Report No. 14929-RU Russia Housing Reform and Privatization: Strategy and Transition Issues Volume l: Main Report August 1995 Country Department IlIl Europe and Central Asia Region Financial Sector Development Department Finance and Private Sector Development Office Document of the World Bank ACKNOWLEDGEMENTS This report has for origin the Technical Cooperation Project on Housing Reform and Privatization carried out between the Russian Federation and the World Bank during the year 1992. This project aimed to generate a better understanding of transition issues in the housing sector and provide immediate policy advice. It was hosted by the Ministry of Construction (Minstroy) and the Ministry of the Economy. The present report has been prepared by Bertrand Renaud (task manager) on the basis of analyses, reports, and information prepared by a number of specialists and experts. World Bank staff, World Bank consultants, and Russian officials or specialists have contributed directly and indirectly to this report in the following areas: Urban Laws and Regulations: Robert E. Ellickson (cons.), Michael A. Heller (cons.), Anvar Sh. Shamuzafarov, Oxana N. Yunina (cons.) Housing Finance System: Dwight F. Jaffee (cons.), Hanna Matras (cons.), Arianna Van Meurs (cons.), David G. Khodjaiev, Valery A. Samoshenko, Alla K. Abramova Management of Housing and Andre Massot (cons.), Gerard Lacoste (cons.), Catherine Taisne (cons.), Housing Privatization Leonid N. Chernyshov, Nicolai T. Lopatkin, Ludmila V. Kuznetsova, Vladimir G. Mettus, A. M. Bazhkin, Leonid E. Paidiev, Nataliya V. Kalinina (cons.) Building Industry and Patricia Hillebrandt (cons), James Meikle (cons), Igor V. Aristov A. Housing Development: VanMeurs (cons.), H. Matras (cons.), William McCulloch (cons.) Land Use, Urban Planning, Alain Bertaud (Principal Urban Planner), Vincent Renard (cons.), and Urban Land Reform: Joseph Comby (cons.), Rodrigo Acosta (cons.), Joseph K. Eckert (cons), Nataliya V. Kalinina (cons.), Mikhail P. Berezin, Olga Kaganova (cons.), Vladimir K. Linov, Oleg Matiukhin (cons.), Andrei V. Lazarevsky Report Preparation: Bertrand Renaud, Michael Heller (cons.), Hanna Matras (cons.), Elizabeth Durst (cons.), Andrew Jenks (editor), Rosamund Gamer Efim V. Basin, first as Chairman of the Russian Parliament Commnittee on Construction, Architecture, and Planning, Housing, and the Communal Economy, and currently as Minstroi of Minstroy Gosstroy; Alexander S. Krivov, Deputy Minister, Boris A. Furmanov, formerly Minister of Construction, followed the work of the technical cooperation project from its inception. The Technical Cooperation Project also benefitted from the cooperation and support of government officials and professionals at the federal level and in the cities of Moscow, St Petersburg, and Riazan. A 26-member Russian committee was appointed by Minister Furmanov to follow the project and evaluate its interim results. This committee had representatives from the Minstroy, the Parliament Committee on Construction, Architecture, and Public Housing, the government apparatus of the Russian Federation, the Ministry of the Economy, the Ministry of Social Protection, Sberbank (Savings Bank of Russia), legal experts of ministries, and other experts from government institutes. Dr. Nataliya V. Kalinina (Institute of Economic Forecasting, Russian Academy of Sciences) also coordinated the work in the field. This report has benefitted significantly from the joint World Bank-WIFO Seminar on the Building Industry in Transition Economies held in Vienna, Austria on 23-25 November 1992. Washington, D. C. i Glossary of Terms and Abbreviations Birzha: Stock or Commodity Exchange BTI: Biuro Technicheskoi Inventaritsatsin, Bureau of Technical Inventory for property registration CBR: Central Bank of the Russian Federation (see Gosbank) DSK: Domostroitel'nyi Kombinat, housing construction combine, see "kombinat" Oblast: Administrative Subdivision of a republic, Province Lrao: Territory, administrative subdivision of the Russian Federation Raion: District Gorod: City Mikro-raion: City planning sub-district Selo: Village GKI: State Committee for the Management of State Property Gosbank: State Central Bank (see CBR) Goskomtsen: State Price Committee Goskomstat: State Committee on Statistics Gosnab: State Committee for Material and Technical Supply Gosplan: State Planning Committee Gosstroi: State Committee for Construction Affairs (which has subsequently become the Ministry of Construction (Minstroy) since 199_) Gosstandart: State Committee for Standards Ispolkom: Ispolnitel 'nyi komete or executive committee. (Obkom or obispolkom = executive committee of an oblast. Raikom or raiispolkom = executive committee of a raion. Gorkom or gorispolkom = executive committee of a city) Kombinat: A large vertically integrated organization undertaking the manufacture of heavy concrete panels, their assembly, and finishing into housing units. (see DSK) Moskapstroi: Moscow organization centralizing construction capital investment functions (see MKS) PKU: Proizvodstvienno Koordinatsionoe Upravlenie. Department coordinating building trests production activities. (in Moscow) Propiska: Residency permit REU: Housing maintenance and operations administration in Moscow (Remont: maintenance, repair, renovation. Ekhsploitatsie: operation. Upravlenie: administration) Shabashnik: Informal work team in construction and agriculture Sberbank: National Savings Bank of the Russian Federation ii SU: Stroitelnoe-montazhnoe Upravlenie, Assembly and Construction Administradon. This is a sub-department of a construction trest Trest: The main operational organization in a construction project. TUKS: Temitorialnoc Upravienie Kapitelnogo Stroitelstva. Territorial Agency under Moskapstroi Zakazchik: Client or issuer of an order. May also be the clients' representative and the manager of much of the construction process. 7hEK: Zidleshno-Ekhsploitatsie, housing management office, local level. ZhSK: Zhileshno-stroitel'nyi kooperativ, housing construction cooperative HOUSING REFORM AND PRIVATIZATION IN RUSSIA VOLUME1 TABLE OF CONTENTS EXECUTIVE SUMMARY: The Need for Housing Markets and the Road Ahead PART I: The Background of Reform Chapter 1: The Context of Russian Housing Reform .......................... 1 PART II: A Strategy for Housing Reform Chapter 2: The Role of Privatization in Russian Housing Reforms ................. 15 Chapter 3: Flow of Funds Through the Housing Sector and Emerging Role of Rents ..... 45 PART III: Progress of Housing Reforms and Sectoral Issues Chapter 4: Progress and Limits in property Rights Reforms ..................... 79 Chapter 5: Housing Management and Pricing of the Social Housing Stock .... ........ 91 Chapter 6: Housing Finance and Banking Services for Housing ................. 109 Chapter 7: Access to Urban Land: City Efficiency and Urban Land Reform .... ...... 131 Chapter 8: Housing and the Construction Industry: Reforms ...I.I.I.I.I.I............ 163 STATISTICAL APPENDIX ....................................... 189 v LIST OF TABLES, FIGURES, AND BOXES: Tables: TABLE 2.1: Russian Housing System Before Reforms ...................... 21 TABLE 2.2: Ownership of the Existing Stock: Russia Versus Other Countries ... .... 23 TABLE 3.1: Combining Uniform Rent Increases with Housing Allowances ... ...... 66 TABLE 4.1: Legal Framework for Russian Housing Reforms .................. 88 TABLE 6.1: Russian Federation: Housing Investments by Sources (Milliards of Rubles) 114 Figures: FIGURE 2.1: The Russian Housing System Before Reforms ........ ........... 19 FIGURE 3.1: Recent Shocks to the Traditional Housing System ....... .......... 57 FIGURE 3.2: Stabilization Strategy for Housing .......... .. ............... 60 FIGURE 6.1: USSR Central Planning System for Housing Investment (1990) ........ 112 FIGURE 7.1: Industrial Land Use and Job Density Patterns ....... ........... 136 FIGURE 7.2: The Socialist City Compared to the Market City: Moscow Compared to Paris 139 FIGURE 7.3: Emerging Market Land Price Gradients: in Moscow, Krakow, Poland . .. 142 FIGURE 8.1: The Construction Industry in a Market Economy: Role of Developers and Contractors ................. .................... 167 Boxes: BOX 2.1: The Economic Value of Socialist Tenant Rights .17 BOX 2.2: Obstacles to Privatization Through Sales .28 BOX 2.3: The Decision to Own or to Rent in a Market Economy .36 BOX 2.4: What Privatization Pace Can be Expected? .43 BOX 3.1: Insuring a Sound Aggregate Return to Housing: The German Rent of Reference .50 BOX 3.2: The Two Interrelated Markets of Real Estate: .56 BOX 3.3: The Components of Economic Rent .63 BOX 6.1: Housing Prices and the Role of Housing Finance .122 BOX 6.2: Financing Construction Under High Inflation .126 BOX 7.1: Socialist Cities Without Land Markets: St. Petersburg's Land Use Pattern 134 BOX 7.2: Land Use Allocation in the Market City: The Fundamental Locational Trade-Off Made by Households .146 BOX 8.1: The Developer: A Missing Profession in the Russian Construction Industry 166 BOX 8.2: The Housing Development Process in Moscow (1992) .169 BOX 8.3: Contracting, Risk Allocation, and Construction Industry Restructuring . . . 180 BOX 8.4: The Institutions and Professions of the Market .185 vii EXECUTIVE SUJMMARY Notice to the Reader Housing is not a very complex technical good to produce in an industrial society. However, it is perhaps the most complex economic good to analyze and manage properly. The durability of housing units is measured in decades. They are quite heterogenous in terms of design, building technology, age, and available utilities. Their value is also linked to the ecological quality, social services, and infrastructure of the neighborhood where they are located. A fourth major feature of housing is its extensive financial, fiscal and physical regulation by government. These characteristics of housing explain why indirect policy instruments operating in decentralized, locally regulated housing markets work much better than direct, centralized interventions by the state in raising the efficiency of the sector, and meeting the needs and preferences of the population.*- Given the complex economics of housing, an adequate account of current Russian housing conditions, where many components of the housing system are changing at once, has necessitated lengthy documentation. To meet the need of different users and remedy the unavoidable bulk of this two-volume report, its executive summary can be read as a self-standing document. This executive summary has four parts. First, it outlines the salient features of Russian housing and the legacy of the administrative-command system. Then it links recent overall economic instability to conditions in the housing sector itself. This is followed by an account of the Russian govermnent's evolving response to these housing challenges. Finally, a reform strategy to move to market is proposed. Like financial reform, and for similar reasons, housing reform is definitely not an event, but a process. The presentation of this strategy takes two forms: a narrative, and a matrix. The matrix summarizes the actions needed across the ten major areas of a housing system during its transition to market. The proposed strategy includes a sequencing of the reforms. Therefore the matrix desegregates needed actions across these ten areas into recent measures taken, immediate next steps, and medium-term reforms needed to reach the goal of a more satisfactory, decentralized market-based housing economy. This matrix is not intended as a rigid blueprint but as a means of apprehending better the functional links between priority policy actions, new incentive structures, new institutions and new professions. Every effort has been made to evaluate the nature and performance of the present Russian housing system as accurately as possible. However, the pace of reforms and rapidly changing political, economic, and legal conditions make it impossible to be fully up to date at the time of publication. Laws and regulations have been changing rapidly in Russia since the beginning of market oriented reforms. Rather than aiming at an up-to-the last minute reporting on government decisions, this report places its emphasis on the consistent analytical framework needed to evaluate the choices being faced in the housing and urban sector of Russia. * See Housing: Enabling Markets to Work. World Bank Policy Paper, September 1992. viii I. LEGACY OF THE ADMINISTRATIVE-COMMAND SYSTEM 1. This executive summary has four main sections. First, it presents the legacy of the administrative command system which still shapes the institutions of the housing sector today. Then it provides an overview of current conditions and shows why housing reform has met such an early and broad support in Russia. Third, it summarizes the response of the Russian government to the housing challenge that it faces. Finally, it proposes a reform strategy, identifies the issues to be addressed, and proposes options to consider. 2. The comprehensive scope of the housing reforms now initiated in the Russian Federation cannot be fully understood without knowing the legacy of the administrative-command system used to manage the former Soviet economy, including housing and urban development. This legacy is an extremely distorted and rigid housing system compared to market economies. The most important of these distortions are: one of the highest rates of state ownership in the world; trivial rents charged to users and poor maintenance by state organizations; the overwhelming dominance of state financing in new construction; strong state monopolies over production leading to barren uniformity and low quality of the housing stock from which flow mediocre to poor housing services; last but not least, the absence of land markets has had large and durable negative effects on the structure of Soviet cities. Today, Russia still has one of the most distorted housing systems anywhere, even among socialist economies. 3. Housing conditions in the Russian Federation explain why there has been much earlier and much broader public consensus about housing privatization than about any other sector of the economy. There is a multiplicity of compelling reasons for making housing reforms and privatization a very high national economic priority: the large and direct impact of subsidy pressures on central and local government; the severe constraints on labor mobility and employment location linked to the system of state allocation and very long waiting lists; the inappropriate economic burden which housing places on enterprises; and the inefficient internal operations of Russian cities caused by the structure and location of the housing stock. 4. Because Russia is fully urbanized and not an underdeveloped economy undergoing urbanization, privatization implies the transfer of real estate assets to new owners on an extraordinarily massive scale. The benefits of a successful privatization for the well-being of the national economy will be commensurate. A flexible housing system responsive to local conditions will need effective local governments. Because the housing system has been heavily centralized, local governments have had great difficulties in managing urban affairs vis-a-vis strong sectoral administrations. They have emerged from the Soviet era in weak condition to manage privatization and the emergence of market cities, in addition to an unanticipated load of new social responsibilities. OVERWHELMING DOMINANCE OF PUBLIC OWNERSHIP OF HOUSING 5. Russia has the most skewed urban ownership structure among the main socialist countries. In 1992, 83 percent of the housing stock was under state control in Russian cities, by comparison with 67 percent in China, 56 percent in Poland, 33 percent in Romania, and 25 percent in Hungary. Cities like Moscow and St-Petersburg had almost 100 percent of housing in public ownership in ix 1990. Western shares of public housing are found at the opposite end of the ownership spectrum. In January 1991, the composition of urban housing in Russia was: departmental (enterprise and administration) housing-46 percent; local governments-32 percent; cooperatives-6 percent; individual housing-16 percent. Enterprise housing has often proven significantly more costly to operate than municipal housing. Its quality is much more heterogeneous and sometimes in a worse state of disrepair than municipal housing. STRONG SOCiALIST TENANCY RIGHTS 6. Under the Soviet regime, land and buildings were under public ownership. Yet tenant rights under the Soviet housing law were so broad -- including lifetime occupancy rights, rights to inherit, and near-impossibility of eviction -- that household incentives to participate in an emerging real estate market were thereby diminished. Moreover, tenants' rights were often vague and federal authority to act was unclear. Until now, rents paid by households covered such a small fraction of operations and maintenance, utilities were so heavily subsidized, and state-built housing was so heavily favored in terms of amenities that being a state tenant was economically much more attractive than being an individual owner who bore all maintenance costs. At the beginning of reforms, individual housing in Russia carried the unusual connotation of slum housing. TRIVIAL RENTS AND EXTREMELY LOW COST RECOVERY FROM OCCUPANTS 7. The Russian Federation also has some of the most - if not the most - distorted rents and housing prices in the world. A conspicuous feature of the Soviet housing system was that the basic rent charged to households had been frozen between 1927 and 1992 at 0.132 rubles per square meter of living space per month. In late 1990, before high inflation, a full cost recovery rent for operations and maintenance (O&M) including capital recovery should have been about Rbs 4.5 per square meter. However, deferral of maintenance was the de facto policy, and no capital cost recovery was intended. New buildings were fmanced on a cash basis from other budget sources. Then they were simply transferred to housing administrations (ZhEK's). In practice, the resources actually devoted to 0 & M by ZhEK's were Rbs 4.5/mr and covered about 70 percent of full O&M requirements. Local housing administrations financed themselves in approximately the following proportions: 3 percent from residents, 78 percent from government budget transfers, and 19 percent from cross-subsidies from rents on commercial real estate. Compared to municipal housing, cost recovery and internal cross-subsidies for departmental housing" are not easily known as they are included in enterprise social funds and/or investment budgets. " Under the Soviet adminisrative-command system, deparmental housing refers to housing belonging to ministries and their subordinate enterprises, or to non-production oriented government agencies. It contrasts with municipal housing belonging to cities and towns, cooperative housing, and individual housing. Eah form of tenure has its own financing mechanism and operating features. x HEAVILY SUBSIDIZED UTILITY CHARGES 8. Utility rates charged to residents were heavily subsidized at rates of 70 percent to 80 percent. Total housing payments for a 50 m2 apartment was Rbs 16-20/month in 1991. On-budget subsidies for utilities (water, sewerage, heating, electricity and gas) represented about 5 percent of GNP in 1990. In 1990, Russian domestic oil prices were 6 percent and coal prices were 8.5 percent of world prices. Adjusted to world prices and market exchange rates, such utility subsidies to households become extraordinarily large as a notional share of GDP (over 60 percent or more). That same year, Russian households devoted only 2.4 percent of cash income to total housing payments (rents plus utilities) but over 3 percent to liquor and cigarettes. The only exception were cooperative residents (6 percent of the urban stock) whose effort ranges between 10 percent and 20 percent of income, even though these households have incomes comparable to municipal housing residents. Very high levels of inflation since 1991 have further distorted the situation as price changes have not been fully passed on to households. QUASI TOTAL FINANCING OF HOUSING CONSTRUCTION FROM STATE SOURCES 9. Three features of the Russian financing system are important. First, until recently, an overwhelming share of housing investment funds were always financed by the state under the central planning process. Second, enterprise funds played no role in financing housing until the enterprise reforms of 1987 which gave more leeway to enterprises in using their investment funds for housing. By 1992, however, "departmental" funds had become dominant in state funding. Third, the direct contribution of the population has always been and remains very low. Raising the population's share of funding has been a priority objective of the Government Housing Reform Program since 1993. The system of housing cooperative, which was revived in the mid-1980s, is designed to mobilize more funds from the population on waiting lists without altering state monopolies on construction. Until 1985, the production of new individual housing was illegal in cities over 100,000 residents. The dachas on which many Russian families lavish so much care and energy are regulated as seasonal residences only. Their year-round use is also prevented by a frequent lack of utilities, no social services and poor access to work. STATE MONOPOLIES IN THE BUILDING INDUSTRY AND IN HOUSING MAINTENANCE 10. It is a truism of urban development that cities are built the way they are financed. Under the administrative-command system, state monopoly over financing, reinforced by state monopolies over land and over access to building materials has led to a highly monopolistic construction industry in every urban region. Housingfinance does not exist in the market sense of banking services. Instead, the funding of housing is provided from government budgets and state-enterprise budgets. Construction organizations have had no reason to differentiate between housingfinance i.e. banking loans to be repaid at competitive market rates and housing subsidies i.e fiscal grants originating from the state. Up to 85 percent of new housing construction was financed directly from the budget or by state enterprises, but these budgets are now being drastically cut. To make matters worse, state monopoly over local production became a managerial goal in the early 1980s under the concept of "one client, one designer, one builder" across the 150 largest cities. This managerial goal, however, was not reached due to contemporaneous shifts in sources of funds. xi 11. The housing product itself consisted primarily of high-rise apartment blocks of heavy, reinforced-concrete large panels. This assembly line housing technology is not liked by most occupants. It is of low quality, high cost, and energy inefficient, yet it constitutes now over 60 percent of the national stock. Alternative technologies, designs, skills, and materials have been neglected. The rate of innovation has been extremely low in Russia and has often been blocked by building regulations. The incentive structure to construction organizations rewards them on the basis of square meters produced not quality. Deferred maintenance is an endemic feature of the system. Once a building has been delivered to its intended owner, repair and rehabilitation of the existing stock is often seriously neglected. O&M costs per square meter are much higher than in market economies due to poor design, frequently poor construction, always poor finishings as well as the absence of utility metering at the apartment unit and building levels. LONG RUSSiAN TRADITION OF LTED PRIVATE PROPERTY RIGHTS 12. Certain aspects of housing policy in Russia have shown a remarkable amount of continuity over the past several hundred years. In particular, Russia has never had a strongly developed notion of individual land ownership. The second decree passed by the new revolutionary government in October 1917 abolished the private ownership of land. Before the year 1917 was over, all large residential buildings in cities had been nationalized. Also, Russia has long limited freedom of movement and settlement with institutions ranging from serfdom in medieval times to the 'propiska' residency permit system. 13. At the time of the 1917 revolution, Russia was the least urbanized European economy with a level of urbanized population of only 16 percent. Today Russia's urbanization is essentially completed and its system of cities has developed without any reference to private individual property, market mechanisms, or private financing -- and without the institutions associated with them. Instead, due to the administrative-command nature of central planning most land use laws and regulations tended to have a narrow and ad hoc sectoral focus. The legal continuity of real estate property rights through a wide variety of rural and urban uses and recycling is a new perspective in the Russian Federation. ABSENCE OF LAND MARKETS AND NEGATIVE RESULTS FOR SOVIET CITIES 14. Except for the old historical city centers, almost all of Russian urban growth has taken place during the socialist era. All the urban investment which was necessary to build the Russian urban system was based on three major price distortions: site value was not priced, capital had no interest, and energy prices were a small fraction of world prices. The resulting socialist cities have a structure that is strikingly different from market cities. The fact that urban development took place in a period when land was nationalized and administratively allocated rather than sold on an open market for a price has had a very profound impact on the internal organizations of Russian cities. The Russian administrative-command economy has generated an urban development process with two characteristic features of large land use inefficiencies: xii (1) Areas with obsolete land use occupy large amounts of prime land in the total city area creating a barren industrial city core,2' and (2) Households concentrated in the periphery with increasing densities further from the center and "historically" low densities in central areas. Yet, the location of jobs remains very centralized compared with market cities. As the Russian economy fially shifts to world prices, transportation costs will also shift. The result will be a temporarily negative asset value for significant sections of residential suburbs until residential choices and employment location have shifted on a scale large enough to reflect the true economic cost of access to various parts of Russian cities. 