5 Myths of Russian Construction

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5 Myths of Russian Construction
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The average living area for a Russian is 24 square meters. In Europe this figure is 45 square meters, and in the USA, more than 70 square meters. These figures definitely show how we lag behind in this sphere. The modern term “real politics” is very much applicable to Russian construction, though it is subject to different kinds of myths. 


Myth 1 — house price increases are not connected with rivalry in housing construction.
Myth 2 — the only constraining factor for the housing construction progress rate is the acute shortage of lots for building houses, and that’s why it’s necessary to increase their number.
Myth 3 — it is necessary to increase the integrated development of new suburban and intra-urban territories.
Myth 4 — the development of low-rise construction must be a priority as a solution to the housing problem.
Myth 5: housing construction is a driver of the economy.

Let’s consider each of the myths separately.

Rivalry for the chief’s ear
Before 2008 there had been real price growth on the market due to the proposal deficit: an average of 8—10% a year. An additional factor was the development of mortgage loans. Since 2006 the annual volume of loans granted had increased by up to 2% of GDP, and credit debt had grown by up to 4% of GDP by the end of 2014.
According to the Executive Director of the “Urban Economy Institute” Foundation, Tatyana Polidy, the analysis of the housing market in the RF 61th region showed that the elasticity of the Russian housing accommodation offer is from 0 to 3. To remind you, the elasticity figure illustrates the growth percentile of offer volumes on the market if the price is 1% higher. Market sensitivity to demand growth is lower in wealthy and economically developed regions than in less developed ones. In other words, the developers there have more market power, which, together with less rivalry, allows them to gain more profit.
In the opinion of the Managing Director of JSC “Federal Center for Project Finance”, Ilia Ponomarev, the chief rivalry today is not in the sphere of construction technologies nor among contractors, but in the sphere of “having the boss’s ear”. So, there is no demand for an increase in work efficiency because its doubling gives only a 5% increment in profit, but a good get-together with the mayor means an increase of at least 20%.
Two years out of three, on average, of an object’s construction are spent on approval procedures. It is possible to alter this situation only by reducing the factors which prevent a rival’s development on the market.
According to the analysis, there are three such factors: unequal access to communal infrastructure; uneven social sphere expenses, which depend on an agreement with local authorities; and administrative barriers at all stages. These factors arise from the union of contractors and the authorities taking decisions. The result is an absence of rivalry on the Russian development market.

Is clearing useful?
Russia is thought to have a lot of undeveloped land. For the previous three years, only 20% of potential construction volume was implemented on land allocated for that purpose. This means that either some sections were acquired for other purposes, or that three years is not enough for the implementation of a construction project in Russia. That indicates that barriers exist in this market.
Since the beginning of the 2000s, the volumes of new housing supply have been growing. But the demand was much higher, and was mainly satisfied by the means of integrated development of new territories but not the reconstruction of those already developed. And if, in 2000, reconstruction investments were 10 times lower than new territory development, in 2012 they were 20 times lower: that is, extensive development triumphed over dwelling stock in poor condition. The result is that from 2000 to 2012 the share of obsolete and worn-out housing grew from 15% to 18.5%. It significantly lowered the effect of new construction as far as citizens’ housing provision was concerned — the latter grows more slowly than dwelling stock. Thus, the development of construction in this period of economic growth didn’t yield the expected results.
And how are existing Russian cities’ territories developing? In 2014, this issue was investigated after a request from the National Association of Dwelling Developers (NOZA) and NOSTROY. Cities with a population of more than 250,000 people were studied. Their capacity was 262m square meters of housing instead of old and substandard housing. In reality, only 16m square meters of living area are being built in these cities per year, so it will take 33 years to implement these volumes.

Forward, to the past!
Let’s consider dwelling construction according to the types of housing. According to the data of the expert Tatiana Polidy, the share of individual housing construction (squatter development) is 40% of the total volume. This is the same level as in 1939 as regards implemented areas.
About half of the dwelling put into operation in 2014 (in total, 80m square meters) was constructed outside of the market without any business scheme. Only 6.6% of one- or two-storey cottages were created by professional developers. One should take into account that the housing market in Russia is defined by the specific character of cities. In northern cities, practically 100% of all possible living space is not squatted or developed, while in southern areas most of it is used.
A number of experts greatly doubt that low-rise construction is an effective strategy for providing housing to Russian citizens. Specialists consider the compact development of Russian cities to be more economically efficient. Moreover, the population in these cities isn’t increasing. Such development should be carried out by increasing the density of built-up areas.

