Sistema Hals neck-deep in debt

Graham Stack for business new europe (www.businessneweurope.eu)

Sistema Hals tops the list of Russia’s most financially endangered real estate companies, in the wake of the financial storm that has swept over from Manhattan to Moscow.

“All real estate companies are having problems due to the financial crisis, but HALS are right out in front with $1.2bn debt, and only $30-$40m on its books. HALS in in trouble,” says UralSib real estate analyst Eldar Vagabob.

Confirming the developer’s difficulties, Sistema HALS announced Wednesday 17 that it would sell almost a quarter of its illiquid projects to raise up to $500m cash. Sistema Hals stock has fallen 66% since the beginning of the month.

“They’re in danger, but they won’t go bust,” argues Rencap’s Alexei Yazykov, pointing to the Sistema parent holding’s deep pockets.

Sistema Hals is a subsidiary of Sistema AFK, owner of Russia’s largest mobile phone operator MTS. “Sistema automatically covers for them, so they will find finance on a holding level if need be,” says Yazykov.

According to Vagabob, HALS has not only strong financial support, but powerful political patrons. Sistema holding owner, oligarch Vladimir Yevtushenkov, is a close friend of long-serving Moscow mayor Yury Luzhkov, and the concern was created in the 1990s on the back of Moscow’s fixed line operator and other municipal assets.

Critics says that precisely this powerful backing has created the moral hazard allowing HALS to run up mountainous debt without real cash flow.

In particular, Yevtushenkov’s appointment of his 26-year-old son Felix as president of the real estate division in 2006 raised eyebrows. Such apprehensions only increased at the end of May, 2008, when Yevtushenkov junior announced immediate plans to raise a further $600m debt, despite the credit crunch.

Six weeks later, his father removed him as CEO, replacing him with the experienced Sergei Schmakov. But the move now seems to have come too late.

Sistema HALS specializes in high-end commercial properties, including building the Moscow headquarters for German industrial giants Siemens and Daimler Benz, and launching projects for the Sochi Winter Olympics in 2014.

If HALS ran into real trouble, it would be highly embarrassing for Moscow city hall, and the inbred Moscow development sector, shortly before Mayor Luzhkov is due to depart office and would like to secure succession.

Storm clouds around the PIK

Storms clouds are also seen to be gathering around major residential developer PIK.

Fitch Ratings put PIK on negative rating watch on Friday, September 18.

Fitch estimates that half of PIK’s total gross debt matures before 31 December 2008 – placing it in a very tricky position.

Rencap’s Alexei Yazykov however disputed this.

“According to our information, PIK has total debts of $1.5bn, $900m of which is short-term. But with short term we mean within twelve months. They may have difficulties funding future projects, but they won’t go bust.”

Vagabob also argues that, compared to Sistema HALS, PIK has “stronger balance sheets and greater exposure to residential projects with pre-sales supporting cash flows.”

As recent as September 15, PIK was able to draw a $230m Sberbank loan to finish payment on a $350m project.

The loan also points to PIK’s good links to the largest Russian banks.

PIK does not have the same level of backing of Sistema HALS. But, as Yazykov and Vagabob point out, as Russia’s largest developer of mass residential housing, it has political significance nonetheless. Acceleration of mass housing construction is a key plank in President Dmitry Medvedev’s programme.

“Big state banks would be told to rescue it should anything happen,” says Yazykov.

But even if none of the large companies were to go bust, many projects will now be put on ice. Sergei Polonsky, chairman of non-listed Mirax, one of the main builders of Moscow’s prestigious City project, said Wednesday his company would not “start any new construction work nor take a single credit nor buy any new projects,” according to Vedomosti.

The real estate sector is particularly hard hit by the financial crisis, argue Fitch, because of the debt-intensive business model, with cash flow only coming late in the day.

Besides Sistema Hals and MIrax, Fitch include LSR Group and Open Investments on their negative outlook list.

However, Alfa Bank’s Elena Mills points out that individual business models vary hugely from company to company within the sector.  AFI Development, for instance, counts as a cash rich company.

According to Natalia Oreshina of commercial real estate agency Art Property, smaller speculative operations will suffer. “Every second company has been trying to invest in real estate without doing the calculations. There has been a lot of speculation.”

Now speculation is focused on who is going under first.

House hunt for Red October

Graham Stack for business new europe

The Red October Chocolate factory is an icon of the Soviet-era. For more than 30 years Russian children have grown up craving Alyonka chocolate bars, the factory’s flagship product, and the chubby face girl on the wrapper is one of the best known faces in the country. But at the end of the 2007, the owners of the factory caved into temptation: situated on one of the most desirable locations in Moscow, they decided to close its doors and redevelop it as top-end residential apartments that are sure to sell for millions of dollars a piece.