15. This urban land-use pattern increases transport costs and pollution by requiring higher energy expenditures without providing better amenities such as larger plot size or a better environment that would be the normal trade-off for increasing commuting distance in a market economy. High density residential areas surround these old polluting industrial cores acting like a containment barrier, thereby increasing environmental risks to residents. 16. Barren Industrial City Cores and Rusting Factories in Prime Locations. The failure to recycle land occupied by old activities of little value -- the "fallow land" syndrome-- yields several spatial outcomes: centrally located industrial belts, large total amount of urban industrial area, low job density in the industrial belts, and central land areas fragmented by dense railway networks. Of these pathologies, the most startling are the old industrial belts that ring Moscow and St. Petersburg. Developed during the 1930s and 1950s, these belts are still spread between 4 and 8 kilometers from the city centers. These industrial land use bottlenecks have never been recycled, even though the land values would have been prohibitively expensive for the enterprises still found there had market land prices been used. The absence of market signals resulted in a land use freeze that pushed residential areas further toward the city periphery than in market cities. Meanwhile, obsolete and low density activities have remained as enclaves on accessible and well serviced land. 17. Transitory Negative Asset Values in Residential Suburbs. The impact of socialist urban investment on the housing stock is that there is a very clear possibility that large sections of Russian cities have a negative asset value under realistic pricing aligned on world market conditions. The rents that can be received from these units are lower than their operating costs." Occupants of some suburban housing are now jointly faced with sharply escalating operations and maintenance costs, as well as rapidly rising transport costs. Yet, the housing they occupy is identical in size and amenities to that found in much better locations. In 1992, rents were increased but in trivial amounts: a typical rent was Rbs 1.8/m per month but new O&M costs were Rbs 80.0/m per month, 21 Note of the Russian Editor: This is not quite correct. The downtown areas of very large Russian cities have been primarily a location for administrative buildings and elite housing. The territories immediately outside downtown areas which were suburbs, are now dominated by industrial buildings, and the bulk of residential areas are now in new suburbs. 3/ Note of the Russian Editor. This observation, which is correct in general terms, is not universal. Such new residential districts in the outskirts of Moscow as Krylatskoe or Strogino, due to their advantages, ecological in particular, have very high values, like similar suburbs in Paris or Washington. xiii leaving aside capital costs as sunk costs or consideration of replacement costs. A similar pattern of nominal rents lagging behind operating costs and monthly inflation prevailed in 1993. RUSSIA AS A FULLY URBANIZED ECONOMY AND THE IMEPLICATIONS 18. A distinguishing feature of Russian housing is that public ownership and the administrative- command system have been operating in full force precisely during the decades when Russia was becoming fully urbanized. This completed urbanization has two main consequences now compared to the case of developing socialist economies. First, the possibility of further urbanization under market conditions no longer exists. Population mobility across urban areas is predominantly a zero- sum game like in many advanced market economies. Russia faces a complex mix of growing and declining cities. With a very slow growth of the overall urban population, opportunities to expand the urban physical plant in every city under new and more efficient market mechanism are rather limited. Second, the share of urban assets in the national economy is very large and at least 20 percent of total reproducible assets. Hence the urgency of an economically sound restructuring of this wealth. 19. The dominant Russian task will be to restructure the existing urban stock. In January 1992, 74 percent of Russia's population of 148.8 million lived in cities. During the post-war period the Soviet Union experienced the highest rate of urbanization among the nine main UN demographic regions of the world. As a result a high proportion of the housing stock is of recent vintage compared to European or US cities. However, this urban growth was distributed differently from market economies. Russia has a relatively lower degree of urban concentration in large cities and a low share of population living in cities of over one million people. The period of economic and political adjustment which Russia is now undergoing will cause significant flows of migration. Some residual rural-urban migration can also be expected if agricultural productivity increases to Western levels. City to city migration will dominate, but the emergence of sustainable new towns is not likely to be significant. Therefore, most housing and urban investment efforts during the 1990s should be directed to raising the international competitive capacity of existing Russian cities. There is considerable Russian interest in using population control and distribution policies to favor small town development, and in particular to repopulate Central Russia. This interest is motivated by deep environmental, social, and cultural concerns. However, such population decentralization policies could have a very high up-front capital cost. They would be economically inefficient and usually inconsistent with economic recovery, free mobility, and effective employment generation." 4/ Note of the Russian Editor: The issue of the economic inefficiency of small towns, especially historical towns in central Russia is far from simple. The evidence of this is their economic advantages, the existing mentality of local Russian patriotism, the lack of necessity to create expensive engineering and transportation facilities, the lower cost of land, etc. Complete migration from country to town is so far very unlikely, since we are witnessing the reverse process. All these issues are beyond the scope of this study and have been covered in the General Scheme of Population Distribution in the Russian Federation, confirmed by the Russian Government. xiv POTENTIAL MAGNITUDE OF REAL ESTATE ASSET TRANSFERS UNDER PRIVATIZATION 20. Until the economic liberalization of early 1992 which dissipated the monetary overhang, a glaring problem of the Soviet housing system was its large-scale asset misallocation and the consequent loss of efficiency. The state owned most of the physical assets and the households had the liquidities and financial savings. Households accumulated savings which they could not use to buy housing, while the state could not organize well enough to produce attractive units in adequate quantities. In 1990, the value of capital assets controlled by households was trivial. Household wealth was only 3.6 percent of total net reproducible assets in the economy. Household balance- sheets in the market economies of Western countries are totally different. Housing assets are a greater share of national wealth, almost all of it is owned by individuals: Share of Housing in Share of These Housing Assets National Reproducible Assets Owned by Households France (1970) 43% 89% Germany (1977) 33% 96% U.K. (1975) 26% 80% U.S. (1975) 29% 99% Russia (1990) 20% 14% Although the share of housing in national wealth of the socialist economies in transition (TSE's) is lower than in market economies of similar level of development --in part due to the depressed value of the stock caused by public policies prohibiting trade and the social and private gains benefit associated with it-- housing privatization entails a potentially massive transfer of assets. In addition to its massive scale, this housing stock to be privatized is characterized by its uniformity, its recent vintage, and low construction quality, and poor maintenance. WEAK CONDITIONS OF LOCAL GOVERNMNTS AT THE END OF THE SOVIET ERA 21. Good market-based housing systems require sound natibnal laws and central-level policies on regulations and finance. However, to operate well on a day-to-day basis, housing markets are dependent on strong and well-managed local governments. In the largest and most diverse country in the world, the success of housing policy rests on local governments provided with a sound national policy framework, adequate autonomy, and resources. Not all Soviet cities' governments have the powers exercised by Moscow or St. Petersburg which are autonomous cities with the status of oblast (region). For both technical and political reasons, city governments under the soviet socialist regime have often been weak, lacking administrative autonomy and significant financial resources. With the dominance of central-level and sectoral planning over local and spatial planning, cities always had inadequate resources and limited power to control their own decisions. The local Soviets and their executive committees (ispolkom) were the designated decision-making bodies in their area of jurisdiction. However, the principle of dual-coordination made all local departments responsible both to the Soviet at their level and to the corresponding line organizations at the next highest level. As a result, in case of conflicts, Oblast-level governments and line ministries usually prevailed over local preferences and better knowledge of local conditions. xv H. CURRENT CONDITIONS IN THE HOUSING SECTOR A DIFCULT STABILIZATION AND REFORM PHASE 22. The Russian economy has entered a difficult phase of its stabilization and reform program which has a strong negative impact on the short-term performance of the housing sector. Current domestic fiscal and monetary policies and inter-state trading conditions are making economic liberalization and price stabilization more uncertain. They are affecting privatization options in all sectors of the Russian economy, including housing and construction. However, these unstable economic conditions must be faced. They do not invalidate the general market orientation of reforms. In fact, it is delays in economic reforms during the 1980s that have made reforms today more difficult. Therefore market-oriented housing reforms must be initiated as part of the return to stability. A reform-based revival of the housing sector can contribute both to economic recovery and the modernization of the sector itself. STRONG IMPACT OF THE ECONOMIC CRISIS ON THE HOUSING SECTOR 23. The impact of economic contraction and very high inflation has been particularly severe on housing which is one of the longest-lived goods in the economy. National output has been contracting sharply for several years: GDP declined by about -5 percent in 1990, - 9 percent in 1991, -20 percent in 1992, and by about -11 percent in 1993. Inflation has been bordering on hyperinflation with a rate of 2,480 percent in 1992. Since then, monthly inflation has been fluctuating around 15 to 20 percent.5 This economic crisis has been unfolding in stages since the early years of Perestroika in 1985. The housing crisis itself has several dimensions. The composition of funding for new construction is changing very rapidly. New housing production has dropped dramatically.6' Inflation-adjusted household incomes have fallen sharply while construction costs have risen sharply, making housing affordability even more problematic. Dtie to inflation and deep cuts in central subsidies, resources for housing maintenance have shrunk abruptly. Faced with the prospects of rapidly rising expenditures on operation and maintenance of the municipal stock, local governments are deferring alnost all maintenance. With this generalization of deferred maintenance, particularly since early 1992, the housing stock is depreciating at a high rate, most likely at considerably more than 3 percent per year. The precipitous fall in new construction combined with generalized deferred maintenance has resulted in a rapid contraction of the total supply of housing services, and worsening of housing conditions. MAJOR CHANGES IN THE FLOW OF FuNDS THROUGH THE HOUSING SYSEM 24. Rapid changes are restructuring the flow of funds through the traditional Russian housing system. Some of these changes reflect early reforms of the administrative-commnand system. Other more recent short-term measures have been imposed by the economic crisis. Now more decisions 5/ Consumer prices rose by a factor of 26 in 1992, 9 in 1993, and by approximately 3-3.5 in 1994. 6/ In 1990, 61.7 million km2 of new housing was commissioned; in 1992 -- 41.5 million kin2; in 1994 -- 38.5 million km2. xvi are aimed at forward-looking reforms. All are modifying the behavior of the housing system in lasting ways. There are four main types of changes: (1) the reduction of the share of central budget financing; (2) the sharp contraction in overall public funding of new production; (3) the large cuts in subsidies for housing maintenance and the rising burdens of local governments; (4) the emergence of (state or private) employers as the dominant source of financing for new housing; and (5) the use of new financial instruments to obtain household and enterprise savings for housing construction. This new dominant role of employers is reinforced by the sharp fall in real household incomes and the deteriorating household income distribution. SHIFT AWAY FROM DIRECT BUDGET FUNDING AND DECENTRALIZATION OF FINANCING 25. The financing of new housing construction began to change in the mid-1980's. The main component of this change is the shift of investment funding away from direct budget resources of all levels of government to enterprise profit-based funds, and, to a lesser degree, to resources of the non-state investors. This trend started in 1987 during the first year of enterprise reforms. The composition of financing has changed profoundly as follows: * The share of all forms of state or parastatal funds (central budget, enterprises, municipalities) which was about 84 percent in 1986, declined by a modest amount to about 80 percent in 1993. However, the composition of this state financing is now dramatically different and greatly more decentralized. The contribution of central budget financing to the total production of new units has fallen rapidly from 83 percent in 1986 to only 53 percent planned for 1993. The share of "departmental" funds, which include enterprises, has risen from zero in 1986 to 30 percent in 1993. As enterprises continue to be privatized, this line of funding will move to the private sector. * Because of the particularly difficult housing conditions of military personnel, defense budgets7' played a significant role and financed 15 percent of total housing investment in 1993. * The local government share of new construction had risen from zero to a modest share of 6 percent. * The share of financing from the population going into new construction through housing cooperatives declined from 5.4 percent in 1986 to 4.5 percent in 1993 due to the decline of state subsidies to cooperative production. * The most remarkable change regarding individual housing is not so much its increased share from 5.9 percent in 1986 to 13.4 percent in 1993. It is the absolute 7" Refers to the budget of the Ministry of Defense and other ministries and departments responsible for the armed forces. xvii increase in housing production by 14.3 percent between 1992 and 1993 during one of the most difficult economic years.8' * The share of Russian-style private sector enterprises (business cooperatives and newly privatized enterprises) and other organizations supporting their staff needs rose from zero in 1986 when they were still prohibited to 29.4 percent in 1993. Overall, such changes are desirable as they give more direct control over housing production to the ultimate users. The current problem is that this positive qualitative shift is accompanied by a sharp drop in housing funds and a contraction of output. SHARP CONTRACTION OF THE BUILDING INDUSTRY OUTPUr 26. Changes in the sources of funds coincide with a major contraction of the flow of funds for housing investment, and maintenance. Due to preferential treatment by the Central Plan, the construction of new housing had been rising in the late 1980's when many other types of investment were being reduced. However, by any measure, the residential building industry in Russia is in crisis today: (a) in terms of total housing stock, in 1990, floor area per person in Moscow was 17.8 m2 and in Russia it was 16.4 m2, compared with typical floor areas per person in developed Western countries of 30 to more than 45 m2. The Russian floor area per person is typical of middle-income countries with per capita GNP ranging between $1,500 and $2,500; (b) In terms of the flow of new housing, production of new dwellings has been declining at an accelerating pace between 1990 and 1992. The 1993 output of 41.8 million square meters of floor space (or about 661,000 units) was only 57 percent of the peak 1987 level of 72.8 million in2. 1993 was rather similar to 1992, but there was an improvement in output linked to the completion of apartment units which could not be completed in 1992. This level of new output equaled 1.7 percent of the total existing housing stock. It barely matched the traditional volume of removals from the existing stock of dilapidated units, which was low by international standards; (c) Construction costs have experienced explosive increases with price liberalization partly because the monopolistic production and distribution of materials and supplies has remained in place; (d) Construction delays are endemic because of misplaced incentives to start new projects rather than finish existing works. There has also been a significant increase in the volume of unfinished construction. In 1988, officially, work-in-progress represented 84 percent of annual housing output; by 1990 it reached 103 percent; while the estimate for 1991 had reached over 300 percent. The situation finally stabilized in 1993. CUTS IN OPERATING SUBSIDES 27. With the shrinking of funds for new construction, the historical practice of diversion of maintenance funds in favor of new construction has worsened. Appropriations for maintenance and repairs have fallen from 60-70 percent in 1990 to 25-30 percent of needs in 1992 and 1993 according to Gosstroy (Construction Committee, which is now the Ministry of Construction, Minstroi) estimates. Scheduled capital repairs had already fallen from 43.8 million ni2 to 20.0 million in 1991. el In 1994, the volume of individual housing construction still increased to 26%. xviii These cuts were applied to housing maintenance estimates which were chronically underestimated. * In 1992, the recognized housing and housing-related subsidies and transfers constituted at least 6.1 percent of all federal budget expenditures and 2.2 percent of GDP. However, implicit housing subsidies, especially energy subsidies were large. * Responsibility for the maintenance and operation of the existing stock was passed on to local governments in 1991. With price liberalization, housing-related subsidies were growing rapidly and were feared at one time that it would reach 12 percent of all local budget expenditures. As noted earlier, local governments are compressing housing maintenance costs to around 4 percent of their budgets through massive deferred maintenance and, therefore, a sharp reduction of the flow of municipal housing services. Low HOUSING AFFORDABILITY AND WEAK EFFECTIVE HOUSEHOLD DEMAND 28. Under the central planning system, production decisions were made in the plan itself (see Figure 6.1 in Chapter 6). Imbalances between the true production cost of new housing units and the limited purchasing power of households were irrelevant since housing was provided as a form of income in-kind and allocated administratively. Under a market-based system, housing affordability by households can be monitored by measuring the ratio of the median sale price (not production cost) to median annual household income. This housing price-to-income ratio, or PIR value, is a key indicator of housing affordability. It reveals the relative balance between demand and supply conditions: the lower the PIR value, the better the market is. Today, PIR values are high and unstable in Russia due to high inflation, very rapid shifts in relative prices, abrupt increases in materials and construction costs, and sharp divergences in inflation-adjusted household incomes. All of these apply to fragmented emerging urban markets. 29. The transition from predominantly state-financed housing to housing markets where the great majority of households would pay full price for their housing is difficult. Direct sales of new units to a broad segment of the population are constrained by low wages leaving very little room for savings and housing finance. Pending full wage reforms and economic recovery, private demand seems destined to remain constrained by the rate of growth of the grey or second economy. The issue of who can afford housing at full cost and who can afford housing at reduced costs with the help of subsidies is a central concern. However, a major and readily available remedy is the rapid privatization of housing which will give many households an asset which can withstand inflation and be traded if and when needed. * The inflation-adjusted income of most social groups was declining. Overall, in December 1992 the real wage level was only 47.7 percent of the December 1991 level. 64.5 percent of total income was spent on food by the Russian population during the third quarter of 1992. For poverty groups this food share was 68.3 percent. The official social minimum, which was estimated at Rbs 2,150 per month in September 1992, has been adjusted several time since then. In 1993, the decline of real wages slowed. Wages began to gain against inflation. xix * Economic conditions have brought significant changes in the population's income distribution. Analyses of the joint Goskomstat-World Bank income monitoring survey show that about 37 percent of the total population was below the Russian definition of the poverty line in 1992. The data suggests that the top quintile of the population may have incomes twenty times higher than the poorest quintile. Thus, since 1982, the Russian household income distribution would have deteriorated from being similar to that of the U.K. to one now simnilar to Brazil's. * Inflation in construction and building material costs was extremely severe in 1992 and higher than overall inflation. The cost per square meter rose from 900 to 11,000 rubles for large- panel buildings in 12 months. Minstroy (Construction Ministry in operation during 1992) and the Economy Ministry estimated that average construction costs could reach 50,000- 60,000 rubles in 1993.9' For maintenance, O&M costs rose from Rbs 4.5 to 80.0/m2 per month but covered only 30 percent of O&M requirements instead of 70 percent. These costs continue to rise on a monthly basis but more in line with inflation. * Under these conditions, housing price-to-income ratios (PIR values) are high and unstable. The average monthly household income in 1992 is approximately Rbs 6,750 (or Rbs 81,000 per year) while the cost of a typical apartment of 55 m2 ranges between Rbs 0.4 and 1.1 million or about 5 to 13 times annual income. Auction prices are considerably higher and reflect business rather than household transactions. The resulting PIR values are indicative of the demand for commercial estate and emerging land markets. In Moscow, units in peripheral locations were selling in early 1993 for Rbs. 2.4 million (PIR=29) and for Rbs. 7 million (PIR=86) in Central Moscow.'