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. Last Updated: 07/27/2016

Capital Needs Capitalist Tools

One major reason for the scarcity of high-quality office space in Moscow is that renovation work is eating up much of the capital that could otherwise be directed toward constructing new buildings.


While restorations are finding their niche today, many see the trend of refurbishing and upgrading existing buildings as insufficient for future needs.


Apart from the usual business risks associated with Russian investments, several specific points contribute directly to the problem of raising capital for new buildings.


First, the high-cost nature of the asset requires that property developers in most countries take out long-term financing to buy time to construct the project and begin earning a return. However, Moscow has very few lenders willing to risk funding long-term projects.


Adding to the frustration is that Russian legislation relating to ownership and the mortgaging of land and buildings is not conducive to long-term secured lending of capital.


Although mortgaged lending -- one of the most common methods of financing construction in many countries -- is possible under Russian law, it is difficult to put into practice and almost impossible to implement for buildings still in the planning stages. Russian law permits a mortgage only when it is registered with the government organization which registered the building's title. If no building exists over which ownership can be registered, a mortgage is unenforceable.


Given the difficulty in Russia of mortgaging either the land or the rights to use the land on which a new building is to be located, a major problem for lenders is that there are usually no other assets available to mortgage. And if a new building is constructed and a registered mortgage is possible, an obligatory notarization fee of 3 percent of the value of the mortgage can make such financing commercially unviable.


Nevertheless, some new building developments are being financed in Russia using several methods.


The most successful projects are those that have been internally financed by the developer itself. That is, the developer has sufficient funds of its own to construct a building and then to await receipt of tenant payments before recouping its costs.


Pre-leasing space in a building before construction is complete can assist in earlier cost recovery. Obviously, this scenario poses great risks for the developer, which must be sufficiently large and reputable for tenants to gamble on leasing space which is only partially completed.


An alternative method involves a joint-venture arrangement whereby several parties share the risks. For example, a bank may contribute cash, a building contractor can provide materials and equipment and the developer or project manager offers management expertise or the rights to use the land on which the building is to be situated. Upon finishing construction, all parties share in the ownership of the building and subsequent rental streams.


Other financing structures and methods can also be used. Foreign developers can use guarantees from an offshore parent or bank as a type of short-term bridging finance, and lease assignment agreements or escrow arrangements perform similarly in the case of pre-leasing.


Russian developers sometimes seek overseas financing from countries where interest rates are lower, but there are often difficulties overcoming restrictive Central Bank currency regulations. Municipal or federal government funding of some projects is also available on occasion.





Eric Michailov is an attorney with White & Case.