Construction Market Overview: St. Petersburg and Northwest Russia Regions

October 2006

Author: Julia Vlasova, Bisnis Representative in St. Petersburg, Russia

Summary

This report provides an overview of the construction market focusing on residential and commercial construction. It also contains statistical data and expert forecasts of the market development trends. The report identifies large industrial projects of potential interest to American manufacturers and suppliers of construction materials. The last section contains information about the construction materials market. American companies that specialize in mining and processing of raw materials used for construction materials manufacturing, as well as those providing construction equipment-leasing services, may find a niche in the Northwest Russia market.

END SUMMARY

MARKET OVERVIEW

St. Petersburg, the second largest city in Russia with a population over 5 million people, experiences high demand for residential housing and commercial premises. The Northwest region holds a 13.8% share of investment in capital assets in Russia, behind only the Central, Volga and Ural regions. The Northwest region share is distributed between St. Petersburg, holding 32% of the region’s share and the Leningrad region and Vologda region, each with 14.5% with the remaining eight regions accounting for the remaining 39%.

According to the Association for Economic Cooperation, the volume of construction works in the Northwest region in 2005 increased by 99.9% over the previous year, totaling 218,5 billion rubles (about $8 billion). Volume of construction in most of the Northwest regions increased: the Nenetsky region increased by 37.4%, Arkhangelsk by 32,5%, the Komi republic by 31,5%, Murmansk by 22.7%, the Kaliningrad region by 17.2%, the Novgorod region by 14.2%, the Karelia republic by 10.5%, and the Leningrad oblast by 7.9%. A few regions, however, such as St. Petersburg, Pskov and Vologda, experienced a decrease in volume of construction.

More than 8,000 buildings were erected in 2005 in the Northwest region, 3,000 of them in the Leningrad region and St. Petersburg. The volume of residential construction amounted to 3.9 million sq. meters, 6.2% more than the previous year.

In the last five to six years the construction material production has experienced massive changes. Especially as regards production of dry mixtures, roller-compacted concrete, roofing materials and other common construction materials.

In 2005 a number of new manufacturing facilities were put into operation. For example, production of ceramic tiles with the annual capacity of 2,16 million sq. m. has been initiated in the Leningrad region; facilities for producing metal-plastic window and door frames with the annual capacity of 55 thousand sq. m in the Kaliningrad region; a new plant with the annual capacity of 42 thousand sq. m. in Karelia started production of doors and windows based on polyvinylchloride extrusion technology.

In 2006, Danish company Rockwool is planning to open a plant producing heat-insulation materials. There are several other new production facilities in the Northwest region that are currently under construction. However, many of currently existing production facilities in the region are underutilized.

The rate of Construction market growth is very high in St. Petersburg and the Northwest region, notwithstanding signs of stagnation in the residential construction sector. One of the main reasons for growth is the recent adoption of the City General Construction Plan, and a number of important laws and resolutions regulating activities on the construction market. Among them are:

- Law that sets the price of land in St Petersburg.

- Law on Privatization of the Property owned by the city of St Petersburg, which allows for the selling of property formerly owned by the State to a private investor.

- Law N 282–43 of 17.06.2004 (with amendments on 22.12.2004) On the Allotment Procedures for the Real Estate Objects Owned by St. Petersburg for Construction and Reconstruction This law offers investors an easier way to acquire real estate assets.

- In June 2004, the St. Petersburg city administration conducted the first open tender for land plots.

- Private mortgage became available in Russia (this topic will be discussed under “Residential Construction” section of this report).

There are many construction investments opportunities in St. Petersburg, namely the following:

- infrustucture development around Pulkovo airport;

- construction and development of seaport terminals in St. Petersburg;

- construction of hotels in the center of the city;

- construction of sewage (purification) facilities;

- construction of home appliances manufacturing plants;

- relocation of industrial facilities away from the city center.