°' LENGTHENING WAITING LISTS 30. Longer enterprise and municipal waiting lists are a direct result of the sharp contraction in the delivery of new housing units to 58 percent or less of the 1987 output. The number of households registered on waiting lists had risen from 8.0 million in 1986 to an estimated 10 million in 1992."' The percentage of urban households in the housing queues (including one-person households) was over 21 percent of the total number of urban households. These lengthening waiting lists were caused by the greater rate of job changes, more internal migration, and a much faster rate of household formation than of total population growth. Because of these lengthening waiting lists and rising prices for daily necessities which local governments subsidize, local authorities objected to abolishing the propiska which finally happened in 1993, except in Moscow and St. Petersburg. The propiska system as a means of population control was a blunt and crude administrative instrument with high 9' By the end of 1993, these costs had already reached 300,000 rubles and by the end of 1994 were 800,000 rubles. IO/ By the beginning of 1994, these prices had increased by more than 5 times. II/ After 1992 the numbers on the waiting lists began to diminish, reaching the level of 9.6 million by the beginning of 1993; 9.1 million by 1994. xx economic efficiency and equity costs. As a better alternative, local governments are considering targeted housing programs and selective social safety net measures. POsITIVE ADJUSTMENTS IN HOUSING TECHNOLOGY 31. Changes in the sources of residential construction financing favor greater control over quality, design, and prices by clients and households as ultimate owners. These changes are expected to lead to a shift away from the large panel, high-rise buildings towards more attractive low rise buildings that can be quite efficient in terms of land use. They are also expected to lead to improvements in housing unit prices which must be in line with the purchasing power of the population. Diversified financing will encourage diversified technologies such as traditional brick and wood technologies, and small pre-fabricated elements for low-rise and individual housing construction. The share of large-panel industrial housing in total output is expected by Minstroy to fall from 52 percent in 1991, to 42 percent in 1992, to a combined share of large-panel industrial and related technologies of approximately 20 percent by 1995. One effect of the 1992 price liberalization has been to bring into full view the fact that this capital and energy intensive housing technology delivers a mediocre product which is also one of the most expensive types of housing construction. FISCAL DECENTRALIZATION AND NEW BURDENS ON LOCAL GOVERNMENTS 32. The system of intergovernmental finances is in transition. The restructuring of fiscal relations and municipal finance reform has just begun. New federal laws and decrees have burdened local governments with extensive mandatory responsibilities, without providing a stable and predictable revenue base. Given these circumstances, cities are barely coping with increased housing costs. The problem of covering deficits incurred in operating and maintaining the existing stock is bad, the lack of funds is even worse for housing investment. Local governments funds cannot replace central budgets for housing construction. This central share fell from 74 percent in 1987 to approximately 53 percent in 1993. This meant a real cutback from 970 thousand out of 1,312 thousand units in 1987 to about 350 thousand units out of a total production of 661 thousand units. 33. The short-term coping actions currently taken by local governments are not a substitute for a strategy to manage their local housing sector. In particular, most local governments do not have meaningful financial plans against which they can gauge alternative options. Ad hoc decisions could have serious detrimental effects both within the housing sector and at the city level. Cutting the volume of current repairs and rehabilitation is causing an accelerated deterioration of the already badly decapitalized stock. The practice of deferring all but the most essential payments to utility companies and other service enterprises appears to be almost universal. Local services enterprises - - particularly housing organizations which have few goods to trade -- appear to be at the end of the long chain of arrears against which they have little leverage. Too often, local governments are disposing of non-residential capital assets to finance current expenditures which is a financially undesirable practice, especially in times of high inflation. A HOUSING SYSTEM IN FLUX 34. The Russian housing system is now in a state of flux. So far, the traditional mechanisms of central planning are breaking down faster than market mechanisms are emerging. A whole society xxi has to relearn and recreate the conditions of a demand-driven housing market. High inflation, rapidly shifting relative prices, and the contraction of output in the sector do not facilitate the transition to markets. This transition has two main dimensions: restructuring of the existing stock, and encouraging the emergence of a competitive, market-based production of new housing 35. Housing privatization is receiving wide support and the ownership of the housing stock has been changing monthly since mid-1992, when it was approximately: 38 percent in municipal ownership; 40 percent in departmental ownership including state enterprises; 6 percent in state- controlled cooperatives; and only 16 percent in individual ownership, most of it located in the smallest cities. Given the economic conditions prevailing in Russia, rapid and voluntary privatization of the housing stock is a beneficial trend. Yet, in managing the transition the government of Russia faces several constraints. First, the old state system and the new market system will coexist for some time. It is unrealistic to expect that the Russian housing system with more than 90 percent of the stock in public ownership in all large cities will transform itself overnight into a housing system similar to that in the U.S. with only two percent of the stock in public ownership. Efficient -- preferably private -- forms of new management of the remaining public housing stock must complement privatization of the public stock. 36. The transition to markets of the production of new housing has many large legal and institutional requirements. But at the core it means moving from needs-based, state-financed housing construction to demand-based, private financing of real estate development. Due to the economic crisis, most state financing has been abruptly cut. Meanwhile employer organizations, be they old- style departmental units or new private and privatized enterprises, have become the main source of funds for the time being. Aggregate flow-of-fund analyses of the Russian economy highlight the problem that the enterprise sector has remained profitable during the current crisis while household earnings have fallen sharply. The substitute development of a market-based supply of long-term finance has four major requirements. First and foremost economic stabilization and the end of inflation. Second, the privatization of land and the development of basic land market institutions. Third, good mortgage and foreclosure laws and regulations. Fourth, sound mortgage lending services by banks. HOUSING AND ENTERPRISES 37. Successful housing reforms imply that the direct role of enterprises and employers in providing housing eventually will come to an end. Freeing enterprises and other employers from housing provision activities -- in which they have no comparative advantage -- is more than a housing sector requirement - it is an economy-wide need. Cutting the Gordian knot, that is tying enterprises, housing and labor markets, together in a most inefficient way, has several dimensions. 38. A primary need is to reduce as rapidly as feasible most departmental ownership of existing housing through privatization of units to households. The general housing privatization framework is provided by the 1992 Federal law on the Principles of Housing Policy (Article 9). It is less rigid than the housing privatization rules provided in the earlier Presidential Decree on Enterprise privatization. Several temporary problems with enterprise housing are that enterprises still play an important role in the Russian's social safety net and housing transfers to local authorities are blocked by municipal lack of funds. Other problems arise from the fact that a high but variable percentage xxii of occupants of enterprise housing units no longer work for that enterprise. Regarding the maintenance of units that have been privatized, a major void has been filled with the Presidential Decree No. 2275 of December 1993, which establishes provisional condominium regulations until the final condominium law is passed. 39. Another needed reform is to restructure existing enterprise social funds fnancing new housing so that they will fall under the direct control of future household owners and can finance a competitive privatization of housing production. Such funds oriented toward new housing construction will eventually disappear in favor of full market wages. Voucher systems can also play an important role. The building industry itself, a first form of privatization took place in 1993. Given existing industry in Russia, competitive and innovative construction will proceed very rapidly wherever the three traditional local monopolies over access to finance, urbanized land, and building materials, are elirninated. III. RUSSLIN GOVERNMENT RESPONSE TO THE HOUSING CHALLENGE 40. Facing the challenge to stabilize and restructure the housing system, the Russian Government has initiated far-reaching reforms. Housing reform is regarded as one its key structural reform priorities by the Russian Government. Over the past two years, the Government has guided these reforms by reference to an evolving policy framework, to which the technical cooperation project between the Russian Government and the World Bank has contributed. RECENT LEGAL REFORMS 41. Over the period 1992-1993, the Russian Government has made important progress in developing market-oriented urban laws. These laws introduced key concepts without which effective privatization could not have progressed and they promoted the development of constituencies for further improvements. However, further developments in basic legal rules, implementing regulations, and administrative and judicial institutions at the federal and local levels are needed to create a fully functional urban legal system. The transition 'from a system of well-established socialist rights to a market-oriented housing system will not be a simple or linear process. KEY URBAN LAWS 42. Key urban landmark laws were passed in December 1992. Articles 12 and 58 of the old RSFSR Constitution were amended by the VIIth Congress of the Peoples' Deputies of the Russian Federation to permit ownership and free trading of land plots for housing construction and to redefine the right to housing in terms consistent with a market economy. The Parliament also passed the "Law of the Russian Federation on the Basic Principles of Federal Housing Policy," intended by the Government to be a "Housing Bill of Rights" that provides the foundation for the move to a market economy. This law modifies the earlier "Law on the Privatization of the Housing Stock" of July 4, 1991 to allow the free distribution of housing, simplifies privatization procedures, broadens the types of housing stock that can be privatized, and establishes the right for condominium owners to choose the maintenance companies of their choice. A "Law on the right of citizens to acquire private property and to sell land, dachas, and individual housing units" introduces private xxiii property of land in urban and rural areas. The "Law on Pledge" establishes the concept of mortgage, but not the legal procedures to enforce a lien. A law "On the Basic Principles of Urban Development in Russia" was passed in July 1992. However, this law still adheres to rigid, normative and administrative concepts of urban planning which have repeatedly been shown as undesirable by international experience. THE RSFSR HOUSING PRIVATIZATION LAW OF 4 JULY 1991 AND rrs DECEMBER 1992 AMENDMETmS 43. The Law on Privatization of Housing was passed in July 1991 by the RSFSR, prior to any agreement by the Soviet Union government on housing privatization. It establishes the right of a duly registered tenant occupying a state unit to become its owner with fully guaranteed property rights. The law provides guidelines on transfer terms for the implementing regulations of local authorities under a two-part transfer: a free-of-charge transfer of floor space per person and payment of the difference between the value of unit and the entitlement assessed at average price of square meter in the locality. The right to privatize a unit on these terms can be exercised only once. The December 1992 amendments to the Federal Privatization Law switch from the "free norm plus residual payment" formula to a giveaway transfer. RiSING RATES OF PRIVATIZATION OF THE HOUSING STOCK 44. A major development has been the large scale acceleration of voluntary housing privatization since mid 1992. Under the original Soviet privatization law of 1989 a trivial 10 thousand units (0.03 percent) of apartment units were privatized. Following the Russian privatization law, only 122 thousands units were privatized in 1991. The benefits were not clear to many; the law was new, rents were very low, and administrative procedures were not in place. In particular the registration system was weak. Attitudes have changed since then. By the end of 1992, 2.6 million units had been privatized. 45. With the increased perception of housing as an asset of refuge during a period of high inflation, the trend accelerated in 1993 when 8.59 million apartment units, representing 24 percent of the housing stock, were privatized. This is a very significant and steep rate of socio-economic change. When this new private stock was added to the 16 percent of earlier individual housing, by the end of 1993 over 40 percent of the urban stock was privatized. It is anticipated that privatization will continue through 1994 and could stabilize at around 55 to 60 percent of the urban stock. Some departmental organizations, such as those dependent on the Ministry of Defense are faced with the serious problem of housing military families. They are, therefore, holding onto their stock while working on new housing programs which include new construction and voucher systems. OPERATIONAL LAND CONSTRAINTS TO THE PRIVATIZATION OF URBAN REAL ESTATE 46. A systemic obstacle to efficient housing privatization and to the smooth emergence of market- based real estate systems in Russia is the dissociation between the ownership of buildings and title to the land on which they are built. Apartments and commercial buildings can be transferred while ownership of the land is left unclarified. Moreover, land boundaries under individual buildings and housing estates are imprecisely and inadequately recorded raising fear of numerous practical conflicts in future privatizations. This is a very serious legal, administrative, and technical bottleneck lying xxiv on the path to better housing management. Its elimination first requires the clarification of private property rights and the passage of a condominium law. EVOLVING LAND TENURE FORMS 47. The privatization of land has been a highly debated issue in the Russian Federation. A USSR law on private property passed in March 1990 had formally ended the principle of state monopoly on ownership of land. Yet this law had many flaws for both agricultural and urban economies. During the years 1990 to 1993, tenure confusion increased as three new forms of land tenure were created, each limited to certain kinds of owners or certain land uses. The current objective of land privatization is to convert the traditional "right of use" to one of these three forms as quickly as possible. (1) Hereditary Life Tenure. This type of tenure was reasonably adapted to single family dwellings or garden plots by providing a legal guarantee of permanent use and the right to pass on the property through inheritance. The main drawback is that the property cannot be sold or leased to others. Municipal authorities retain the right to cancel possession rights with compensation for the cost of the dwelling, but not for the land. (2) Lease. Recent legal changes have introduced the leasehold form of ownership with terms up to 49 years allowed under the responsibility of municipal authorities. (3) Ownership of Agricultural Land. Until now, private ownership of agricultural land was allowed subject to the restriction that it not be resold for ten years or leased for more than five years. IMPORTANT STEPS IN THE DEVELOPMENT OF URBAN LAND PROPERTY RIGHTS 48. Full private ownership of urban land has remained a controversial issue until now. Long- term leases have remained the main form of tenure for urban development. In December 1992, the Seventh Congress of People's Deputies passed two amendments to the current Constitution of the Russian Federation which were critical to housing reform, yet did not deal adequately with the full requirements of urban land reform. The Amendment to Article 12, part 3 removed the restriction on the right to freely possess, use and dispose of land plots owned lby individuals. It eliminated previous "anti-speculation" restriction on sales. The amendment remains inadequate since such land can be sold without any restriction only if it remains in residential uses. The large-scale needs for land recycling across land uses of Russian cities still remain unanswered. An amendment to Article 58, dealing with the rights of citizens to housing has made it more consistent with market-oriented reforms since the state's obligation to provide housing can be fulfilled, satisfied through a household's purchase or construction of its own dwelling, the provision of housing through a naym (social housing) contract, payment of housing allowances, or construction and maintenance subsidies. The December 1992 Law on the Fundamental of Russian Housing Policy also created the possibility of full private ownership of urban "real estate" defined to include land. xxv PRESIDENTIAL DECREE OF 27 OCTOBER 1993 49. A Presidential Decree primarily aimed at agricultural land and titled "On the Regulation of Land and the Development of Agrarian Reforms" was published on October 28, 1993. It allows all landowners, whether corporate or individual, to dispose of land at their own discretion through sale or purchase, bequest, gift, as mortgage collateral, wholly or in part. Moreover, the value of land is improved through the abolition of compulsory deliveries to the state and of the mandatory transfer of agricultural products to government starting in 1994. This Decree is a major step for the privatization of land in all its uses. In addition to changing drastically the perspective on land privatization, the decree has the direct benefit of facilitating land use conversion. It permits local authorities to transfer the use of land from agricultural to conimercial use. However, it is important to note that this decree is temporary and will only be in force until the new parliament passes more permanent legislation which might differ in content. NEW RUSSIAN CONSTrrUrTON OF 14 DECEMBER 1993 50. The new Russian Constitution approved by the population on December 14, 1993 marks a historical turning point by clearly and broadly recognizing the right to private ownership of land. Its impact on efficient land use and the emergence of urban land markets, rural land markets, and rural-urban land conversion will be major over time. IV. REFORM STRATEGY: ISSUES AND OPTIONS 51. Housing reform is not an event, it is a process. There is widespread public support for breaking away from the old administrative-command system which has lead to such unsatisfactory housing conditions. However, the housing stock of Russia represents a mnajor share of national wealth. To move from today's system to a broad market-based system where housing will be predominantly private, major and well coordinated changes are necessary. These changes are necessary on both the demand and supply sides, at the federal and local government levels, and in the existing stock and new production. This section elaborates further the evolving Russian strategy. This strategy reflects the intrinsic economic characteristics of housing and current conditions in Russia across the ten main areas of a housing system. It provides a sequencing of reforms and distinguishes between inmmediate actions and medium-term measures needed on the way toward the ultimate goal of a sound, decentralized, market-based housing economy. 52. Ten Key Areas of Housing Sector Reform. Given the Russian situation, a comprehensive reform strategy must address ten key areas where the Government has an important role in facilitating the emergence of housing markets and regulating them soundly: a. Institutional Reforms including (1) new institutions at the central and local levels better able to manage competitive and decentralized housing markets; b. Demand-Side Reforms, including (2) the basic framework of property rights, (3) housing privatization from the state to individual ownership, (4) rent reforms and improved targeting of subsidies, and (5) related issues of maintenance and xxvi management of public housing, (6) housing finance systems, (7) fiscal reforms including taxes and subsidies; c. Supplv-Side Reforms, including (8) building industry restructuring and privatization, (9) land use and urban regulation, and (10) municipal finance and residential infrastructure provision. 53. The content of this strategy has been summarized in the matrix provided at the end of this summary. This matrix touches only the most salient reforms within each area of the policy framework. The following discussion amplifies the matrix by discussing key issues, recent reforms, and policy options in each area. 54. The stabilization of conditions in the entire housing sector requires urgent actions which will also benefit the longer-term development of housing markets. The objectives of these immediate reforms cover both the existing housing stock and new production. They also include the protection of vulnerable groups, and institutional improvements in managing the sector. In every one of these areas the government of the Russian federation has usually taken major actions already, and considerable experimentation to find solutions suited to local conditions is taking place at the city level. A short-term program should have four main thrusts which are to: (1) Encourage rapid and voluntary privatization of the state housing stock under appropriate regulations. Pass a sound real estate registration law and condominium law to allow easier trading among households and to stabilize operating conditions after privatization. (2) Improve resource mobilization to finance new housing construction: (a) allow unrestricted private ownership of land in cities in order to reclaim the much needed real estate wealth lost under industrial "fallow land"; (b) develop the legal framework for lending to the housing sector (mortgage law, foreclosure rules); (c) develop workable transitional financing to make feasible the sale of newly built housing to average households. (3) Use on-going and new building projects to support the rapid privatization of the building industry and prevent avoidable losses in valuable skills during the present sharp output contraction in the sector. (4) Downsize and restructure subsidies in the rental sector through the creation of autonomous maintenance companies. This is important because the state remains responsible for a very high percentage of all housing maintenance, rent reform, and a social safety net clearly targeted on the most vulnerable groups. 55. These four objectives imply significant organizational, legal, and financing changes affecting the ten main areas of the housing system. xxvii 1. INSTITUTIONAL ADJUSTMENTS TO MANAGE THE TRANSITION TO MARKETS SHORT-TERM NEEDS 56. Market-Oriented Federal Ministries. In market-oriented housing and construction ministries, one usually finds four major functional units: (1) one for construction covering both building and public works, (2) one for spatial planning covering national infrastructure plans and internal urban regulatory processes, (3) one for housing, and (4) one for legal, statistical and general market affairs. Under such an executive structure, the federal level sets the rules and supervises their sound application, while local governments implement these rules according to local conditions and make day-to-day decisions with regulatory authority over all local land use activities (including those of higher levels of government). 57. Five important roles of a policy-making national ministry responsible for an entire economic sector are: to promote change in the regulatory framework; revise the existing land codes, urban planning codes, construction codes, and to develop real estate codes; develop new procurement rules; guide local authorities in the process of revising norms and regulations regarding land use and urban planning; and coordinate with the legislative branch and other ministries to ensure that financial and fiscal (taxation and budget) policies for the sector are consistent with both national policies and sectoral needs. 58. Public funds and timely and reliable information will be very scarce in the housing sector, particularly in the short-run. It will, therefore, be very important to develop a decision-making process which encourages cooperation rather than competition among the government units responsible for policies and programs which affect both the use of the existing housing stock and new production. International experience in more that eighty countries shows that, just like extreme centralization and public monopolies, institutional fragmentation is not conducive to a well performing housing sector nor to the development of a broad-based, sound real estate industry. Fragmentation impairs the policy-making ability of governments by dispersing scarce skills, reducing information flows, and encouraging inconsistent decisions and regulations which, in turn, sharply increase the economic cost of enterprise operations. As shown in Chapter 3 of the report, the property market which consists of existing units and the new construction or asset market of a housing system are economically and functionally related. These two types of markets cannot be regulated separately without running the risk of significant, possibly major policy failures. MEDIUM AND LONG TERM ISSUES 59. Division of Central-Local Competencies. The division of law-making authority among the different levels of government is a crucial reform area. Clarification of local rights and responsibilities will have a pervasive effect on the development of further housing reforms. At present there is a complex mosaic of relationships anchored by the "Federal Agreement" of March 1992 which sets out basic principles of Federal-Republic relations. A similar Law on Administrations sets out central relations with other independent, non-Republic jurisdictions such as oblasts and krais. Finally, the July 1991 Law of the RSFSR on Local Self-Governments delegates xxviii substantial authority in the area of land use and housing to local governments such as cities, townships, districts, and settlements.'2' 60. Need to Strengthen Local Governments. Oblast and city governments are playing a vital role in housing and urban reforms. Good housing systems cannot flction without effectve local governments. In a vast territory like Russia there are considerable differences in the pace and nature of housing reforms and privatization. With generally very low rates of mobility, local identity and the desire for autonomous action are very strong. Major cities with autonomous status like Moscow and St.