functions of the controller since it has the right at any time to give information to the funding institutions. Moreover, there was an interesting story — in Belgium, it is the contractor, not the developer that is credited. The candidacy is agreed with the bank that is responsible for the project implementation, with the interest rate paid by the final builder.

The following control mechanisms are used everywhere: the bank with a considerable department that is able to check the documentation and insurers, who will check your actions at every step.

— And the loan there is, probably, like that in the Soviet Union, isn't it?

— Belgium, in general, demonstrates an astounding figure — 1.4%. I looked at the development calculations, they include it with a margin of 1.8%.

— It seems that the West adopted practices of the USSR, unlike Russia ...

— No, we all have been developing in one trend. Any construction site needs to be controlled: we had Stroibank taking up this issue, on the other hand — Stroinadzor and a customer service. Everything was the same as it was there. We had been developing in the same directions. Then, 1991 year arrived, when the thesis “Take sovereignty, as much as you can” was proclaimed. Independence was taken by everyone: republics, regions, all professions took it. Then, bacchanalia began in the construction, defense industry — wherever.

And when they began to impose restrictions, it turned out that the construction had developed so much for that period of time that it was quite difficult to regulate its activities. Today, we need a mechanism that will financially control the construction. Not a whip and a carrot, like supervision, but using the internal financial leverage.

— But insurance already exists, isn’t it? Recently, I visited a court session in the case of Tsaritsyno residential compound and part of co-investors was referred for compensation to a company, which insured the construction of new buildings...

— Compensation for 1% of the equity participation contract is a story made up in a rush, in order to do something. No insurance company receiving 1% is able to withstand this pressure. While I am referring to the mechanism for insuring the liability of the developer, contractor and the entire construction hierarchy. Yes, this will be more expensive but a real leverage.

I have an object in Omsk, we are building a complex and paying to insurers 1.5% for each property item that we register — I have not even seen these people. Once they arrived, nodded: “Yes, we believe you,” but what's next? When they included first apartments in their fund, they had to come in and ask for the construction plan, look through the documents with contractors and supervise the construction on a monthly basis.

— Perhaps the project financing will become an effective mechanism?

— The number of registered equity construction contracts has recently increased by 15%. Everyone was frightened, people are willing to sell the facilities before the amendments to the law come into force in July. I'm frightened by the following: Russian banks are not prepared for this, they are extremely sluggish, extremely inert — this is the first point. The second. It so happened that I provided consultations regarding a number of Belgian objects. There is the equity participation in the country, from the moment of registration, and Belgium is doing fine, without any hoodwinked investors. Tighter insurance mechanisms.

And now about the main concern. Suppose I am building a house and come to a bank since I need money. No problem, the bank says — 30% are yours, 70% are mine. No, I say, I came to you because I had the rest of the money and purchased a plot of land. How much would you estimate it? Well, before the crisis, it cost 30% but now 15%. However, you have a very good opportunity today — I'll close my eyes to the fact that by the time of financing you are already selling equity construction contracts for the remaining 15%. You will sign a memorandum and when the second or third floor is completed, I enter the project and finance it. That’s all, you have got the deal. That's exactly how today small and medium-sized developers build. But now they tell me, “there is no need for housing equity holders, go to the bank and it will give you money anyway.

— A vicious cycle.

— It is impossible that only five largest companies operate in the country or there will be no country. I am small, I sold the inherited apartment, I bought a piece of land, I have been elaborating a project for three years. And still, I cannot start construction. I am an honest person, I want to live in this city, I want to build a house, I am a businessman — but I am small. All my business is this house with an area of 7,500 square meters. Its price is 300 million (rubles — editor’s note). 30% stands for 90 million, while the land is estimated at a maximum of 35-40, and the project costs 15 — now I have to raise more money. I am known in this city, I was seen breaking the ground, I started doing something myself, but they buy apartments on a foundation pit at a cheap price. That's what the meaning of the 214th, and it really worked.

And yet, not a single object can do without the bank financing, there is no such sales dynamics. But under the new scheme, it turns out that the bank will earn not 30 million but much more. Before the crisis, loan servicing cost, provisionally, 8 million. Today this is 30 and will be even more because I will not be able to repay loans because of the sale of apartments under equity construction contracts. Based on real calculations, I have the loan grow from 30 to 50 million. Tell me, whom should I transfer these costs to? The matter concerns Omsk and the business environment there is such that one has nothing to do but phase out the business.

— Then, who will remain on the market?

— I suppose, there is a task to exclude small and medium-sized builders from the market. We get in the way. Now we will be thrown out of the market. As for us specifically, we are still able to hold out for a while, because we have the name, connections. But what about those who do not have them? In Germany, there is an equity construction, as well as in the Emirates. Well, the USA does not  — and so what? Should we equal ourselves with the world’s first economy?