The landmark redbrick building is perched on the Bolotny Island in the middle of the river Moskva. It is a short walk from the Kremlin and overlooks the rebuilt Church of Christ the Saviour cathedral on the opposite bank. Locations in the poorly supplied heart of Russia’s capital don’t get better than this.

With property prices soaring to astronomical levels over the last five years, the factory owners, Russian conglomerate Guta, decided to move the chocolate operations to the city’s outskirts and convert buildings and grounds into a luxury residential complex where prices are rumoured to reach $32,000 per square metre (sqm). The three main redbrick buildings and the famous chimney will remain, while 30 other buildings that have accumulated on the territory over decades will be razed to make way for new developments.

Internationally renowned architects are contributing to the factory conversion, where the most prestigious properties will be loft apartments created from the spacious top-floor production halls: boasting huge windows that afford a magnificent view across the river and of the Kremlin. “After such a long time in coming,” says Ekaterina Thain, director of residential department at Knight Frank Moscow, a consultant to the Red October redevelopment project, “finally sales will be starting next year. There has been a lot development for the high end of the market, but these buildings will be a chance to buy a little bit of Soviet history too. They are unique in the city.”

Bottomless pit

Property prices have soared across all of Central and Eastern Europe in the last two years and were up by just under a quarter in Russia, one of the fastest growing markets in the region. While the Red October development makes the headlines, it’s the emerging middle class that’s the driving force behind a booming residential property market. “Growth in 2006 was simply astonishing,” says Renaissance Capital real estate analyst Alexei Yazykov. “We’re talking about more than 100% over the year in Moscow.

The capital has led the market, but in the last year the regions have joined the fray and prices in all the millionki – the 11 regional cities in Russia with populations of more than a million people – are now close on the capital’s heels. Prices in northwest Russia rose 76% in 2006 – St Petersburg, Russia’s “other” capital, also saw prices double – and homes in the Volga Region saw their value jump 84%, according to Renaissance Capital.

The leap in prices is being driven by powerful GDP growth and rapidly rising incomes. Between 2004 and 2007, Russia’s GDP growth averaged 7% per year and the growth is still accelerating: the Russian economy expanded by 7.6% in 2007, although the brouhaha on international credit markets is expected to the edge of growth in 2008, which is forecast at 6.7%. At the same time, real incomes have been increasing by an average of 12% over the same period and were up by 20% over 2007, according to official preliminary estimates. Put another way: when the late former president Boris Yeltsin stepped down in 1999, most Russians were earning $50 a month; after eight years under President Vladimir Putin they are earning $500. Since 2001, they have access to credit too, meaning whole swathes of the population have crossed the threshold where they can consider buying new apartments.

Counter-intuitively, the fact that 65-80% of the population already owned their own apartments, thanks to the free-of-charge privatization of the 1990s, simply fuelled the explosion in demand. “High level of home ownership has created seed capital allowing people to continuously trade up,” explains Alpha Bank’s real estate analyst Brady Martin.

The Soviet legacy of pitifully undersized apartments means that Russia’s housing stock is around 21 sqm per capita – lower than CEE peers such as Poland (23 sqm) and considerably lower than Western Europe (with an average of 36 sqm in the EU capitals). “It is hard to get your head around just how short the supply of accommodation in Russia is,” says Roland Nash, head of research at Renaissance Capital. “But to increase the average living space per person in Russia to just the average enjoyed in Moldova – an economic basket case – would require the construction of the equivalent of two cities the size of Moscow.”

And most people don’t want to buy many of the apartments that are already there. According to Jones Lang LaSalle, over two-thirds of Russia’s housing stock is over 30 years old, and an astonishing 60% requires renovation – 15% is in critical condition and 12% is officially considered uninhabitable. The upshot is that although the majority of Russians own their apartments, virtually no one is happy with them, creating a powerful upward draught that is fanning the flames.

This huge pent-up demand and lack of supply has sent the real estate market spiralling upwards since about 2003, when the mortgage industry really started to take hold. Price have increased 10-fold in the last decade, but the difficulty in obtaining mortgages eventually put a ceiling on the market 2006. “Prices simply rose to a level out of reach of all but the most wealthy citizens,” says Yazykov, “and so they could not go any higher.”

The meltdown of the US sub-prime market has also been a drag on price growth, which slowed sharply in 2007 – especially in Moscow. Many banks have been financing their mortgage programmes with international borrowing and securitizations of mortgages were just appearing. As liquidity on the international credit markets evaporated, Russian banks have been cut off from their favourite form of refinancing loans, which has put the squeeze on property prices, which plateaued in the second half of last year.