-Petersburg have frequently been ahead of the Federal Government in their reform attempts. Local experimentation by cities will be a major contributing factor to the identification of inmovations suitable to the country context. Despite their diversity in reforms, all cities share a common and urgent need for training in basic municipal functions such as budgeting, financial controls, and better management of urban regulations. 2. PROPERTY RIGHTS AND LEGAL REFORMS IMMEDIATE ACTIONS 61. Establishment of Basic Property Rights in Land and Housing. Russia has crossed a major threshold regarding property rights with the new 1993 Constitution. What is now needed is the full development of the unified framework for privatizing, owning, registering, and trading real property. A unified national framework means that residential, agricultural, commercial, and industrial land will be treated in a consistent manner allowing the transition from one use to another subject only to reasonable local land use controls. The federal framework should define the basic principles and processes while allowing regional and local governments the flexibility to create institutions and implement regulations best suited to their local conditions. 62. Law on Mortgage. The passage of the Mortgage Law, which was submitted to the Parliament in March 1993, is a critical step. Implementing regulations are equally urgent. Similarly, stronger foreclosure rules have been allowed in the basic housing reform law. They also need implementation rules. 63. Registration of Interests in Real Propertv. The registration of interests in real property affects all aspects of real estate and all forms of business transactions where location is a factor. A decree law is urgently needed to provide the basic framework to register real property interests and make records available not only to public authorities, or banks, but to any individual citizen. It needs to resolve the conflicting claims of the number of agencies which produce and/or have partial claims to such information. The goal is to have a single agency, at the local level, consolidating, maintaining records and providing information on all interests in real property, including land, buildings, mortgage liens, and other interests in the title. The organization of this agency will be a 121 The new Russian Federation Constitution, adopted in December 1993, clarifies to a considerable extent all questions regarding the division of authority among the Federal Govemment, the Republics, and Local Self- governments. xxix determining factor in the level of transaction costs in the real estate sector and the efficiency of the urban economy for years to come.'3' 64. A series of decrees and regulations would need to be issued rapidly to minimnize unnecessary bottlenecks during the transition. Specific areas where decrees and/or regulations are needed are indicated below in the relevant sections of this strategic framework. LPLEMENTING THE BASIC FRAMEWORK OF PROPERTY RIGHTS AND LEGAL REFORMS 65. Components of a Market-Oriented Legal Framework. Russia can be expected to build a civil law framework for housing made up of a dozen key elements: (1) The Constitution; (2) Civil, Land and Housing Codes; (3) Local Government Laws; (4) Land Use and Spatial Planning Acts; (5) Property Registration Laws; (6) Building Industry Laws; (7) Housing Finance Laws; (8) Co- ownership Laws; and (9) Landlord-Tenant Law. As an economy in transition, Russia has two additional areas in its legal reform framework: (10) Housing Privatization Laws, and (11) Rules for the Division of State Assets. Because, in market systems, housing is the central asset of most households and intersects a complex set of relationships, a final area of reform can be succinctly summarized as (12) Other. These other areas, which will not be discussed separately here, include rules on eminent domain, nuisance and trespass, famnily law governing concurrent owners, bankruptcy law, environmental law, and natural resources law. Finally, unlike the experience of Central and Eastern Europe, Russia has been spared a significant debate over restitution of expropriated property because it appears land and housing were seized long enough ago that there is no effective lobby for direct compensation. 66. Remaining Legal Gaps. The 1993 Constitution now permits the unrestricted private ownership of land.'4' The Housing Law and other recent laws also clarify the direction of reforms. Yet there remains a wide gap between Russia's socialist property rights system and a new legal system able to fully support the emergence of competitive housing markets. The old system is based on bureaucratic controls with unclear property rights that make legal private transactions difficult. A market system requires: transparent, verifiable rights; a carefully delimited sphere of public regulation; and judicial processes to clarify private rights and enforce private contracts. One danger in the process of dismantling the bureaucratic and administrative structure of central planning is that Russia may neglect to put in place the indirect legal and regulatory tools necessary for the development of housing markets. The most difficult technical task for Russia to achieve is an appropriate balance of regulatory intervention as local conditions continue to evolve. 13/ The Implementation of the January 1, 1995 Civil Code established that real estate ownership rights will be subject to registration, through legal institutions, in a unified government registry. However, until this registry and associated institutions are created, the existing incomplete and imperfect system of real estate registration will continue to operate. 14/ However, this constitutional right in practice has not fully entered into force and will be more precisely defined only after the adoption of the Land Codex. For example, in Moscow the sale of land into private ownership is presently forbidden; land may only be transferred by rental or lease. xxm 67. Avoiding a Narrow Sectoral Focus. In the first phases of property rights reform, the current incremental approach to drafting laws is understandable. However, to the extent practicable, drafters should create legal tools of general applicability, rather than confining their work to a narrow sectoral focus. What is special to housing are policy issues, rather than strictly legal tools. When the housing sector is viewed as a whole, the legal tools necessary for its management do not have - - nor need to be given -- a special or separate character. Rather, they should be integrated in a systematic legal structure. 3. HOUSING PRIVATIZATION AND SUPPORTING REGULATIONS LM[EDIATE ACTIONS 68. Central Role of Privatization in Housing Reform. The development of market-based relations is essential to a decentralized and organic restructuring of the housing sector and the urban economy. The centralized administrative housing system has amplified transaction costs and lowered productivity. Most particularly, it has failed to take the preference of residents into account. As a result it has produced units at a very significant resource cost, yet low actual economic value to end users. Housing privatization will also have multiple indirect benefits for the Russian economy beyond the housing sector by allowing a better use of the existing housing stock, encouraging household savings, facilitating labor mobility, and improving the economic efficiency of Russian cities. 69. Immediate Benefits of Housing Privatization. The rapid and voluntary transfer of housing for free or at nominal cost to households remains the best economic strategy in Russia under present conditions of extremely high inflation. The present laws already allow the four basic objectives of housing privatization, which are: (1) to improve housing mainte.iance by transferring decisions on repairs to owners/occupants;'5' (2) to improve utilization of the housing stock by enabling owners to move freely between dwellings by paying their full costs; (3) to create a market for new dwellings by allowing new owners to sell their unit and use the funds as full or partial payments for new homes; and (4) to enable private individuals and enterprises to provide and manage housing, relieving government of these responsibilities. These activities will contribute to economic recovery by ending the artificially depressed state of residential assets. However, privatization in Russia is running somewhat ahead of appropriate regulations for future market-based operations. This vacuum could negatively affect the process and can be filled. 70. Housing Codex. Until the new housing codex is issued, Russian cities continue to operate under the housing code of 1972. This code should be updated rapidly taking into account the provisions of the 1992 Law on the Fundamentals of Federal Housing Policy, as well as the provisions of the 1993 Constitution. 151 At present homeowners are still far from fully taking advantage of this right because, with insufficient development of non-governmental housing maintenance firms, owners are obliged to turn to those same bureaus which carried out the maintenance of state-owned apartments. xxxi 71. Key Role of Operational Condominium Provisions. Without workable condominium regulations, the state would be forced to continue to maintain the newly "privatized" stock. Most socialist countries in transition have either had condominium provisions adopted before or concurrently with housing privatization. Early phases of privatization without condominium rules in Russia left a significant gap in the transition to private ownership and management of multi-family buildings. A national condominium regulation has been enacted making state withdrawal from building maintenance more flexible. Implementation of this condominium law, with relatively simple implementing procedures, is the next high priority. 72. Not Every Building Is Suitable for Privatization. Due to the need for speed, Russian privatization has so far been based on apartment units and not on buildings. This new situation of mixed ownership of one building can be addressed in the condominium law by allowing the public sector (appropriately represented legally) to be a co-owner for the units it still owns with exactly the same rights and the same obligations as the co- owners of the newly privatized apartments. To aim at a viable Mix of private and public owners within the new owners' associations, state representatives should come from the level of government closest possible to the building residents. 73. Based on Western experience, the appropriate privatization policy should have considered that not every building is suitable for instant privatization. Such a policy derives from two objectives: (1) avoid management difficulties by scattering privatized housing units throughout the housing stock, and (2) insure that the remaining public rental sector is sound and viable. Building occupancy should be specialized with some buildings remaining undivided, public property, most other buildings being entirely transferred to private owners. A housing unit privatized by a household need not be the one it currently occupies. Local governments should also develop procedures to encourage, not force, remaining public renters to relocate and regroup into predominantly public buildings in order to leave the other buildings in the hands of fully private condominium associations. Rapid, technical and social analyses should be carried out to help identify buildings where residents are immediately capable of self-management and self-maintenance. 6I 74. The Problem of Waiting Lists. With 23 percent of all Russian households on waiting lists, the problem of compensation during privatization cannot be ignored. Waiting lists are not totally caused by strong tenancy rights at near-zero rents or the extreme difficulty to trade units. Part of the Russian shortage of housing is genuine. In the transition, compensation to families unable to obtain housing could be made in the form of vouchers or transfers in kinds. The operational design of such vouchers systems will be very important. Poorly designed vouchers could lack credibility, be ineffective, or generate inordinate administrative costs. Another kind of compensation has been the free distribution of "garden" or "suburban" building plots to people on waiting lists in Moscow and St. Petersburg. The distribution of land assets can have negative urban development and 16/ Note of the Russian Editor: The recommended differentiation of residential buildings according to the form of ownership is desirable, but under the present circumstances in Russia, it can be reached only in the last stages of housing reforms, since, at present, in a typical urban apartment building, some of the apartments are privatized while the rest remain the property of the municipality. Thus, for example, the decision by the Moscow authorities to allow condominiums to be created (only] in apartment buildings where 51 % of the space is privately owned. The municipal authorities will join such a community as an owner of non-privatized apartments. xxxii ecological impacts which must be fully evaluated. As long as public housing remains, waiting lists will exist. However, changes must be made to cover only the needs of vulnerable social groups. Realistic rents, changes in the tenancy rules for state-owned housing and freedom of choice and exchanges can be expected to have major positive effects on both household satisfaction and dramatically shorter and different waiting lists."' INSTITUTIONS AND PROFESSIONS FOR HOUSING AND REAL ESTATE MARKETS 75. Development of the Institutions and Professions. The development of market-based relations will be essential to a decentralized and voluntary restructuring of the housing sector and the urban economy. This process will continue for a long period of time. Essential to its success will be the development of the rules and the professions to operate housing markets such as appraisers, brokers, real estate analysts, and production of market information. This is a long-term project which should be started in parallel with the revision of the various laws and codex. 4. DOWNSIZING AND RESTRUCTURING OF SUBSIDIES: RENT REFORMSI8/ SHORT-TERM ACTIONS 76. Urgent Need for Rent Increases. To bring balance between household financing ability and O&M costs, raising the aggregate flow of rents above 15 percent of aggregate household income should be the long-term objective. The decision taken by the Council of Ministries in September 1993 mandates rent increases over a five-year period to fully cover operating costs. This should be combined with subsidies to vulnerable groups. However, convergent forces are making a real increase in the rent level paid by households to a sufficient level temporarily difficult. First, the real wage level has fallen sharply. Second, the income distribution has deteriorated significantly with about 37 percent of the population falling below the poverty level and average food expenditures for the entire population represented 64.5 percent of income by mid-1992. Third, the operating costs of the type of housing built in Russia is high. What is needed in the short-term is to improve cost recovery by raising rents according to individual household's ability to pay. Rent increases must be closely coordinated with safety net measures as directed by the council of ministries.'9' 77. Russian Versus Western Housing Conditions. When designing assistance systems for vulnerable Russian households, it will be essential to understand that the housing problems of the 17/ In recent years, the number of families (and individual citizens) registered for improved housing conditions declined. In the beginning of 1992 there were 10.3 million, in 1993--9.64 million, and in 1994--9.1 million families on the list. Is/ Refers to a type of housing rent paid, according to a contract, when occupying housing which is part of the State or municipal stock. 19/ In 1994, a majority of the regions of Russia raised payments for housing and communal services. For example, in Moscow since January 1, 1995, the rent for 1 sq.m. of common space in a house with all conveniences was 302 rubles per month, compared with 16.5 kopeks in 1992. Subsidies were provided to families for which the payment of housing and communal services exceeded total household income by 10% in 1994, and 15% in 1995. xxxiii Russian poor are exactly the opposite of those of the Western European or American poor. In Western industrial countries, the main problem of the poor is not inadequate housing but exceedingly high rental payments. In Russia until now, the problem has been just the opposite: rental payments are trivial, but housing quality is too low. As sound rent setting develops, this situation will reverse itself. This poverty issue is different from, but complementary to, the housing problems of cities where the supply response is inadequate and demand-side subsidies are rendered less effective in solving low-income housing problems. A third structural difference with Western social policies is that housing assistance has to be provided for a small minority of the population, while in the Russian Federation it would be required for a significant share of the population, especially under worsening trends in income distribution. 78. Resources for Housing Assistance and the Social Safety Net. The present flow of household resources within the housing stock is too low to carry a major share of the cost of social protection through cross-subsidies i.e. net rental income could not cover full O&M expenses even if rents paid by richer citizens were partially redistributed to limit the expenditure of poorer families. Resources external to the housing system will continue to be required to stabilize living conditions. Given the scale of the population to be reached, simple administrative procedures have proven to be the most effective. The municipal housing system has severe difficulty surviving on its own. Other resources must be found, for instance, from central subsidies which are neither likely nor fiscally advisable at present, or from funds of the small scale privatization.20' A difficult balance has to be reached -- usually, city by city -- between the level of sustainable public subsidies, the rent increases demanded of households and the shape of the rent schedule, resources from paid privatization, loans, and other sources. 79. Housing Units in 'Negative Value-Added" Suburban Housing. Significant sections of many Russian cities appear to have a housing stock of negative value which is being revealed as domestic prices are adjusting to world prices. The value of the housing services provided may be below the resource cost to produce them. These units are in the industrial high rise towers built in distant suburban locations far from employment. They have operation and maintenance costs that are quite high for the real income of their occupants. No broad strategy emerges to solve such problems. Individual work-out solutions will be required at the city level, hMusing estate by housing estate. The problem also suggests that a significant part of the housing stock might well remain under state ownership or require public resources until a significant recovery of household incomes takes place. It will therefore be very important for each city to develop its own 'asset management plan" for the local housing system to determine the cost of minimum necessary repairs and rehabilitation and identify viable ways to finance them. MEDIwM AND LONG-TERM RENT REFORMS AND IMPLEMENTATION OF HOUSING ALLOWANCES 80. Housing allowances. The introduction of housing allowances is very important for the sector. International experience in industrial countries shows that housing allowances are an important element of rent reform: they imnprove targeting and subsidy transparency; they clarify resource costs; 20/ It is economically logical to allocate privatization revenues originating from asset sales to investment expenditures such as major repairs and rehabilitation. xxxiv and in the long-term they are not an obstacle to local government resource mobilization like rent control. The principle of housing allowance for households economically at risk is by now accepted best practice in the affluent and well-functioning markets of Western Europe and North America. However, the implementation of such a practice on a large scale in Russia today is impaired by four difficulties: the rising poverty levels, low housing quality, administrative overload, and generalized shortages caused by poor pricing. 81. Coordinated Rent Increases and Rehabilitation Programs. For administrative and technical reasons, it is readily apparent that a substantial share of housing subsidies will continue through the supply side. In order to make real rent increases more acceptable, it will be most effective to coordinate the new rents with rehabilitation programs. In particular, technical surveys show that energy rehabilitation programs have a very high economic rate of return. When evaluated in 1991, energy savings conditions in building were so poor that the recovery period between the required marginal investment and energy savings was 16 years. Since Russian energy prices were at that time 1/16th of world prices, the true recovery period was closer to one year at realistic energy prices. 5. MANAGEMENT OF PUBLIC HOUSING SHORT-TERM NEEDS 82. Management of the MuniciDal Housing Stock .The management of the municipal housing stock and other forms of publicly owned housing should aim to follow international best practices. The following policies should be pursued by local governments to improve their housing systems. First, transfer the management of the public housing stock from Government or industry to bodies which are autonomous as regards management and financial decisions, and are independent legal entities whose mandate is to balance their accounts within a specified short period of time. Second, differentiate clearly all matters concerned with housing maintenance on one hand, and urban services (water, sanitation, trash disposal, urban heating, electricity, etc.) produced and billed by specialized, autonomous institutions, on the other. Accounting and billing must distinguish clearly between three categories of expenses: individual household utilities (gas, power, telephone) billed according to family consumption; ordinary housing operating costs paid by the occupant of the housing unit; repairs, management costs, taxes, loan repayments, paid by the owner. Such financial and accounting clarity is indispensable. Third, provide, by means of a gradual rent increase, financing for the upkeep of the housing stock, taking into account the service costs which progressively become totally independent of the annual public budget. Subsidies will transit through the demand side and housing allowances for vulnerable groups. 83. Privatization of Housing Maintenance. One of the important lessons of Western countries regarding social housing is that the private provision of public services is often the most efficient way for all parties. Based on available experience, appropriate decrees and regulations should be drafted with a specific timetable to permit local governments to contract competitively with private firms to maintain municipal housing. Enterprises should be free to proceed along the same path as quickly as they wish. Preferably, model contracts should be developed and tested for wider use in a variety of cities, as is already done in Moscow and a small number of cities. xxxv LONGER-TERM REFORM OF THE MAINTENANCE AND MANAGEMENT OF SOCIAL HOUSING 84. Management of The Enterprise-Owned Housing Stock. Departmental housing forms the largest share of state-owned housing (46 percent) and reform in this segment of the housing system is extremely important. Departmental housing faces problems similar to those of municipalities. This segment of the housing stock is often not well maintained and of lesser quality than municipal housing. However, enterprise housing reforms are intimately linked to enterprise profitability, wage reforms, and enterprise privatization. That is to say that the scale and nature of the problems encountered by various types of enterprises is much more diverse than in the municipal stock. Many enterprises use their housing as a way to attract manpower and are reluctant to privatize. Others find that a third of their stock is occupied by workers who no longer work for them, owing to the permanency of socialist tenant rights. 