Detailed information about current and upcoming construction projects in St. Petersburg is available at the specialized section of the St. Petersburg city administration official Web site at www.st-petersburg.ru

Other Northwest regions, especially those with significant manufacturing base, also have many potential investment opportunities in construction sector.

Currently, many foreign companies are active on the Northwest Russia construction market. Finnish companies are among the most active in that arena. According to Terho Salo, CEO of the Finnish Union of Construction Industry, 9% of all Finnish construction production and services are exported to Russia. The value of construction projects, construction materials and construction services exported from Finland to Russia in 2003 exceeded 1.5 billion Euro. According to Mr. Salo, there is an opportunity to increase this amount five times by the year 2013. Among Finnish construction companies actively operating in St. Petersburg are YIT, Lemcon, and SRV. YIT, for example, has been working in Russia for more than 40 years, and currently, around 35% (or 94.3 million euros) of the company’s overall construction turnover is from work in Russia.

Finnish company KONE, the world’s fourth largest elevator and escalator company, is also planning on expanding its operations in Russia and St. Petersburg in particular. Antti Herlin, CEO of KONE, speaking at a news conference in Helsinki, said that currently KONE occupies 21% of Russia’s import market for their type of equipment.

The example of Finnish companies’ successful on the Northwest Russia construction market is a good indicator for other foreign companies, including those from the U.S.

RESIDENTIAL CONSTRUCTION

St. Petersburg has always been among the largest cities in Russia, with a population of 2 million people before the World War II, and about 5 million people currently. Total demand in Russia for the residential premises is over 1.6 billion sq. meters. To meet this demand, the supply of residential premises has to be increased by 46%. More than 61% of Russian population needs to improve their living conditions, but only 12.4 % of them can afford to buy an apartment using personal savings or bank mortgage.

Soviet-legacy construction has left an abundance of poor-quality “Khrushevka”-type buildings and panelized housing. During the Soviet Union days, the have been a monopoly of Housing Construction Enterprises (DSK), that produced serial multi-unit residential buildings providing 120 million sq.m. per year. After the fall of the Soviet union and disintegration of many industry sectors, including residential construction, the annual output has fallen dramatically, however, it has been slowly recovering, and the current target is to achieve at least 80 million sq. m. per year in residential construction volume.

While the construction market in Russia is booming, St. Petersburg and Northwest regions are experiencing shortage of affordable housing due to several factors. Currently, construction firms have the opportunity to set a price for a sq. m. as they wish with the only limit being the market demand, which was very high until 2004. The high housing demand resulted in the following prices:

Review of Average Cost* of Residential Property in St. Petersburg and Other Northwest Regions as of August 2006

Northwest Region	Average cost of 1 sq. m. (new premise) $	Average cost of 1 sq. m. (previously inhabited premise) $
St. Petersburg	1,861	2,194
Nenetsky Region	1,488	1,488
Karelia Republic	777	1,237
Leningrad region	867	1,187
Komi Republic	1,181	1,181
Kaliningrad region	806	1007
Novgorod region	733	872
Arkhangelsk region	926	796
Murmansk region	1,130	781
Pskov region	667	725
Vologda region	604	665

Source: www.spbpromstroy.ru

* Note: exchange rate used is $1=27 rubles

As evident from the above table, the highest prices are in St. Petersburg, and the lowest are in the Vologda region. The price range is from $600 to $1,900 per sq.m. for new construction and from $680 to $2,200 for the previously inhabited housing.

Construction Regulations and Permits

Construction is a capital-intensive sector. Cost optimization is one of the factors in Western countries, where construction firms fight for every 5% profit on the highly competitive market. In Russia, the construction market is still volatile primarily because of lack of construction norms and inadequate construction legislation. However it would be wrong to say that there is no legislation at all. Russian Federal government and regional governments have adopted a number of laws and regulations and established governmental bodies that regulate construction sector activities. The problem is, however, that these laws and regulations provide opportunities for misinterpretation and, oftentimes, are not effective.

