Collective mode of investment

Mutual funds are rarely used to finance construction projects. However, the scheme exists, though it has become quite rare in recent years.

A couple of years ago, mutual funds were used to optimize the taxation, but after the amendments to the Tax Code have been made and the property tax has returned, the scheme has become less interesting. Nevertheless closed mutual funds (CMF) or closed real estate mutual funds (CREMF) are not gone from the market and a small percentage of projects are funded in this way.
According to Kirill Ivanov, Commercial director at "PENOPLEX St. Petersburg", total investment of CMF in real estate (in the country) to date is about 173 billion rubles. This is a relatively small figure.

Effective for external financing

As a collective form of investment, allowing significant means’ consolidating, CMF are surely an effective tool for external financing of new construction. In some cases, they may act as an alternative to the current common mechanisms of borrowing in construction industry, such as bank loans, bond issues and equity co-financing.
"As a rule, the investment strategy of these funds is designed for the period from one year up to 2-3 years and involves investing in the acquisition of rights as per equity construction agreements, mainly in the most liquid projects of economy-class. After the completion of construction and commissioning of a facility the rights are exercised in the market and fund shares are redeemed, the profit is generated by the project’s margins," Maxim Klyagin, Analyst at "Finam Management" says.
However, at this stage property CMFs as an instrument to finance new projects are not widely distributed. More dynamic growth is hampered by the high entry barrier – the lowest share value is approximately 1 million rubles, which given the relatively low standard of living makes it difficult to form a large amount of funds. "In addition, there are other negative factors, such as system constraints, for example, the closed nature of funds. Investments are actually frozen in the project for several years, which given the rapidly changing external environment, of course, involves some risks. Against this background, most of the funds are focused on the most marginal projects that are in high demand, so they are mostly limited to the geography of Moscow and the Moscow region, as well as to just a few large projects in other key cities. The total amount of such funds, according to approximate estimates, is about 200 billion. In the mid-run, in the wake of demand rising and welfare flourish, the number of such projects may increase," Mr. Klyagin says.

Universal tool

Mr. Ivanov notes that CMFs are mainly involved in financing of commercial real estate construction. Their share in the total volume of funding, according to the expert, does not exceed 5%.
Evgeny Kaur, Managing Director at LCMC has a different point of view: "Mutual funds are mainly invested in housing, since it has the most transparent scheme of payback and minimum risk. Their share in commercial real estate is negligible."
Sergei Vladimirov, Head of Capital Markets at JLL in St. Petersburg believes that CREMF is a versatile tool for the real estate investments. "These funds can invest in residential and commercial real estate at either on the stage of project development or on the operational stage. CREMF are mostly used in the sector of residential development – shareholders invest in the equity construction agreements at the “zero” cycle for the purpose of further renting of the finished apartments and/or reselling them at a later stage of construction.
This is due to the fact that residential housing is the most liquid asset in the real estate sector; it is worth remembering that any fund primarily takes care of saving shareholders’ capital. For the same reason CREMF invest in rental assets in commercial real estate, in which the rental stream is guaranteed by the long-term lease with fixed annual indexation.
As a rule, management companies seek to make a diversified portfolio of assets, including both more profitable investment in housing under construction and more stable rental assets," Mr. Vladimirov says.  He also notes that a special case of CREMF’s use is owners’ withdrawal.
If the object is so large that the investor alone cannot afford it, then the owner can "pack" the property to CREMF. The owner with the help of the management company "puts" the object to the fund, becomes the owner of all the shares, then partially or completely leaves the project through the sale of shares on the secondary market.
 
Pros and cons

The advantages of project financing through CMF is the fact that such money can be long money – loan issuance period is up to 15 years, which is rare in the banking sector. "Mutual funds want to have bigger return on the ruble invested, though," he notes.
"The advantage of such a fund is that investments of CREMF are long: the fund has a fixed life span, shareholders cannot withdraw their investment.
Since most investors/developers are interested in high-acquisitions, CREMF may cover emerging gaps in market liquidity by purchasing ready-made objects after completion and allowing developers to start new projects. The downside is the higher return on capital in relation to the interest rate," Sergei Vladimirov agrees with his colleague.
"Such segmentation and low popularity among developers can have the following reasons: the idea of mutual funds was greatly discredited by the crisis in 2008, plus a non-fixed rate of return, the commission of the management company – all together look dangerous and expensive; the market lacks active individual private investors wishing to use these tools; amorphous legal framework does not add any appeal to this tool; for a private investor with "free" money it is easier and safer to buy an apartment or commercial property at once," Mr. Kaur says.
She also notes that one cannot say that the market of mutual funds in Russia is undeveloped – there exist just better tools.
Andrey Boyko, Partner at Rusland SP says: "The scheme of mutual funds is often used in the projects where a lot of independent investors exist. Collective investments are much safer to carry out through the CMF scheme."
It is possible that in the near future CMF share in the total mass of financial schemes may grow. This will happen if the lending rate by traditional financial institutions (banks) will go up, says Mr. Ivanov, which may happen soon, taking into account the present macroeconomic situation.

Opinion:

Aleksandra Smirnova, Head of Investment brokerage at NAI Becar
Mutual funds are more prevalent in the West. The advantage of financing construction projects through the mutual fund is the fact that the procedure for obtaining funds is easier, compared to the banks. In Russia, the mutual fund as a full investor is not involved in projects construction. This is due to the fact that the implementation of construction projects in European countries has minimal risks and those risks are transparent. In today-Russia investing in construction projects is accompanied by high risks. In Russia, mutual funds are often involved in construction projects as shareholders, or prefer to invest money in already built properties. Thus, the share of investment of mutual funds into projects construction in Russia is not substantial.