85. A Distinct Entermrise Housing Reform Program. Enterprise housing reform will remain one of the highest priorities for the medium-term. With price liberalization and rapidly rising operating costs, many enterprises are already anxious to dispose part or all of their housing stock either through transfer to employees or to municipal governments. Enterprise privatization is leading to an accelerated transfer of units to households. In cases where units remained, enterprise responsibility a basic transition strategy should be for enterprises to sirnultaneously raise rents to cover actual 0 & M costs plus replacement costs, and bring up nominal salaries by comparable amounts. The benefits will be to encourage workers to consider their best alternatives -- including privatization -- and to raise the asset value of enterprise-owned real estate, making disposal easier, if and when needed. 6. RESOURCE MOBILIZATION AND HOUSING FINANCE BANKING SERVICES VIABLE TRANSITIONAL FINANCING MECHANISMS 86. The outlook for resource mobilization to finance new housing construction is not promising as long as macroeconomic stabilization is not achieved. Developing every means to create new alternative sources of funds to state financing is, therefore, of the highest priority. 87. Five Major Short-Term Obstacles to Banking Services. Five major short-term obstacles stand in the way of the development of banking services for housing in Russia: (1) a severe housing price- affordability problem; (2) the newly created legal framework on land ownership, mortgages, and foreclosure rules remain to be implemented; (3) the impossibility of long-term lending when annual inflation reaches 2,480 percent, as it did in 1992 and continues to range between 15 percent and 20 percent per month; (4) finally, there is a widespread popular tendency to confuse housing finance provided by banks through loans with housing subsidies financed from fiscal sources such as federal or local government budgets, or enterprise funds; (5) last, but not least, Russia still has an underdeveloped banking system which lacks experience in lending to the household sector. 88. New Lending and New Institutions. Until stabilization, it is premature for the Government to encourage long-term lending by banks. In the immediate future government work should focus on the problems to be solved in establishing new institutions with appropriate legal and regulatory frameworks, and the training of professionals. xxxvi 89. Sberbank. Sberbank is the only bank mobilizing household deposits in Russia. However, its share of the banking system has declined sharply with high inflation. Its liabilities are guaranteed by the Government. Its role should, therefore, be evaluated from the broader perspective of the development of the Russian financial system, and not narrowly with reference to the financing of housing. At present, banking services are limited to a marginal volume of financing carried out by Sberbank (Savings Bank of Russia) under negative real interest rates for a trivial volume of lending.21' The primary role of Sberbank should be to provide households with a safe window to deposit their savings, access to the payment system, and a limited source of credit. In order not to jeopardize Sberbank's fiancial soundness, lending to households should be limited to a small fraction of its total deposits. Mandating Sberbank to make housing loans at deeply subsidized rates would be destructive unless Sberbank was fully compensated by the budget, which is not a good policy either. Mortgage lending to households should be allowed only on an experimental basis for a small share of the portfolio in order to develop its loan origination and loan servicing capacity."' 'Me Govermnent should not provide housing subsidies through the financial system, but only from fiscal sources. Therefore Sberbank should lend only at variable interest rates and at a level high enough to ensure full loan recovery in real terms after adjusting payments for inflation. 90. Subsidy Tarzetinz. An important step was taken in separating subsidies from housing financing and in aiming at targeting subsidies to households and the demand side rather than to production and building companies. Decree 1278 of December 1993 establishes the principles that direct subsidies in the form of grants should be targeted to specific households, and that households are not entitled to subsidized credit. A basic subsidy matrix designed according to household characteristics is included in this decree regarding military housing. It initiates a new approach to subsidy design. 91. Affordability Issues for Mortgage Loans. The high ratio of house prices to income is an aberration, due to temporarily high house prices and state-regulated low wages and their markets. High house prices are caused by monopolistic production and costly regulatory framework. They also reflect the temporary inefficiency in construction finance. Within a few years, a major decline in this house price-to-income ratio should occur. Non-subsidized housing production is currently available only to households at the very top of the Russian income distribution and those who are 211 In 1992, Sberbank was obliged to make 20-year loans at 8 percent (plus a 12 percent government budget transfer to Sberbank) when yearly inflation was 2,480 percent. Half of these loans were made in rural areas for individual or garden housing representing about 40,000 units per year with an average of three joint borrowers per loan. One fourth of the loans were to cooperatives in cities. This portfolio amounted to one percent of the total assets of Sberbank in 1991. With high inflation, these unindexed long-term financial assets have lost their value. 22/ Since 1993, Sberbank stopped issuing low-rate housing loans. Deposits made by the public were largely applied to commercial banks. Many of these, promising unrealistically high rates of return, gathered significant sums and then went bankrupt, ruining their clients. In June 1994, the President of Russia issued a special decree on housing loans, with provisions for loans for the purchase and preparation of land for housing construction, short- term finance for construction works and long-term loans for purchasing housing. Lending terms are determined by the banks, in agreement with the borrowers. xxxvii able to trade their privatized units. This production should not be obstructed. Such housing construction still provides benefits at lower income levels through a chain of moves. It also helps the emergence of new types of producers and developers and creates new employment. It is 100 percent privately financed which provides some relief for the fiscally burdensome government housing programs. 92. DeveloDing Workable Transitional Financin2 Mechanisms. Under current macro economic conditions, no mechanism that relies purely on mortgage finance will be broadly affordable to individuals. Increasing cost recovery in the sector will depend on design and implementation of alternative financing mechanisms. It will be extremely important to develop integrated financial plans to evaluate all the transition measures which might be proposed. For example, in order for a household to purchase a new unit at market prices, the financing mechanism might include an in- kind contribution of serviced land from the locality, a locally or centrally funded housing voucher, an equity contribution from the household, or a long-term mortgage loan at market interest rates from a housing finance institution. Municipal governments and enterprises generally own substantial real estate assets which might serve to improve transitional financing. DEVELOPMENT OF A MARKET-BASED, LONG-TERM HOUSING FINANCE SYSTEM 93. Medium-Term Agenda. In the medium term, an additional agenda emerges. It is not too early to begin working on this agenda now, but the expectation is that resolution of these issues will take some time. A separate and detailed study of policies, institutions, credit and deposit instruments would be most appropriate. It would identify key obstacles and possible solutions. With present high and unpredictable inflation rates and depressed wages, no long-term mortgage instrument is viable. Even a dual indexed mortgage, with protection for household affordability and bank protection against inflation, would not work. Nevertheless, as with basic legal changes, it is important to begin discussing and developing the institutional capacity to handle these types of instruments so that as soon as the macroeconomic situation stabilizes, there will not be a lengthy interval before mortgage credit can begin. Because construction finance is short-term, conditions for successful lending will emerge more rapidly. However, to initiate construction lending will require a set of enabling rules and training for on construction supervision and underwriting. A very difficult issue will be the development of term finance. Mutual forms of resource mobilization may prove effective in the Russian context. The development of specialist training facilities for housing fmance is, therefore, a high priority to adapt international practices to domestic Russian conditions. 94. Appropriate Legal and Rezulatorv Framework. Many of the basic reforms necessary for housing finance are the same as those for financial system development, such as a sound charter, adequate capitalization, sound prudential rules, effective internal operations, and good bank regulations and supervision. Several legal rules -- such as real estate mortgage provisions and foreclosure and eviction procedures -- are specific to the housing finance sector and should be enacted. The development of a sound supply of banking services to the sector requires an appropriate regulatory and supervisory framework which has yet to be developed. The development of mutual forms of credit also needs it own regulatory and supervisory system. xxxviii 95. Specialist Training Facilities. The development of training centers for housing finance, which is a very special form of retail finance, and for construction and non-residential real estate finance which is a considerably more risky activity, is important. 7. FISCAL POLICY: TAXES AND SUBSIDIES 96. Central Role of Local Government During the Transition. To manage the transition to markets, reforms are shaped by the fact that under central planning, Soviet housing institutions did not differentiate between fiscal and financial resources, and much of taxation was implicit rather than explicit. This legacy of central planning combined with the transfer of the non-departmental housing stock to cities, and the "Federal Agreement" of 1992 redistributing powers across levels of government, are combining to give a central role to cities during the housing transition. With the withdrawal of central budget subsidies, municipal governments now bear the brunt of the rise in O&M deficits. Cities are very likely to play a key role in reorganizing the flow of funds through the housing sector by the way they can restructure their wealth. At present cities control valuabie assets, yet they are cash poor. Potentially cities constitute the level of government best able to develop integrated local financial reform plans with the cooperation of the most important economic and social groups active in the local economy. They own much of the local real estate stock. They control land use and can regulate the use of the most valuable real estate assets. Many -- hopefully most -- should be able to obtain the cooperation of local enterprises to develop realistic financing mechanisms to finance more housing. 97. National and Local Taxes. Tax allocation and collection in the housing sphere is a complicated, novel area for Russian policy makers. The efficiency and distributive impact of taxes - - how they affect the behavior of economic agents and who ultimately bears their burden -- implies a new perspective on public resource mobilization. Issues to be resolved are competencies to collect different forms of tax among levels of government, revenue assignment from one level to another, etc. The central government may share general tax revenues with local authorities to subsidize either demand-side subsidies such as housing allowances or vouchers, or supply-side subsidies earmarked for specific types of housing construction or maintenance. Local governments typically collect property based taxes which may be used for a variety of purposes, including financing of residential infrastructure. Initial attempts to implement property tax collection in Russia have been hampered by lack of property registers, flaws in the key legislation, and lack of training in alternative techniques of property appraisal such as mass valuation. While an essential area for policy reforms, the development of taxation capacity -- especially at the local level -- is a lengthy and complex process which has been the subject of a World Bank report.23' 98. Subsidies. Similarly, subsidy policy is also a critical area for reform both for the operation of the existing housing stock and for the production of new housing under presently extremely high price-to-income ratio. At present, subsidies are almost exclusively on the supply-side, such as rent controls, and heating and utility subsidies, and underpriced land and infrastructure services. These untargeted, often hidden, subsidies are usually considered the least effective method of assisting 231 Refer to World Bank Report No. 11302-RU, Russia: Intergovernmental Fiscal Relations in the Russian Federation, December 1992. xxxix identified, deserving beneficiaries. Also, supply subsidies usually have a strong tendency to subsidize production inefficiency rather than benefit ultimate users. This tendency is accentuated by non-competitive environments. As rent reforms are implemented, however, it will become increasingly important to design and implement demand-side subsidies that are up-front, explicit, budgeted and targeted on well-identified deserving beneficiaries. Better targeting would also allow central and local governments to better measure and control total subsidies going into the sector. 8. PRIVATIZATION OF THE CONSTRUCTION INDUSTRY REsmuc iRiNG ON(GOING PRjErS TO FACUIATE THE PRIVATizATION OF C 'RUCION ACnVmEs 99. The construction industry operates very differently from any other industry in a market economy. In transition economies, its specific needs are quite often misunderstood. To add to the confusion, the construction industry is more broadly defined in Russia than in market economies, and includes not only public works but also factory design and assembly. In moving to an efficient and competitive system, the contracting process lies at the heart of successful privatization because the own-capital of a construction firm is very small compared to the value of its projects -- particularly for the construction of buildings. The one-of-a-kind, site-specific nature of the construction process centers on individual projects making the building segment of the construction industry one of the most suitable for rapid and successful privatization. Privatizing building materials activities is different from building enterprises and similar to the reform of other typical industrial enterprises. Yet reform of the building materials system is also a very high priority because the changing demand for types of housing units is also leading to a very different demand for construction inputs which are not currently provided by existing state enterprises. 100. Two sorts of supports to the construction sector are needed in the short-term: (1) competition and openness in contracting, including smaller and very frequent bidding lots, and (2) policy guidelines for the reform and restructuring of the building organizations that have been undergoing privatization around the country to make them more autonomous and capable of adjusting to a more competitive and less predictable environment. The privatization and post-privatization strategies for these building organizations has followed the Russian Federation's reform experience. T-here are important technical discussions on whether to privatize the organization as a whole or reorganize vertically integrated structures into independent firns very rapidly, and in what sequence. In addition, a separate evaluation of the modernization requirements of the often obsolete components of the building materials industry is a requirement for the diversification of housing products. These decisions are better left to managers during and after privatization. 101. The most urgent task is the development of competitive rules in public procurement, and the development of a tendering process with lot sizes and a bidding frequency suitable to the emerging medium and small private building enterprises. The on-going process of revising and liberalizing the construction code to permit a variety of new technologies, and more importantly a better allocation of construction risk should be rapidly completed. xl LONG-TERM BUILDING INDUSTRY RESTRUCTURING 102. Construction. An Industry Most Able to Privatize Ouickly. As noted, the characteristics of the construction project cycle make the industry one of the most suitable for rapid privatization. Such privatization will bring the management of project risks to the center stage. Presently, due to central planning, Russian construction monopolies have weak abilities to evaluate the economic, financial, commercial, and even technical risks of a construction project. Industrial restructuring will depend on new work to be done and on the rapid reduction in size and higher frequency of new contracts -- whether they originate from enterprises for commercial and industrial buildings, from local governments for public buildings, or from private demand for residential or commercial use. This strategy is particularly applicable to economies like Russia where the end of the central planning system is very recent. In such economies, almost all demand for building has originated from the state until now, and the recently emerged new private producers are still too small to make up a significant part of the total output in the immediate future. 103. Support to Emerging Developers and New Firms. At a time of collapsing state budgets, support to the emerging developers that are market driven is an area where governments can leverage their limited resources at minimal costs. However, the present regulatory system was not meant for these new and diverse producers, but for massive, very large-scale, industrial state projects. The attitudes of chief architect offices, and of other regulators often constitutes another obstacle. To increase the rate of success among small firms, regulations should be interpreted more liberally. Access to land should be faster and more flexible. Urban planning codes, building codes that are geared to huge projects should be adjusted locally until better codes can be passed.24' 104. Completion of Works in Progress. The large volume of unfinished construction projects is one of the conspicuous ills of central planning. At a time of falling savings and sharpening shortages, the economic rate of return to completing unfinished housing units is expected to be high. An inventory of on-going projects should determine what projects can be completed quickly at low incremental costs. As seen in transition economies of East Asia, under a competitive tendering system, state building enterprises can successfully use these projects for their necessary internal restructuring and efficient privatization. For that purpose, the size of the contracts should be lowered to the smallest size possible and the tendering frequency increased accordingly.2' 105. Use of New Projects to Privatize State Organizations. Project management stands at the core of the performance of construction firms whose capital base is usually a small fraction of the total value of their projects. This construction process is what differentiates construction from all other industries. Policies as well as emerging market forces should encourage the change from large 24/ Note of the Russian Editor: Sufficiently strong standards of architectural/urban-planning regulations for urban construction, while in fact constraining free-market use of urban land, contribute to the resolution of architectural-planning and ecological problems in urban development, and prevent haphazard construction. This has also been the case in the West, such as in the urban centers of Paris and Washington where height restrictions have been imposed on construction. 251 This problem was resolved by Presidential Decree No. 1181, dated June 10, 1994. xli enterprises to many specialist contractors and small enterprises. Bigger projects should be broken into smaller components to gain efficiency in the local market place. 106. Large state organizations which must privatize and adapt to market conditions without incurring severe losses of human and capital assets can consider a series of steps or phases. The more these phases can be collapsed through fewer new projects the better. The initial step would be to break up the present monolithic organization into independent firnms matching its major parts and functions: client, designers, general contractor, each major building trade group operating as a basic subcontractor (siteworks, structural, mechanical, plumbing, electrical, finishes), and materials suppliers. The process of differentiation and business independence can proceed at different speeds for the various units involved in the building project cycle. 107. Widespread Benefits of Sub-Contracting. Sub-contracting in the construction industry is the most efficient way to allocate risks and minimize transaction costs. A building enterprise chooses what to do in-house and what it wants to subcontract. Different markets, enterprises, institutional structures, as well as cultures often require different strategies, leading to a different contracting structure. During the transition to markets we can expect a very rapid rate of enterprise deconcentration and many new small firms due to the advantages of subcontracting in the sector (see Chapter 8). 108. New Housine Demands Imly Imortant Changes in Budding Materials. Conditions for the production of residential construction materials linked to "closed' industrial housing systems are particularly poor: the facilities are often very old and the technology is obsolete. With the new types of housing demand there is a mismatch between the building materials and equipment available and what is needed both in terms of quality (uniformity in dimensions, technical quality, energy efficiency) and volume. The move to a diversified supply of housing production will both lead to and require the modernization of the industries providing building materials. 9. REFORM OF LAND USE AND THE URBAN REGULATORY SYSTEM LmMEDIATE REFORMS 109. Unlocking Urban Land to Finance Major Urban Rehabilitation. Due to the lack of land markets, a very high proportion of central, prime urban land continues to be grossly underused by old factories. Major city rehabilitation programs are urgently needed. The Russian economy is faced with a severe shortage of domestic savings for the foreseeable future. The most important source of wealth available to many cities in the near future may well be these vast tracts of serviced 'fallow industrial land." The major bottleneck is the absence of clear property rights and a land market to recycle them. The unrestricted privatization of all urban land - with sound supporting land use regulations- is among the most difficult decisions that Russia is facing. It is also the decision with the greatest potentialfor unlocking large amounts of wasting urban resources to finance urgent public and private needs. As the analysis of Chapter 7 shows, in Moscow alone this buried wealth amounts to a much underestimated minimum of US $2.2 billion at current depressed prices. Local governments are facing a severe and growing financial crisis, yet they are disposing of very valuable assets at nominal prices or free of charge, while complaining about a shortage of serviced xlii land. Meanwhile, access to central land and permits to build economically valuable projects may not be forthcoming. 110. Fundamentals of Town Planning Legislation. The decrees and codes resulting from the town planning law need to clarify local government powers on land allocation and land use. The urban planning code needs to have three broad dimensions: it should provide open and competitive procedures for land development; it should provide for substantially decentralized decision-making from the federal and regional levels to the local level; and it should reorient master planning away from detailed and rigid "city design" to focus on the siting of the primary infrastructure and on the environmental protection of fragile or historical sites. 