Failed Apartment Deals Open Door to Reform in Russia

Swindled home buyers are legion in the fledgling Russian real estate market, so it was something of a surprise when the latest victims of failed development schemes discovered that reputable realty agents were huddling over how to come to their rescue.

Five established realty firms that built custom apartment projects have collapsed in as many months in this czarist-era capital, leaving nearly 2,000 would-be buyers somewhere short of a new threshold.

What sets the latest bankruptcies apart is that the real estate firms were well-intentioned businesses brought down by last year’s wild stock market fluctuations rather than the blatant deceptions of pyramid schemes and con men that have robbed thousands of people in the past.

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And unlike the cold shoulder given the losers in earlier scandals, the chain of failed ventures here has given birth to a self-regulatory Accounting Center dedicated to protecting clients’ down payments from misuse and seeing that what assets survive are fairly divided.

“Many realtors have taken a lesson from this crisis,” says Alexander Glushchenya, director of the Dinas real estate agency and a founder of the new asset-management center that will oversee the settlement of creditors’ claims and develop a fund to bail out other agencies with wobbly finances.

“Like other businessmen, realtors don’t like seeing money sitting still when it could be earning something,” Glushchenya says. “But it has taken time and unfortunate experience to see that clients’ money should not be used for any purposes except those of which the client knows and approves.”

Unauthorized investments in stocks and securities that lost value in last autumn’s global markets crisis contributed to the debts that sunk the five real estate agencies and turned their clients into creditors.

Some St. Petersburg real estate agents, including Alexander Makarov, the president of the Assn. of Realtors and Homebuilders, contend that “dark forces” are also at work as organized crime seeks to take over a residential property market poised to grow exponentially as Russians accumulate new wealth.

“We believe what is going on is a deliberate destabilizing of the real estate market aimed at its further restructuring and capture,” Makarov says.

But other industry officials blame the collapses on mismanagement and suggest that those looking for criminal ghosts are trying to mask their own losses.

Further bankruptcies among the less successful firms can be expected, warns Alexander Moshkalov, head of the Baltic Assn. of Realtors.

Apartment sales are down sharply over the last few months, and brokers fear that the recent failures have scared many buyers into holding off on purchases or even withdrawing down payments for fear of being caught in another collapse.

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Home purchases in St. Petersburg averaged 963 a month in 1997. In the first three months of this year, they averaged just 328, according to the Municipal Bureau of Apartment Sales Registration.

Throughout urban areas of Russia, and especially in this city, which endures the highest housing density in the country, the vast majority of residents live in apartments rather than single-family homes.

“We’ve been trying to calm down buyers for months now. Hysteria is not going to help anything, and that is the only ‘dark force’ at work here,” Moshkalov says of the spreading panic.

Creating the realtor-policed Accounting Center is a step toward regaining buyers’ confidence by setting forth clear and verifiable procedures for handling their money, he says.

“It is in the interest of legitimate brokers to monitor the behavior of all brokers,” agrees real estate lawyer Steve Butler, counsel to the U.S. government-funded Urban Institute’s development project for Russia. “This is the only way of protecting public confidence in the market.”

Escrow, the placing of a purchaser’s down payment with a third party for safekeeping until sales conditions are fulfilled, exists in principle in Russia, but unfamiliarity with legal restrictions on funds in escrow and ubiquitous violations more often put the money at the disposal of the broker.

The accounting center is likely to prove too little too late for the victims of the recent bankruptcies, but Glushchenya argues that it should help educate future home buyers in the merits of escrow.

Huge obstacles remain on the road to secure home-buying, as Russia’s capricious tax system compels those engaged in real estate transactions to conduct their business under the table.

To avoid staggering and unpredictable taxes, buyers and sellers agree on paper to the “balance price” set on the property at the time it was transferred from the state to its private occupants--a pre-inflation sum that is a fraction of its real market value. The actual sales price is informally agreed upon between buyer and seller, with the real estate broker often the only other player involved in the real cash transaction.

Buyers’ vulnerability in these frontier days of real estate development became painfully obvious in an incident earlier this month in Moscow when federal tax police raided the Miel property agency and confiscated $5 million in escrow funds.

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The Russian Tax Inspectorate claims that the “unregistered repository” constitutes tax fraud and is holding the money as leverage for the fines to be assessed the Miel agency after investigation.

“The right of a government to punish innocents to pursue a tax claim is a little bit overreaching,” says Butler, the Urban Institute lawyer. “If they do this a few more times, it’s really going to cast a pall on the market.”

Moscow’s real estate network differs significantly from the second-largest here in St. Petersburg because Moscow Mayor Yuri M. Luzhkov runs a tightly controlled empire of construction and financing agencies, all under city jurisdiction. Unlike elsewhere in Russia, private land ownership is prohibited in the capital, and all property is available only by city lease.

That strict centralization has allowed swifter development of property and is about to result in the first mortgage system to be offered in Russia. But it has also resulted in hundreds, if not thousands, of home buyers being robbed of their investments when any part of the municipal development network has run into trouble.

While the pitfalls yawning before Russian home buyers are perilous by Western standards, some industry observers note that the real estate market here is still in its infancy. They cite the decades, even centuries, it took to produce reliable property transactions in the West.

“Think back to the 1800s in [the U.S.], in the times of the Wild West, when you had the land rush and huge amounts of real estate transferred to private hands,” says Gerald Gaige, director of real estate consulting for Arthur Andersen in Russia and the former Soviet Union. “You had gunfights and fistfights and people staking out other people’s claims. It was chaos. It took us 200 years to develop an organized system.”

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A reasonable tax code, a land law that enshrines private property rights and regulatory agencies that protect the rights of consumers are still hostage to a Communist-dominated legislature, but analysts say the improvements are within sight, if not yet within reach.

“Where the real bite will come is when people want to take out a mortgage,” says Raymond Struyk, Russia program director for the Urban Institute.

He notes that to get around full income declaration and taxation on home sales, buyers end up paying extortionate interest rates on shorter-term bank loans.

“People will eventually come around to it,” Struyk says of above-board property transactions and their expense. “They’ll just have to look at it as higher closing costs.”