planning has left some of its worst legacy in real estate, especially urban housing. Significant improvements will require changes in the policies of local governments and further development of market institutions. During most of the years of central planning, housing construction was a low priority. There were long waiting lists for small, low-quality apartments in poorly maintained buildings. Nominal rents remained fixed at levels virtually unchanged from those set by Stalin in 1928. Far below the market clearing value, the typical level of rent relative to income averaged about 2.5 percent in the USSR in the 1980s (Renaud 1992), compared with a typical value in the West of about 33 percent. The size of the housing stock in Russia is well below Western standards. For example, adjusted for population, Sweden has twice as many housing units as Russia. The housing stock is meager even compared with many other former Soviet bloc countries, such as Hungary and Estonia (UN-ECE 1994). In Russia’s major cities there are about 1.3 families per housing unit (World Bank 1995). The acute shortage of housing and the low level of affordability are reflected in very high prices relative to income (Struyk 1996). The level of residential construction is now only half what it was in the late eighties. There is now an absence of clear institutions regarding private land ownership, bankruptcy, foreclosure, and eviction. This makes it virtually impossible to use real estate as collateral for borrowing investment funds. At the same time, there is minimal experience with any form of market financial intermediation, the proliferation of private banks notwithstanding. Even the term “real estate finance” is sometimes translated into Russian as “real estate subsidies.” This chapter is divided into two main parts. Part one describes in further detail the current status of the real estate market. Part two offers numerous recommendations to accelerate real estate investment. Real Estate 387 Current Status of the Real Estate Market Privatization Privatization of real estate has progressed furthest in the housing sector as state-owned housing is transferred to individual citizens and to private enterprises. For the country as a whole, at least half of the housing stock has thus far been privatized (Klepikova et al. 1995). The extent of the privatization of existing commercial and industrial buildings is not known in general. In St. Petersburg about 25 percent of total floor area in commercial buildings and premises was privatized by the end of 1996 (Kaganova 1998). No urban land was privatized until recently, with the lone exception of small plots of land allocated to families for single-family homes or privatized by families living in already existing single-family homes. In 1995, after three years of repeated attempts, the privatization of land sites underneath privatized enterprises finally began by means of land purchases by enterprises. By December 1995, about 1300 enterprises across Russia had completed land purchases, and another 2300 enterprises had submitted applications (Limonov 1996). By the end of 1997, the share of privately owned city territory varied from 0.2 to 17.5 percent in 6 surveyed cities (Kaganova 1999). However, the process of land privatization is limited since Moscow and other regions, ignoring the constitution and presidential decrees, allow only long-term land leases. Urban Housing Markets There are striking geographical differences in housing markets, in part a reflection of sharp differences in municipal policies. According to a 1994 survey of several cities, mean income of non-pensioner households varies from about 5 to 21 percent of mean home price (Struyk 1996). Real Estate 388 For a sample of six cities, Kaganova (1999) found that annual turnover rates (sales as a percent of privately owned housing stock) range from 5.0 percent to 8.7 percent, with new homes built accounting for from 19.4 to 49.3 percent of sales of existing homes.1 Fees for infrastructure and other costs imposed by cities ranged from 9 to 33 percent of the total cost of housing development. Initially most residences (apartments) offered for sale were provided by persons planning to emigrate. Currently, the supply primarily represents the redistribution of wealth and migration within Russia. Families leasing out their own residences accounts for at least 2 percent of the housing stock (Struyk 1996). Investments in rental residential properties have yet to occur in any significant amount. New construction of housing is primarily of two types. First, there are high-rise apartments in multi-apartment blocs laid out in the Soviet era. Second, there are single-family luxury houses, a type of residential development without precedent except for the dachas of the nomenclatura. A less prevalent third type are townhouses which are meant primarily for foreign residents. Demand for entire buildings for renovation is growing in the center of St. Petersburg, and presumably central Moscow as well. A building yet to be renovated, with tenants already relocated, commands a higher price per square meter than a high-quality apartment in an unrenovated building (Kaganova 1995). Housing prices are highest in Moscow. A typical three-room apartment of 70 square meters (750 square feet) sells for about $80,000. Apartments renovated to Western-standards cost