The government of St. Petersburg announced its commitment to introduce clear and transparent procedures as regards construction project coordination and issuance of permits. The city administration developed a procedure regulating the order of preparation of project documentation. This, according to forecasts,will shorten the entire construction cycle (beginning with the investment phase) for up to half of a year. Another initiative of the city administration is to simplify document preparation by streamlining the process and having fewer governmental agencies involved in order to complete necessary steps and start the construction process. Presently, a given construction company needs 16-18 months for preparation of project documentation, eleven months of which are spent acquiring permissions, and the next six months, scrambling to finish the actual construction. The most difficult stage is receiving permissions from the ecological service, power supply companies, the Russian Technical Control Service (ROSTECHNADZOR) and the Russian Consumer Service (ROSPOTREBNADZOR). Complications with getting permissions lead to downtime, which -- in turn -- leads to an increase in construction costs.

City administration is also going to make the land plots, sold through the open tenders, interest-free. Right now interest is charged at the refunding rate of the Central bank of the Russian Federation. The builders also hope that St. Petersburg government will establish a “single window” approach for gaining all necessary permissions, akin to the Single Center established by the Federal Tax Inspection, using the same “single window” approach for entrepreneurs wishing to register their companies. This new approach will result in having one governmental body designated to provide assistance and necessary documentation for construction projects.

Another considerable project cost category for a builder is utility networks (power, water and gas supply, etc.), which builders have to conduct themselves. Though St. Petersburg administration declared its intentions to build necessary infrastructure, it would apply to larger-scale industrial and “strategic” projects.

Expensive construction materials

Another reason explaining the high cost of residential premises in St. Petersburg and some Northwest regions is relatively high cost of constriction materials. St. Petersburg and the regions, though trying to revive construction material production by modernizing old facilities and opening new factories, still do not have a competitive environment that would allow a decrease in the average cost of construction materials. See section “Construction Materials” for additional information.

Mortgage

In light of the factors mentioned above, the future of the Federal Affordable Housing (Dostupnoye Zhil’yo) program is not optimistic. The mortgage system in Russia has existed for about 9 years, but still differs from a traditional mortgage system in Western countries. The interest rates set by the banks are very high: 11-14% in dollar terms and 13-16% in ruble terms, which makes the final cost of property (accounting additional expenses such as obligatory insurance, lump-sum payments for preparation of documents, etc.) 2-3 times higher. The average annual income of a St. Petersburg family consisting of 2 adults and 1 or 2 children is about US $1.5 thousand. The average income of a family living in one of the Northwest regions is even lower. Such income is not sufficient to procure a 2-room apartment, which costs, one average, US $100 thousand. Therefore, the Russian mortgage scheme is available only to wealthy citizens whom already own property and want to improve their living conditions. Another disadvantage of the Russian mortgage system is that it works only for the secondary market (previously inhabited property) and thus it is impossible to buy an apartment in a new building even though prices on the new apartments are less.

Several construction companies and local banks are making attempts at offering financing for primary market residential properties. Such banks as Impex Bank and Delta bank announced that they are ready to give mortgage loans for primary housing market. However, this is not a classic mortgage format because the Delta bank, for example, grants loans only against currently owned property that must be located in either Moscow, Saint Petersburg or Nizhny Novgorod. Thus, if a borrower has an apartment in another Russian city, that property can not be used as a collateral for a loan. Similarly, if a borrower has sufficient income to cover mortgage payments, but does not have existing property that can qualify as a collateral, the loan will not be granted.

Another hidden obstacle for getting mortgage loan for primary housing market is that most banks (Impex bank, for example) need to have an agreement with a construction company and set of documentation on those apartment buildings, which can be sold on mortgage terms. There are other requirements that make the process of mortgage financing for primary market properties very problematic.

Real estate market analysts consider the situation on the mortgage loan market as an impediment to residential construction sector growth. It is also said that most construction companies build juts enough units as buyers can afford to buy at the current high prices. Meanwhile, the construction companies blame federal and local authorities that are unable to adopt adequate legislation for construction sector, while the banks blame authorities for not implementing effective mortgage legislation for banking sector.

