A Challenging Market With Great Potential But Confidence Is Key

David Whitehouse

Regional Managing Director

Aecom Russia & CIS

Over the past 20 years Russia has seen great advances in the quality of construction. The reasons are diverse — greater technical skill, higher land prices and rising expectations among clients. Despite the ebb and flow of foreign investment, the capitals and now the regions have modernised — thanks to the emergence of† younger,† well-traveled politicians.

David Whitehouse has observed and helped drive the change during two decades in the country. In 2009, Savant, the project and cost management company he founded, became part of Aecom, a giant in the sector. Its activities in Russia range from offices and stadiums to transport infrastructure: motorways, high-speed rail and bridges.

Other projects include the stadiums and infrastructure for the FIFA World Cup in 2018. Mark Gay discussed the trends, challenges and technical issues of the Rus≠sian market with David Whitehouse, Regional Managing Director for†† Aecom Russia & CIS.

Trends and Opportunities

How does renovation of the twin capitals compare with what's happening regionally?

David Whitehouse: From the inner city perspective, Moscow and St Petersburg, aside from road traffic, are pretty good. Moscow has one of the best metro systems in the world, along with trolleybuses and trams. What it probably lacks now is light rapid transit, over ground that is quicker and more efficient. The infrastructure outside the city centers is largely in decay. There are not enough rail links and they are pretty slow. In Russia you often need an overnight train where in other countries you could travel the same distance in 6 hours on a normal train, not even high speed. So rail is an area that is focused on upgrade, as are regional roads, arterial main roads, and highways from Moscow to regional cities. In terms of airports, Moscow is well equipped, though there are plans to expand the main airports. As for regional airports, we built new terminals in Vladivostok and Moscow, but there are 15 tier two cities with above a million population and the tier three cities, where there are 300,000 to half a million people, have a challenge with airports.

Why is Russia's infrastructure improving so slowly? What holds people back, is it lack of experience?

DW: It is lack of investment. I think regional and federal governments know exactly what's needed because you can see it in other parts of the world but there is so much needed and investment is finite. So the choice now is high-speed rail, or four new regional airports or six new arterial highways. One issue that's being resolved right now is the legislative framework for public private partnership. Countries that have strong infrastructure have gone down the PPP route. The M11 is PPP; the high-speed rail may not†be PPP.

If you take a typical toll road and you have trucks running between Moscow and St Petersburg, are they going to pay 'x' to get there four hours quicker or are they going to go along the existing route free of charge. Some of the surveys were mixed but generally they were positive, hence the project is going ahead.

It's not just about linking one city to another it is what happens around that link. Instead of the past strategy of building a city around something like a river delta or below a mountain, and then building the infrastructure to fit, what a lot of countries do is build the infrastructure, then put in the houses, hospitals and schools. And that is how cities and linkages develop.

Several cities are rethinking their historic centers, moving business, or certain types of development away from historic centers. Does Russia need to do the same?

DW: Many cities that were built centuries ago around rivers for transport have since moved. Almaty moved to Astana, Istanbul moved to Ankara, Moscow has been to St Petersburg and back.

As for business districts, London is expanding and Canary Wharf is becoming the finance district. Moscow has moved business out of the center to Moskva City. It may move further as the agglomeration spreads to the south and west. I think there is a good case to move government. Turkey and Kazakhstan did it to ease traffic, increase business in the center, and create a better hub for the public with more pedestrian space. I think the southwest is an obvious choice. We contribute to a consortium committee for the Urban Land Institute, which advises on the agglomeration. Given the airports and the highways going through Moscow south it seems to be an obvious choice. There is a lot of industry in the east so that limits expansion there.

Would a move out of the center make any difference to the high cost of land in Moscow?

DW: I don't think it will have much bearing on land prices in Moscow which in a lot of cases are prohibitively high, which is why a lot of projects don't get financial close and if they do it impacts what you put on it. This is driving the changing investor approach. They are building investment grade, with a 50-year life — they are doing that because the land prices are so high that you have to put A class offices in order to get long term returns because you can no longer make money on a quick get out as you could 20 years ago when land was very quickly privatized.

What is driving the trend to invest in Russia's regions?

DW: The fact that development inside Moscow is difficult is not Russia specific; it is no different to any capital in the world, New York, London, Tokyo, Paris where because of the capital's size, its ability to control and dictate is much greater. But the regional governments in many places are very investor-friendly because one of their KPIs is to develop the region and they are not going to do that if they are not investor-friendly.

What kinds of business are being attracted to regions?