— Or lower the interest rate.

— Yes, 1-1.5% and I'm ready to work with you. And again, look, all the risks will now be with the bank. It must be 100% sure that the construction will be successful. I think this is an absolutely wrong move. Find leverage on developers, take insurance mechanisms from contractors — take this but not deprive the average builder of the opportunity to participate in the business.

— Now, let's dream a little. What kind of houses would you like to build, what buildings, in your opinion, are best suited for citizens' living in there, and what construction mechanisms should be used?

— The whole range of buildings has the right to exist. However, when it comes to our country, the main prospect is low-rise apartment buildings. These are houses, with which Germany, Belgium, and France are built up. Comfortable enough, with good quality of construction materials, and with a public space. I think that the state should place an emphasis on the construction of such houses. I will motivate — we have a lot of land but we need to develop the infrastructure in any case.

— What is the number of storeys?

— Four storeys at most. Without a lift, apartments for inactive citizens located on the first storey and an elevator on the stairwell — in case the trouble happened to someone on the higher storey. I believe that 20 years later, this will be the main object of construction. In parallel with this, the renovation of a dilapidated housing stock of large cities will be carried out, with the erection of multi-storey houses necessary for resettlement of people from emergency housing.

— Why multi-storey? After all — I also dream — on the equity basis, on the site of one five-story building, another one needs to be erected...

— I am all in favor! But the state or people, who are at the source of the programs, need additional square meters. But there is a real problem: five people live in an apartment with an area of 24 square meters. While according to the regulatory requirements, they will occupy a 3-room apartment, with an area of 60 square meters. Where can I get the difference? That's the only reason that will not allow you to change one fund for an equivalent one.

— Even in this case, it is hard to imagine that the building tallness will have to be increased several times.

— In fact, everything should be in a different way. A smaller house can be built on the site, while those who want to leave will be granted an apartment in high-rise buildings. This will cost money to the state, but it should settle for implementing such a program. I recently traveled from Baku — while going around the city you feel like you were in Paris: all houses are faced with a natural stone. And the guide says, in 1993, the program of rehabilitation of the housing fund was adopted, according to which all houses of the city were faced with natural stone. That is, inside everything remained as it was but from the outside, they are incredibly beautiful. Perhaps, there was better construction, otherwise, they would have already collapsed.

— What mechanisms of funding low-rise construction would you use?

— When it comes to a low-rise housing, it is a lot easier since you can build a house within six months. It will be smaller than this monster, but in a few months it will already be there. Secondly, in Germany, for example, you can not immediately take money from the buyer for the whole house. According to the law: completed foundation — 10%, frame — 30%, etc. Let's adopt this practice. And there cannot be hoodwinked investors any more because the payment corresponds to the dynamics of construction.

— Again, this remains Soviet housing cooperatives.

— Yes, that was the case at that time! One did not have to immediately pay the whole amount, there was a down payment, something else…

— Are banks not interested in low-rise construction?

— Banks do not care. Low-rise construction, first, is cheaper, second, is cheaper at the start. Even a large building crane is not needed here.

— That is, everything depends on the infrastructure, isn’t it?

— Exactly. The state declared that it would take these parameters upon itself, but it cannot do it since there is no money. We face a vicious circle. I cannot start construction if the area planning design is not agreed with the General Plan. And if it is agreed, please, bring here all the infrastructure. So, the state begins to kick itself, in the person of the Mayor, who does not have money to clean the snow, while I am telling him about gas, water delivery and sewage. The Mayor is willing to make me a co-investor as before ... But I cannot and do not want to.

— And yet, who should take the first step? Banks?

— The first step should be taken by the state. It should absolutely clearly formulate the rules of the game. And here it is very important for whom these rules will be written. Who can get in touch with Putin, the Duma today? Well, say, as a vice-president of NOPRIZ, I am admitted to the Duma, someone from the Presidential Administration can call me and ask a question. However, could an investor willing to build up a site in Omsk or Tomsk, get there with his aspirations? No. Who represents him? Nobody, actually. So those guys, who are the high and the mighty, come there to defend their own interests. The state should bang its fist on the table and say: “We are on the side of small and medium-sized businesses”.

In the mouth of the President, equity construction sounds like a curse. Accordingly, the same concerns Menn (editor’s note — Mikhail Menn, Russian Construction Minister), etc. It is unregulated equity construction that frightens. So let's invite professional developers, banks, insurance companies, contractors and registration services. Let’s get together and figure out how to make it so that a participant in the equity construction cannot be deceived.

Interviewed by Petr Larin