Supply splutters

Russia’s residential property market has paused for breath, but most analysts believe the stop will be temporary; continued upside in residential real estate is supported by a severely underserved market and supply side bottlenecks. “There’s definitely been a construction boom here, but even with this boom supply is far short of demand. To give you an idea of the extent to which the market is under-supplied, independent bodies such as the Institute of Urban Economics and the Institute of Urban Land Development estimate the demand for residential properties at 1.2bn sqm. This is a massive amount. At present construction rates, it would take 20 years to fulfill. In terms of just residential stock, this is five cities the size of Moscow,” says Yazykov of Renaissance Capital.

Paradoxically, for a country as vast as Russia, the chief bottleneck is lack of land plots, or rather of plots with sufficient infrastructure to permit development. Where there are no access roads, water or power supply, development becomes prohibitively expensive.

Supply has also been restricted by recent regulatory measures. In 2005, a new housing code came into force that toughened requirements for developers to raise funds from the population. “There’s been more control of residential construction, after local investors got ripped off,” explains Martin. “Previously, developments were funded by presales, even before development even started, and sometime even before obtaining planning permission. Now the new law says you have to start construction before you can start presales.”

However, the tightening of regulations benefits overall transparency and public confidence in the sector. The consolidation it stimulated in the sector also benefits foreign investors looking for respectable and stable partners to develop with or to invest in.

A second regulatory issue is currently deterring foreign investors from the massive Moscow real estate market: the total absence of freehold in Moscow. The city owns the land and makes it available only on long-term lease. This gives city hall enormous bargaining power, which it uses to claim the “the city share” of any development: developers must either transfer apartments to the city for social needs, or build infrastructure for free.

While it remains difficult for international developers to make headway in Russia, Russian developers have internationalized in a big way latterly and raised capital with a slew of IPOs in 2007. “Many companies own development rights,” explains Alfa’s Brady, “but still have no core portfolio yielding properties, so they cannot raise debt. That’s why they are so enthusiastic about equity.”

Russian real estate companies raised $8bn over 2006-2007, exploding from two or three traded companies to 15, including the CIS countries. Most of these companies trade on the London Stock Exchange’s Alternative Investment Market with mixed results.

Another round of real estate IPOs is on the cards for 2008, predicts Brady. Following the US’ sub-prime debacle, other channels of raising finance have closed. Debt for development appeared in 2006 and financing in euros was becoming available at single-digit rates, with amortization terms for 10-20 years. Now rates are back at 14-15% and the maximum loan-to-value available has dropped to 60%.

Moscow is the new London

“Luxury doesn’t care about anything. You know, they say many non-domiciles in London are currently looking for another location, because it is so expensive. The exception are the Russians, who are simply happy to live in a city less expensive than Moscow,” laughs Yazykov.

While it is an exaggeration to say Moscow is more expensive than London, Knight Frank calculates the super-prime property price growth in Moscow in 2007 reached 40.9% and is set to reach London levels within 10 years. “This will continue,” says Knight Frank’s Thain. “The real centre is very restricted in Moscow, and construction is getting smaller and smaller from year to year. There are no more Red Octobers out there. There is no doubt top end is soon going to be close to London prices.”

The recent Wealth Report published by Knight Frank and Citibank Private states baldly: “We forecast that within 10 years, Moscow will vie with London for the most expensive city in the world. While the prime area of the city will be much smaller, the prices achievable for new build prime developments will be comparable. There is huge demand for prime property in Moscow owing to little existing stock and a very small potential pipeline of additional prime property.”

In fact, the London and Moscow markets are already increasingly intertwined. “We have really, really strong connections with our London office,” explains Thain. “Russians are buying a lot of properties in London. In fact, we do not just sell luxury apartments and luxury housing in and around Moscow; we are famous here for also selling apartments and houses in London to Muscovites. Wealthy Russians want firstly an apartment in the centre of Moscow, where their business is; secondly a country house; and then their third location will be in London for sure. Their fourth and fifth locations are summer houses in Italy or France.”

Global real estate players have come in droves to Moscow over the last few years to cater to this burgeoning business. In 2006, Morgan Stanley real estate investment fund made their first investments in Russia, snapping up a 15% stake in RGI International, a developer of elite residential in Moscow, and a 10% stake in Moscow’s R.E.D, developing mostly commercial and some elite residential. In March 2007, Morgan Stanley took a 25% stake in St Petersburg-based RBI Holdings. Deutsche Bank’s real state investment arm RREEF is also involved in prime residential development, and a slew of other funds are following in their wake.

Cushman and Wakefield Residential has been present in Moscow since mid-2006, and is now starting to reap the rewards of the decision. “What we do is arrange investment deals, sometimes we are representing landowners, sometimes investors who want us to find something for them. It’s mostly foreign investors interested in new developments and redevelopments. Most investors we work with are international real estate funds,” Christer Lystad, head of Cushman and Wakefield Residential in Moscow, explains. “Most of these are joint ventures with Russian companies doing the development and international investors contributing the finance, with plans and designs done jointly.” Lystad says projects currently bring a return on investment of over 50%, and earn yields of 7-10%.

