Building a new Russian business infrastructure

Russia is at a critical turning point in its history. Its government leaders, managers and engineers must learn how to provide quality products and services at low cost, and within an efficient timeframe. One of the most fundamental and necessary pieces to complete this economic puzzle is the modernization of Russia's production and business infrastructure.

On July 23, 1992, Mr. Andrei A. Stroyev, chairman and CEO of Perestroika Joint Venture (PJV) and chairman of Mosinzhstroi (PJV's principal Russian partner), stated at the Yuzhinsky Pereulok Office Complex Grand Opening, “Yuzhinsky Pereulok has been our most challenging project in Moscow thus far, … we have been able to integrate the old-world design and construction of Moscow with new-world interiors and equipment. The result is extraordinary.” Earl S. Worsham, American partner and co-chairman of PJV, added, “Projects like Yuzhinsky Pereulok represent PJV'S commitment to the positive evolution of Russia's capital city.… “ The first deputy prime minister of Moscow for city development, Vladimir I. Resin, commended the development: “Moscow's economic growth is directly related to investment in the local infrastructure. The renovation of Yuzhinsky Pereulok and other such projects will stimulate our plans for attracting and keeping foreign investment in Russia.”

BACKGROUND AND GENERAL INFORMATION

Perestroika Joint Venture completed the construction of the Yuzhinsky Pereulok Office Complex in the spring of 1992. Yuzhinsky Pereulok is a six-building, 6,000 square meter (approximately 60,000 square feet) office complex located in the heart of old Moscow. This is PJV's largest and most intricate office development to date. The prime tenants are E.I. DuPont de Nemours, Ciba-Geigy AG and Gruppo IRI.

In 1988, the first year of PJV's operations, Western real estate developers actively working in Moscow were few and far between, and extremely few Western-sponsored projects had been successfully completed. In the spring of 1988, PJV started its first project with a staff of five. By 1990, at the beginning of Yuzhinsky Pereulok's development, PJV had hired an additional ten permanent staff members. Today, PJV has grown to 150 employees.

Moscow's foreign business community began to grow significantly as a result of former President Gorbachev's “perestroika.” But there were many problems to overcome, mostly involving the basic necessities that Westerners take for granted. By Western standards, even the fundamental business infrastructure did not exist in Moscow; two of the most pressing problems were the lack of Western-standard, fully-equipped office facilities and direct-dial international satellite telecommunications services.

CONCEPTION

Early in 1990, Stroyev took a close look at the Yuzhinsky territory. At that time, only two buildings, Mosinzhstroi's printing house and another Mosinzhstroi administrative building, remained standing there. It seemed to Stroyev that something else must have been there before, perhaps built in the 19th century and then destroyed by the Soviets or just destroyed by the elements and time.

Stroyev asked Andrei Meerson, one of Moscow's most renowned architects, and his assistant, Evgeny Serov, to research what previously stood on the Yuzhinsky site, and to obtain original site plans and architectural drawings from the U.S.S.R. government archives. Site plans as far back as 1852 were found. PJV learned that the buildings had been tom down during the Stalin era in 1937, for no apparent reason.

THE PROBLEMS AND THEIR SOLUTIONS

Within two weeks of the initial research, preliminary plans were drawn and presented to PJV and a general meeting of PJV management was called. A decision was made to develop Yuzhinsky Pereulok into a six-building office complex designed and equipped according to state-of-the-art Western standards. During the next two years of design and construction, PJV confronted many financial, logistical and technical problems which at fit glance seem universal and conventional to the construction industry. But, when viewed against the backdrop of the political climate and economic conditions of Moscow during those two years, these problems took on an entirely new meaning.

The major issues confronted by PJV can be subdivided into four major categories: project financing, the Soviet bureaucracy, architectural and construction difficulties, and community relations.

Gaining and Maintaining Community Acceptance Was Key to PJV's Success

Financing

Despite the coming of “perestroika,” the traditional Western methods of financing a real estate development project have rarely been viable options in Russia. The political and economic risks are so great that banks, pension funds and individual investors are hesitant to commit even capital investments that are relatively small by Western standards. The U.S.S.R. refused to reduce those risks by initiating an effective, dependable government-sponsored insurance program to guarantee loans and foreign investments to Western companies interested in the U.S.S.R. As a result, even the high-standing reputation and previous track record of the company seeking financing did not alleviate its difficulties.

By 1990, Perestroika Joint Venture had already completed and fully rented its first project, Pushkin Plaza, to such well-respected companies as BASF, Baker & McKenzie and Mitsubishi Heavy Industries. Construction was well under way on PJV's second and third projects, which were being developed for Monsanto and Bank Austria. Despite the solid success of the venture, obtaining third-party financing quickly turned into a dead end.

