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. Last Updated: 07/27/2016

Developers Looking to IPOs

MTSistema-Hals is redoing the Peking.
Sistema-Hals, the developer slated to reinvent the Soviet-era toyshop Detsky Mir and the historic Peking Hotel, is in the process of reinventing itself as it prepares for the first major foreign listing by a Russian developer.

But as its planned IPO pushes it toward new levels of transparency for the notoriously opaque Moscow real estate market, it remains to be seen how quickly its local rivals will follow.

Several other major construction companies and developers, including residential developer PIK and Oleg Deripaska's construction holding Glavstroi, have said they would like to follow suit, but both appear a long way from naming the day.

"First it was telecoms and consumer products, then metals, oil and gas, and now real estate is starting to mature as a sector," said Gerald Gaige, a partner in Ernst & Young's real estate practice in Moscow.

"But the move towards transparency is happening gradually," he said. "There is a definite trend, but there is not a great rush."

One of the reasons the move is so slow appears to be that companies have to invest huge amounts of resources into transforming themselves into entities Western investors can get their heads around.

When conducting an IPO on a Western stock exchange, a company must carry out extensive restructuring, said Christopher Peters, head of research at Cushman & Wakefield Stiles & Riabokobylko.

Typical requirements include at least three years of audited accounts, corporate governance that meets international standards and, often, changes to corporate structures, he said. All potential liabilities also have to be fully explained and elaborated to potential investors. Then the company needs to create positive awareness of itself and its product, typically via road shows to promote itself -- and the very idea of investing in Russian real estate.

For Moscow developers, working in a market often known for opaque local government contracts and corrupt officials, the process can be particularly hard.

"Real estate is one of the last to mature in Russia for several reasons," said Paul Murphy, the partner in charge of Ernst & Young's IPO practice, "including regulation, the way people do deals, and the amount of cash involved."

But when they do, everyone from the investors to the tenants will benefit from improved management, said Konstantin Romanov, director of Knight Frank's consulting division.

In exchange for these efforts, the companies get access to Western investors, who are generally used to much lower returns than those offered by companies with exposure to Russian real estate.

"In the current situation, anything you take to the market sells well. It's a seller's market," Romanov said.

"Sistema-Hals is going to make a lot of money out of its IPO. It is the first foreign listing of its stature onto the market, although it is an exception in that it will be benefit hugely from the Sistema brand."

Last week, Sistema-Hals confirmed it would list between 20 percent and 30 percent of its stock on the London Stock Exchange in November, in a listing it hopes will attract from $2 billion to $4 billion, Vedomosti reported. The company was unable to comment for this article due to a moratorium on statements about the IPO effective as of Monday.

It will offer investors exposure to its impressive portfolios of both buildings and development projects.

Real estate funds like Fleming Family and Partners, Eastern Property Holdings and Raven Russia have offered investors a way to buy a share in a portfolio of Russian properties in recent years.

Now, exposure to development products is starting to offer Western investors more risk, and potentially higher returns.

Last week Fleming Family and Partners announced the launch of a second fund, which, unlike its existing one, will source projects in development to overcome the lack of completed products on the market, said Oleg Myshkin, one of three managing partners in the fund.

It is planning a $300 million listing on the Alternative Investments Market, a sub-market of the London Stock Exchange, and will aim for returns of over 20 percent, he said.

Western investors putting money into existing investment-grade properties might expect a return of 15 percent to 20 percent, said Knight Frank's Romanov, while investments in development projects can offer returns of 20 percent and higher, depending on the risk involved.

"Development funds attract more opportunistic money that wants exposure to the higher risks and the higher returns that new developments can offer relative to more traditional ways of gaining exposure, such as investing indirectly to funds focusing on standing investments or directly purchasing standing investments," said James Corrigan, associate director at Jones Lang LaSalle Capital Markets.

He said that short of external shocks from world markets, such as rising interest rates and the weakening of the dollar, demand from the West for exposure to Russian development projects was likely to increase.

"The interest is partly explained by the high profits in development due to lack of transparency and hence competition -- there are almost no foreign developers here -- and partly explained by the weight of money under management by the hedge funds, which has to be invested," he said.