Can-do approach
A very important factor is price structure. According to Rosstat data, the average price for a square meter across the country in the primary market is 52—54 thousand rubles. Half of this is down to construction and assembly works, 10% is the price of the land, and another 10% is due to infrastructure. The share of payback loans is difficult to evaluate because our developers work according to a somewhat obsolete scheme, attracting money directly via construction co-investment agreements. This is characteristic of developing countries: in industrially developed countries, loan mechanisms are used and people buy ready-to-inhabit housing rather than those at the blueprint stage. With credit projects, loan pay-back takes 10% more. The rest is the developers’ profit.
It is clear that constructors would be glad to take on loans, but the Central Bank regulation on 100% debt provisioning prevents them from doing so. That’s why even in the most successful years for construction, the rate for the cheapest credit was 18%, and the project implementation period, with regard to sales, was 4 years. If housing is not sold after three years, the developer incurs losses. Nobody wants to work under such conditions, so they look for money from private citizens. It’s our tradition to do everything to try and get money from individuals.
Nevertheless, construction cost decrease is quite a ‘can-do’ goal. According to the President of the “City Economics Institute” foundation, Nadezhda Kosyreva, within the framework of the program “Housing for the Russian family”, which defines the cost of a square meter as 30 thousand rubles, a lot of consultations have been held. This figure was deduced from minimal marginal costs: 20 thousand rubles for construction and assembly work, 4 thousand rubles for communal and social infrastructure, 1 thousand rubles for land rent, and 1 thousand rubles for credit. A number of developers have claimed that the sum is not enough, while others think it is.

The fact that housing prices, according to this program, are 20% lower than market prices is defined by Government Resolution ?404, Alexander Semenyaka, former Head of the HMLA (Housing Mortgage Lending Agency), reminds us. An agency insurance company is ready to underwrite a developers’ business (those who take part in the project). Within this framework, the HMLA implements surrender mechanisms for support facilities at the price of not more than 4 thousand rubles per a square meter. Developers not willing to work under this program won’t get state support. I think it is quite reasonable to bring discipline to the construction market, to define dwelling standards and requirements for developers, and to support those companies certified according to the current standards. The authorities have this intention - we’ll soon see if they have enough power to follow through on it.

A mess of contradictions
However, it is quite difficult to improve the housing provision for the population with the construction only of multi-storey blocks of flats. According to modern tastes, a family of 4 people needs a flat with an area of 140 square meters, and there are no investments for such mass construction at present.
The way out is to rent housing rather than to own it, but the plan was that everybody should become investors and owners. The result is that we have more and more studios being built. But if this continues, the average housing provision will be 18 square meters per person. Construction of business-class housing for everybody is not realistic.
All over the world, people start to deal with investments when their main requirements, including housing, are satisfied. After that, they buy real estate. That’s why we now have a mess of contradictions.
And this is not the only thing. The program “Housing for the Russian family” and other programs are dozens of times lower here as a percentage of GDP than in, for example, the USA. The figure there is not impressive - it is only 0.3% of GDP - but in Russia it is 0.012%. Besides, this support is aimed not at constructors but at the secondary dwelling market.

Grim perspective
The fifth myth of the Russian construction complex is that housing construction is a driver of the economy. It may or may not be so. There are examples of countries which chose this path: Spain and Portugal. The result has been a terrible crisis on the real estate market and whole towns full of unsold houses. And if we keep in mind the American mortgage loan crisis, we will understand what risks exist.
Another fanciful belief is that it is necessary to build as many million square meters as there are people living in the country. That is, 1 square meter of housing per person, as in all developed countries. However, in the majority of states, including European states, the housing provision is less than 1 square meter per person. Moreover, the index itself, measured in square meters, is misleading because it results in the occupation of free territories and ignores those already built, but the population doesn’t increase! This is clear evidence of the absence of any housing strategy, and of the wrong construction and urban development policies. It is necessary to build both housing and all associated objects. Not only communal and social infrastructure should be supplied, but also transportation, education and so on. There is usually, at best, only a nursery school and a primary school on a new-built project in Russia (the Moscow region is an exception). Thus we are copying dormitories of the Soviet type. It is a sad state of affairs for the development of Russian cities and towns.
Additionally, state support for housing programs is not efficient. Its volumes are the same as in other countries – 2 to 3% of GDP per year - but it is distributed according to the principle “the rich get richer”.
Reconstruction and development of built-up territories, and the demolition of old and substandard housing, is more suitable for state investments than the forms that exist now. This practice must be fundamentally changed — the sooner the better.

Vladimir Gurvich
Editorial note: In publishing this personal point of view, we invite our readers to take part in the discussion on the means of development and the priorities in the construction industry.