The commercial property market in Moscow has picked up noticeably this year: new properties are appearing, the amount of vacant space is falling, and rental rates are rising. The hard times for owners might seem to be behind them, but that is only at first glance. Alongside rising occupancy, the property tax rate is going up, and relations with the Moscow City Property Department (the DGI of Moscow) and the state inspectorate are becoming more difficult. Neglect of the basic legal rules can still be fatal for a business today. The managing partner of Consul Group, Sergei Pivovarchik, explains how legislation and court practice affect the market.
What challenges and trends have you seen in the capital's commercial property market in recent years?
First, the fight against breaches in the use of immovable property has intensified. The core of the commercial property market was formed through privatisation, and for decades those properties were not brought into line with legislation that kept changing. Questions of land relations and unauthorised construction therefore arise, and they turn into large fines, long court cases, or even the demolition of the immovable property.
Second, since 2014 more and more properties have moved to taxation based on cadastral value. That leaves its mark on the owners of privatised properties. For 20 years they built their cash flows on the basis that property tax was close to zero, and it has now become a tangible item of expense (on average 15% of the rental stream). All of this confirms a trend on the market: the duty of owners to maintain the property that belongs to them has become more pressing. To remain the owner of that property in future, one has to make sure that the property is correctly entered on the cadastral register, that land and property relations are properly formalised, and that the accounting and tax records are kept properly.
Neglect of the basic rules can become fatal for a business overnight,
- says Sergei Pivovarchik.
And how, in your view, will the situation on the market develop? Could you give a forecast for the next five years?
The legal reform now under way is not so ruinous for large owners of commercial property. The main blow will fall on those who own one or two small properties and whose principal source of income is the letting business. Such owners need a property owners' association that actually functions, and an active dialogue with the authorities. Let me give an example. For the owners of small commercial properties, property tax averages 15% of rental income. Add the risk of penalties and the loss of one large tenant, and a profitable business becomes a loss-making one. The economic situation in the country is deteriorating, and that does not allow smaller players to raise rental rates. If they do, tenants will look for somewhere cheaper, and the business's current finances will suffer. All of this can leave a business without the funds to make obligatory payments to the budget, and then come fines and late-payment interest, and so on up to bankruptcy. In 5-10 years we may see smaller property owners sell their properties cheaply to large owners, because the burden of maintaining that property will be too heavy, and unprofitable set against both the risks and the income from letting it. The money raised by selling such a property is unlikely to be invested in the economy of a country that has taken that owner's income away by pursuing a destructive tax policy.
Are there cases in your practice with a practical effect both for property owners and for the market itself?
We have completed more than one case of this kind, and we are working on new ones. Unfortunately I cannot speak about projects that have not been covered in the media, because they are intellectual assets of the firm. I can mention, for example, our dispute with the Government of Moscow over its Resolution No. 937-PP of 26 December 2016, under which the base for calculating corporate property tax was increased retrospectively for more than 2,500 owners of commercial property. As a result, the total of the additional assessments to the budget came to 12.5 billion roubles, excluding fines and late-payment interest. We won that dispute. The media also wrote actively about the continuation of the dispute, this time with the Federal Tax Service, over the additional tax assessment based on the resolution mentioned above. A great deal could be said about both disputes, but what is notable is that the case of Yumaks, a limited liability company, became a landmark both for the legal services market and for business as a whole. When we built the strategy for this dispute, we understood that it was not a dispute between business entities, and that to win we had to remove the root cause of the additional assessment: the resolution itself. In the end we won the dispute with the Government of Moscow and set aside the retrospective effect of the resolution. Thanks to that victory, some property owners have already been able to recover the additionally assessed tax in full without going into a tax dispute, while others still have to "wrest" it from the tax authority.
I hope this case has shown both business and lawyers that, in a dispute with the state, what matters is to be a couple of kilometres ahead, not one step ahead. Only with that advantage is there a real chance of proving, to the state and to a judicial system that in disputes with the state is often not on the side of business, that your claim is lawful and well founded. An advantage of that kind can be built only when you live this particular subject and work with it every day.
Why was the focus chosen at the outset: commercial property only?