The biggest deal Lystad stitched together to date has been a luxury residential development based on the Otrada Equestrian Club in Moscow. Lystad persuaded Orco Group’s Endurance Residential Subfund to invest $200m in the development. Otrada Equestrian Club is home to some of the country’s pre-eminent polo events such as the Rolex Polo Cup, the Moscow Polo Cup and the Russian Polo Cup. The sporting theme is one dear to Lystad’s heart – he has himself been a professional sportsman in both his native Norway and in Moscow, where he played the outdoors form of ice hockey called bandy.

Lystad says a number of similar elite residential complexes are in the pipeline for 2008 – and, not coincidentally, they mostly come equipped with top grade leisure and sports facilities such as fitness studios. Cushman and Wakefield also facilitated the development of the Mayak yacht club in its picturesque riverside surroundings on the outskirts of Moscow.

Sberbank strikes back on Russia’s mortgage market

Graham Stack for business new europe

New Sberbank chief German Gref has pledged to boost the mortgage financing operations of Russia’s largest bank. He might succeed, thanks to the fallout from the US sub-prime crisis and increasing demand for mortgages in the regions.

With a 0.5-percentage-point cut in its mortgage products announced March 24 and a cut in consumer lending rates, Gref lent substance to his promises to end the bank’s hypertrophied lending policy. He can be sure of the Kremlin’s approval; only two weeks previously, on March 5, President Vladimir Putin publicly criticized Sberbank’s strategy. “Only 18.11% of your assets are from corporate clients, 52.1% from individuals, but you lend in equal proportions to both. So it follows you finance corporate clients out of individuals’ deposits. Why? Sheer laziness?” Putin asked rhetorically.

Gref knew the correct answer: “We should be working for the population, helping people with their needs: housing, purchases.” This admission was easy for him, since he had made the same argument throughout his years as economy minister, which ended in late 2007 with his appointment to head up Sberbank. Since then, he has attracted new talent from international investment banks and consultancies, and launched a review of Sberbank’s strategy that’s expected to see a shift to a more liberal lending strategy. The March 24 announcement is a step in this direction.

Answer to the apartment question

For all the general talk of retail lending, the heart of the matter is developing mortgage lending – a central reform policy launched under Dmitry Medvedev when he was first deputy prime minister, and one that’s set to continue when he assumes the presidency in May.

The Kremlin has homed in on mortgage expansion as the key to one of Russia’s oldest and most intractable problems, famously referred to by writer Mikhail Bulgakov as “the apartment problem,” where the problem is the lack thereof. Analysts estimate five new cities the size of Moscow are needed to bring per capita Russian housing space up to a Western European level.

Mortgage lending is in its infancy in Russia, but grew astronomically in 2007 by 140%, or $17.6bn, in nominal terms, to total $30bn at end of 2007. But it’s still an embryonic business. Mortgages only equal 2.3% of GDP, or $211 per capita, compared with 10-15% of GDP in Poland, Hungary and the Czech Republic. Only 10-15% of real estate in Russia is bought using bank loans, compared with an estimated 30-40% of deals in other Central and Eastern European countries. Total mortgage debt, an estimated 59 euros per capita, ranks among the lowest in Europe, ahead of only Ukraine, according to the European Mortgage Association.

Such under-penetration suggests that 2007’s explosive growth is set to continue. Moreover, according to Natalia Orlova, chief economist at Alfa Bank, the mortgage market offers the highest-quality loans of any market, delivering average non-performing loan rates of below 1% for mortgage portfolios.

The sub-prime crisis is bound to shave off some of that growth, says Alfa Bank’s real estate expert Brady Martin, because, “40% of mortgages were made available from money raised abroad, so the mortgage market will grow slower than the 140% of recent years.”

But Sergei Zharov, executive director one of the leading private mortgage lenders KIT Finance, plays down the effect on lending growth in Russia. “In Russia, there is simply a massive pent-up consumer demand for products ranging from fridges and televisions to mortgages for apartments,” Zharov told bne in December. “And the rate of default on mortgages is around 0.5%. Russians pay their debts – it’s part of the mentality.”

State banks take up sub-prime slack

However, the global financial turbulence has impacted on the structure, if not perhaps the volume, of mortgage lending. Alexander Semenyaka, head of the Federal Agency for Mortgage Financing, announced March 21 that 2007 had seen the state-owned banks Sberbank and VTB dramatically increase market share on the mortgage lending market, despite years of shrinking market share.