several hundred thousand.2 Prices in St. Petersburg are about half those in Moscow for local-quality apartments, and about a third as much for Western-standards apartments. Given the low family incomes in Russia today, a home purchase is out of the question for the vast majority, especially given the absence of mortgages. Due to the absence of institutional lending, prepayment by future homeowners is the primary source of finance for housing construction, while in commercial real estate, construction equity investment is very high. A recent study found that in Moscow and Rostov-on-Don, about Real Estate 389 two-thirds of projects are financed 100 percent with the developers’ own funds (Kaganova 1996). Much of the inflow of capital may be illicit in origin, since construction offers a way to launder money. Commercial Real Estate The market for commercial properties is very active: the annual turnover rates (sales as a percent of privately owned stock) is around 40 percent in some cities. Office rentals are also active. It is common knowledge that rental rates on office and other commercial space are impacted by the cost of mafiya protection, at least in big cities. Office space at Western standards of quality is usually in reconstructed or new privately owned buildings and exists only in major cities. Its supply consists largely of business centers that function as foreign enclaves providing telecommunication facilities, apartment or hotel rooms, restaurants, and garages. In addition, there are three types of local-quality space: (1) low quality office buildings, often poorly managed, belonging to privatized enterprises; (2) premises used as income properties by municipal agencies; and (3) premises occupied rent-free by public institutions (state research institutes, state universities, defense institutions, etc.) which rent out part of their space to obtain revenue. These leases are often legally questionable since the premises are actually owned by the city or the State. New businesses and foreign companies desire offices in prestigious central districts, but many office buildings are located far away from the center and are often in industrial zones. The difficulties in obtaining land sites limit the ability of private developers to fill this gap. In Moscow the average net rent for offices of Western standards was about $825 per square meter in January 1996 with a total occupancy cost of about $1050, ranking the city sixth highest in the world for office rents (Ellis 1996). Rental rates are substantially less in other Russian cities.3 The cities themselves are the largest owners of commercial and other nonresidential properties. In St. Petersburg, authorities of inner-city Real Estate 390 districts hold about 13,000 active lease contracts on nonresidential premises, and about another 10,000 contracts are held by other city authorities. There is still no private management for municipal properties. Lease terms are standardized and rents are calculated by a formula or, for smaller spaces, are determined by officials who often can be bribed. The municipalities are not responsive to market conditions, either losing revenue because of below-market rents or losing tenants because of rents and terms less attractive than those offered by private owners. Only St. Petersburg has begun implementing more objective methods (mass appraisal) for setting up rent rates for municipal commercial property. Retail space is generally less expensive than office space, unlike in cities with developed real estate markets. There are several reasons. First, demand for retail space is a function of the public’s overall purchasing power, which is low. Second, in the process of privatization restrictions were imposed on many retail and service-sector premises with respect to permitted activities. Third, the commercial real estate market is still a long way from equilibrium, and the unsatisfied demand for office space exceeds that for retail space. Industrial Property In all industrialized Russian cities, industrial buildings and warehouses are available for lease or purchase as the result of privatization. Vacancy rates are high because of the economic depression as well as lack of fit to the requirements of potential renters. In St. Petersburg the typical annual rent for industrial properties is from $30 to $60 per square meter. Land Markets As should be clear from our discussion of privatization, the market for urban land is very thin and consists mostly of family owned sites zoned for housing or gardening. As a rule, such sites are not provided with a full set of utilities (sewage, gas, electricity, water, etc.), making them Real Estate 391 unsuitable for construction. As one would expect, turnover of land sales on sites privatized by enterprises is high in some cities; we discuss later the potential consequences of allowing the privatization of industrial land in the absence of other privatized urban land. Proposals Real estate markets depend on the ability to exercise and transfer well-defined property rights. In the current context, property rights require that Russian law guarantee: (1) the rights of owners of individual residential apartments, and the rights of enterprises and developers holding long-term land leases, to make appropriate use of owned, or leased, real property; and (2) the right to sell, rent and mortgage these