REAL ESTATE: How will Obligatory Insurance Influence Developers and Equity Holders?

10 January 2013

REAL ESTATE: How will Obligatory Insurance Influence Developers and Equity Holders?

President Vladimir Putin has approved the law on insurance of developers’ civil liability for non-performance of obligations on transfer of residential accommodations to equity holders. Market participants are explaining how this innovation will influence activities of conscientious developers and equity holders themselves. Some of them earnestly believe that this law will only worsen the position of private investors.

Let us remind that in 2012 the authorities many times raised the topic of protection of equity holders’ rights but insurers flatly refused to take part in this process explaining that it is not profitable for them to insure houses being built. As Zinaida Kuzmina, Director of Financial Risks and Liability Insurance Department of AlfaStrakhovanie told Realestate.ru, the probability that a natural person who buys a flat in a house being built will not receive the keys and a developer will disappear or will be recognised as a bankrupt is too high. “Insurance companies are not ready to accept such risks for insurance”, the expert explained.

Developers in their turn also were not eager to let themselves in for that.

Darya Pogorelskaya, Head of Legal Department of MIC Group of Companies, when commenting on the proposed law to a Realestate.ru correspondent, said that the document provides for creation of developers’ mutual insurance societies and members of such companies will have to undertake risks for non-fulfilment by other members of their obligations towards equity holders. “In fact the proposed law offers developers to chip in for compensation of losses inflicted by third parties. And those construction companies which fulfil their obligations, construct and commission houses on time, gain nothing from such “insurance”. For conscientious developers an insurance premium is just an additional expenditure,” she noted.

Though experts criticise the law, it still has been approved personally by President Vladimir Putin. The law envisages two ways of insurance: by a developer’s participation in a developers’ mutual insurance society or by concluding an insurance agreement with an insurance company.
The minimal amount of insurance shall be calculated on the basis of the price of agreement and shall not be less than the amount calculated from the floor space of a residential accommodation to be transferred to an equity holder and an average market price of a square meter in a constituent entity of the Russian Federation defined as of the date of conclusion of suretyship agreement or insurance agreement.

The majority of experts are sure that someone will eventually have to pay for this insurance. And it’s most likely that all the expenses will come upon the final customer which will inevitably lead to price increase. However the new law should help to protect equity holders from unfair developers though there is an opinion that developers’ risks may vice versa grow, and, moreover, grow exponentially.” Apart from that, the majority of experts interviewed are sure that prices of flats will also grow because of the new law.

 

“The law may prompt developers to withdraw into the shadow side”

Andrey Kirsanov, Deputy General Director of MR Group

Insurance should be eventually paid for. Developers are likely to put expenses under a civil liability insurance agreement or a suretyship agreement for proper fulfilment of obligations on equity holders. This is why as soon as the newly adopted rules of submission by a developer of a civil liability insurance agreement or a suretyship agreement for proper fulfilment of obligations enter into force, an increase of prices for real estate under construction can be expected. This is a very optimistic forecast.

Even worse is that some developers are already circumventing the legislation on shared-equity construction and attract funds for construction by other ways, whereas attraction of citizens’ funds for construction of blocks of flats and/or other real estate items is only allowed by the means specified in the Law on Participation in Shared Construction.

Price increase because of an insurance premium may prompt those who work today in a lawful manner to abandon it. It is likely that in case of further increase of prices for real estate, conclusion of agreements in accordance with the Law on Participation in Shared Construction for legal persons will be not a rule but an exception from it.

“The Innovation Will Hit Small regional Developers”

Grigory Altukhov, Advisor to President of Leader Finance and Construction Corporation:

- It should be mentioned that the law will apply to those projects whose date of registration of the first equity participation agreement will be one year after the official publication of the law, i.e. from the beginning of 2014. The procedure for selection of the first 30 developers-participants of mutual insurance will be defined within half a year.

At the end of the previous year neither insurance companies nor banks were ready to offer any options of their participation in developers’ insurance, both as regards requirements to developers and possible cost of their services. Therefore, the procedure for admission to membership of mutual insurance, the amount of membership fees, the cost of banking guarantees and insurance premiums as well as requirements to developers from the part of mutual insurance societies, banks and insurance organisations are likely to be specified not earlier than by autumn of 2013.

