"Real Estate and Investments. Legal Regulation", the journal

Issue 1, 1999

Current Issues of the Real Estate and Privatization Market Development in Russia

Bagrov S.E., head of the Real estate department of the RF Government Office

Evolutionary development of real estate market in Russia stopped with the begin-ning of Socialist Revolution in XX century. At the end of the century real estate market is forming as a result of reforms & resumption of market relations.

Modern realty market started with dwelling market development. First legal deals on selling & buying apartments in Moscow were made in 1990. In other cities dwelling market appeared with economic liberation in 1992. For the past few years Dwelling mar-ket has made a long way of its growing & development in the extreme conditions of com-ing to the market economy. Social part of the housing problem is high customers' de-mand for dwelling that was going up & down depending on political & economic situa-tion in our country. Analysis of dwelling's supply & demand dynamics showed there is a regularity in dwelling's cost changing throughout different cities of Russia: a rise in price up to the market one with the following stabilization at the world price level. Social & economic situations in the regions was getting worse, so, the rise stopped (there is a tem-porary decrease in prices) Table 1.

Changing in price of dwelling per 1 sq. meter in different cities of Russia in 1993-1998

Table 1.

*)(II & III stages of a dwelling market development)

At the very beginning of dwelling market development the price was low. Private dwelling became a property mainly in the process of free privatization. Nowadays, the most of Dwelling Moscow Fund became private.

Dwelling's cost underestimation on the first stage of dwelling market development caused the fast rise in price (in some ways, the rise was caused by the inflation). In two or three years dwelling prices increased 7 times in Moscow and 3-5 times in other cities. On the second stage the price increase fell (in Moscow 30-50% a year). On the third stage the price rise stopped & the prices began to decline (Table 1).

There was a dwelling market crises in some cities. There were many unsold apart-ments in Moscow even though the social demand for dwelling was high. The Moscow Government decided to increase demand by selling the apartments to all citizens of Rus-sia & legal persons. It didn't matter where they lived and where they were registered (Mayer's Decree N 353-RM, April 10, 98).

However the Moscow Government's decision helps criminal immigrants push out the intelligent Moscovities in the conditions of decreasing labor productivity and wages.

Analyzing the mutual connection "income-prices" we can see that in the late 80s, in the early 90s there was a real possibility to use personal facilities of Russian citizens in the dwelling sector.

The situation had changed in 1992: price liberation depreciated citizen's savings.

The main barrier to the dwelling market functioning was Russian citizen's income differentiation and the big difference between wages and commercial dwelling prices. Now the most developed realty market is in Moscow. Proprietors' class appeared in the process of the company's privatization. First, they were storeowners after the free priva-tization in the sphere of services.

The Moscow Government tried to make privatization to be paid for. It gave shops for rent with the following selling. Just after privatization they didn't have money to redeem the premises from workers, that's why the premises in Moscow were suggested to be rented.

So, the number of premises' owners went up and supply for selling the premises increased. The privatization of industry shops and state premises (such as scientific insti-tutes, military buildings, schools, universities, etc) was held after the trade and everyday services privatization. After redeeming the realty they got a right to sell it or give it for rent.

There has been an intensive construction of new buildings especially offices since 1991. Besides, the reconstruction of old mansions and giving people other apartments us-ing their old small houses in the center of Moscow for offices became popular. As a re-sult, there were many offices for rent in special business centers and in office buildings of Moscow.

Nowadays, there are premises on the secondary realty market which became prop-erty after privatization or which were bought on a primary market's auctions. In 1992-1993 the redeem price was very low and differed from secondary market prices. In 1994-1995 primary market prices went up to the market ones as a result of the Moscow policy.

In the structure of the Commercial Realty Fund the biggest areas are trade offices. They make 80% from the Commercial Realty of Moscow. Total office areas in Moscow are 7-10 mln.sq.m. West standard offices make 10%. Demand for the office areas is 12-13 mln.sq.m.

Structure of the Commercial Realty Fund (Moscow 1996)

An office market has been in Moscow since the late 80s, when centralized econ-omy started transforming into the market economy. High demand without high quality office supply led to the rental rates increase in the early 90s(from $500 to $1000 per sq.m. a year). The rates were ones of the highest in the world reaching over $1500-2000. The construction reduced deficit but the prices stayed high ($850 in 1993). In 1994-1995 the rental rates rose. In the middle 1995 solvent supplies for offices started falling and then the rental rates decreased.

Differing from the west standard offices, which material base came from the build-ing's construction and reconstruction, our offices are ex-uninhabited buildings. These of-fices consumers were small companies, just started their business at the beginning of coming to the market economy.

