The construction industry in Russia is rapidly recovering from the COVID-19 crisis. Already in the first quarter of 2021, business activities in this sector reached the "pre-pandemic" level.
According to the CBRE report, in the nine months of 2021, investments in real estate in Russia amounted to 281 billion rubles, which is the highest level in the entire history of the Russian real estate market1.
This increase is particularly notable in residential realty. Favorable factors for this were (i) the demand growth against the Russian Central Bank monetary policy and (ii) the state preferential mortgage program.
Investments in commercial realty still lags significantly behind the residential one, which is primarily due to the continuing effects of the pandemic. Nevertheless, the positive trend in the construction in general gives grounds for optimism regarding the prospects of this sector.
At the same time, the level of foreign investment, unfortunately, is still very low (4% of the total). Partially, the low interest of foreign investors may be due to the lack of sufficient information on the legal background of real estate and construction sphere in Russia.
This article focuses on a brief overview of the main stages of a construction project, as well as on identifying the risks that await future investors (developer) at each stage.
Stage No 1. Selection of a land plot
The first step of every construction project is a selection of a suitable land plot. At this stage, there is a risk to choose a land plot that is not suitable for the construction.
The placement of capital construction facilities on the Russian territory is carried out in accordance with territorial planning documents (territorial planning schemes, master plan, rules for land use and development, the concept of land surveying and land use plan). Rational and proper use of lands is the main purpose of territory planning.
Non-compliance with requirements of these documents makes it impossible to obtain a positive expert opinion upon a review of the design documentation, which is essential to start the construction.
In order to minimize the risk, all these documents that apply to the selected land plot should be considered and the requirements should be compared with the parameters of the future object.
Stage No 2. Registration of rights to a land plot
As soon as the investor has selected a land plot, he must acquire a land title in a form of ownership or lease. The land title serves as a prerequisite for acquiring the status of a developer.
In Russia, foreign companies and individuals may own land plots, except for certain cases, for example, land plots located in border areas, agricultural land plots, and plots within the seaport boundaries.
A foreign investor can lease a land plot on equal terms with Russian legal entities and individuals without additional restrictions.
One of the specifics in Russia is that most of the land is a public (state or municipal) property. If this applies to the land plot chosen by the investor, it will be necessary to participate in public tenders in order to obtain the right to purchase or lease this plot. The law provides for cases where land plots may be acquired or leased without tenders: for example, in case of implementation of a large investment project.
Usually, investors lease land plots. However, lease agreements also involve risks that should be taken into account. First of all, it is necessary to check that the agreement does not contain onerous conditions for the lessee. Such conditions, in particular, may include restrictions on the use of the plot, the unconditional right of the lessor to unilaterally terminate the contract, etc. It should be also borne in mind that lease agreements concluded for a period of more than one year require a state registration.
Before entering into a lease agreement or purchasing a plot of land, it is also necessary to check all the previous owners and the reasons and circumstances for the rights transfer. Such a check is aimed at prevention of the risk of reclaiming a land plot, for example, if the rights for the plot were transferred against previous owner's will.
Unified State Register of Immovable Property contains all information about the transfer of rights to real estate units, an extract from which can be obtained in electronic form on the official website. The extract also contains information on whether the land plot is arrested, subject to an easement, or pledged.
Stage No 3. Facility design
The Town Planning Code regulates the design and construction of capital construction facilities. The design phase of a project includes, engineering site investigations for construction, the actual design and preparation of detailed design documentation.
In Russia, a customer of design and construction works (i.e. a developer) must be a professional market participant. This means that in order to conclude an agreement with the contractor, the developer must be a member of a self-regulatory organization, i.e. a specific professional association of contractors and designers. Alternatively, the developer can hire a "technical" customer for this – a professional organization that will communicate with contractors on his behalf.
The designer (as well as the construction contractor) also have to be a member of a self-regulatory organization. Such obligation provides a possibility for the developer to claim for damages from the self-regulatory organization in case the contractors have caused damage to third parties.
Should be said that in most cases the design documentation in Russia requires expert examination – either state or non-state, depending on a type of the object. The purpose is to confirm that the future facility meets the requirements of reliability and safety.
The expert examination of the design documentation is a quite serious and labor-consuming process. Therefore, it is important that a contract with the design organization provided for the obligation of the latter to amend the documentation during expertise, if needed. The final payment is better to make upon a receipt of a positive expert opinion.
In recent years, Russia actively develops and applies building informational modeling ("BIM"). BIM enables to create a three-dimensional model of a building containing all the necessary information for its construction and use. It is already possible to submit the design documentation to the expertise in a form of an informational model. Starting from 1 January 2022, BIM-modelling becomes mandatory for the objects whose construction is financed with budgetary funds.
Stage No 4. Facility construction
4.1. Selection of a contractor
Construction is, undoubtedly, the most important stage, and it comes with a lot of risks and pitfalls.
Based on our experience, we may conclude that the key factor of success in a construction project is a selection of a reliable and reputable general contractor. If the developer is led solely by cost-reducing motives and enters into an agreement with the contractor offering prices below the market, this may have disastrous consequences, such as the money loss and construction delays.
The most significant risk is a "typical" situation where a contractor was paid in advance, but further he withdraws funds, transfers all the company's assets to affiliated parties, and declares bankruptcy.
Therefore, it is necessary to make a detailed check of a contractor, including a financial situation, portfolio of projects, business reputation, etc. at least, the check should include the analysis of open sources, such as a Commercial Cases Database, Enforcement Proceeding Database, Unified Federal Register of Information on Bankruptcy, etc. Having all information about the contractor, it is possible to conclude whether he is trustworthy or not.
When entering into the construction agreement, it is necessary to pay attention to conditions that protect the investor from possible losses. In particular, it is a common practice for parties to open a special bank account for the needs of a particular project. In this case, the customer may obtain a right to authorize transfers to other persons and control the use of advance payments.
Another important aspect is a security of obligations by the contractor. The most common instruments are (i) the bank guarantee provided by the contractor and (ii) guarantee retention of part of the payment for works (usually, up to 10%) by the investor. It is advisable that the security of obligations covered as many of the contractor's obligations as possible, including a refund of the advance payment, penalties, and defects liability.
The detailed check of a contractor is also necessary in order to minimize tax risks connected with the additional Value Added Tax ("VAT") payment. The point is that in case the contractor fails to pay VAT and the developer fails to prove that due diligence of the contractor was conducted, the tax authority may claim the unpaid VAT from the developer.
4.2. State regulation
Since construction is connected with people safety, this area is quite strictly controlled by the state. Thus, in most cases it is necessary to obtain a construction authorization before starting the works, i.e. a confirmation that the design documentation meets all construction requirements. The unauthorized performance of works may result in administrative liability, and the object may be declared unauthorized and subject to demolition.
In the majority of cases, the state controls the performance of works. Competent state officials control a compliance with mandatory technical requirements, the correctness and timeliness of drafting the day-to-day construction documentation, and issue orders to address violations.
The indispensable condition for commissioning of the facility is an official document confirming that the constructed facility meets the requirements of the design documentation and building by-laws.
The last step in the implementation of a construction project is obtaining an operating license – а document that allows the developer to register the capital construction facility in the cadastre, register the right of ownership and put the object into operation.
In conclusion, let us emphasize that the implementation of a construction project in any jurisdiction is a complex and multi-stage process involving significant risks both in legal and technical spheres. High-quality and professional management of these risks is the key to successful project implementation and, ultimately, to making the planned profit. In this regard, it is extremely important to entrust the legal support of the project to consultants from among the recognized leaders in this field.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.