Evaluation of the investment risks in the field of tourism construction industry in Sochi

Housing market and infrastructure development

There are more than 5.000 spa and tourism buildings in Sochi. The developers who build new hotel complexes are losing their interest in these projects in Sochi as they see the investment returns much lower than the prices of such buildings. The tourism construction industry, which is connected to the oncoming Olympic Games in 2014, has an impact on more cities and places around Sochi. It has its impact even on the Imereti Lowland, a former reservation which was far from being built-up in the Soviet era (partly because of the earthquake risks and complicated relief).

The Lowland has become attractive to developers because of the Olympic Games, without which no hotel complex would have been finished. Building projects of the hotels in Sochi, Imereti Valley and Krasnaya Polyana are supposed to offer about 40,000 hotel rooms. The question remains over whether or not these projects are still lucrative (due to the large number of rooms). The biggest demand is for apartments for about 100 USD per night, although developers are building five star hotels, or something akin to housing estates at this stage. In summer 2012, 46 new accommodation complexes and two Olympic villages are being built in Sochi. At the seaside, an Olympic zone of 50 buildings is being built and some of them will be finished soon. The hotel by the sea harbour, where the members of the International Olympic Committee will be accommodated, is nearly finished. Nevertheless, according to some sources, it is also possible that the whole Committee may be accommodated in a hotel which should be built in December 2013 by the Otel Stroy company for more than 225 million USD.

The Otel Stroy company is the business partner of GlavStroy, company of well known oligarch Oleg Deripaska, and it is the common project of Rogsibal and Otel Development companies. The ex-president of Inturist, Abbas Aliev, is supposed to be the head of Otel Stroy. Aliev is going to build a five-star hotel under the auspices of the Radisson brand in the Imeretin Valley.

Some of private investors are currently having financial problems so they can’t fulfil their contracts and dates. The Russian Federation is going to punish these investors with some extra sanctions, arguing that the investors have also signed their responsibility with this Olympic development. Each day after the deadline, in each stage of the project, will cost the investors 2 million RUB (650 000 USD). The AST Group, owned by controversial businessman Telman Ismailov, refrained from hotel complex development about a year ago.

Ismailov had control over the biggest market in Moscow – “Cherkizovskiy rynok” – which was closed in 2009 by the government. Ismailov had spent a year in Turkey before he went back to Moscow where he made really friendly relations with Moscow ex-mayor Yuriy Luzhkov, who fell from grace in fall 2010.

Ismailov had originally planned to build a complex with 5,000 hotel rooms in the Imereti Valley, but this number was later reduced to 3,600. Ismailov handed the control of this under construction hotel complex over to the structures of the oligarch Viktor Vekselberg (whose wealth is 12.5 billion USD). The main cause of this sale could be the fact that Ismailov wouldn´t have been permitted to obtain state credit due to his unclear reputation – the construction of the whole complex costs about 540 million USD and it should be finished in 2013 with 10 years investment return (it also ought to be the biggest horseshoe-like hotel complex in Europe). It is assumed that the journalists and the partners of the OG will be accommodated in this hotel during the 2014 OG. Also, the first hotel Hyatt (a 27-storey building) will have been built in south Russia by the time of the 2014 OG. The Marriott hotels company is entering the market as well – the Marriott Sochi Plaza will emerge in the centre of Sochi in 2013, the Marriott Krasnaya Polyana should be built by the end of 2013 and the Marriott Sochi Golf Resort by the beginning of 2014.

The investments risks

The returns and the attendance of tourism or sports infrastructure after the OG are over remain the main investment risks. Most of the objects and buildings can’t be used effectively after the Games. These one-off investments constitute about 15-20 % of the Olympic project budget – that means 150-200 billion RUB (5-7 bil. USD). The whole expenditure of the 2014 OG should be 30 billion USD, but some experts expect that this sum may increase up to 45 billion USD because of the security and transport costs. The 2010 OG in Vancouver, Canada had expenditures of 6 billion USD and this investment hasn’t been returned as well. There are also the return risks at the buildings which can be used after the OG. For example, the public transport capacity will be fully utilized only in season (150 days a year). Sochi is expected to end up with a total loss of 500 billion RUB (over 15 billion USD).