As to protection of equity holders, the concept of the law envisages elimination of unfair developers at the stage prior to the beginning of sales to customers. Problems may arise in the course of its practical implementation. First of all it is necessary to cut off shadow banks and insurance companies (to which unfair developers are likely to address). Secondly, it is necessary to provide access to mutual agreement societies to conscientious but small and unknown regional and local developers (otherwise already near dead residential construction in regions will come to a standstill).

The law will bring certain cares and increase of prime cost by the amount of liability insurance to large federal and Moscow conscientious developers; however it is unlikely to influence their activities directly. As for small regional developers, they often work with small profits. And as it is almost impossible for them to receive high credit ratings with banks and insurers, for them the cost of banking guarantee or commercial insurance may be equitable to profit from project sale and that actually raises the question of reasonability and break-even of their activities.

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“Prices are likely to increase by 4-6%”

Roman Chernigovtsev, Head of Press Service of SU-155 Group of Companies

- Conscientious developers as well as all participants of this market will have to bear additional expenses on depositing a pledge and on one of additional ways of securing fulfilment of obligations.

This amendment indeed reduces risks of equity participants to get deceived. But it is unable to fully exclude negative case scenario: repayment of money with compensation of losses is envisaged but only after the court’s decision on the claim on non-fulfilment of obligations by developers. Therefore, it will be hardly possible to avoid losses because of delays in receiving a flat.

According to our estimates, the law should not additionally increase the price of a square meter by more than 3-5% still providing additional guaranties of fulfilment of terms and conditions of an equity participation agreement. However, upon condition of implementation of at least a part of the measures provided for by the road map of housing construction development, dynamics of growth of absolute figures of prices is unlikely to exceed the forecasted 4-6% to inflation.


“Customers Will Not Notice Price Increase”

Natalya Kozlova, General Director of JSC Glavmosstroy Nedvizhimost

- Even conscientious developers are not fully protected from the crisis in the real estate market. And in such case the law will act in their interests. And if procedures for payment of insurance compensations are clear, simple and transparent and will not take many years, it will also help equity holders.

 Expenses on insurance will be added to the price of a flat but they will be practically unnoticed by buyers because prices will still stay within the usual range of prices for a project of this segment.

The Law Will Protect Equity Holders Until It Is Invented How to Circumvent It”

Igor Zherzdev, Owner of the Company CENTURY 21 ANK-Development:

- The law exists not in the final variant: there are comments to it and implementation documents are likely to be drawn up intended actually to underline everything good it has.

Actually, the law is meant to equalise developers and equity holders in rights and responsibilities. It will first of all affect affiliated companies. Nowadays almost all developers do their best to circumvent Federal Law No. 214-FZ that was elaborated in order to clear the market from small companies. Before 2003 developers were enabled to gather money from equity holders at any time and law No. 214 changed the situation: it became possible to raise money only after preparation and approval of a project as well as lots of other quite expensive procedures. To avoid this disappointing inconvenience developers started to create small affiliated companies and assigned flats to them so that these companies would carry out sales to physical persons. In these circumstances in case of a failure the developer does not bear any responsibility before equity holders. And in accordance with the new law responsibility will be borne by all: both the developer and his affiliated companies.

It will, of course, protect equity holders but until a new scheme to circumvent the law is invented.


Deceived Equity Holders Will Come Through All the Seven Circles of Hell:

Timur Sukharev, Commercial Director of Restavracia N:

- It is yet another item of expenditures and unnecessary bureaucratic acrimony for conscientious developers. If a developer has “inner census” and his market experience shows that he fulfils his obligations in due time, the procedure of insurance will make his work more complicated.

Please note that an unfair developer will get another trump – insurance. But in case of negative course of events an equity holder will have to come through seven circles of hell dealing with an insurance company or a mutual insurance society. The new proposed law is unable to protect interests of equity holders for 100% as de facto developer’s sound reputation and competence do reduce risks of equity holders.


“It Will Be Impossible to Buy Anything for Insurance Compensations”

 Sergey Popravka, Director of Legal Department of Penny Lane Realty:

- I don’t think that the law if it is adopted will have a good impact on conscientious developers. What will they gain by that?! They already fulfil their obligations towards equity holders and now in fact they are made obliged to cover the harm inflicted by unfair developers.

Insurance of developers’ liability is going to have a good impact on the level of protection of equity holders but it will not be the panacea. The main factor here will be time factor. From the moment of payment of money by an equity holder and until occurrence of the insured event and then till receipt of insurance compensation, the price of real estate will grow, taking into account price growth dynamics and inflation, and it will be impossible to buy similar accommodations for the insurance compensation received.