111. Land Auctions. As chapter 7 shows, the absence of land markets has been particularly harmful to Russian cities. Open access to land is key to a competitive construction industry, and it is urgent to harmonize all forms of land auctions. Local governments can and should be required to adopt uniform procedures for land auctions for residential development by private builders/developers. In light of the new constitution, ambiguities and confusion regarding the developer's rights to later convey land ownership to house purchasers need to be removed. A critical issue in starting land markets in Russian cities is the release of public land for competitive bidding on a sufficient scale in lots of a size suitable to emerging new developers. Cities should be required to make available for sale as early as 1994 at least 25 percent of vacant land in lots of 10 hectares or less. This does not mean that all this land would be sold and developed instantly, but only that monopolistic scarcity would be eliminated. LONGER-TERM REFORMS 112. The inability of the administrative-command system to evaluate even approximately the value of a land site and its opportunity cost -- its site value according to highest and best use -- has generated striking spatial anomalies and urban inefficiencies. The critical economic benefits to cities of allocating scarce urban sites according to highest and best use are not well understood. As a result, many of the current urban land reforms are piecemeal and lack an overall framework. They also tend to remain purely physical and normative, lacking an economic content. Russia urgently needs a coherent program as well as implementation guidelines for the clarification of land ownership rights, land valuation and effective mechanisms for the trading of urban land. Longer term reforms need to develop along four main lines: a. First, local governments will need to ensure the availability of land for new housing construction in areas where there will be the highest demand. While this new demand has not yet manifested itself, the rough outline of its characteristics can be anticipated: land consumption per unit of floor space should increase from the center toward the periphery. b. Second, better planning practices are not the most important factor for improving land use efficiency in Russian cities. Rather, the most important factor will be establishing tradable land property rights. When those rights are established and a real estate market starts functioning, the role of urban planning will again become important. xliii ' c. Third, the government will need to support new or improved infrastructure and social facilities required by land use changes under market conditions. Provision of this new infrastructure must be guided by the reference to land market forces, so that investments are made in areas where they will provide maximum benefits in a short period. d. Fourth, in the area of the urban environment, new regulations will have to be drawn quickly to protect from the market the limited amount of land occupied by historical monuments and unusual traditional neighborhoods. Valuable natural features such as forests, lakes, river, or sea shores should be clearly protected.26' 10. MUNICIPAL FINANCE AND RESIDENTIAL INFRAsTRUcTuRE MUNICIPAL FINANCE AND RESIDENTIAL INFRASTRUCTURE 113. Land Tax and Propertv Taxation. Russia has been developing a property tax system in order to improve the resource base of local government. However, the present land tax is not soundly structured and is not consistent with efficient land use allocation. Instead of assigning nominal prices and taxes according to type of use, the method of property taxation should rely on tax rates applied as a percentage of market value. Similarly, the transfer taxes on the sale of units should be lowered substantially. Western experience with housing transaction taxes show that excessive taxation rates do not lead to much higher revenues, and are very harmful to the flexibility of housing markets, and to household mobility according to changing job or family circumstances. MEDIUM AND LONG-TERM NEEDS 114. The New Role of City Governments. The on-going reforms are thrusting very important functions on local governments for which they are not well prepared. Russian cities have the potential to play the leading role in successful housing reforms, but this is not a foregone conclusion. 115. Addressing the Crisis in Municipal Finance. The crisis in municipal finance calls for immediate action. As yet, cities have done little to cut expenditures, improve efficiency, increase tariffs, or improve financial procedures. Expenditure reductions could include hiring freezes, reductions in administrative staff, and postponement of capital expenditures. Efficiency improvements could be obtained by improving procedures and supervision, by privatizing appropriate city functions, and by using competitive bidding. This should be done before services are cut. Unless expenses are reduced in a planned way, services will have to be cut haphazardly to an unacceptable level. Tariff increases are required for rents, public transport, water, sewer, and heating. Additional revenues could be raised by selling city property and by imposing property 26/ Note of the Russian Editor: The Author's recommendations on the usage of urban lands are of interest, although they seem disputable. World experience shows that territories distant from old historic centers but most favorable in terms of climatic, ecological and architectural characteristics quite often happen to be the most attractive for housing construction. xliv taxes. Finally, financial systems are poor. New budgetary, accounting, and information systems should be put in place, along with financial controls. 116. Development of City Level Financial Management Tools. One of the reasons why local governments are in a position to play a central role in reorganizing the total financing of the housing sector is that the competition between subsidies to operate the existing stock and housing allowance programs, subsidies for new construction, and the need to complete works in progress is extremely fierce in the current depressed state of the sector. Central government guidelines on how to manage trade-offs in allocating resources across uses together with competitive allocation rules across cities can play a major role. Yet, the best progress will come when cities will evaluate the total flow of funds available to finance local housing needs and work out trade-offs and gain the cooperation of the key local decision-makers in the sector. In a period of scarce resource to finance the sector, many cities should also be able to make good use of their undervalued centrally located land to finance at least part of local housing and infrastructure needs. 117. Infrastructure. Presently, cities may be giving away land plots without accounting for subsequent residential infrastructure obligations the city may be incurring. Recycling already serviced land by creating functioning land markets is a much less profligate method for local governments to increase home ownership. Local governments should devise mechanisms to share the cost of tertiary infrastructure with land developers who pass on costs to purchasers. In addition, tax or bond mechanisms will have to be developed to provide trunk infrastructure. m:\rhsector\green. 1\sumetc\exec-sum.v9 August 11, 1995 4:37 am RUSSIA - MATRIX OF HOUSING REFORM POLICIES Area/Issue Recent Immediate Over the Medium Term Ultimate Goal of Interest Policy Measures Next Steps Next Year (Five Years) (Long Term) 1. Institutional Reform Institutional changes Provide new government Streamline federal Reorganize all key sector Housing production is initiated in the structure and decentralize institutions into specific institutions no longer a direct public sector sector. responsibilities. directorates suited for function. market development Shift MOC role to Federal Housing Integrate housing sector- policies. regulation/enforcement A market-oriented government Reform Office related institutions (Gossiroy monitoring of rules and structure is in place for the urban created. and Committee for Housing Recruit finance and processes. sector. and Communal Services). management advisors. Regulatory Transfer housing/land use autonomy and Clarify assignment of Train staff for new regulations to Responsibilities of central and local ownership of federal-local responsibilities. functions at federal and local governments. governments are differentiated. housing stock local levels. Every function is carried out at the granted to local Create city-level housing Continue lowest possible level. governments. reform offices. Retrain redundant on-the-job training. staff, redeploy to operations. 2. Property Rights/Lepl New Laws Passed: Allow private property of Redefine public Implement land and Consistent laws and regulations Reform urban Land in any use. interest for eminent mortgage registries. apply to all types and phases of real 1993 Constitutional domain procedures. estate development. Reform, including Pass key housing laws, Promote publicity of all right to private including property Detail regulations, real estate transactions. Private ownership of land and ownership of land. registration, and model contracts. housing is prevalent. condominium. Expand role of Law on Basic Introduce systematic notary offices. Property rights are clearly defuned Federal Housing Issue regulations to property registration and well protected. Policy; Urban implement new legislation. and land titling. Regulate with Civil Law Development Law; contracts all Trading and exchange of properties Law on Pledge. Introduce civil law contracts Develop legal tools for rental/ownership is efficient, transaction costs low. for all renters. private rental and transactions. Drafts of Mortgage, home purchase. Owners and tenants rights are well Property Register Define clear land titling Strengthen judicial balanced. Laws rules Introduce laws for appeal/procedures. eviction/foreclosure. xlv Area/lssue Recent Irnmediate Over the Medium Term Ultimate Goal of Interest Policy Measures Next Steps Next Year (Five Years) (Long Term) 3. Privatization of Major amendment Create local committees to Speed transfer of local Privatize most of the Minimum ownership of public Public Housing passed to 1991 handle privatization. government and public housing stock. housing. Housing departmental housing Privatization Law Provide incentives for rapid to private ownership. Encourage listing and Efficient brokerage of market that allows local privatization. information services for transactions at low cost. flexibility. Write laws for sale of units. Streamline regulation and brokerage services. Reliable and timely information 18 cities have administrative procedures. Support the development across the entire housing systems is organized Development new of a network of real estate readily available locally. privatization Revise waiting lists and their registration systems. centers in each province. process. functions . Develop housing Train new professionals. Some cities are information systems allowed to services. experiment ahead of the federal laws. 4. Rent Reform 1992 Budget Law Design process to Give incentives to Charge rents covering full Subsidies are restricted authorized local de-control rents. local governments to O&M costs. to vulnerable groups. Their choice governments to raise rents on public of types of housing has been increase rents. Encourage local experiments housing and provide Use rent vouchers for low broadened. and minimum schedules., income families. assist cities. The overall rent level reflects 1993 Presidential Coordinate housing mnarket demand and the cost of Decree prohibits Develbp city level financial rehabilitation with rent capital in the economy. experiments by local management plans for increase programs. governments. municipal housing. Full cost recovery is achieved by all types of owners (private and De-control rent on privatized Coordinate rent social non-profit). dwellings. reforms with new safety net policies. The housing system has become a self-financing industry. xlvi Area/lssue Recent Immediate Over the Medium Term Ultimate Goal of Interest Policy Measures Next Steps Next Year (Five Years) (Long Term) 5. Maintenance and Local housing Restructure and differentiate Develop training Generalize correct Most social housing companies, Management of Public agencies are the rent payment system. programs for the new accounting, charging and have a corporate status.Municipally Housing municipalized. housing managemnent billing procedures. owned housing is very smfall. Revenues do not Adjust rental payments to companies. even cover ordinary cover operation and Generalize the energy Management of the social housing O&M costs. maintenance. Clean up accounting, rehabilitation program. stock is under financially and billing framework and managerially autonomous local Funding for mnajor Create autonomous housing commingled communal Continue to reduce the housing companies. rehabilitation and management companies. economy funding. scale of Housing capital cost recovery Management Companies. The average scale of a social remains a universal Provide privatization rules Create financial housing company has fallen much problem. to avoid mixed tenure within schemes for financial Every city has a fully below 4,000 units. Management one building. balance of individual operational city-wide boards are representative of key housing companies. financial planning and local interests (residents, management system. employers, financiers, local Initiate a large-scale government). energy rehabilitation Every city has its own program for housing. competitive, private O&M Rents insure full recovery of O&M, firms. replacement costs, and local taxes. Introduce competition Explicit public subsidies for low- allowing private firms Resident mobility across income resident insure fuiancial to carry-out O&M. the social housing stock balance of housing companies. within and between cities has been greatly increased Individual housing companies are through reform of waiting supported by regional and federal lists. professional associations which mnonitor performance, publicize audits every year, provide training and advice. xlvii Area/lssue Recent Immediate Over the Medium Term Ultimate Goal of Interest Policy Measures Next Steps Next Year (Five Years) (Long Term) 6. Financial Policy Two-tier banking Link housing finance to Issue mortgages law Implement key laws and Subsidies and finance are clearly system introduced. overall financial sector supporting regulations. procedures to secure separated. reforms. loans. Interest rates only Implement training An efficient housing finance system partially adjusted to Design training center for programs for housing Housing now investment is in place, based on competing reflect inflation, and banking services for housing rimance. attracts private funds. private banks. macro-economic and other real estate. instability prevents Test new mortgage Lending and deposit rates Regulatory and supervisory systems long-term lending. Design viable construction tools when macro- are market-determined. are in place. and mortgage finance economic conditions Pledge Law passed, instruments. allow. Begin charging full price Banking mechanisms are in place to but not other key on new housing starts raise the supply and management of laws affecting the Design a viable transition Design new housing based on new products. term credit by banks. use of housing and fliancing plan for the private savings mechanisms. other real estate as sale of new housing. Reduce credit subsidies collateral for loans. Develop mutual forms and allocate them Pass Mortgage Law. of housing finance. competitively. xlviii Area/Issue Recent Immediate Over the Medium Term Ultimate Goal of Interest Policy Measures Next Steps Next Year (Five Years) (Long Term) 7. Fscal Poficy Drastic budget cuts Develop consistent budget Plan to remove most Implerment fully the The role of the federal government affect all aspects of guidelines on competing budget and in-kind restructuring of demand- is primarily to monitor and regulate housing operations: demands: O&M, subsidies to housing side subsidies and the sector. maintenance, rehabilitation, completion of production. production subsidies. rehabilitation, and works in progress, and new Budget resources to subsidize the new production. production. Insure that new Target any residual sector are targeted to vulnerable demand-side subsidies subsidy to well identified groups, their share of the national Allow and promote local are up-front, explicit deserving beneficiaries. budget and GDP are consistent with experiments in the taxation and budgeted. macro-economic stability. of land and real estate Implement a consistent property. Develop new methods taxation framework for Full periodic fiscal reviews are to charge for the housing covering both tax prepared for the sector covering provision of urban expenditures and budget both direct budget expenditures and services. subsidies. indirect tax expenditures. Creation of a single The detailed management of 'Housing Fund' to housing budget transfers is left to manage, and regulate local governments. only subsidies to the sector. Area/Issue Recent Immediate Over the Medium Term Ultimate Goal of Interest Policy Measures Next Steps Next Year (Five Years) (Long Term) S. Privatization of the Prices and Imports Reorient the construction Adopt and apply Stop all direct subsidies to Most contractors and suppliers are Construction Industry Liberalized ministry away from direct competitive state enterprises. private. The number of sub- control of sectoral SOE's. procurement law. contracting specialist firms is very Some SOE's Use competitive bids on large. Privatized End local monopolies over Use new procurement all major public works supply of building materials. rules in new projects contracts. Construction management, pricing to help emergence of and cost control methods are in End price regulations over subcontracting new Develop market place. Profitability - not volume - is construction activities. firms. intelligence services. the driving incentive. Draft new building codes to Develop a market- Create rules for bonding, Government enforces legal allow new types of housing. oriented legal insurance, and guarantees framework for private contracts. framework for of good completion. Guaranties of good delivery are in Draft Procurement Law. construction and start place. the restructuring of Develop the institutions Initiate a major review of the housing Kombinats. and professions of the Project life-costing is a common restructuring of the building market. practice: 0 & M requirements are materials industries. Reduce or terminate fully integrated into project design. subsidies to builders Develop project and suppliers. management, cost controls A wide variety of technologies are and firm management available and building products Start competitive bids programs. respond to user demands. on major public works contracts. I Area/lssue Recent Irnumediate Over the Medium Term Ultimate Goal of Interest Policy Measures Next Steps Next Year (Five Years) (Long Term) 9. Reform of Land Use Urban Development Clarify division of central- Implenent open rules Revise current master Sufficient land is zoned to meet and Urban Regultion Law passed, but it local responsibilities for for selling urban land. plans, zoning and demand for housing development. is focused on city urban development. subdivision regulations as Fallow industrial lands in prime design rather than Remove implicit and needed. locations have been recycled. on urban investment Draft federal rules on access explicit administrative Cities are efficient and livable. regulation. to urban land, leave barriers to new Establish procedures and implementation to cities. housing types. institutions for public Procedures may be standard across Ownership of urban participation in land use Russia, but substantive land use land for housing Streamline land-use Encourage design and decisions and appeals. decisions are local. allowed, but it regulations. planning innovations to should be extended diversify supply of Higher levels of Urban planners do not design cities. to all uses to housing. governments can neither They establish minimum rules that generate resources disregard nor overnile all potential land users must meet, for local Protect historical and local planning decisions and the limits within which the land restructuring. other sensitive sites in reached through new legal market will operate. This city centers. and regulatory processes. regulatory process is local and public. Local planning is done locally, not by central Historical sites and urban amenities institutes. are protected. 10. Munipal F_nce Municipalities to Densify development Limit master plan rolc Municipalities assume Developers provide the and Residential control urban where infrastructure, urban to location of primary responsibility for trunk secondary infrastructure charging infrasirctun developnent and services are easily available. infrastructure by the infrastructure provision. its costs within price of dwellings. provide public sector. infrastructure. Abolish concept of Property tax contributes to Major trunk infrastructure is "communal economy' and Develop market- infrastructure finance, as financed by local government develop the basis for oriented land valuation well as impact fees. through long-term credit. individual pricing of each techniques. urban service. Develop public/private Public/private investment and Develop a property tax methods of providing operation mechanisms are in place. system. local infrastructure and services. NAUIJOSA MM& Ar II. 1905:18 _1 ii liii FOREWORD MINISTRY OF CONSTRUCTION THE RUSSIAN FEDERATION Housing reform may be rightly considered one of the most important examples of structural transformation in Russia during the past few years. The development of the housing market, and the construction and construction materials markets - although beginning under the then-prevailing administrative and budgetary system - has now reached the stage where they demonstrate a number of important successes. These results have been facilitated by analyses and studies of the changes currently taking place in the housing sector as part of the liberalization of the economy in Russia. It has also been important for us to draw on the experience of other economies of Eastern and Central Europe which have embarked on the path of market reform and structural transformation. Experts from the World Bank have participated actively in these developments and have undertaken a series of analytical studies which underscored the need to transform the housing sector in Russia. Doctor Bertrand Renaud - relying on a wide range of source materials, the efforts of his colleagues, and his own outstanding capabilities and expertise - has prepared this work for publication. Its publication in Russian will greatly help our own experts to adopt internationally- accepted solutions to the problems of housing reform. Moreover, the specific nature of the situation in Russia may be clearly seen in the work. The time has come for the next step in the process of housing reform in Russia. A key role will be played by investment at every level and from every source--from household savings to the capital of large corporations, banks and funds--directed towards the development of real estate and all aspects of the housing market. The Ministry of Construction of Russia appreciates the participation of the World Bank and its experts in the implementation of housing reform. The lending policy of the Bank will, undoubtedly, greatly promote this effort. A. Krivov State Secretary Deputy Minister of Construction of the Russian Federation Iv RUSSUIN EDITOR'S PREFACE The World Bank's Report, entitled "Housing Reform and Privatiation in Russia: General Strategy and Special Measures for the Transition Period," has been prepared by Mr. Bertrand Renaud together with a team of consultants and experts from the World Bank, as well as Russian experts, pursuant to the agreement between the Russian Federation and the World Bank on the project of technical assistance for housing reform and privatization in Russia. The Report is a fundamental work dedicated to a profound and ambitious analysis of the initial, most complex stage of housing reform in Russia. This stage is taking place against the background of deep political and economic transformations characteristic of the transition from the system of central planning and management of the national economy to a market economy. The Report was reviewed and received a favorable evaluation at the interministerial meeting held in the Russian Ministry of Construction in October 1994. This meeting was attended by leading experts of the Ministry, representatives of the Ministry of the Economy, Ministry of Finance, and the State Privatization Committee (GKI), outstanding scientists, as well as legal experts in the domain of housing rights and housing reform. The World Bank was notified about the results and assessments of the aforementioned meeting in a letter signed by Alexander Krivov, first Deputy-Minister of Construction of Russia. The structure of the study reflects the wide variety of aspects to this issue. The three parts (8 chapters) of the main text (historical survey, housing reform strategy, progress achieved and recommendations for the future) are preceded by a summary which provides a brief overview of the content of the entire work as well as the author's point of view on the development of and prospects for housing reform in Russia. The study is supplemented by extensive statistical data, the collection of which was no small effort for the authors, given the chaotic economic conditions in Russia in 1991-1992. The study is based on analysis of the economic situation in Russia, legislative and regulatory acts and statistical data covering the period from 1991 to the first half of 1993, although it was completed in 1994. Therefore, it is especially interesting to see the extent to which the estimates, projections and recommendations contained in the report have come true and proven to be useful by the time this foreword was written, i.e. the beginning of 1995. This should provide an objective criterion on the value of this work for the broad circle of Russian professionals dealing with the scientific, legal, and practical aspects of implemening housing reform in Russia. In this regard, the concluding part of the executive summary is of special interest. It presents a table showing all the aspects of housing reform and provides an analysis of each in terms of its initial stage and the decisions