According to Semenyaka, speaking to the daily Vedomosti, at the start of 2007 Sberbank and VTB together had a share of 15% of the mortgage volume. By the end of the year, their share had reached 31%, with 10 large private banks holding around 33%. It was the smaller banks that surrendered market share over the year. Some 40% of mortgage lending at the start of 2007 was by banks outside the top 12. By the end of 2007, the figure had plunged to 25%. Regional and smaller banks experienced difficulties obtaining funding in the wake of the liquidity crisis and responded by cutting lending and selling their mortgage portfolios to state banks.

“The fast-growing private banks who pioneered many retail products and have been cutting inroads into Sberbank’s markets share in recent years are reliant on wholesale financing,” explains UralSib banking analyst Leonid Slipchenko. “But mortgage lending really requires long-term funds, and it is the state banks with their huge deposit assets that have these.”

Another trend in mortgage lending that began in 2007 is the shift in growth away from Moscow to the regions. Regional data suggest that mortgages were expanding in Russia’s regions in the second half of 2007. The share of mortgages issued in Moscow in the second half of 2007 dropped to 16.8% of the Russian total, against 30.2% in the first half. “Growth possibilities in Moscow are slowing as prices soar and more and more real estate is built by investors,” says Alfa Bank’s Orlova. Most notably in St Petersburg, the volume of new mortgages issued in the second city was almost twice that in the first half of the year, reaching 7% of the Russian total.

The jury is out on how these two trends – a relative strengthening of state bank lending and accelerating regional growth – will interact. Sberbank has not only better access to long-term financing than private banks thanks to its deposits, it also has a major advantage when it comes to competing for the regional market: an extensive network of branches. This explains why the mortgage market outside Moscow remains dominated by Sberbank, which issues 90% of its mortgages to the regions, with runners up UralSib 81.6%, Absolut 59.8% and VTB 56.7%. “Sberbank’s branch network is a huge advantage, and it could support their market share” says UralSib’s Slipchenko.

Will Sberbank under Gref build on the slight growth in mortgage market share achieved in the second half of 2007, or revert to its trend of declining share of mortgage and overall retail lending?

Natalia Orlova sees a lot of the regional growth being captured by the aggressive private banks moving out from Moscow to the regions, and is sceptical about lumbering Sberbank’s ability to control costs. Ironically, she sees Sberbank as more suited to work with corporate clients – for all that one might wish otherwise. “Gref was thinking more as minister of the economy than as CEO of the real existing Sberbank,” says Orlova of the latest Sberbank interest rate cuts. “After all, he’s new to the banking business.”

Overtaking on the inside track: Israeli developers facelift Moscow – with a little help from their friend

One of Moscow’s best kept secrets is that Israeli developers are doing their bit to facelift the Russian capital and bring it into the 21st century. They benefit from their international experience, expertise and reputation, and from their Russian connections.

Israeli newspaper headlines erupted December 2007 with the news that high-profile tycoon and religious benefactor, Israel’s richest man Lev Leviev, was leaving Israel to set up house in London. Where upon the London headlines erupted with the news that another “Russian-Israeli” oligarch was on his way, and had just snapped up London’s most expensive house for $70m – and an Bombadier 5000 luxury executive jet for just a little less.

Speculation was rife as to the reasons for relocation – running from his distate of Ehud Olmert’s ‘appeasement’ of Palestinians to the popularity of London as tax haven.

However, the official reason given by Leviev’s real estate holding Africa Israel was that as of December 2007 Leviev had become chairman of the board of directors of AFI Development, Africa Israel’s Russian subsidiary, listed in London, and that he intended to focus his entrepreneurial efforts on the Russian market.

With some of Moscow’s most grandiose projects under way, and a total of $10bn in investment pledged, this argument was not only official, but also the most plausible: Lev Leviev deemed the potential of the Russian market so great, and his personal influence so vital to execution – that it demanded his hands-on attention.

‘Mr. Leviev regards Russia as being one of the main growth engines for Africa Israel,” confirms AFI corporate director Igor Solomon.

Building the 21st Century in Moscow

Russia is undergoing a real-estate revolution, with prices spiraling at double, and occasionally triple digit, figures per year. In 2006, Moscow residential real estate famously grew by over 100%. In commercial real estate, prices in 2007 leapt by over 50%, and in 2008 should grow at only slightly lower rates for all the global credit squeeze. Construction is booming everywhere you turn, but it is still decades away from meeting demand.

This is the backdrop to Israeli companies’ taking Moscow by storm.

Pride of place among their projects goes to AFI’s Moscow City Central Core, the space-ship like heart of Moscow’s futuristic “City”. This is Russia’s answer to London’s City: the country’s financial centre, where office space will accommodate around 144,000 work places. To get an idea of the scale, add an on-site metro station, high-speed rail links to two of Moscow’s three major airports, direct access to major traffic arteries, 300 retail outlets, a 6,000-seat concert hall, and an ice rink,. AFI’s stake in the project is valued at $1.2bn.