Some experts predict that residential property rental will continue to be the primary form of housing in the near future. The reason is in significant cost difference between average monthly rent vs. mortgage payment. For example, the monthly mortgage payment for a one-room apartment (with the loan duration of 15-20 years) is about $1,000 and for a two-room apartment is about $1,500. Monthly rental fee for a one or two-room apartment is around $400-500. In addition, in the case of rental property, there is no need to put up a down payment (usually, 10% of the property value) as in the case of buying property using mortgage financing. To illustrate this trend, in St. Petersburg only 2 thousand out of over 5 million residents have bought property using mortgage in the last 9 years.

As the result of the aforementioned factors (low inventory of affordable residential properties; cumbersome regulations and paperwork procedures; expensive construction materials and ineffective mortgage programs) the volume of residential construction in Saint Petersburg in 2005 fell by 25%. Number of construction workers employed by large and medium-sized construction companies, which constitute about 20% of the market, decreased by 5,000 people. Production of steel-reinforced concrete materials fell down by 12% and of construction brick -- by 20%.

COMMERCIAL CONSTRUCTION

Commercial construction is a steadily developing market. The members of the Russian Guild of Realtors estimate that prices for commercial property in St. Petersburg and Northwest regions will continue to grow during the next 15 years due to the fact that this market is still at the initial stage of development.

Unlike residential premises, demand for commercial premises remains steady. Average returns on commercial real estate investments are 7.5- 8%, which is higher by 1.5% than in most European countries. By contrast, Moscow commercial real estate returns are decreasing which leads to St. Petersburg becoming a more attractive market in this regard.

Because of the sector’s good investment potential, foreign companies have become very active in the commercial construction segment of the market. However, the points of caution are: potentially low quality of construction work performed by some local contractors, unreliable partners and imperfections of current Russian construction legislation.

Government Incentives

The city of St. Petersburg won a federal competition to organize two Special Economic Zones (SEZ) that give special tax and customs benefits to companies who decide to establish offices or production facilities in these zones. For more details on SEZ, please see reports posted at: http://www.bisnis.doc.gov/bisnis/bisdoc/0611rusezs.pdf and http://www.bisnis.doc.gov/bisnis/bisdoc/0604RFFedLaw_SEZ.htm.

Other important legislation by the St. Petersburg city administration that lowers tax burdens on investors in capital assets include:

· St. Petersburg Law N 81–11 of 14.07.1995 (with amendments on 01.01.2006) On Tax Benefits: allows for a decrease in income tax and property tax.

· City conducts engineering works at the areas to be offered to businesses (for big industrial and strategic projects);

· General construction plan finally approved and adopted.

Pskov Regional Administration has also made steps to attract investors in the region by introducing the following benefits: income tax -- 13.5% (vs. 24% in other regions of Russia) and property tax -- 0.01% (vs. 2.2 in other regions of Russia).

Arkhangelsk, Murnmank, Kaliningrad as well as other Northwest regions have also adopted a number of resolutions directed at improvement of the investment climate. As a result, in Novgorod region, for example, 136 large investment projects have been implemented in the course of the last 11 years. More than 30 countries have invested in construction of production facilities in Novgorod region such as Dirol Cadbury, Amkor Rumch Novgorod, Chudovo RWS, Madok, Ursa Chudovo, Novtruck, Pestovo Novo, Setnovo and the Novgorod Metallurgic Factory.

Relocation of production facilities from St. Petersburg center

Industrial manufacturing has historically been located in the city of St. Petersburg. As the city expanded its perimeters, such previously established industrial zones ended up being in the center of the rapidly growing city. This situation is economically disadvantageous and results in unfavorable ecological situation in the city. Thus, the St. Petersburg City Administration has decided to move the industrial and manufacturing facilities away from the city center.

