A Shadow of a Building Boom

What is all this construction everywhere? Legislation passed in 1993 is responsible for much of it.

In 1993 the Moscow city government passed Decrees Nos. 5 and 6 for the construction of new space and the reconstruction of existing space in the center of Moscow. The decrees are designed to foster construction and reconstruction of buildings.

The plan is simple: Investors submit construction or reconstruction projects to the city, and when a project is accepted the investor builds or rebuilds a building and receives half of the building as its property.

If there are several offers to the city regarding a single development, the city holds a tender and the project is awarded to whomever makes the best offer. Once an investor wins a project it enters into an investment contract with the city, spelling out what the investor is supposed to build, and who gets what once the building is completed.

In theory the plan is simple but the resulting situation is not.

Few developers are willing to develop a building and give half to the city. It is just not practical in most cases to have a single building with a split management team. For this reason, many contracts provide ways for the investor to acquire the entire building.

How projects have been allocated by the city is unclear. Most projects are held by companies that do not have the funds to build them. These companies now have the sole rights to develop choice properties -- and time and time again they are able to extend their project deadlines and tie up these properties.

These "investors" without funds to invest are not stupid. They are marketing their projects.

In exchange for financing their projects the "investors" are willing to give up part of their "deals."

Unfortunately, most investment contracts for projects being marketed in Moscow leave a few issues unclear, such as: which half of the building the investor gets, the price necessary to buy the city's half, and the exact type of project that needs to be carried out at the other location. Some investment contracts been have clauses that allow the "investor" to stand between future investors and subcontractors and make a profit on all services paid for by subsequent investors.

Any of these points is a potential deal killer and Western money cannot commit to projects based on ambiguous contracts. However, "investors" are generally unwilling to renegotiate their contracts for fear the city will take notice of the investors' lack of funds and take the project away.

Furthermore, "investors" often feel these problems with their contracts are unimportant details that will be solved in smoke-filled rooms at a later date to everyone's satisfaction.

In the end these problems usually cause Western firms to walk away from projects that they are able to finance.

So the next time you take note of the construction boom, consider that it is only a reflection of what could be.

Jamison Firestone, a partner at Firestone Duncan and Associates, has been practicing law in Moscow for 3 years.