Affiliated Development: Freedom or Servitude?
Nowadays, banks operate fairly actively on the real estate market, financing the construction of office, shopping, residential and other buildings, financing projects and so forth. Some financial structures have their own dedicated divisions for working with real estate borrowers. Others have departments designed to seek out investment projects. Yet others go further and create their own development company. In these cases, specialists believe that it is hard to speak of any unified prerequisites for creating an affiliated development structure. “We started to get involved in development, when on the one hand we understood that the bank had accumulated a certain volume of assets and, on the other hand, considered that the level of profit associated to development was acceptable to us,” comments Andrei Lukyanov, director of real estate investment at the Rossiysky Kredit Bank.
The level of independence of a development company depends on the selected concept and volume of work conducted by the company. “The developer’s activity may be aimed at seeking out investment projects, analyzing potential sites and acquiring them, forming a concept for their use and drawing up business plans. Subsequently, the company may expand into a developerbuilder. At any of these stages, the development company may be responsible for an independent profitable business, working in the market or on behalf of clients. The degree of freedom of the development company in its collaboration with third party clients is defined by the bank’s investment policy and the boundaries of its development business portfolio,” explains Ilya Velder, deputy head of project financing at AK BARS BANK.
Who’s the master of the house?
From a formal point of view, development in the context of a banking structure is illogical simply because it is not a profile business for banks. While well acquainted with the essence and specifics of, for example, project financing, banks are not masters of development and cannot offer all the required resources for a project’s realization, and therefore, cannot compete with profile market players. Moreover, for development and banking structures that work together there is an unavoidable conflict of interest – banks always want to sell their money more expensively, whereas developers, on the contrary, wish to find the cheapest possible capital in order to increase the return on their building. As a result, when working as part of the same chain, one of the parties is forced to compromise, and consequently only one business works effectively.
All of this leads market specialists to believe that there is no more productive way for a development and banking business to work together, than autonomously and independently of each other. In this case, the development business may be divided into a separate company unrestricted by obligations towards the affiliated bank, and may represent, like the bank, part of a group of companies.
“In our holding, the company Promsvyaznedvizhimost is not obliged to borrow exclusively from Promsvyazbank, just as Promsvyazbank is not obliged to provide loans to its affiliated developer,” explains Vladimir Aristarkhov, general manager of Promsvyaznedvizhimost. “If I want to take out a loan I must go through all the same steps as any other developer with Promsvyazbank. I must provide a deposit, the full package of documentation, pass the credit committee and so forth. Moreover, sometimes an application for a loan can be rejected. If a loan is granted, the interest rates are market rates; Promsvyazbank makes no special allowances here. At the same time, our development structure can approach other financial institutions for better rates of financing than our bank can offer. In my opinion, this is the most appropriate type of relationship; otherwise one of the businesses will suffer.”
Andrei Lukyanov also agrees with this opinion. His view is that, on the one hand, the bank and development structure should be free from each other. On the other hand, affiliation ideally suggests that a developer going through the credit committee with its “own” bank and providing certain guarantees, will obtain financing for the first stage of the project’s development, and subsequently, the developer can attract cheaper, outside financing. This is the model used for the development projects of Rossiysky Kredit Bank such as for example, financing the reconstruction of the Minsk hotel, which was initially done by the bank, but for which subsequently outside investors will be attracted.
“You shouldn’t put all your eggs in one basket. If the bank finances its own developer to a large extent, its risks – as a financially independent structure – immediately double,” asserts Dmitry Bolshakov, deputy director of development at MOSINZHSTROY Development. “Let’s imagine the following situation: the bank finances the realization of its own developer’s projects. At one point the situation arises whereby the bank is ruined. What happens? The development structure also sinks as its own bank no longer has the resources to finance its projects and other structures are now unlikely to finance its construction. In the opposite case, if the development project fails, then the banking structure is exposed to the risk – whereas if the bank financed other clients, it would have guarantees.”
In fact, relations between developers and banks in each each case are arranged differently. “In the context of our company, there is no centralized development structure, we resolve this issue individually for each specific project,” explains Alexei Gusov, CEO of Mosstroyekonombank. “For example, Mosstroyekonombank is currently investing in the second phase of Smolensky Passazh. But nearer the time of starting to build, we will probably create a development company/technical investor. This structure will be directly responsible for the project’s realization.”
Specialists consider that the existence of a bank and development company within a single structure can to some extent simplify the development business. Firstly, as already mentioned, some banks will finance the hardest – initial – stages of a development project’s realization. Affiliated banks that do not do this may provide the developer with guarantees so that the developer may obtain financing from other financial institutions. In this case, the bank helps not with resources, but with its name. Indeed, specialists note that in these cases banks should seriously consider the risks so as not to endanger their reputation.