A close second is AFI’s Tverskaya Zastava development, at the top of prestigious Tverskaya Ulitsa, 3 km from the Kremlin, where AFI is basically redesigning an entire district in the heart of Moscow. The combined projects will incorporate both a built-from-scratch interchange at Moscow’s busiest intersection, Moscow’s largest underground shopping center and over 224,000 sq m of office, retail, hotel and residential space, with total value over $2.1bn.

Impressive as this is, AFI Development is only of four major Israeli developers at work in Moscow. Mirland, affiliate of Israel’s massive Fishman group, showed it can hold its own with AFI by securing the rights to built the aptly named ‘Skyscraper’, a 48-storey premium class office and retail tower in downtown Moscow, to be completed in 2011. The company’s 100% stake in the project is valued at $141m.

Israeli-run RGI International implement exclusive ultra high-end projects, such as the recently-completed Butikovsky office complex in the exclusive Ostozhenka district adjacent to the Kremlin, valued at $55m. They have just broken ground on a a similarly high-end retail development on Moscow’s famous Tsvetnoy Boulevard, with six floors of retail space valued at $141m.

RGI is also creating an ultra high-end residential development two kilometers from the Kremlin, aptly named Chelsea. Moscow’s Chelsea will be worth $528m – double the price Roman Abramovich payed for his.

Big boys in a small country

For a small country, Israel breeds big industrial groups. According to Ben-Gurion University professor Daniel Maman, around 12 business groups dominate the economy, among them Leviav’s group, Fishman and Gaidamak’s Ocif. Such big groups have in recent years being looking further afield – with great success.

“Israel is a very small place, and at some stage if you want to keep growing you need to get out,” agrees AFI Development’s corporate director Igor Solomon. “The other thing is that business in Israel is so competitive, so the big guys are simply very good at it. In Israel you’re playing for several basis points spread, so when you have the opportunity to enter a market with great returns, you certainly take it.”

According to Maman, the move by Israeli concerns to invest abroad is “a new phenomena, which started at the end of the 1990s and accelerated in the early 2000s. This development is the result of Israeli state policies – which by deregulation (changing the law, tax policy etc.) open the way for the big business and business groups to invest in other countries. Russia is only one example.”

Moreover, according to Maman, “most of the big Israeli business groups have real estate development components. Until the late 90s their real estate operation was mainly in Israel. Now its all over: US, Europe, East Europe, Asia etc.”

“It’s not just Russia and not just real estate,” says Solomon. “Israelis are very present in East European insurance, for example.”

And Russia, he says, is short of the world class development quality the Israelis bring, leveraging their parent company’s expertise.

The Israelis offer world-class quality and international experience: Africa Israel, AFI Development parent company, has over 70 years of multinational experience in development, construction and management of large real estate projects. The Mirland parent company Fishman group boasts over 20 years of experience in international real estate development, and a current portfolio of over 4 mln sq m, an estimated 80% of which is outside of Israel.

Aviv Ocif, acquired by Arkady Gaidamak for $200m in April 2007, which he intends to enter the top five Russian developers, is one of Israel’s oldest and largest development companies, specialized in advanced complex construction technologies and internationally active.

So, while these companies are newcomers in Russia, their backers are considerably more established than any Russian company. In comparison to them, as Brady Martin notes, many of Russia’s newly-floated development companies are “young” and “have limited operating histories overall and even less experience as public companies,” and are consequently facing “steep learning curves”.

The Russian connection

But it’s not just the need to grow outside Israel, and the booming Russian economy offering huge opportunities, that has induced Israeli developers to take the plunge. It’s hardly a coincidence that three of the four Israeli developers active in Russia today are Soviet émigrés.

“It’s the Russian connection,” explains AFI Development’s Igor Solomon.

The most high profile of these Russian Israelis is Lev Leviev.

“He’s easily the biggest benefactor of Jewish communities in the CIS,” says Solomon. “Two of our key success factors are AFI’s backing from the Israeli parent company – and Mr. Leviev’s contacts in Russia.”

Legends surround Lev Leviev, reputedly Israel’s richest man with a fortune of around $5bn. He emigrated from Soviet Uzbekistan to Israel as a 15 year old in 1971, went into the diamond business in the 1980s, and became a billionaire by breaking De Beers monopoly on marketing diamonds by sourcing raw gems in Africa.

A deeply religious man, Leviev perceived the collapse of the Soviet Union not so much as a chance to do business, as primarily to finance and support a large-scale revival of Jewish religious belief and culture on the territory of the CIS. He founded the Federation of Jewish Councils (FJC), an umbrella organization both providing financial support and Orthodox education to Jewish communities across the CIS, and lobbying on behalf of Russia’s Jews in the corridors of power.