already taken, and recommendations for further Ivi measures which the author views as necessary in the short term, the coming year, the medium term (5 years), as well as the final goal attainable in the long term. The two years following the period of the study have verified that a significant portion of the forecasts and recommendations contained in the report have in practice been realized, although some of them with a discemable lag. A significant amount of legislative work has taken place in Russia. During the period between 1993 and 1994 about 40 laws and regulations have been adopted with the goal of bringing housing reform to life. The first part of the Civil Code has been approved; it defines procedures for the execution of real estate transactions, and defines the rights of ownership and other property rights in the housing sector. In 1995 a Federal meeting is expected to adopt Housing, Urban and Land Codes, and laws on mortgages, registration of real estate, condominiums, functional zoning of territories, drafts of which have already been prepared. The authority of regional and local governments of the Russian Federation over decisions concerning all housing issues has been greatly expanded. Since the end of 1994, already more than half of all the housing in Russia was under private the ownership of citizens and legal entities. Budgetary allocations and subsidies for housing construction have significantly decreased, while the utmost encouragement has been given to extra-budgetary investments in housing. In 1994, only 22% of all new housing was built with federal budgetary funds, whereas the share of housing built with private and mixed finance was 61 %. In the majority of the Russian cities, reform of rent and utilities fees, in coordination with of social safety measures for the low-income population, has begun. Commercial banks have demonstrated interest in financing housing construction. They open targeted housing accounts, issue securities, and establish mortgage banks. The overwhelming majority of construction and constructing materials enterprises have been privatized. Investor tenders and contractor bids are being conducted. Private housing maintenance and rehabilitation firms have emerged. At the same time, some of the recommendations of the report, while theoretically sound, do not seem to fully take into account the Russian mentality, formed over many decades. Related to this, the expediency of their implementation in Russia is not universal and may mean that the realization of these recommendations will be accompanied by difficulties or may require a longer time period. This refers to the unrestricted right of ownership for urban land, the rationale for moving enterprises from industrial zones already existing in large cities to new areas, the pace of privatization of housing, and the share of private housing, which, most probably, will not exceed 65-70%, following the pattern of European countries, as well as some other issues. More time appears to be necessary to create a state register of real estate, a clear-cut system of foreclosures, extensive imnplementation of rent-based forms of tenure and use of housing, as well as a number of other aspects of housing reform. lvii Above all, the dynamics of implementation of various reconmendations will depend to a great extent on the pace of transition to the market economy in Rusia, economic growth, the reduction of inflation, fiail stabilization, and increag invesbnent acdvity. In any event, Russian professionals will read and study this fumntl wok with great attention, interest and gratitude to the World Bank and the ors. David G. Khodzhaiev Editor of the Russian edition Deputy-Chief of the Department of Housig PoUlcy of the Ministry of Construction of Russia Corresponding Member of the Rusian Academy of Architecture and Constrution Scienes Moscow, April 1995 lix ACTIONS OF THE GOVERNMENT OF THE RUSSIAN FEDERATION IN THE HOUSING SECTOR Enactment of two laws: "Revisions and Amendments to the Law of the Russian Federation (RF) On Privatization of the Housing Stock in the RF" (No. 4199-1 of Dec. 23, 1992) and "Fundamentals of Federal Housing Policy" (No. 4219-1 of Dec. 24, 1992) late in 1992 should be considered the real start of the housing reforn in Russia. By the beginning of 1993 the primary regulatory base of the new housing policy was created; the basic objectives are briefly stated as follows: 1. Gradual transition from allocation of housing built by the state centralized capital investments to sales of housing to individuals or legal entities for their own funds, but the state will maintain the right to allocate housing from state or municipal housing stock in accordance with the norms and privileges established by the law to low income and socially insecure citizens free of charge or for an affordable charge. 2. Increase of the share of private existing housing and housing under construction owned by individuals and legal entities; enforcement of the system housing construction loans and allowances and formation of the housing market; mechanisms of housing sales and rent will be one of the conditions for realization of the free will of citizens to select residence, job and activity. 3. The gradual reform of the system of housing rent and communal services charges with simnultaneous introduction of targeted housing allowances along with ensuring of maintenance and repaid of the housing stock, and transfer to complete self-sustaining housing sector in the long run. 4. A gradual conversion of the ratios of the housing construction by types and structural systems; an increase in the share of low-rise buildings, including individual houses, with the appropriate change in structure of production base of the housing construction; decrease of energy requirement for coiistruction and operation of housing, improvetnent of the functional, architectural and aesthetic and urban planning qualities of dwelling houses and complexes with strict adherence to the environmental regulations. The objectives listed above were developed in the State targeted program "Dwelling" approved by the Resolution of the Government of the RF (GOR) No. 595 of June 20, 1993. What is fundamentally new in these initial documents of the housing reform - Laws and Program? The forms of realization of the right of citizens to housing are clearly stated by Article 40 of the Constitution of the RF as: application of the existing system of allocation of housing to low income and other groups of population envisaged by the law under the lease agreement within the established norms; construction or purchasing of housing for personal resources without restrictions as to the space; rent of housing as a new form of realization of the right to housing which essentially is a type of leasing of housing from its owner under agreement. lx A number of definitions of important terns are given to be used in the housing reform regulatory acts such as "housing sector," 'real estate in housing sector," "housing stock," "social norm of housing space," "lease agreement," "rent agreement," "condominium," "compensations (allowances)," "developer." The housing stock is clearly classified by forms of ownership: private housing stock owned by citizens or legal entities; state housing stock including enterprise housing, municipal housing stock including enterprise housing, public housing stock, housing stock owned collectively. It is established that the social housing and condominium (association of owners in a single complex of real estate in the housing sector) are introduced. It is established that the social norm of the size of housing is defined locally, depending on the achieved level of available housing, family size and some other factors. It is established that transition to payment for housing and communal services under the lease agreement within the amount allowing to recover the housing maintenance, repair and services costs will be accomplished gradually within a period of 5 years with provision of allowances (subsidies) to low-income citizens. A procedure for the use of communal apartments and a new procedure of exchange of housing space of any type of ownership are established. Provisions are made for the citizens to obtain compensations (allowances), credits (including mortgage) and loans for the realization of the right to housing. Tax privileges are ensured to citizens and enterprises, institutions and organizations producing or purchasing housing. A course to increase the share of low-rise (including individual) housing was undertaken which will require restructuring of a large amount of housing construction enterprises. After enactment of the above laws it became clear that their application is impossible without a mechanism of implementation which will require additional regulatory acts. Within less than a year and a half several dozen of such documents have been enacted. In Sept. 1993 the Resolution of the GOR on the transition to a new system of pavment for housing and communal services and procedures for provision of compensations (allowances) to citizens for housing and communal services pavments (No. 935 of Sept. 23. 1993) was approved. The established norm for housing and services expenses (within the norm for housing space and services) is 10% of the total household income in 1994, 15% in 1995 and 20% in 1998; compensation is provided to those ciizens whose expenses exceed the norm. By December 1993 when the annual housing commissioning results and the federal budget possibilities to fmance housing construction became known, it became clear that since the budget allocations are limited, the housing construction finance and crediting became the key issues of the housing reform. lxi The Decrees of the President of the RF No. 2281 "Development and Implementing of Non- Budgetarv Forms of Investments in the Housing Sector" is of major importance. It clearly states a number of options for non-budgetary housing finance. The first to be approved was the Resolution of the GOR No. 1278 on approval of provisions for subsidies to citizens who need improvement of housing conditions for housing construction or purchase. This Resolution envisages fundamentally new forms of state support of the citizens who need imnprovement of the housing conditions and who can afford to use part of their own resources for this purpose. It was decided to provide those in need of improvement of the housing conditions with subsidies in the amount of 5 to 70 percent of the average construction of sales price depending on the income of the household per capita and the date when this household was registered on the waiting list. To accelerate the process of subsidizing in the localities, Gosstroy of Russia and Ministry of Finance of Russia (Minfm) worked out an approximate list of documents that citizens are requested to submit when applying for a subsidy and samples of those documents were published, along with a detailed explanatory note in magazine Economy and Life No. 12" in March 1994. The Order of the GOR No. 962-p of June 22, 1994 orders the Ministry of Economy of Russia (Mineconomy) and the Minfm to envisage in the Federal investment program for 1994 a separate item for centralized capital investment in the amount of 600 billion rubles for these types of subsidies. Special bodies were formed in a number of regions to service the subsidies, appropriate resolutions were adopted and the process of subsidizing has started. As of September 12, 1994 the Mineconomy had received applications for 61 subjects of the RF and 25 ministries and institutions. More than 116 households expressed their wish to obtain free subsidies for a total amount of 6.5 trillion rubles which will require a capital investment of 12.4 trillion rubles and commissioning of more than 7 million sq.m of housing area. The Minstroy of Russia works on the analysis of data, prepares appropriate recommendations on the basis of the positive experience. The second option for the introduction of non-budgetary sources of finance to the housing sector is the establishmnent of the regional and local housing development funds. On the 15th of June, 1994 the GOR approved the Resolution No. 664 "Model Procedure for Establishment and Use of Regional and Local Non-Budgetary Housing Development Funds." The procedure for the creation of these funds has been established, along with their main tasks and guidelines for the use of the funds. According to the available information many subjects of the RF and separate cities made decisions on establishing regional or local housing development funds, approved the fund charters that were worked out on the basis of the Model procedures with consideration of local specific conditions. Ixii The third option for use of non-budgetary funds in the housing sector is connected with the Decree of the President of the RF No. 1180 "Housing Credits" of June 10, 1994. This Decree states that besides subsidies for construction and purchase of housing, citizens and legal entities may obtain loans for construction (rehabilitation) and purchase of housing as well as for land development for housing construction. "Provision on Housing Credits" was approved to provide three types of credits: (a) short or long-term credit for acquiring and development of land for housing construction (land credit); (b) short-term credit for construction (rehabilitation) of housing (construction credit); (c) long-term credit for acquisition of housing. A variable interest rate, adjustment of the principal debt, deferment of credit repayment can be used as the credit tools under which the conditions of high inflation will make the credits affordable for a broader group of population and reduce the risks of the banks. The housing credit system so far covers mainly the high-income sector of population because the existing interest rate is high and the credits terms are short. The housing mortgage system will substantially increase the number of citizens and legal entities who will be able to get the housing credits. The Presidential Decree on implementation of non-budgetary forms of investment envisages establishment of a federal agency of housing mortgage. This not yet fulfilled assignment is of tremendous importance for acceleration of the housing reform implementation as the experience of many countries show. Despite the fact that the Law "On Mortgage" has not yet been enacted, a number of the subjects of the RF started to develop the housing mortgage system on the basis of the local decisions. In Yaroslavl, housing loans are given against collateral for 10 years at 26% interest rate with adjustments; similar experience have Altai krai, Sverdlovsk oblast and others. Substantial agitation of the housing crediting may be expected if the taxation system is changed by tax exemption of the bank income from housing credits as it was proposed by the Minfm and Minstroy to the GOR on June 15, 1992. Issuance and circulation of housing certificates envisaged by the Presidential Decree No. 1182 of June 1994 is an important option for attraction of non-budgetary funds and free funds of citizens and legal entitles in particular to housing construction. Enterprises and organizations that have a right to be a zajazchik for housing construction, a right to a land plot and housing design documents as well as legal entitles to which all above rights are transferred in the established order can become emittents of the housing certificates. A housing certificate is a special type of bond, the face value of which is set in units of total housing area and its monetary equivalent. A housing certificate certifies the right of its owner: lxiii - to get the adjusted face value of the certificate from the emittent immediately upon the request; - to enter into an agreement with the emittent on getting an apartment provided the housing certificates cover not less than 30% of the apartment cost and the rest of the cost is paid for in any way. In accordance with this Decree the GOR received proposals on the taxation procedure for the housing certificate transactions. The Minstroy prepared the draft Instructions on issuance. circulation and repavment of housing certificates and sent it to the Minfin. At the moment the instructions are approved and will be enacted in the near future. Enactment of the Presidential Decree encouraged a wide spreading of the practice of issuance of housing securities in a large number of regions and cities of Russia (Nizhniy Novgorod, Irkutsk, Moscow, Samara, Ryazan, Tver, Kirov, St. Petersburg, etc.) which ensures protection of the investors from unfaithful emittents and lowers the risks of commercial organizations ready to realize the housing certificates by housing development. The above regulatory acts created a sound regulatory foundation for replenishment of the capital investments to housing development at the expense of the non-budgetary sources. But to implement this in practice in the localities, it is necessary for the banks to get economical benefits from lending and the borrowers from borrowing of the housing credits; and for the developers to benefit from issuance and citizens and legal entities from buying of the housing certificates. Under the market conditions there is only one way to gain such benefit - by setting certain tax exemptions so that relatively low losses of the federal budget caused by these exemptions could be multiple-fold covered by the cut of direct budget the housing construction allocations and replacement of the latter by the non-budgetary funds. Decree of the President of the RF "Measures for Completion of Unfinished Housing Construction" No. 1181 of June 10. 1994 is also very important for the implementation of the State targeted program "Housing" and for overcoming recession in the housing commissioning. To implement this Decree, Minstroy and the State Committee of Property (GKI) prepared and approved the Order of the GOR No. 1387-, of August 29. 1994 which authorized the Minstroy to be the primary zakazchik of unfinished housing construction in cases when former zakazchiks were the federal executive bodies, organizations and institutions financed by the federal budget. The Department of the housing policy of the Minstroy formed a special operative unit to fulfil these functions; a letter to the subjects of the RF, ministry and institutions was prepared dealing with the initiation of the investment and commercial biddings for unfinished housing construction. A resolution of the GOR No. 743 "State Su22ort of the Cooperative Housing Construction" was a2oroved on June 22. 1994. Ixiv The procedure approved earlier for 70 percent compensation for the housing expenses increase to the low-income households and to those who are on the waiting list is now applied to the cooperative housing construction at the expense of the federal and local budgets (equally shared). On July 8. 1994. the Decree of the President of the RF No. 1485 "Implementation of the Prograin of the Housing Construction for the Russian Military Withdrawn from Germany" was aDroved. At the moment within this Program 13000 apartments are ready, another 14000 apartments are expected by the end of the year and the last 8000 apartments in 1995. The GOR has an assignment to make decisions for providing the participants of the Program with tax credits until the end of the current fiscal year by various types of taxes and compensations and before Sept. 1, 1994, to submit to the State Duma of the Federal Assembly a draft law on complete tax and fee exemption of the Program. It is also recommended to the state bodies of the subjects of the RF and to the local governments to make decisions on exemption of the participants of the Program of the State taxed and fees. The state tax service of the RF by its letter No. BG-4-16/81H of July 15, 1994, ordered the state tax inspection to suspend charging of taxes to the federal budget and financial sanctions for violation of the tax regulation up to the moment of revision of the tax legislation, and to submit proposals to the local governments on exemption of the Program participants from the established taxes and fees. Similar actions were made by the Department of tax police of the RF (letter No. BR- 1347 of Aug. 23, 1994). On July 20, 1994, the State Duma of the Federal Assembly approved the Law "Revisions and Amendments to Separate Laws of the RF on Taxes and Exemptions to Obligatory Payments to non- budgetary state funds." It may be signed after the approval of the council of the Federation, that is after the parliament vacations in October this year. At the moment the German side pending the Law does not approve next contracts within the framework of the Program and suspends construction waiting for the complete settlement of the legal issues. On July 8. 1994. the President of the RF signed Decree No. 1486 "ImRlementation of the Program of Housing Provision for the Russian Resigning Military financed from the Grant Drovided by the US Government." The Minstroy, along with USAID, implements this grant though American and Russian companies - winners of the bidding. The Program envisages construction of 2500 dwelling units and issuance of certificates with average value of US$25000 for purchase of another 2500 apartments. At the moment 500 certificates are ready for issuance; in cooperation with the Ministry of Defense of Russian and local administrations the regions for sales of apartments for certificates and for construction of the rest of the apartments are identified. The tax and fee exemption of the grant transactions envisaged by the Decree of the President of the RF and the Agreement between the Governments of the RF and USA will be effective either after the Council of Federation approves and signs the Law already approved by the Duma or after the State Duma ratifies the inter-governmental Agreement mentioned above. lxv Currently the Minstroy together with the Ministry of Justice, Minfin and other interested ministries and institutions of the RF completed the first stage of preparation of the drafts of two most important laws "Housing Code of the RF" and Law "On Condom iiums" that are now presented to the GOR for consideration. To ensure even financing of the housing development, the GOR made a decision on attracion of funds of commercial banks to the housing development against guarantees f the Minfin. In a munber of regions this process is already being implemented. The above regulatory acts will make it possible to expand attraction of the non-budgetary sources of fiance to the housing sector, increase the amount of commissioned housing at the expense of the completion and commissioning of the unfinished housing construction, they will ensure acceleration of the implementation of the housing reform. Besides the above regulatory acts, the Minstroy adopted a number of institutional regulatory acts supporting the implementation of the housing reform. The Minstroy intends to discuss the progress of implementation of the State targeted program "Housing" and the results of introduction of the non-budgetary sources of fiance to the housing sector at the end of November at the meeting of the Interministerial council of architecture, construction and housing maintenance in Barnaul. The list of the regulatory acts related to the implementation of the housing reform is attached. lxvi COMMISSIONING OF HOUSING IN THE RUSSIAN FEDERATION BY ENTERPRISES AND ORGANIZATIONS OF ALL TYPES OF OWNERSHIP Enterprises and organizations Commissioned in 1993 Commissioned in Jan. - June, 1994 Thou. sq.m as % of share in total thou. sq.m of % of Jan.- share in total of total area 1992 amount total area June, 1993 amount Total 41808.2 100.7 100 10608.8 92 100 including: State property 15030.4 94 36 3458.5 90 32.6 including: 11736.0 federal property 3294.4 95 28.1 2949.9 98 27.8 property of subjects of RF 90 7.9 508.6 60.2 4.8 Municipal property 6954.9 108 16.6 1166.3 61.9 11 Property of public associations 79.2 111 0.2 12.0 38.9 0.1 Private property 10248.5 102 24.5 2683.6 103.4 25.3 Mixed Russian property 9495.2 98 22.7 3288.4 84.9 31 without foreign participation lxvii PRIVATIZATION OF THE HOUSING STOCK IN THE RUSSIAN FEDERATION as of Jan.-June 1994 Number of privatized apartments: from the beginning of privatization 9,961,658 (29.4%) in Jan.-June 1994 1,421,050 ( 5.6%) Number of privatization applications 1,543,015 Total area of privatized apartments 67,746.2 thou.sq.m Average size of privatized apartments 48 sq.m Total cost of privatized apartments 749,241.2 million Rb Number of sold vacant apartments 5,917 Including those sold to organizations 1,926 Their total area 335.4 thou.sq.m Sales price of sold apartments 57.355 million RB lxix LIST OF LAWS AND REGULATIONS RELATED TO HOUSING REFORMS I. LAWS OF THE RUSSIAN FEDERATION 1. Constitution of the Russian Federation, Enacted by the national referendum on December 12, 1993. Articles 25, 40, 72 para. "k. " 2. "On the Privatization of the Housing Stock in the Russian Federation," as of July 4, 1991 (Vedomosti of the Supreme Council of the RSFSR, 1991, #28, artick 959). 3. "On Introduction of Changes and Amendments to the RSFSR Law "On Privatization of the Housing Stock in the Russian Federation" as of December 23, 1993 # 4199-1. 4. "Fundamentals of Federal Housing Policy" as of December 24, 1992 #4219-1. 5. "On Introduction of Changes and Amendments to the Russian federation Law "On Privatization of the Housing Stock in the Russian Federation" as of August 11, 1994 #26-F3. II. DECREES OF THE RUSSIAN FEDERATION PRESIDENT 6. 'On Measures to Ensure Citizens Rights to Housing" as of April 9, 1993 #4427. 7. "On Approval of Temporary Provisions on Condominium" (Temporary Provisions) as of December 23, 1993 #2275. 8. "On Development and Introduction of Non-Budget Forms of Investing Into the Housing Sector' as of December 24, 1993 #2281. 