We did not want to be lawyers spread across many lines of work, chasing volume at the expense of quality. In 2014, when the Consul Group team was being formed, we made a conscious decision to work in one field only: real estate. It is a very large field, and at the time few could offer qualified, comprehensive legal support. The so-called cadastral reform had begun in the Russian Federation. It consisted not only of the move to taxing real estate by reference to its cadastral value, but also of large-scale work to bring the state real estate cadastre into conformity, work which later produced a variety of problems for the owners of commercial properties. That came on top of the consequences of privatisation, when the mass transfer of real estate from the state sector into private hands was rarely accompanied by qualified legal help. The main problems we now resolve in our clients' interests appeared in that period.
How quickly did you learn to resolve them?
At the start we understood that the market did not know us and was unlikely to entrust us, at the first attempt, with difficult problems. We were fortunate: it was from 2014 that owners of commercial property began actively looking for consultants able to reduce corporate property tax by challenging cadastral value. Our team included people equal to such tasks. It was our chance to show the market that we were not simply lawyers or valuers, but highly qualified specialists in real estate. For the first three years, however, we had to advise clients almost free of charge on other questions concerning real estate, in order to prove our competence and build a portfolio of completed projects.
Because of our active work on challenging cadastral value, we fell into the trap of a stereotype: our clients did not see us as consultants on legal and tax questions in real estate, and associated us exclusively with cadastral disputes. We spent the years that followed showing clients and the market, by example, who we are. And, as I see it, we succeeded,
- explains Sergei Pivovarchik.
What achievements over the firm's six years would you single out?
For me the main achievement is our team. Forming it took five years. The key task was to bring together people who look at a problem in the round, not along a single line. Russian universities still turn out a great many lawyers and economists whose training is of very poor quality. That is a problem not only of the universities, but of the graduates themselves. Some people decide to become lawyers or economists because nowhere else will take them with the knowledge they have, or simply because they have not decided what they want from life. These courses are easier to get into than, for example, the faculty of mechanics and mathematics. The result is millions of people with degrees in law, economics and accountancy who cannot resolve the tasks set before them and do not want to. Bringing together a team of experienced experts who enjoy their work is a difficult task, and we carried it off with an "excellent".
No less important an achievement is our clients, with whom we have carried out a number of large and complex projects and whom we therefore regard as partners. It may seem strange, but it matters to us not only that our partners are comfortable working with us, but that we are comfortable working with them. There are people with whom we will not work, as a matter of principle, because our views differ. The difference is not about the tasks on a project. It is about the "client-consultant" relationship. We set great store by every partner who is, as the saying goes, on the same wavelength.
And what plans are you setting for the near future?
Any successful business should aim to become more successful still. We are continuously developing personal qualities, professional qualities, and the quality of the service we provide. Our competitive advantage now is full-cycle legal advice for owners of commercial property. We have our own departments for legal advice, tax planning (including international tax planning), asset valuation and cadastral works.
We do not bring in outside specialists to deal with clients' problems. Having those specialists on our own staff makes us the ideal consultant for any owner of immovable property,
- adds Sergei Pivovarchik.
Let me give an example in which a five-minute telephone conversation saved a client about 100 million roubles. The client came to us asking for a market valuation of 100% of the charter capital. It turned out that the founder had to be changed in one of the legal entities in the group, and the purpose of the valuation was to calculate the personal income tax payable to the budget by the seller of the interest. From us the client learned that the sale of an interest in a limited liability company which the owner has held for more than five years is exempt from personal income tax. To achieve the intended aim, one needs only an approximate price for the interest (and not a report), and one needs to claim the tax relief in the return. Consider how things might have gone if this client had approached a firm that does only valuation. He would first have received a valuation report, and would then have calculated and paid personal income tax to the budget of about 100 million roubles. A comprehensive approach, in which we do not confine ourselves to the terms of the client's technical specification, makes it possible to reach the client's real aim, even if at the outset he cannot formulate it himself.
We are not stopping at what we have achieved. We always put ourselves in our clients' place. We are sure that anyone who has run into a problem wants a view in the round. Today we provide a comprehensive and the most effective possible resolution of all the legal problems that property owners face. We also see that our partners have a need in the field of brokerage. If today we help to resolve those tasks by preparing the financial case and by supporting such transactions, in the near term we plan to form our own team of experts working in that field.
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