Stroyev, to overcome this obstacle, pioneered a financing structure perhaps common in other areas of the world, but unheard of in Russia. He found three companies, E.I. Du Pont de Nemours, Ciba-Geigy AG, and Gruppo IRI (Italy's largest consortium), and convinced them to pay several years of rent payment up-front. The exact rental agreement differed for each company, but each made a three-stage, six-year advance payment for a ten-year lease term; 40 percent due at the coming into force of the lease agreement, 50 percent due at the prime-shell-completion date, and 10 percent due four weeks after the prime-shell-completion date or the date of tenant occupancy. PJV used these monies to finance the construction of Yuzhinsky.

What makes this financing scheme so remarkable is that it is almost entirely based on trust in Russia, in Perestroika Joint Venture, and in Stroyev and his word. Du Pont, Ciba-Geigy and IRI had little power to recoup their $20 million prepayment if the deal went sour. The prevailing political conditions and property laws in the U.S.S.R. offered shaky legal protection at best to the tenants. As PJV had just recently started its real estate development activities, it lacked the capital to personally guarantee the prepaid funds. In short, these companies had little to no recourse.

Nevertheless, Stroyev convinced these companies to make the prepayment and thereby finance the project. This format for financing real estate developments was soon adopted by PJV's incoming competitors as a standard in the Moscow real estate industry.

The Soviet Bureaucracy

At the time Perestroika Joint Venture began developing office buildings in Moscow, the U.S.S.R. building norms and codes in use were considerably outdated. There was no overwhelming demand for anything more sophisticated—international developers with their Western construction technologies, materials, and standards operated in a fairly limited capacity in Russia.

PJV intended to build a state-of-the-art office facility with all of the conveniences and aesthetic amenities of any Western downtown office building. This included the construction of Moscow's first private office underground parking garage and the construction of two atriums, one of them connecting two separate, free-standing buildings in the complex.

At every turn, PJV had to battle to change or update the antiquated Moscow building codes. Two representative difficulties which PJV fought to resolve with the government authorities involved the codes for constructing the atriums and the garage. At the time, U.S.S.R. norms for the construction of an atrium did not even exist. An underground garage, by Soviet standards, could not exceed the size necessary for a 25-car garage, and must not be located underneath any public spaces (e.g., a cafeteria) in a building designed for mass use.

How Perestroika Came to Be

In 1987, the Soviet Union began to take the first steps towards a market-oriented economy. With the ultimate goal of privatizing a large portion of the U.S.S.R.'s manufacturing and service enterprises, the Soviet government implemented a program of “self-financing.” As soon as a state enterprise became self-financing, it no longer received money (hard currency or rubles) from the state budget.

Mosinzhstroi, Perestroika Joint Venture's principal Russian partner, is the Moscow municipal enterprise responsible for all infrastructure and civil construction in the city of Moscow. Andrei Stroyev, chairman and CEO of Perestroika Joint Venture, is also the chairman of Mosinzhstroi. “Self-financing” soon turned out to be the foremost challenge of Stroyev's career.

Winters in Moscow are harsh and construction conditions difficult. Only imported technology, such as Hitachi excavators and Kamatsu bulldozers, can perform under such circumstances. In 1987, Mosinzhstroi had over 10,000 foreign-made construction vehicles in its fleet-that amounted to a price tag of over $160 million. The turnover rate for foreign equipment is approximately 10 percent per year. For Mosinzhstroi, this amounted to $16 million annually. But, as Mosinzhstroi became “self-financing,” the government cut all but $300,000 in state budget allocations. A creative solution was needed to generate the remaining sum. Otherwise, Moscow's infrastructure would quickly disintegrate, leaving the city's residents without heat, running water, natural gas, sewage facilities, or roads.

Stroyev decided to find a Western partner and form a joint venture in commercial and residential real estate development that would build projects catering to Moscow's growing foreign business community. In 1988, Perestroika Joint Venture was registered, with Mosinzhstroi as the main Russian partner and The Worsham Group, an Atlanta, Georgia-based real estate developer, as the primary American partner. Glavmosarchitektura (presently Moscomarchitectura) and Dialog Joint Venture are also founding members of PJV.

Today, Perestroika Joint Venture is the leading real estate developer in Moscow. It has completed and rented over 15,000 square meters (161,000 sq. ft.) of office space and is currently developing Syetun Townhouse Community, which provides over 17,000 meters (183,000 sq. ft.) of residential space, community and sports facilities, and other amenities and services.