Relocation is a very costly process, however, and not all enterprises can afford such a move. The St. Petersburg administration introduced tax incentives for industrial investors. Those companies who invest up to 300 million rubles (US $11.2 million), will have a reduced profit tax of 22% and those who invest more than 300 million rubles will have a profit tax of 20% (vs. the average profit tax of 24%).

The administration is going to support all projects dealing with the relocation, and will entice manufacturing companies to relocate from the city center. At present, there are more than 100 industrial objects (20% of the total city area), which need to be relocated. More information about relocation projects in St. Petersburg can be found at www.bisnis.doc.gov in the report called “Investment Projects Supported by St. Petersburg Administration”.

Development of Hospitality Infrastructure

St. Petersburg is becoming one of the prominent tourist destinations in Europe. Last year, more than 1.8 million tourists visited the city. Realizing benefits associated with tourism industry, the city of St. Petersburg is developing hospitality infrastructure that will support the high volume of visitors. The website “Investments in the City Hotel Infrastructure” (www.hotelinvest.ru) is designed to provide potential investors with the information about current opportunities in this sector. At present, there are more than 200 sites (building and land) suitable for hospitality infrastructure development offered for sale in the city. Most these sites are purchased through the open tender organized by the St. Petersburg City Administration.

All interested companies can contact St. Petersburg Committee for Investments and Strategic Projects to get full information about the sites.

E-mail: contact@cisp.gov.spb.ru; Tel: +7 (812) 576 6988; Fax: +7 (812) 576 6067

Sector Opportunities for American Companies

In 2006 more than 1 million sq. m. of shopping center premises will be commissioned. Several large international companies came to St. Petersburg and have launched development of grand-scale trade and logistics centers. Among these companies are: Vinci (France), Promocentro (Italy), Ikea (Sweden) and Stockmann (Finland). In 2005 the following trade centers were open: “Grand Canyon” (73,000 sq.m.), Ramstor (41,000 sq.m.), “O’Key” (38,000 sq.m.) and others totaling 152,000 sq. m. In 2006, a considerable increase in construction of trade centers is planned with the anticipated total size of premises equaling 660,000 sq. m.

All these trade centers will need utility infrastructure, security and analytical detection systems. Specifically, the following sub-sectors represent opportunities for U.S. equipment and technology:

- water, heat and power saving devices;

- information systems (TV, cable TV, advertisement broadcasting)

- system counting visitors

- sound and odor analyzing systems

- security systems

Analyzing tendencies of the construction market development, the following 3 directions can be selected:

1. Entrance of new developing companies on St. Petersburg market, which would search for, prepare the documentation and implement construction projects in different segments of the construction market.

2. Companies, which are currently engaged in mass construction, will transform into financial-industrial complexes with broad geographic diversification.

3. Specialized companies accomplishing customized services on the small segments of construction market will appear.

In these conditions, the role of management companies will be important. At the present moment there are only few companies on the St. Petersburg market, which integrate all these functions, such as LenSpetsSMU and LCP.

Construction Materials AND EQUIPMENT market

In the beginning of 2006, there was noticeable growth in the volume of production of main construction materials and structures. In comparison with 2005, cement production increased by 4.6%, production of cement-asbestos boards by 6%, construction glass by 40.8%, heat-strengthened glass by 0.9%, linoleum by 19.5%, ceramics by 6%, mineral cotton and items made of it by 10%, non-ore construction materials by 6.8% and ballast and gravel by 7.8%. Production of wood materials used in construction, except wood and brick, has also increased.

