Vitaly Mozharovsky: Legislation Changes Faster than Developers Can Keep Track

Starting July 1, 2006, a number of amendments to the existing land legislation came into force. Can you talk about these changes in more details. In your view, how will they impact both the land market in particular and the commercial real estate market as a whole? Who will emerge the losers and winners?
That’s right on July 1 a large number of amendments came into force, bringing with them a large number of changes.

Most importantly the federal legislation transfers virtually all powers regarding unassigned state land to municipal authorities. Before this issues relating to the sale or lease of state land were resolved differently in different regions. Either everything was decided on a regional or a municipal level or up to a certain limit at a municipal level and then at a regional level.

From one point of view, the amendment makes good sense. It is very well known that municipal budgets are insufficient to fund social programs, road construction, infrastructure improvements, etc. The main source of funding for municipal authorities is income tax, which in the majority of regions does not represent a very large sum. In my view the reasoning behind this amendment was an attempt to boost municipal budgets.

On the other hand, however, in the regions where the regional administrations have played a significant role in the granting of land the reaction was of course negative. Regional authorities began to comment that the municipalities are not properly prepared, lack the necessary qualified staff and it will be hard to avoid the squandering of land. There may well be a grain of truth in this, but viewed as a whole it is insignificant. I believe that with time the bugs will be ironed out.

Is this unhappiness on the part of the regional authorities just that or have specific steps been taken to prevent the new amendments taking effect?
The situation surrounding the passing of these amendments was quite amusing. In April the Federation Council voted virtually unanimously (as usual) in favor of the amendments. Then in June shortly before its came into effect I had the pleasure of attending public hearings in the Federation Council devoted to the possibility of reversing these amendments. So the amendments had not even come into effect when the lawmakers were trying to find ways to reverse them!

Opposition to the amendments was expressed not just in the public arena but in regional legislative initiatives. The most recent of these well­known cases occurred in Nizhny Novgorod. The new federal law provides two exceptions regarding the transfer of the right to grant land to municipalities ­ Moscow and St. Petersburg where this is done by the city administrations and populated areas which are also administrative centers like, for example, Ryazan, Yaroslavl, Ufa. Accordingly the Nizhny Novgorod authorities awarded each population center the status of an administrative center.

Another example is the Moscow region. Here regional lawmakers did not set out to contravene the new law but were quite inventive in introducing a requirement for obtaining approval. So, while the municipalities can dispose of land all, Acts regarding the granting of land, leasing, privatization and even the parceling of lots must also be approved at a regional level.

I think that in both the first and second examples the new regional legislation may simply backfire. Think about how much extra work they now face. All this involves not just lots of 100­200 ha but thousands of allotments of 600­1500 sqm. I think it would have made more sense to establish criteria, for example, smaller areas could be within the authority of the municipalities and larger projects could be overseen by regional authorities, as has worked well up to now in many regions. It makes more sense to wait for a liberalization of these rules otherwise the regional authorities will become bogged down by the huge volume of work. Also, you have to bear in mind how all this will affect foreign investors. In terms of larger projects once investors find out that the regional rules are at odds with the federal legislation and the deal could be challenged later they may think twice about whether they need this kind of risk­laden land. I hope that with pressure from the business community regional legislators will gradually smooth this out.

How is the concept of the assignment of state land altered by the new amendments?
The July amendments annulled the law regarding the assignment of state land that was passed in 2004. The previous law provided a very complex, formalized procedure that required the obtaining of approval at a municipal, regional and federal level for each lot as well as a Decree regarding its assignment from the federal government. All this took about a year for each lot. However, one of its advantages was that it avoided future conflicts since each lot had obtained so many approvals that the situation was quite clear. But taking into account the volume of work involved the process of assigning state land this would have taken decades. So the decision was taken to replace it.

The procedures surrounding the registering of land will no doubt be streamlined by the merging of the State Land Cadaster with the Bureau of Technical Invetory. How do you envisage the future changes to these bodies?
Currently a process of integration and centralization of state services is underway. If you recall, three to four years ago a decision was taken to merge the Land Committees and Land Cadaster Chamber into one department because they overlap certain functions. Today the process of merging departments continues. Next will be the merger of the State Land Cadaster and Bureau of Technical Inventory (BTI). Of course this is a positive development since reducing the number of departments and centralizing their functions will lead to the adoption of a single standard. This merger will have an impact in practical terms. At the start the plans for land lots were simply empty rectangles. Already now these plans are beginning to show buildings accompanied with detailed information and technical specifications. So we will be seeing not just abstract ‘black rectangles’ but lots complete with the buildings they occupy.

Of course unification takes time. However I think that in 5­10 years time this process will be complete. As for the reform of the Cadaster Registry, this will also take place gradually. Currently pilot regions are being identified in which the new system will be tested. So as experience is gained it will slowly enlarge eventually incorporating the entire country. I think this is a wise approach and will avoid the same mistakes being repeated in different regions.