One of the Many Elegant Common Areas of the Complex

The Old World Exterior Belies the Modern Facilities Within the Yuzhinsky Pereulok Complex

PJV worked closely with the Government Institute for the Design of Automobile Transportation, “Giproavtotrans,” and the Institute and Administration for Fire Safety to work out a compromise for the garage at Yuzhinsky. PJV intended the project to have a 49-space garage. In addition, due to the Yuzhinsky site's small size, PJV could not physically avoid building the garage under the complex's public spaces. Official after official in these organizations were totally unfamiliar with Westem-standard building operations and the building technologies that PJV intended to implement at Yuzhinsky, and it took creative measures to convince those officials of their validity. After many negotiations, PJV was authorized to build its 49-space garage.

A similar history occurred as PJV worked closely with the Institute and Administration for Fire Safety to create acceptable codes for the construction of Yuzhinsky's two atriums. Ultimately, PJV was allowed to build both atriums, and they are by far one of the most stunning and impressive features noted by the complex's Russian visitors and staff.

PJV'S attempts to modernize U.S.S.R. building codes for its own developments led to an unprecedented reevaluation of Moscow norms. Using the construction of the Yuzhinsky Pereulok Office Complex as one of itsprincipalprecedents, the Moscow Organization of the Union of Architects of Russia created a special set of norms designed specifically for modem, Western-style developments. MGSN 1-91, “Multifunctional Buildings and Complexes,” will play an integral role in Moscow's continuing Western-sponsored real estate development.

Architectural and Technical Difficulties

The architects and builders of pre-revolutionary Moscow left an exquisite and charismatic architectural legacy, a legacy which during this century has been sadly neglected. Many buildings in Moscow that once stood picturesquely in the city's old, historic center now lay partially or completely destroyed. Many people believe these buildings need to be not only reconstructed, but reconstructed in the spirit of their original architectural style, form, and spirit.

The neighborhood surrounding the Yuzhinsky site is just such an old, historic part of Moscow. When Stroyev requested the archival drawings and plans of the Yuzhinsky site, he discovered that the site had gone through several different building stages. Although the general feeling and style of the buildings were the same, each era brought in changes and additions in the individual buildings.

PJV was forced to decide which period in history to elect as the best guide to Yuzhinsky's authentic restoration. With the help of Andrei Meerson and the State Inspectorate for the Preservation of Architectural Monuments, PJV studied the archival documents and site surroundings and determined that the basis for the reconstruction of Yuzhinsky would be the first recorded documents filed in 1852.

When Perestroika Joint Venture began the construction of the Yuzhinsky complex, it faced many problems. These problems, as a whole, were created by a few underlying conditions:

•The central, historic part of Moscow is supported by a very old and fragile infrastructure. The region's utilities—heating, electricity, and running water—were already operating at maximum level. The six-building Yuzhinsky complex, with its Western facilities (computers, air conditioning, hot water year round), would have overloaded the system. PJV, at its own expense, relaid new utilities for the entire region and installed an electrical transformer substation.

•Moscow has a distinct set of trouble-some geological conditions. The soil composition of 70 percent of the city consists of clays, sandy loam and water-bearing sands, which create unstable building conditions. Moscow specialists have concentrated on a few specific construction techniques to reinforce, solidify and harden the soils in the Moscow area, including dewatering, artificial soil freezing, diaphragm wall construction, and piling.

• The Yuzhinsky site's soil water problems were exacerbated by PJV'S intention to build an underground garage. To build a garage, PJV needed to excavate a 7-meter pit, but soil waters began at a depth of 1.5 meters. PJV worked closely with the Geological Institute of Lyublana to determine the best technique for lowering soil waters to the necessary level. A decision was made to hammer in piles around the contour of the planned garage and to drill six, 12-meter wells that would be equipped with pumping machinery configured to lower soil waters.
• There were additional complications to lowering the soil waters at the Yuzhinsky site. Most of Moscow's remaining 18th, 19th and early 20th century buildings are extremely fragile. Their foundations are weak and brittle, ready to crumble from any heightened stress. As a result, PJV took the additional measure of simultaneously reinforcing the foundations of the surrounding buildings with cement and silicates. Unfortunately, these techniques were not sufficient to adequately lower the level of soil waters. An additional drainage system consisting of trenches and l-meter concrete wells was built and the water problem was successfully resolved.

Community Relations in the Era of Glasnost

Seventy years of Communism, what did it teach the Russian people? Among many things, Russians mastered the ability to live by our old American adage “If you have nothing nice to say, then don't say anything at all.”

Open demonstrations and public objections to any Communist party- orgovernment-sponsored activity (and all activities before “perestroika” were in some way or another sponsored by the party or the government) were strictly forbidden and highly taboo in our society. Complaints were kept behind closed doors. Those that chose to speak out were labeled dissidents and sent to jail, Siberia or a psychiatric ward.

With the onset of Gorbachev's “perestroika” and “glasnost,” Russians began to vent their frustrations and to complain about the system, but were careful to choose politically correct targets. One of the most politically correct targets was, and still is, the economic stratification of the Russian people.