 

 “There Will Be One Paper-Laden Process More”

Irina Mosheva, General Director of the Joint Venture RDI Group and Limitless:

- Any insurance will be related to developer’s expenses and these expenses should be covered by sales revenue. However the share of expenses on insurance is usually very small if compared to other expenses of developers, that’s why it is unlikely to have any impact on developers’ activities.

It will give additional; guarantees to equity holders and, probably, will speed up cover of losses for buyers in case of non-fulfilment of obligations by developers. Eventually, the buyer will pay for these expenses of developers but it will be an insignificant amount.

“No Step-by Step Price Increase Shall Be Expected”

Leonard Blinov, Director for Marketing of Urban Group:

- First of all, the law, of course, spells additional financial expenses; either it is going to be bank guarantee or liability insurance. It is necessary also to remember about efforts as security of developer’s obligations should be established under all equity participation agreements, and there also appear control and supervision authorities to whom it is required to report; and it is unlikely to be managed without attraction of additional human resources.

Mitigation of risks always entails increase of cost of final product which is quite fair. It should be mentioned that step-by-step price increase by 2-3% in relation to entrance into force of this law should not be expected as this amendment is unlikely to have retroactive effect, i.e. it will affect only those projects construction of which will begin after introduction of this amendment.

“Risks of Equity Holders Will Increase Exponentially”

Konstantin Kovalev, Managing Partner of Blackwood, Vice-President of the Russian Union of Engineers:

- The opportunity not to participate in a mutual insurance society but conclude a traditional insurance agreement with an insurance company looks like a certain mitigation. But it is difficult to say so far what way will be more beneficial for a developer.

Several situations can happen at once where an equity holder will not receive compensation he is entitled to.

For example, agreement of developers and their creation of a mutual insurance society with the purpose of minimising of insurance rates; joining such society that is knowingly unable to fulfil the purposes of its creation.

Apart from that, large developers are most likely to create insurance societies with the same large developers as they are or with their affiliated structures and not to accept other developers. And it means that small developers will unite into their much less reliable mutual insurance societies. Therefore, risks of equity holders are increasing exponentially. 
First of all, medium-sized and small developers have fewer resources and are more apt to non-fulfilment of their obligations. Secondly, mutual insurance societies created by such developers will also bear increased risks of insurance compensation payment which just may not be enough for all equity holders.

“Work of Small and Medium-Sized Companies in the Market of Newly Erected Buildings Will Become More Complicated”

Vasily Sharapov, Deputy Head of Legal Department of the Developing Company City-XXI Century

- Compulsory insurance will entail tendency to consolidation of participants of the market of newly erected buildings, increase of transactions on mergers and acquisitions of developing companies. As the result of adoption of the law work of small and medium-sized companies at the market of newly erected buildings will become more complicated. Their business is now dependent upon policy of banks and insurance companies or upon activities of developers’ liability mutual insurance societies.

And equity holders will have additional legal guarantee of return of money invested into equity-shared construction in case of bankruptcy of the developer. By means of insurance compensations or submission of claims to the bank they will be able to get back their investments much faster. But there is a disadvantage in the new law for equity holders: expenses on risks insurance or banking guarantees will be included into the price of flats. So far it is difficult to estimate how prices for flats in newly erected buildings will increase.

“Insurance of Equity Holders is a Step Forward”

Alexander Pypin, Director of Analytical Centre Gdeetotdom.ru:

- Undoubtedly, the first years will be difficult and critical but in the long view implementation of this law will remove from the market the most unprofessional and unreliable developing companies. They will be unlikely to receive banking guarantees, to conclude insurance agreement or join mutual insurance society. They will be just denied or impracticable rates will be offered to them.

Actually the adopted law has left to developers themselves the issue how to build up mutually insurance system.

It is important also to realise that guarantees provided by this new law to equity holders are strictly limited. It turns out that by the time a deceived equity holder receives his money back, it won’t be possible to buy an accommodation of equal worth taking into account that price for real estate is usually growing. It is not quite clear if the matter can be solved in court and whether there will be enough money in the compensation fund of a mutual insurance society.
Please note that implementation of the adopted law by itself can trigger prices increase at the market of newly erected buildings because of reduction of supply volume, potentially, up to 5%.

Source: RealEstate.ru

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