The Moscow authorities in the 1990s were closer to another Jewish organization,  the Russian Jewish Congress, headed by media mogul NTV owner Vladimir Gusinsky, an ally of Moscow mayor Yury Luzhkov. N.B: Vladimir Resin, Moscow’s long-serving vice mayor who oversees Moscow’s entire real estate construction and development sector, was and is a member of the RJC’s presidium.

Lev Leviev seems to have initially had better links to the Kremlin, with Putin attending the opening of the FJC’s Moscow Community Centre in 2000. When Vladimir Gusinsky was imprisoned and exappropriated in 2001, subsequently fleeing to Israel, Leviev’s candidate Rabbi Berel Lazar replaced the RJC man Adolf Shaevich as Russia’s Chief Rabbi, apparently with the Kremlin’s backing.

However, to the extent that Moscow Mayor Yury Luzhkov became increasingly reconciled with the Putin administration, Leviev has seemingly managed to retain the favour of both the Kremlin and Moscow City Hall.

Arkady Gaidamak, owner of Israeli real estate giant Aviv Ocif, regarded as a controversial maverick and populist in Israel, has long been a prominent benefactor of Russian Jews. Gaidamak emigrated to Israel from the Soviet Union in the 1972 as a twenty year old for Israel, and then lived twenty years in France, with a variety of business interests, including partnership with Leviev in Angolan diamond dealing.

After the collapse of the Soviet Union, Gaidamak backed the Congress of Jewish Religious Organisations and Associations of Russia, a successor to the Soviet-era Jewish organization. Now he is its president.

In addition, since announcing his move into Russian real estate in August 2007, Gaidamak has publicly backed the Kremlin in Israel, facilitating in December 2007 the return of two Orthodox churches to Russian ownership, and discussing funding the construction of a new Russian Embassy in Tel Aviv.

Compared to Leviev and Gaidamak, Boris Kuzinets, owner and CEO of RGI International, keeps a low public profile, and focuses instead on personal contacts. Kuzinets emigrated for Israel from Latvia in 1971, but relocated to Russia in 1990, building up his development business from scratch as one of the first developers to build contemporary architecture in Moscow, according to Alfa’s Brady Martin.

Despite Kuzinets’ Moscow location, RGI Development, registered in Guernsey, is a recognizably Israeli company, with five of seven board members Israeli citizens, and the remaining two Americans.

Kuzinets now has a string of successfully completed high end residential development projects to his name. For all the Israeli background, his long experience in Russia makes him the ultimate insider, considered be “extremely well-connected,” in the words of Iskyan. Indeed, according to Alfa bank, the main risk connected with RGI International is the company’s overweening “reliance on a single person for sourcing projects”.

Playing Moscow Monopoly

Such connections are a vital resource when it comes to playing the game of “Moscow monopoly’. Moscow real estate, agrees AFI Development’s director Igor Solomon, is a “pretty much a closed shop,” and largely out of bounds to foreign companies – with the Israelis the exception that proves the rule.

“Nothing in the real estate market in Moscow happens without the mayor playing some role, so you can make the obvious logical jump,” says UralSib’s Kim Iskyan. “Any real estate deal in Moscow has the city as a partner. Either they have about a 30% stake or they get in on the deal in some other way.”

“Put it this way,” says Iskyan, “You and I can’t just tomorrow decide to go into high end residential development in Moscow and get anywhere at all.” According to UralSib research, “lack of transaction transparency is a defining characteristic of the Russian real estate market.”

Such opacity restricts competition, meaning returns to those operating on the market are higher. As Renaissance Capital’s Alexei Yazykov says, this is hardly a great surprise when one of Moscow’s major construction companies, Inteko, is owned by the mayor’s billionaire wife, enjoying 20% Moscow market share, and another major player, Sistema Hals, also has, according to Alfa bank “strong connections with Moscow government both at the parent company level and through multiple infrastructure projects completed for the City of Moscow.”

The city government’s pervasive involvement in real estate is institutionally secured by the refusal to privatize land – a political victory won by Moscow mayor Yury Luzhkov over Kremlin reformers in the mid-1990s that has shaped the Moscow political economy ever since. The city makes land available only on long-term lease – meaning that every real estate deal is dependent on the goodwill of the authorities, and the city uses its bargaining power to the full

“They’ve had connections that have served them well,” says Iskyan of the Israeli companies. “It takes time to build these up. There’s certainly links to city hall, I wouldn’t want to speculate on their exact nature. These things you only see in the results. You and I can’t just tomorrow decide to go into high end development in Moscow and get anywhere at all. So the fact that these guys have, says something about their connections.”

AFI Development’s public relations manager Vladimir Rosin, says simply of Lev Leviev that “he’ s quite influentional in Russia and familiar with the Russian president, and has good relations to the Mayor of Moscow. Indeed, the Mayor of Moscow is very aware of Mr Leviev, and they met this year, several times throughout the year.”