property rights. Property rights are not meaningful unless there are clear and effective mechanisms to ensure that local authorities, courts and police are willing and able to enforce these rights. One basic component is an effective system of property recording (title registration). Legislation passed in the last several years has helped to clarify property rights, but contradictions remain at various levels of Russian law, and implementation has not been consistent or strict. Although the constitution states that land relations are regulated by federal law, primarily through the land code, many presidential decrees challenge this constitutional provision by addressing a number of areas related to land rights and registration. Also, although the constitution states that juridical entities may own land in fee simple, and privatization laws state the same, many cities in Russia, including Moscow, refuse to grant anything but land leases. Municipal Policies Municipal policies should be changed to take into account the reality that private funds are now the main source of construction and reconstruction financing. Authorities in many cities, including Moscow Real Estate 392 and St. Petersburg, do not sufficiently realize that the private investor/developer of today and the municipal contractor of Soviet times are not the same and need to be treated differently. Currently, the authorities offer investors contractual relations for a construction period, and the prototypes for these investment contracts are contracts with hired contractors. Investment contracts assign no property rights to investors and allow the cities to dissolve the contract unilaterally, should the developer violate the terms. The official policy of many cities is to attract as much foreign investment into real estate development as possible. The mayors of Moscow and St. Petersburg travel across the world to market their cities. Nevertheless, the total number of projects with foreign participation and the amounts of investment are surprisingly small. Even in Moscow, with its high real estate prices and office construction boom in 1995, foreign investment is negligible. A study conducted by Kaganova (1995) of St. Petersburg in 1995 identified the main obstacles to foreign investors: (1) lack of secure property rights during the construction period, since titles and long-term land lease agreements are available only after construction is completed; (2) unreliable real property registration systems; and (3) uncertainty concerning the expense requirements imposed by the city. A less frequently cited concern was the general political and economic instability in Russia. Russian investors are apparently less concerned about these problems, although the absence of mortgageable rights during construction is an issue for them as well. The courage of Russians to invest under uncertain and unclear conditions can presumably be explained by their relative inexperience and, in some cases, the priority of money laundering over investment return. The Russian construction industry remains highly inefficient, with a great deal of power remaining with the large kombinat enterprises inherited from the Soviet past. Their power lies in relationships with the municipal agencies that provide land and construction approval, and in priority access to construction materials, both from established networks Real Estate 393 and from direct control (vertical integration). To increase competition in the construction industry, new entrants should have equal access to land, building permits, and construction materials. Property Registration and Professional Services Many countries are offering technical assistance to federal and municipal governments and to private business and professional organizations. While generally constructive, this assistance can undermine efficiency and fairness when local circumstances differ from those under which recommended models evolved. Technical advice is often contradictory as well. The recording of real property and the guaranteeing title are important illustrations. Under the European model,4 a government registrar checks the validity of each property transfer before recording it. The government then takes responsibility to guarantee title. If someone were to establish the validity of a conflicting claim, then the government would resolve the conflict according to law and pay any and all compensatory damages. There is a strong rationale for favoring instead the American system. Rapid privatization over geographically vast territories, the rapid development of local markets, and the absence of a strong and effective centralized administrative system are all factors in the evolution of the American system which exists in Russia today. These factors may be interpreted as typical for a “frontier society”.5 The American system relies less on government and more on the market. Government recording of transactions is done without the registrar establishing the validity of the recorded documents other than to check that they are notarized. The recordings are voluntary, and the government bears no responsibility. Private title insurance is the mechanism for ensuring the validity of ownership transfers and other property rights. In practice, the American system is faster but more expensive for users than the European system.
Real Estate Development 