The new system has another advantage. Today in order to receive a cadaster survey of a site you need to file a statement in the region in which the building is located. Starting in 2012 when the entire country is working under the same system you will be able to receive a cadaster survey for a building in Samara from Moscow. A single software program and database of building and lots will make this possible. I think that the department merger is an exceptionally well­formulated concept which will reduce the time needed to conclude deals and realize projects.

At the end of July a Decree was passed by the Government of Moscow “On the Transfer of Land Lots Located within the City of Moscow into Private Ownership.” Do you think that the process for purchasing land in Moscow will become more streamlined as a result?
When I heard about this decree I was pleasantly surprised. However when I began to study it in detail I understood that it is unlikely to fundamentally alter the situation. Put concisely the decree does not relate to how land should be sold but rather to how it is should not be sold. In the preamble it says that is well but the rest of the text goes on to say the opposite. About a third of the text is devoted to the basis for refusing to consider an application at all possible levels. I got the impression that the Moscow authorities were so fed up with hearing the criticism that land can’t be sold in Moscow that they wanted to show that such a document existed and if people can’t buy land it is their own fault because all the rules are written down.

Starting January 1, 2007 there will also be a new law relating the real estate market – the abolition of construction licenses. What will happen to the quality of construction?
To be quite honest I would not pay this too much attention. While ten years ago getting a license was quite difficult, today it is easy and anyone could do it. Nowadays possessing a license does not mean that that you are a reputable and reliable construction company.

By way of analogy let’s look at the situation surrounding licenses for pharmacies. In order to receive a license any pharmacy, even if it doesn’t sell medicine, must have a refrigeration storage unit. An acquaintance of mine told me that if a company doesn’t have a fridge they can still get a license. Apparently there is a company which specializes in providing fridges for very short­term loan. The fridge is delivered the inspectors arrive and the next day the fridge is returned.

I am not of the view that construction licenses currently have any particular value in terms of state control. Taking into account all the different types of control mechanisms: pre­design approval and approvals from the chief architect, fire safety service, Sanitary & Epidemiological Station and the Environment Institute, I think construction licenses have become obsolete.

In conclusion, what today is the most significant factor holding back the development of the commercial real estate market?
At present more sites are being built, the secondary market is very busy and vacancy levels are close to zero. A key issue is the concluding of preliminary agreements regarding future sites.

Every second lease we come across is for a future site and every second acquisition of warehouse real estate concerns a future site. At present the conclusion of preliminary agreements is regulated by arbitration since an agreement about non­existent real estate is regarded as incomplete and cannot be enforced. At the same time the market needs guarantees for the sides involved in concluding the deal. It is important for the developer that the tenant for whom the site is being built doesn’t change their mind. The tenant in its turn needs to be confident that the developer will not offer the site to another party. The market has to accommodate this.

Nowadays preliminary agreements usually come in the form of three documents. The first is a preliminary lease agreement which states: the construction deadlines and engineering and technical specifications of the future site and the deadlines for the first, second and third tranches. Then there are two lease agreements: a long­term and a short­term one. Why are these necessary? Well the bitter pill of reorganization has not eluded Rosregistratsiya. The reform of Rosregistratsiya took place at the start of 2005 in which all its functions were transferred from a regional to a federal level dealt a serious blow to the system on the whole.

This poorly­formulated reform meant that while the volume of work remained the same the salaries in Moscow region alone reduced four­fold. Naturally this led to the most experienced employees leaving, some moved to other departments and others into the private sector. The remaining employees – mostly young, inexperienced and underqualified – began taking decisions and attempting to bring their influence to bear on commercial deals. Now you often come across absurdities like documents are rejected because the preamble to the agreement doesn’t contain the taxpayer identification number, which is traditionally found on the last page of agreements. The industry has had to adapt to these new conditions.

Short­term agreements do not require registration and are in this case employed in order to provide insurance against somewhat unpredictable registrars. The agreement is only there to cover the time period between the signing of the deal and registration and the coming into force of the long term agreement. In previous milder times registration took about 2­4 weeks. Now however it can take up to six months. In order to work through this period and receive lease payments a short­term agreement is concluded. Many would be happy to see the previous fast­track registration system return. It offered a legal and officially approved way in which to receive registration in a week in exchange for a reasonable sum.

There is yet another stumbling block – frequently changing legislation which developers simply cannot keep up with. A good example of the problems this can cause was provided by a recent deal we reviewed regarding the privatization of a land lot. The buyers and sellers were convinced that the right to dispose of the land rested with the municipality. They said that in the Introductory Act to the Land Code it is clearly stated that the municipality has the right to decide upon the fate of land lots. However there is also a comma followed by the phrase “unless legislation establishes otherwise.” In actual fact four months before the deal a law was passed at the regional level according to which the granting of a lot of that size is undertaken by the regional authorities.

There are still a lot of rough edges in the legal practice relating to commercial real estate. However judging by the latest set of amendments we are starting to move in the right direction. I hope that some time soon developers, investors and tenants will be able to operate according to more transparent, predictable and civilized rules.