Leviev’s personality seem important enough to the company for a sharp drop in AFI post-IPO share price to prompt him to take over in London.

“He wanted to pay more attention and participate in terms of more control more closely,” says Rosin. “Externally I think it’s a very positive and strong sign for the investment community and real estate players,” says Solomon. “But it won’t of course be a change for us internally because Mr Leviev was very closely involved in the activities of company since its inception.”

Surviving the credit crunch

If good connections in Moscow help Israeli companies get a foot in the door where other foreign companies stay outside, then the Israeli connection provides an advantage over Russian companies in times of financial turbulence.

“It should be an advantage for them having access to the Israeli market, since the yield will be more attractive. Where the parent companies are Israeli, it opens up other channels in terms of financing,” says Alfa’s Brady Martin.
This argument seemed to be borne out in November, when, with markets reeling under subprime fall out, and debt financing tightening in Russia, RGI International still successfully placed an approx 128m shekel bond ($32m) in Israel.

Renaissance Capital’s Alexei Yazykov points out, that, in the case of AFI Development, should things turn really nasty, the Israeli connection will provide “the potential to tap emergency financing should unforeseen events prevent AFI Development from funding its projects through more traditional sources of capital. We feel the financing potential is a real benefit.”

AFI’s Igor Solomon agrees that the company is relatively secure in terms of funding: “of course the market has become quite tight, but we have negotiated and secured a major project finance for our Tverskaya scheme in August and we are negotiating further funding for our biggest schemes on a project basis, and it seems quite promising that we will get the financing at reasonable terms. Being a globally diversified company helps in terms of access and experience.”

“We’re just normal people”

The larger than life Russian-Israeli trio of AFI Development, RGI International and Arkady Gaidamak’s Ocif are focused almost exclusively on the giant Moscow market – and thus dependent on good relations with City Hall.

The odd one out among Israeli developers in Russia is Mirland, subsidiary of the Fishman holding, one of the largest Israeli business groups. The Fishman family have no sort of “family connections” to Russia.

As a result, their strategy in Russia differs significantly from the Russian-Israeli developers. 49% of portfolio value comes from projects outside Moscow, and the company aims in the future as well to keep the Moscow / regions balance at 50 / 50. Moreover, their business in Moscow is dominated by one single massive project – the Skyscraper – mentioned above, compared with dozens of projects spread through the regions.

Mirland also stand out among Russian developers in five of the nine directors being independent, ‘a rare exception’ according to Alfa’s Brady Martin.

“If at one end of the spectrum there’s insiders like Sistema Hals,” says Kim Iskyan, “who basically can say we know everyone, then at the other end of the spectrum, if there’s no one who says we don’t know anyone, but a company might say ‘we’re just normal people trying to get the job done’, then Mirland are closer to that end of the spectrum.”

“Of course,” he continues, “they’re not going to say we don’t know people, because you can’t get anywhere without knowing people, but they are not flashy about it and they don’t brag about it. They say ‘there are the rules, and we try to play by the rules.’”

“This explains their regional approach,” says Iskyan. “It’s much easier to do this in the regions, where you are dealing with regional administrations who are not spoiled for choice, they don’t have lines at their door wanting to invest, and therefore they facilitate investment, rather than repelling it by demanding 30% stakes and whatever else.”

Mirland has successfully pioneered this approach in Russian real estate development. However, when the Fishman Group tried to replicate their “we’re normal people” approach in another business direction, they very quickly and very publicly found themselves in major difficulties.

In 2007, Tamir Fishman Venture Capital in partnership with the European Bank of Reconstruction and Development submitted a bid for venture financing from Russia’s new state-backed venture investment fund. Their minority Russian partner was a certain Oleg Shvartsman, head of Finantsgroup, who had originally proposed the idea to Fishman.

The whole world now knows that, in early December 2007, Shvartsman proved to have been a poor choice as business partner, and Mirland were exposed as looking very foolish in the Russian context.

Shvartsman, a hitherto unknown financiere and amateur poet, became famous overnight when Russian business daily Kommersant published an interview he had given on the sidelines of a technology conference in Paolo Alto.

In the interview he claimed to act on behalf of the Kremlin in employing a whole arsenal of extra-legal means to pressure companies into “voluntary deprivatisation”. In this capacity, according to Shvartsman’s detailed and plausible account, he answered directly to Igor Sechin, presidential aide and the alleged leader of the much-feared ‘silovilki’, the Kremlin hardline faction. A collective shiver ran down the backs of Russia watchers and company directors, as his account chimed true with what many had long suspected.

On the scandal breaking, Tamir Fishman and EBRD pulled out of the venture capital deal with egg on their faces.

Elmad Fishman, who runs the venture capital side of the business, could only comment ruefully afterwards to the press that: “Russia is complicated – and it’s very important to choose the right people.”

Lev Leviev no doubt agrees.