There is a famous Russian anecdote that typifies a distinct difference between Russian and Western mentalities.

In America, one man has a goat, the other does not. The man without the goat thinks to himself, “How can I get one of those goats for myself?”

In Russia, one man has a goat, the other does not. The man without the goat thinks to himself, “How can I kill the other guy's goat?”

Russians, after 70 years of Communist philosophy, are categorically against a world of visible “haves” and “have nots.” During the era of Communism, the “haves” always tried to hide their wealth in inconspicuous places. As a result, at least on the surface, everyone appeared equal. With the coming of “perestroika” and “glasnost,” that changed.

This created an unusually tenacious situation for PJV, as well as for the government. Yuzhinsky Pereulok was a precedent-setting project in more aspects than one. In the middle of a residential neighborhood in great need of an internal and external face lift, PJV was building a stunning multi-million dollar complex. In addition, as the Yuzhinsky site was so small, access to it so cramped, the houses around it so rickety, and the infrastructure supporting it so overburdened, the neighbors, of course, were forced to bear many inconveniences during the construction period.

At first, opposition to the construction of Yuzhinsky was overwhelming. Perestroika Joint Venture went out of its way both on an official and personal level to make friends with community members and to convince them that the construction of Yuzhinsky would improve the general living conditions for everyone. A special PJV task force was created that was responsible for maintaining daily contact with the residents, and Stroyev himself attended monthly meetings.

In addition to installing a new utilities system for the entire surrounding region, PJV made extensive efforts to solve localized, concrete issues concerning its immediate neighbors. PJV renovated several apartment block common areas as well as three yards adjacent to the Yuzhinsky complex. As the city of Moscow did not have the necessary funds, PJV also paid over $200,000 to replace the antiquated heating systems of Tryokhprudny Pereulok 6 and 8, two houses near the site. During the height of construction, in the summer of 1990, PJV sent the majority of the local neighbors to a popular summer resort. But it was the one-on-one contact, the time spent by PJV staff members chatting with the Yuzhinsky neighborhood's little old “babushkas” sitting on their doorsteps, helping them solve their individual concerns, that finally made PJV and Yuzhinsky Pereulok a welcome member of the local community.

LESSONS LEARNED

The main lesson that can be learned from working in the Russian market in general, and in the Russian real estate industry in particular, is that a management team must approach every day and every situation with a spirit of innovation and a penchant for creative problem solving.

Sir Winston Churchill described Russia as a riddle wrapped in a mystery inside an enigma. He was right. And it seems that the old adage, “The more you learn, the less you know,” also applies full force in Russia. Thus, the second, and no less critical lesson is that before a foreign company embarks on any project in Russia, its managers must attempt to understand the culture, the people's mentality, and the local conditions.

The political, economic and social conditions in Russia are changing daily, and drastically. A management team will encounter unpredictable surprises at every turn. It is vital that the correct people are chosen for the correct positions when working in Moscow. There is so much that can go wrong on the “outside” that there is not much margin for error on the “inside.” For the real estate industry in particular, it is imperative that those managers selected for project management positions dealing in any capacity with city officials and the municipal bureaucracy must have extensive experience and a wealth of personal contacts in that sphere.

The preceding idea leads to the last lesson learned. Many foreigners come to Moscow expecting to “do it their way.” The result is often not what they expected. It is wise to never underestimate the knowledge, the skills, and most importantly, the experience of your native Russian partners and staff. They have grown up with their system and they know how to be effective in it. And without their support, your project will be stopped dead in its tracks.

Ms. Tracy E. Kwiker currently serves as the director of marketing for Russia's largest and most successful commercial and residential real estate development company, Perestroika Joint Venture (PJV). In this capacity, she is responsible for client base development, PJV's overall marketing and advertising strategy, news media and public relations, event management and market research.

Ms. Kwiker is a Summa Cum Laude graduate of Tufts University, Boston, Massachusetts. Before earning her Bachelor of Arts degree in Soviet and East European Studies, Ms. Kwiker won a position at a nationally competitive study abroad program which allowed her to attend the Plekhanov Academy of the National Economy, Moscow, in 1989. In addition to receiving the Tufts “Russian Prize” in 1989 and 1990, Ms. Kwiker was elected member of Phi Beta Kappa, a national academic honor society, upon graduation in 1990.

During her final year at Tufts, Ms. Kwiker worked as a program coordinator for Independent University, Washington, D. C., where she successfully created and implemented a marketing program to attract students to participate in a 1990 summer study abroad program at Moscow State University.

Prior to joining Perestroika Joint Venture, Ms. Kwiker came to Moscow as a member of Americom International Corporation's small permanent advance team responsible for the start-up of the American Trade Center, a full-service business center located in the Radisson Slavjanskaya Hotel.