Another advantage of developers and financial structures cohabiting with each other is that the affiliated bank deciding to finance a project after analyzing it can help the developer to identify the level of risk. “The experience of banking analysts and bank partners based on the analysis of numerous business ideas and realized development projects, helps to avoid wellknown mistakes in planning project deadlines, expenditure levels, generated income, and means that it is possible to correctly appraise the time frames and risks to returning the bank’s invested resources and their return. The bank’s position of healthy skepticism together with its market knowledge helps to correctly appraise the project and its risks, to eliminate the risks and reject a project in time,” comments Ilya Velder.
Given such a large number of advantages, surprisingly a large number of developers do not advertise their affiliation with large banking structures. “When it appears that there is a powerful financial structure behind a developer this causes contracting parties’ to raise their prices. When the developer appears to be a less wellknown company, contracting parties will moderate their zeal and offer more realistic job rates,” believes Alexei Gusov. “This is why many development structures try not to incite partners with largesounding bank names, and do not advertise the fact that their financial capabilities may be sufficient to realize expensive projects.” Showing affiliation can also provide another disadvantage, if one structure sustains a fiasco, the other’s reputation also suffers. Therefore, why join two brands, if in practice the companies’ activity is separate?
From hand to mouth
Aside from equitable relations, there is another scheme whereby a development subdivision is created as a business to serve the bank, making it possible together with other schemes for investing money (bonds, shares, etc.) to increase the bank’s assets. The task of the subsidiary development company entails acting in the interests of the banking group, choosing and realizing projects in accordance with jointly defined criteria in terms of return, capitalization and completion deadlines. In the end, the subsidiary developer earns precisely on behalf of the bank and in the bank’s interests.
“If the development structure is created by the bank and the bank is at the head, the developer serves the financial structure meaning that all development projects must be agreed with and approved by the bank. In this case, the developer cannot at any time receive the required sum from the bank and cannot individually decide which projects to realize. The structure is under the bank’s control and the bank defines the rules of the game for the developer,” explains Alexei Gusov.
On the one hand, subsidiary development is easier because the affiliated bank provides the financing. On the other hand, the developer’s “hands are tied” to a certain extent – it not only has to constantly show the bank the worthiness and profitability of specific projects but also to ask the bank for permission to obtain financing from other structures. “If the bank is managing the project, in all events, attracting resources will depend on its decision,” highlights Igor Laskavets, deputy manager of investment projects at GLOBEX bank. The logic here is simple – the developer works under the bank’s brand and not as an independent structure. If the project fails, the shadow of the unsuccessfully realized concept falls precisely on the financial structure’s reputation, which is why the latter carefully monitors its projects in order to minimize the risks.
The activity of a “pocket” structure in this case can be complemented with outsourcing – hiring the services of profile companies working in separate spheres. Given the bank’s concentration precisely on strategic management and financial provision, it is also responsible for the project office, which coordinates work on a project. Narrow tasks, such as market analysis, project research and conceptual analysis, predevelopment, construction management and others are conducted by either the “pocket” structure, or by specialized professional companies.
In fact, the market also has the exact reflection of this model, whereby the developer creates its own bank. In this case, the bank serves the developer, with the latter basically financing the bank’s activity. “Large holdings create pocket banks to manage their own cashflows. As a rule, these banks do not have any external activity, they simply turnover the resources coming from the parent company,” notes Dmitry Bolshakov. A “pocket” bank’s activity is generally not profitable. The developer has certain expenses to keep its money and maintain the instrument to realize its own projects. “In this case, the bank totally serves the development company and is not a market player,” emphasizes Pavel Kosov, vice president of Vneshtorgbank.
Who needs this?
While the level of return of the development business remains high, not all financial structures are interested in development. Above all, as already mentioned, this is related to banks’ strategies, and in particular to whether they can work with more profitable market segments. Moreover, the issue of lacking resources is currently fairly pronounced, and not in terms of financial resources so much as professional ones. “The market of professional developers is still fairly young. There are just a few valuable specialists on the market working for large development companies under reasonable employment conditions, which makes them hard to entice. This is why often it is necessary to develop one’s own professionals. As a result, at present there are more interesting projects and financial capabilities to realize them than there are personnel resources to manage them,” notes Vladimir Aristarkhov. The issue of competition is also a vital one – the market has an impressive number of professional development companies that not everyone is in a position to compete with. “In all events, given that the real estate market is actively growing, a great proportion of banks, even those whose strategies do not consider this activity, secretly wish to work in it. Every banker, to a some extent, wonders how to enter the real estate market,” notes Alexei Gusov. “Obviously, it’s not easy, but if the process is correctly devised, the risk is worthwhile.” “The development business is specific in that it is a very complicated business. It is not the FMCG market, where if one product line is unsuccessful the conveyor belt is stopped and another product is manufactured. In development it is important not to make a mistake at the business concept stage and to understand what the market will need at the time the site is released on the market. For this it is vital to have impressive resources, which financial institutions cannot always provide” adds Dmitry Bolshakov.
Regardless, banks, as structures interested in the most profitable market segments, once again prove the attractiveness and promising prospects of the real estate market, and within the limits of their capabilities try not to miss the choice opportunities offered by this sector.