The rates stayed low and demand was satisfied. Special legal renting laws were keeping the rates low. First, managers of state organizations (scientific institutes, exhibi-tion and concert halls, hospitals, etc.) acted as landlords even though they didn't have le-gal rights for that. The rental rate consisted of two parts: first was fixed in an agreement and the second was paid the director in cash (it was a way of avoiding to pay taxes and making the Board of Directors rich).

In 1994 the Government increased the rental rates and that influenced the rates on the secondary market. In 1996 the Government confirmed the norm of subrental agree-ment registration in the Moscow Property Committee. It also caused a rate rise.

Before crises in August 1998 Russian standard repaired offices with a separate en-trance and security were suggested at the rate of $700 in downtown; and unrepaired of-fices-at the rate of $400-600. The rates were going down to $170-200 for the premises out of downtown Moscow. The average rates were within $250-550 and stayed more sta-ble. The forecast for the coming years is the following: supplying better quality offices at the same rate; a decline of demand for bad quality offices and a rate fall.

Second largest uninhabited premise's market is a trade premises market. It mostly consists of the stores, which are in private property or rented. The demand structure says that 80% of people prefer to rent and 20%-prefer to own.

In the early 90s Moscow was fulfilled with booths. Its owners had up to $10.000 revenues a year. It happened because of private trade development and lack of trade ar-eas. The situation had soon changed, because the demand structure changed in favor of expensive goods and high quality trade premises on one hand; in favor of wholesale clothes markets on the other.

Production areas market is, actually, not developed because there is no new pro-duction projects now. It partially explains the misbalance in supply and demand.

As a rule, the large production areas (500-1000 sq.m.) of ex-factories, scientific institutes, etc. are put on the market. At the same time, there is demand mostly for small areas (50-300 sq.m.) to do small business such as car service, mini-bakeries, confection-ery, etc.

Actually, the situation on the production areas' market shows us the crises in the real economy sector, and mostly in the industry. So, in Moscow after privatization the Government owned the major interest-51% of shares, or half of the major interest-25% of shares. It would let keep the economic situation under control. However, the Government didn't have this possibility without the State Property Share Management System.

Besides, state property company's statues stayed the same. A state organization is still working according to the USSR Law "about state organizations". So, those compa-nies are under their administration's control and The Federal Government can hardly in-fluence their activity. Thus, the state organizations are in the same situation as limited companies. The Government cannot get its additional profit from its ownership without working mechanism that lets state company's revenues fulfil the Federal budget. So, the Russian Government signed The Decree №1024, September 9, 1999 "Con-ception of state property management and privatization in RF". There are some negative aspects of state companies management, it also shows that companies activities are not in accordance with the state interests.

There are no required periodical audits in the state organizations. That's why it is very hard to control their financial activities. The Conception says that full power of the state companies directors without strong management, control and motivation causes:
a) a finance transfer from the state companies to subsidiaries. As a result, subsidi-aries get the profit of the state companies;
b) the deals, that are interesting for The Board of Directors in the state companies. It leads to the false rise in production cost, and to the state Property embezzlement in some cases.

We see that our state companies' management is not effective, and it should be changed. They suggest to evaluate the activities of all state companies and to make its quantity optimal for carrying out the objectives.

Realty management improvement should help to carry out the following objectives:

  • maximum federal property revenues increase;
  • efficacy of carrying out the social functions by the Government when it uses the Federal Property;
  • stimulation of the real economy sector development;
  • easy & convenient entrepreneurs' access to the realty.

There are some important actions that are suggested for reaching the goals:

  • to make the realty balance which includes quantitative, technical, cost & legal realty characteristics;
  • to apply knowledge of market evaluation when using the realty;
  • to change the realty selling mechanism that lets buy realty at low prices.

The Conception suggests ways to reach goals of state policy in the sphere of state property privatization. The ways are:

  • differential approach to privatization of companies depending on its liquidity High Liquid companies are owned according to its real price evaluation that is close to the world level. We think it would be more expedient to use the crite-ria of assumed market income;
  • selling low liquid companies to effective proprietors, who are liable by the in-vestment & social obligations at low prices;
  • using more ownership's tools;
  • making own decisions, thoroughly analyzing potential investors' long-term plans to develop companies; & signing the agreements that regulate investor's obligations;
  • social approach to "privatization".

When you are making a decision to own state property it is necessary to consider social consequences, & companies development, environmental protection, citizens' health.

Free Property distribution made some directors & authority representatives rich. They were trading and gibing property for rent at the market prices. Thus, the Govern-ment didn't get enough resources to develop the economy.

Actual proprietors get unearned income from the realty without social oriented both legal & fiscal base.

Property income dozens times more than labor income of common people. Taking in an account low standard of living, it is getting clear why young people have a negative attitude to labor productivity & why there is a criminality increase.