DW: Manufacturing industry. That develops regionally, it provides workforce and revenues and, on the back of that, there is a need for housing, hotels and infrastructure. Twenty years ago everybody outside Moscow wanted to get to the capital and it was a lifelong dream just to get to Moscow. Now people are moving between regional cities and there is competition between regions. Ten years ago it was Novosibirsk and Yekaterinburg. Now there is a big push on Vladivostok region and if there are investment and jobs, people will move.

Foreign investors are not as present as they were. Is it the cost of land, the fact that local develops hold the land banks, is it confidence or perception of risk?

DW: Some investors and developers came here and for want of a better word were burned or had a bad experience. The ones that have remained here are the ones who are confident, can manage the risk, and have been through the process numerous times, the likes of Hines or AIG. They are doing building after building and they know the expectations. To come back in the second time is harder because you need a far greater confidence level than you had the first time. And land prices are higher.

Some outsiders cannot understand the level of risk because they struggle to measure the risks in Russia. What is your advice?

DW: There is also the fact that some developers just are a more trustful. I think there is trust. The problem with Russia is not what your risk is today but knowing what it could be tomorrow. Things can change rapidly. In London or New York change takes place slowly, in consultation with business, where here it might be: 'as of Monday morning we are putting a motorway by your office and there is nothing you can do about it' or 'we are moving the business district to the southwest of Moscow' so whoever has just developed in Moskva City, what are you going to do with those buildings? It's faith and a lot of the developers have good contacts and can see more easily than someone who has just come to the country.

Problems and Challenges

How is Moscow changing?

DW: Moscow has a high ratio of inner city residential which is why you see a lot of business centers spread out. It's changing in Moskva City where you are getting a commercial district. It is not like some cities where you have a commercial district, a retail district and residential. The residential is being pushed out of the city but that is being hampered by the transport links back into the city. It takes decades to build homogenous districts and transport links.

The center still has a big problems with poor roads, and bad drainage and when you get out of the city, a lot of roads should probably be ripped up and totally rebuilt. Why is it so difficult to get around to fixing basic utilities?

DW: Highway maintenance is a contentious issue. The problem is the budget available and the quality of product and workmanship that is putting it down is inferior, in terms of the design and base of the road: compaction, how deep is the base. I often get told Moscow is not like London because we have climatic swings from plus 30 to minus 30 Celsius. Which is true but it is no different to Canada, Finland, Sweden or Norway who have exactly the same temperature issues.

The other aspect is the same companies put the same inferior roads down year after year and then maintain them the following year so there is a revenue stream. Instead of putting a road down with a lifespan of five to 10 years. It's about lifetime costing: you pay a lot more in the beginning but your maintenance costs are lower and that whole philosophy has not yet arrived here in terms of federal government roads. It is here in terms of privatization roads. If you look in 10 years' time at the maintenance needed on the M10 it will be far different to an arterial road that was laid down two years before.

Will the use of PPP to create more privatized roads change things?

DW: I think that alone will change attitudes because government ministers will ask why are we spending so much maintenance on this road and not that one. They'll weigh up that it would have cost them 40 percent more to build but they'll see that the actual costs are lower over the lifetime. That also brings into question the transparency issue. There has to be the will and if the will is there the money is there.

Is this problem common to all the countries you oversee in the CIS and Turkey: what is the difference in attitudes?

DW: It is different in different countries. For example, if you look at parts of Kiev, like the highway to the airport, or Baku, which is a prime example of quality in road infrastructure for new main arterial roads. If you go there you do not see annual repairs to roads. Generally it's well built because they've done it properly in the first place, paid a premium to put quality down and they recognize in the longer term it is a better investment. Kazakhstan is different. There are some decent aspects around Astana but if you go to other cities you see the old style strategy. Turkey is not CIS but it is in my region. Their major road infrastructure is good.

In Moscow, there is a lot of progress with the introduction of bikes and the greening of the city but a lot of the districts are still islands, cut off by poor roads. There are competing organizations responsible for different elements to the road. What is the way around that?

DW: We have worked with Moscow city government in a bid to ease traffic congestion. Cycle ways is an example of where we are working with the city. They'll be on the edge of the road in most cases. We also are working with pavements and sidewalks. We have advised a whole host of issues to alleviate traffic: parking issues, locations of bus stops, traffic light control, turning strategies off main roads, whether you turn left right. It is a difficult city in terms of tunnels because of what is underground in Moscow: the metro, gas and water utilities. All sorts of things have been proposed from elevated rail on top or under roads, or light rapid transit. But there is a finite amount of money that can be spent and when you are doing that you are not doing your high speed inter city rail.

Many international architects and designers have been engaged and the city has adopted a lot of their ideas but it seems the nice-to-have are being adopted first and the harder problems are being addressed slowly. Should investors pay a lot of attention to these visions of a future Moscow or should they just take the city as it is, and live with the problems?