It is the seasonal character of the tourism business in Sochi itself that disables the acceptable price returns to these hotel projects. We need to understand the perspective of Sochi´s development after the OG is over to understand and value the attractiveness of these investment projects. This development also depends on regional or municipal authority. All the sources are currently focused on the OG organization, but clear plans for future development are still missing. The principle of social responsibility in these investment projects of the Imeretin hotels is apparently more important than the economic efficiency (in Russia, the social responsibility of a business means its subordination to the state interests and implementing states requests). The emergence of competitive tourism seems to be the biggest problem with the investment returns after the OG are over. Instead of staying in Sochi for 3 days, the Russians prefer to fly to Egypt or Turkey for one week, all inclusive and with services on a much higher level. What surely could solve this situation is the reformation of taxation which will legalize many tourism property objects, reduce the tax burden and also enable the lowering of prices for services and accommodation. Also, the small business support programmes, the standardization programmes and the national classification of the tourism industry objects, which will be focused on the harmonisation with international and national standards and not just on money extortion – will all help to solve this problem.

What seems to be a quite big problem these days and should be changed is the education and the preparation of the personnel. According to the MACON Reality Group calculation, the hotel property market in Sochi will be balanced if the annual growth of the number of tourists will exceed 20 % at least 5 years in a row after the OG are over. The Russian Formula 1 Grand Prix in 2014 and 2018 FIFA World Cup may make this destination more interesting for tourists, however more systematic changes are needed. Sochi and its vicinity should absolutely be integrated into the Azov-City gambling zone (gambling was banned in Russia nationwide except for a few zones where the gambling is allowed).

Meanwhile, some of the private investors have realized the impossibility of achieving a return on realized buildings and they demand a percentage subsidy on loans from the state bank Vneshekonombank (VEB) and want the state to buy a share in their companies. This problem with investment returns is partly caused by the Olympstroy company – this national corporation didn´t provide much needed infrastructure to the investors, so companies had to build it with their own money, which caused the price of the projects to go up and delayed the building schedule (the investment of the Interros company, owned by the oligarch Vladimir Potanin, which is taking place in Krasnaya Polyana, has increased from 1.5 billion up to 2.3 billion USD and even the construction work may be delayed). During the 2012 OG in London, the Sberbank chairman German Gref contacted the Russian government with the request for some special protective measures for the investors, which could help to return their investments.

Risk minimizing measures

a) Drafts to create a special tourism-recreation economic zone in the Adlersky city district should be proposed by the government (the creation of this zone will cost 1,5 billion USD of private investment). Olympstroy and the Bilalev brothers structures are currently struggling to gain the privilege of control over this zone. The Bilalev brothers are in contact with the Krasnodar governor Alexandr Tkachev. Tkachev had proposed the Northern Caucasus Resort Company to be the administrator of such zone. The NCRC is controlled by the Dagestani businessman Akhmed Bilalov and its founders are his brother Magomed Bilalov and the state-owned bank Sberbank. The foundation of this zone enables the Olympic investors to become the zone´s residents and gain benefits such as exemption from paying taxes on property (2 percent of object value) and on land tenancy.

b) Another state-owned bank Vneshekonombank (VEB) simplified the situation to investors with the possibility of reduction of the minimal sum needed for co-financing to at least 10 % of the total value of the project. That means that 90 % of the Olympic project expense will be ensured by the state in the form of a loan. Nevertheless, the sum of private developer expenses may not change due to the expense growth of unplanned projects. Moreover, the private investor must give a guarantee to pay back 20 % of the price in case of project failure. The possibilities of national support for the projects are currently evaluated – partial compensation of some percentage of credit is possible. The increase of the expense will unfortunately have to be paid by the private investors.

Some extra information about the investment and real estate in the Krasnodarskiy Kray are available on info@cbap.cz. We are also preparing a special analysis of the Olympstroy, which is responsible for the infrastructure preparation for the Olympic Games in Sochi.

Author: CBAP

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