Production of wood and construction materials in the Northwest regions

	2005	% against 2004
Wood, mln m3 (Делoвая древесина)	33	97
Sawn timber, mln m3 (Пилoматериалы)	6	101
Plywood, thsd m3 (Клееная фанера)	940	110
Wood-fibre plates, mln m3 (Древеснo-вoлoкнистые плиты твердые)	77	110
Wood-shaving plates, thds m3 (Древеснo-стружечные плиты)	995	101
Cement, thsd tons	2,985	103
Brick, mln	754	96
Ceramic tiles, mln m2 (Плитки керамические oблицoвoчные)	13.5	146
Linoleum, mln m2	9	103

Source: www.spbpromstroy.ru

Concrete -- another very important construction material – has not been produced in sufficient quantities due to the fact that most production facilities became very old and do not meet increasing demand. Recently, five Finnish companies, manufacturers of concrete equipment, such as Laite-Saraka Oy (concrete pumps and mixers), Mecmetal Oy (concrete production lines), Polarmatic Oy (heating systems), Turbomatic Sal-product Oy (pallets for sandwich-elements) and Tecwill Oy (concrete-mixer plants Cobra) have established an association to work on the Russian market. General Director of Finnish Concrete Association believes that this step will allow the companies to enhance their presence in St. Petersburg, and enter the markets of the Northwest regions where construction volumes are also growing. Direct competitors of Finnish companies on the St. Petersburg market are German and Italian companies.

According to Russian construction experts, each year, there are 5-10 new concrete manufacturing plants opening up in St. Petersburg. In 2005, companies spent about 120 million rubles (over $4 million) to establish new concrete manufacturing facilities. Several large Russian companies, such as СОЭЗ and RzhevMash, produce concrete manufacturing equipment, however, the equipment quality is significantly lower than that of imported equipment, whereas, the cost is approximately the same (about 30 million rubles per one plant). Therefore, the demand for foreign-made concrete manufacturing equipment is much higher than Russian-made equipment.

Speaking of construction equipment in general, the foreign-made equipment is almost always preferred over the Russian-made versions; therefore, this entire sector represents potential export opportunities for U.S. construction equipment and machinery manufacturers.

Construction materials based on nanotechnology also represents an opportunity category for U.S. companies. Usage of nanotechnology in production of construction materials will allow not only for improvement of the characteristics of a specific material, but also will lead to decrease production costs and – therefore – greater profit margins.

In Russia nanotechnology is developing, but at a slow pace. According to some experts, Russia is 10-15 years behind the USA and other European countries and, therefore, it would be difficult for Russian companies to compete with their American and European counterparts in this sector.

Specific interest is in nanotechnologies used in cement production. For example, Portland cement with admixtures (concrete performance-enhancing additives) and nanoparticulates, such as microsilica could be of great interest to Russian construction companies. Also becoming popular are construction materials utilizing fullerenes and – specifically -- shungit. A Novgorod company Dekor-1 has started tong and groove panel manufacturing using shungit; and a St. Petersburg Alpha-Pol is utilizing nanotechnology in production of dry construction mixers used for construction plaster and certain floor covering materials. Seventeen types of intumescent paints and coatings are now produced in Russia utilizing nanotechnologies, however, the market demand is for greater volume and variety of such materials. The local production of construction materials utilizing nanotechnology does not meet rapidly growing demand, therefore, this market segment represents good opportunities for U.S. exports and investments into local manufacturing.

MArket access

Trade exhibitions and fairs are becoming increasingly popular in St. Petersburg. They may be helpful for U.S. manufacturers of construction materials in finding potential buyers or distributors.

Another good venue to market a company or a product line are industry publications. There are a number of trade magazines specializing in the topics related to construction and building materials industry. Also, many general industry publications compile specialized editions, focusing on various industrial sectors, including construction. U.S. companies interested in marketing products in Northwest Russia should consider advertising in these publications.

CONTACTs

For more information on this report, please contact:

Julia Vlasova, BISNIS Representative in Northwest Russia

U.S. Department of Commerce

U.S. Consulate General in St. Petersburg, Russia

Ph.: 7 (812) 326-2585

Fax: 7 (812) 326-2561

E-mail: julia.vlasova@mail.doc.gov

For more information on Northwest Russia, visit BISNIS online at http://www.bisnis.doc.gov/bisnis/country/nw.cfm

BISNIS (www.bisnis.doc.gov) is part of the U.S. Commercial Service (www.export.gov).