DW: I don't see a massive change any time soon. I see slow progressive change so investors will accept what it is and build around it.

But there are some quick wins on traffic congestion: legislative change so if you have an accident you don't have to leave your cars where they are, hold up the traffic and wait for the police for four hours. You can move your cars to the side of the road, exchange insurance details, and drive on. Cultural change. This is not with disrespect, but if I am in England and driving I will not park on a double-yellow line because I know it's wrong. In Moscow in some cases you cannot walk along the pavement because of parked cars. And that cultural thing will take time. That is more of a generational thing; you are talking about a potential 25-year change in generations. That is why you are seeing change from what I saw 20 years ago. Younger people are coming into government.

What changes are we seeing?

DW: We're seeing more innovation and the use of technology in buildings and infrastructure. The whole point of Skolkovo is to accelerate that change. We're seeing a change in political stance — a lot of the younger politicians are now willing to accept that something from outside of Russia works well, so why not try to replicate it as opposed to the fixed-in-a-rut attitude of it's got to be right because it's in Russia. I've spoken to several ministers and deputy ministers who are between 35 and 40 years old, which is young for any country and you can see a difference in passion for change. It is no different to any country.

Technical Issues

How competitive is the construction consultancy business and does the high cost of construction mean clients want more for their money, not because of regulatory standards, but because of expectations?

DW: We saw a rapid rise in construction costs in the 90s then a plateau, then a drop in the crisis of 98, and then we saw a rapid rise, plateau and drop in 2008. Now we're seeing a rise again. Pricing now is very similar to pre crisis levels of 2007 and 2008. But while prices are no higher than their peak, what you get for your money is better therefore margins must be coming down and competition is growing which is good for Moscow and the industry.

Is it changes in the labor force and has something changed in the construction teams and the Russian skills.

It has changed: materials first. In the past you used to buy steel and concrete here and everything else was imported but now the vast majority of components are being produced in country, except for some finishing materials, marble etc. The second thing on labor is you always had your internal decorators form Ukraine, ground workers from Tajikistan. All of that is changing because in the past 20 years the Russian workforce has been trained on the job. At mid management level there has been a strong advance in Russian labor and contracting management.

The construction teams are still foreign but the management is local?

DW: A lot of the contractors in the past acted as a contractor and subcontracted the work. That is changing, especially with the big Turkish contractors who will self-perform because they have the ability to bring large teams in. If they do that competitively and they have confidence then that same team goes from project to project.

What about the difference between Russian and international regulations?

DW: There is a misconception outside Russia that everything has to be built to Soviet snip codes and you are not going to get great quality and everything will take a lot of time. I think that's wrong. The Snip codes are here as a minimum standard and in some cases are more stringent than the west, certainly in terms of fire, sanitary and, in certain parts of Russia, seismic issues. A lot of projects are built to international standards, Euro code or US standards, which are sometimes higher than snip, code so you then revert to snip codes as a minimum standard. If we were to design something purely to soviet snip codes as opposed to a blended mix it would be more expensive, likely longer and likely the lifecycle costs would be more expensive. Russian developers understand this and so they allow blended codes and more likely Russian codes will be rewritten to be closer to international codes, as Turkey has done.

What change has there been in the time to complete a project?

DW: Building used to stop in November and restart in March. Projects used to finish the design stage in October but not start groundwork until March but that's changed. We're building right through the winter because of better practices: you can heat concrete, you can put chemicals in it — it all adds to the price and the time but you can build right the way through unless it gets below minus 25, which is not that often in Moscow nowadays.

Russian contractors have developed over two decades, you are seeing more fast track development due to better processing, just-in-time ordering, less reordering of damaged materials, better planning, better supply chain, and a better-trained workforce. I think we will see an even greater improvement in the timetable.

But there is still a significant difference in costs compared with other countries, isn't there?

DW: It is probably 20 percent more than North America, 20 percent less than the UK. I always tend to benchmark against Europe and North America because that is our client base. Construction in the UK is expensive but the product is good. Construction in say Germany is probably not far off a par with Russia. In terms of time, to physically build a project here is probably 30 percent longer than in London. If you take the whole project cycle it's probably more like 40-plus percent because of the statutory approvals process and because you cannot work with overlaps as you can in other countries. Also you have the infrastructure issues. In a European country the privatized electricity provider will bring the power to your site. Here it is not privatized so you either have to pay for it yourself or agree they bring it to†you as part of the contract with the municipality.

Apart from the comparison with Europe and the challenges, what's your outlook for Russia after your decades here?

DW: Having been here 20 years I've seen improvement continually and I still think that while challenging it is a good investment market for local and international businesses and will continue to be.†