9. "On Housing Credits" ("Provision on Housing Credits") as of June 10, 1994 #1180. 10. "On Measures to Provide for Completion of Unfinished Apartment Houses" ("Provision on Procedure for Transfer of Unfinished Apartment Houses for Completion of Construcion Work and the Sale Thereof) as of June 10, 1994 #1181. 11. "On Issue and Circulation of Housing Certificates" ("Provision of Issue and Circulation of Housing Certificates") as of June 10, 1994 #1182. 12. "On Implementation of the Program of Housing Construction for the Russian Military Withdrawn from Germany" as of July 8, 1994 #1485. 13. "On Implementation of the Program of Housing Provision for the Russian Resigning Military financed from the Grant Provided by the US Government" as of July 8, 1994 #1486. Ixx m. REsOLUnIONS OF THE RUSSIAN FEDERATION GOVERNMENT 14. "On the State Targeted Program 'Housing' (State Targeted Program 'Housing," Provision on Set Up of the Interministerial Commission for Implementation of the Program 'Housing.'") 15. "On Acceleration of Commissioning Unfinished Apartment Houses" as of June 20, 1993 #569. 16. "On Considering Invalid and Introduction of Changes in Some of Resolutions of the Russian Federation Government Related to Enactment of the RF Law" On Fundamentals of Federal Housing Policy" as of June 23, 1993 #726. 17. "On Transition to a New System for Rent and Communal Services Payment and the Procedure for Providing Compensations (Subsidies) to Citizens for Rent and Communal Services Payment" ("Provision on Procedure of Allocation of Compensations (Subsidies) for Rent and Communal Services Payment" as of September 22, 1993 #935. 18. "On Approval of the Regulations on Allocation of Allowances (Subsidies) Free of Charge for Construction or for Purchase of Housing to Citizens in Need to Improve Housing Conditions" as of December 10, 1993 #1278. 19. "On Additions to the Resolution of the Council of Ministers - Government of the Russian Federation as of September 22, 1993 #935" as of December 23, 1993 #1329. 20. "On Privileges to the Clients of Sberbank of the Russian Federation Getting Lumpsum Allowances for Housing and Communal Services Payment" as of February 18, 1994 #124. 21. "On Approval of Sample Provisions for Forming and Using Regional and Local Non- Budget Funds for Housing Construction Development" as of June 15, 1994 #664. 22. "On Measures of State Support for Restructuring of Housing Construction Production Base" as of June 19, 1994 #664. 23. "On State Support of Cooperative Housing Construction" as of June 22, 1994 #743. 24. "On Signing the Agreement between the Russian Federation Government and the United States Government of Provision of Grant for the Program of Housing Construction for the Russian Resigning Military" as of July 28, 1994 #875. IV. INSTRUCTIONS OF THE RuSsIAN FEDERATION GOVERNMENT. 25. "On Priority of Financing of the State Programs for Housing Construction for the Resigning Military" as of May 6, 1994 #670-r. lxxi 26. "On Changes in the Membership of the Intergovernmental Group for Implementation of the State Targeted Program 'Housing.'"as of May 25, 1994 #782-r. 27. 'On Allocation of Centralized Capital Investments for Provision of Subsidies for Housing Construction or Purchase" as of June 22, 1992 #962-r. V. MINISTERIAL REGULATIONS. 28. "Provisions of Procedure of Establishing Contractual Relations in the Municipal Economy" approved by the former Roscommunkhoz as of May 17, 1993 #1-1. 29. "Sample Provisions on the Customer Service for Rendering Housing-Communal Services within the System of Local Councils of People's Deputies" approved by the former Roscommunkhoz as of August 21, 1993. 30. "Methods of Calculation of Economically Feasible Rates and Tariffs for Housing- Communal Services" approved by the former Roscommunkhoz as of November 9, 1993 # 56. 31. "Methods of Determining Standards for Consumption of Housing-Communal Services" approved by the former Roscommunkhoz as of November 22, 1993 # 60. 32. "On Fulfillment of the Program 'Housing," Restructuring of the Construction Production Base and Implementation of Commissioning of Civil Construction Projects Targets in 1993." Resolution of Gosstroi of Russia as of November 26, 1993 #2. 33. "On Modern Trends in City Planning and Housing Policy of Russia." Resolution of Gosstroi of Russia as of February 22, 1994 #1. 34. "On Tentative List and Forms of Necessary Documents to be Presented by Citizens when Submitting Applications for Housing Construction or Purchase Subsidies." Letter of Gosstroi of Russia and Minfin of Russia as of March 3, 1994 #BE-19-6/9. 35. "On Approval of Tentative Provisions on Procedure of Competitive Selection of Housing Maintenance Enterprises for State and Municipal Housing Stock Maintenance and Repair." Resolution of Gosstroi of Russia as of April 1, 1994 #18-24. PART I THE BACKGROUND OF REFORM CHAPTER 1 THE CONTEXT OF RUSSIAN HOUSING REFORMS Table of Contents I. BACKGROUND ..................................... 1 I. HOUSING POLICY IN RUSSIA, 1917-1990 ..... ............ 2 A. The Pre-revolutionary Period ....... ................. 2 B. First Years of Soviet Government, 1917-1920. 3 C. Impact of the New Economic Policy (NEP), 1921-1928. 4 D. Development of Housing During Industrialization, 1929-1955. 5 E. The Search for a New Housing Policy, 1985-1990. 9 m. BASIC FEATURES OF THE RUSSIAN HOUSING SYSTEM .10 IV. CURRENT CONDITIONS IN THE HOUSING SECTOR .13 CHAPTER I THE CONTEXT OF RUSSIAN HOUSING REFORMS I. BACKGROUND 1.1 The Russian Federation, spanning eleven time zones and covering 17 million square kilometers, is geographically by far the largest country in the world. About one quarter of its territory falls in Europe and the remainder in Asia. It runs 4,000 kilometers from north to south and 9,000 kilometers from west to east. The northernmost part of the country is arctic desert and tundra; south of the tundra stretch enormous forests, then the steppes, and finally the deserts of Central Asia. The bulk of the population and economic activity is located in the plains of the West and European Russia. This is the most densely populated region of Russia. In terms of natural resources Russia is a very wealthy nation. Although natural conditions (inadequate warmth, inappropriate moisture, permanently frozen subsoil) constrain Soviet agriculture, the country nevertheless has a substantial endowment of good agricultural lands. The best known agricultural land is the black earth zone in West Central Russia. Most of the natural wealth is located in areas of inhospitable natural conditions. The bulk of new raw materials is in Siberia, with its harsh climate and transportation problems. 1.2 The Russian Federation is characterized by a high degree of regional and cultural diversity as well as a complex administrative/political structure. It comprises 16 autonomous republics, 6 territories, 49 regions, 5 autonomous regions, and 10 autonomous areas. For broad reference it is convenient to consider that the Federation has 88 major administrative regions including two cities of special status: Moscow and St Petersburg. These regional units vary greatly in terms of land area, accessibility and urban population density. Russian regional diversity is also reflected in the ethnic composition of the population. The total population is almost 149 million people, of which 83 percent are Russian. The writers of the Russian Federation write in 50 languages. 1.3 Urbanization is another important aspect of Russian regional development. The urban transformation has been extremely rapid. In 1926, just before the beginning of the Stalinist industrialization drive, only 18 percent of the Russian population was classified as urban. Today, the Russian Federation is a fully urbanized country with 74 percent of its population living in cities. The rural working population is only 15 million workers. The Russian urban system has 1,030 cities and towns. Its capital Moscow has almost 9 million residents. Urban concentration in large cities is less marked than in market systems: the share of urban population living in cities over a million is only 26 percent. In Russia this outcome was achieved in part through administrative control of population movements with internal passports and a rigid residency permit -- the propiska -- without which housing could not be obtained. 1.4 The strategy for economic growth in Russia and the rest of the Soviet Union was established in the First Five Year Plan of 1928, and remained fundamentally unchanged for the next 50 years. The approach centered on accelerated industrialization, required the rapid 2 Chapter 1 mobilization of capital, labor, and material inputs, with lesser emphasis being placed on their efficient use (so-called extensive development). The services sector -- an integral part of a city was constrained. With over 90 percent of production brought under direct state control, and the coordinating role of markets almost entirely suppressed, the implementation of the broad economic objectives required detailed, centrally-determined plans for inputs and outputs of all branches of the economy. To facilitate monitoring, branch ministries were established along sectoral lines. Annual plan targets were allocated amongst the individual enterprises under the control of sectoral ministries. In general the primary target was specified in terms of the physical volume of production such as millions of square meters of housing floor space. Private economic activity was strictly circumscribed by law. II. THE SOVIET LEGACY: HOUSING POLICY IN RUSSLA, 1917 - 1990 A. The Pre-revolutionary Period The Development of the First Urban Housing Crisis 1.5 Pre-revolutionary Russia was a country with a much lower degree of urbanization than the advanced European countries of that time: by 1914 only one-sixth of the population lived in cities. The majority of these urban dwellers had moved from the countryside between 1850 and 1914, on the wave of the rural-to-urban migration that accompanied the process of rapid industrialization during this period. The massive migration caused the urban population of Russia to triple. Thus, the urban housing crisis had arrived and developed already a few decades before the revolution. 1.6 The dimensions of this crisis can be measured by the extent of the overcrowding and shortage of municipal services such as sewerage and water supply. In 1912 in St. Petersburg and Moscow, roughly nine people lived in each apartment, while in the European cities such as Berlin, Vienna and Paris the numbers were 3.6, 4.2 and 2.7, respectively. At least a quarter of the apartments in these two cities did not have either running water or sewerage facilities. Moreover, the dominant building material was wood, not stone, even in St.Petersburg, which made housing susceptible to frequent damage by fire. Though most of the housing stock was privately owned, large enterprises in industrial regions built accommodations for their workers; conditions in such communal "bunk and closet" dwellings were particularly squalid."' The Urban Crisis and Local Administration 1.7 The municipal authorities were not well equipped to deal with the rapidly changing circumstances. While the legislation of 1870 granted municipal governments limited autonomy, I/ By 1900, 35% of the entire population of St.Petersburg lived in "bunk and closet" accommodations, basements and attics. Chapter 1 3 they faced increased fiscal responsibilities and very low per-capita revenues as compared with major European cities. The regulatory bodies such as the architectural and planning commission established in the late eighteenth century no longer existed, and the Technical Building Committee set in 1885 to monitor the urban development proved to be utterly ineffective. By the end of the 1800's, zoning restrictions and architectural controls had collapsed. Finally, the urban crisis was compounded by the re-centralization of local governments following the Municipal Act of 1892. The central government did not intervene in the housing sector until 1914. In 1916, it enacted a Tenant's Protection Act, introducing rent control on the entire territory of the Empire. B. First Years of Soviet Government, 1917-1920 Nationalization of Land and Urban Housing 1.8 Upon assumption of political power, the Soviet government issued a host of decrees that introduced fundamental changes in all facets of political, economic, and social life. The key legislation involved private property. Land was nationalized, and along with it most of the urban real estate. In towns with over 10,000 inhabitants, residential buildings valued above locally set limnits could no longer remain in private ownership. Housing belonging to the nobility and the bourgeoisie was expropriated and redistributed according to the new space norms. The August 1918 decree sanctioned the ongoing expropriations by giving the local Soviets full discretion as to the municipalization of urban housing. The Emerging New Role of the Soviets 1.9 Organizations of workers which eventually evolved into Soviets appeared long before the revolution, and since 1905 their networks began to spread rapidly. At the onset of the USSR, the Soviets emerged as an eminent part of the new political reality. Their role as a grass-roots vehicle for public opinion was entrenched by the 1918 constitution for the Russian Soviet Federative Socialist Republic, on which the subsequent 1923 Union constitution was modeled. This entrenchment had imnportant consequences for municipal governments. The local Soviets and their executive committees (ispolcoms) were set as the effective decision-making bodies in their areas of jurisdiction. However, to assure control from above, the invoked principle of dual subordination made all local departments responsible both to the Soviet at their level and to the corresponding organizations at the next highest level. The Ffrst Rent Control Legislation 1.10 Immediately after the October Revolution, the payment of housing rent for specific categories of tenants and accomnodations was suspended. Subsequently, in July of 1919 rents in Moscow and Petrograd were frozen at the July 1 level. With high inflation, the value of rent quickly eroded. Moreover, the tenant committees set in 1917 to manage housing and carry out necessary repairs failed to prevent the rapid deterioration of the stock. Thus, during the first 4 Chapter 1 three years of Soviet power, due to the combined effect of nationalization and low rents, the housing stock as a whole diminished in size and fell into a state of disrepair. C. Impact of the New Economic Policy (NEP), 1921-1928 1.11 The NEP came after the end of the civil war, and was introduced to stabilize the economy, acceleiate the reconstruction and legitimize the new Soviet regime both at home and abroad. To achieve these goals, the government decided to allow some elements of free enterprise into the system. The NEP had also led to policy changes in the housing sector. The size of the housing stock continued to decline, and the government was not in a position to finance massive investments for the new house-building program envisaged to meet the rapidly growing demand. Thus, the temporary liberalization was necessary to enlist the participation of the private sector in providing both the adequate management of the existing stock and the capital for new construction. The NEP period was also an important phase in the development of what has emerged as a Soviet housing delivery system. The legislation enacted between 1921 and 1928 had formally established the basis for assigning urban housing. Linited Restoration of Properfy Rights 1.12 The legislation passed in 1921 and 1922 sought to restore a certain degree of private ownership rights. The laws enacted during this period reversed some previous property sequestering, and then finally allowed individuals to own and freely dispose of property that had not been municipalized. In 1924, individual builders were granted permission to build and lease residential and non-residential premises and charge free rent. Consolidation of Municipal and Departmental Housing Tenure 1.13 The municipal property of buildings was defined in the decree of May 1923. The following year the municipalization process had formally been terminated and from then on the expansion of that sector could only proceed according to regulations specified in the RSFSR Civil Code.2' Local soviets were also requested to register all municipal buildings. The Housing Census of 1923 listed a riere 17% of residential buildings as state property, but they already housed 38% of the urban population and in terms of value constituted 60% of the total urban stock. The distinction between the municipal and the departmental sector was made in 1925 legislation, whereby all nationalized buildings not forming a part of departmental stock were henceforth classified as municipal.3' 1.14 In 1925, the legislation once again confirmed the position of local soviets as the highest organs of state power in their territories. Their role as the main providers of housing was also 2/ These included new construction carried out by local soviets or dwellings confiscated in specific cases such as an unauthorized use. 3/ Departmental stock includes building belonging to industry, transport, ministries, etc. Chapter l 5 reaffirmed. A January 1928 decree "On Housing Policy" made the local soviets and enterprises responsible for new construction, but stipulated that in large cities the new construction should be carried out predominantly by local soviets. The Establishment of Rental LegisWaion for the State Sector 1.15 During the period between 1921 and 1922, the Soviet govermment experimented briefly with rent-free housing. This option proved impractical and the payment of rents was restored. The amount of rent to be paid in the state housing, departmental, or local soviet was established in 1926. Some modifications were introduced by the subsequent legislation of May 1928. It has to be stressed that rents were originally calculated to cover maintenance costs and depreciation. In later years, ideological and political reasons for keeping the housing rents low took priority over economic considerations. Neither the basic fixed tariffs nor the ceiling of the 13.2 kopecks per m2 established in these decrees had been changed since the 1920's until 1992. The Emergence of Housing Cooperatives 1.16 The legislation of August 1924 established two types of housing cooperatives: the leasing cooperative and the construction cooperative. The creation of the first type was a response to the vastly inadequate maintenance of the existing housing stock and the failure to organized tenants to improve management of their dwellings. By the end of 1926, two-thirds of the local soviets' housing was rented out to leasing cooperatives. The construction cooperatives were expected, along with the private sector, to help the state alleviate the housing crisis by attracting capital from individuals, which could be invested in new housing construction. D. Development of Housing During Industrialzation, 1929-1955 1.17 At the beginning of the 1930's, the Soviet govermnent embarked upon a program of rapid industrialization of the country. The foundation of this strategy was the central coordination of investment, executed through the system of five-year plans, the first of which was launched in 1929. The concentration of investment resources on heavy industry under state control relegated all other sectors, including housing, to a low priority. The overall contribution of the private sector was severely curtailed. The housing sector policies were also reassessed. The Shitfrom Private to State-Financed Constucdon 1.18 The suppression of private house-building after 1928 was closely tied to the policy of eliminating the rich peasants -- kuhks - as a class in agriculture. In 1930, the govermnent suspended the individual builder's access to credit and building materials, and the acquisition of land plots became difficult. Private building for rent stopped. Private urban construction for one's own use continued to decline, both in absolute and relative terms, throughout the two five- year plan periods. The private contribution to new urban construction fell from 54.2% during 1927-1928 to 9.1% in 1933-1937. 6 Chapter 1 1.19 The concentration of house-building resources under state control, apart from being considered economically and administratively more efficient, was also forced by technological considerations. The main premise of the government's new housing strategy was the industrialization of the construction industry and the widespread use of standardized prefabricated components in house building for the assembly line production of housing. The Increased Role of the Departmental Sector 1.20 With the onset of industrialization and five-year plans came the rapid development of the new housing construction by industrial and transport enterprises. Their share in publicly funded investment rose from 52% during the period of 1924-1928 to 76% during 1933-1937. By the end of 1930's, the bulk of all housing investment was channeled through the departmental sector. As indicated earlier, the term "departmental housing" refers to a work unit may be either a state enterprise or some other state institution or organization. The Legislation of October 1937 1.21 The laws enacted in October 1937 established the framework for the housing delivery system which continued until the 1980's, even though particular regulations were revoked or amended. The main responsibility for the administration of the existing stock and new construction was assigned to the state, with the private sector relegated to a residual role. The legislation abolished all cooperatives, which were not reinstated until the 1960's. 1.22 Even though private house-building did not recover its significance from the NEP period, the 1937 legislation actually revived the sector by linking it with the industrial enterprise and departmental housing. Loans for private construction were now granted and channeled through enterprises. The relative share of the private sector's output in urban construction increased from 9.1% during 1933-1937 to 16.5% during the third five-year plan 1938-1941. The Housing Situation at the Onset of the Second World War 1.23 The outcome of the investment priorities of the 1930's industrialization strategy was a progressively worsening shortage of urban housing. The under investment in new housing construction, as measured by a meager 12.8% of the total capital investment during the five-year plan of 1933-1937, coincided with an extremely rapid pace of urbanization. The average annual increase of urban population between 1922 and 1940 was 4.6%. By 1950 the average amount of living space per person was less than four square meters -- less than one-half of the minimum established by the Soviet authorities in 1922. The Aftermath of War: The Policy Response to the Deepening Housing Crisis 1.24 The destruction caused by the war compounded the existing housing crisis. Between 1941 and 1945, approximately one-sixth of the country housing stock was destroyed and at least another sixth damaged. The government responded with a three-fold real increase of housing Chapter 1 7 investment in the first post-war five-year plan. At the same time, the share of housing in total capital investment rose to 19.4 percent. 1.25 In view of the shortage of funds, greater scope was once again granted to the private sector. Legislation of 1944 and 1948 reinstated the access to state credit and further promoted an employer's support for individual house builders, particularly in regions where government pursued an aggressive industrial policy. Local governments of all levels were required to provide land plots and public services. As a result of these measures, the relative share of urban private construction during the late 1940's rose to about 30% and continued at 25% of total output throughout the 1950's. Three Decades of the Soviet Housing Model: Policies of 1955-1985 1.26 The 1955-1985 years were a period of numerous changes in housing policy which were implemented without affecting the fundamental premises of the housing delivery system developed in previous decades. The ownership relations and ideological postulates as well as basic economic considerations remained largely untouched. At the same time, the shortcomings of central planning in general and the central planning of housing in particular were becoming increasingly evident. The persistent housing shortages had been only slightly alleviated by repeated government attempts at minor alterations in the basic housing delivery system. The Municipal and Departmental Sectors 1.27 The main theme of policies affecting the municipal and the departmental sectors was their continuous institutional conflict, of which housing issues are only a small part. The local soviets have traditionally been a weaker party. Indeed, in the national framework of economic and political decision making, city soviets have never held a very prominent position. The policy of priority industrial growth made it necessary for territorial planning to be subordinated to sectoral interests. 1.28 Over the three decades between the 1950's and 1980's, legislation repeatedly sought to give more power to local soviets and to create an environment in which they could more effectively exercise their legal rights. Three such decrees, enacted in 1957, 1971, and 1978 called for all non-city facilities such as enterprise housing and infrastructure as well and municipal service industries to be brought under municipal authority. The housing transfer policies, which continued throughout the 1980's, largely failed; the 1991 figures at the Federation's level show that the transfers by and large did not take place. The ministries and enterprises still controlled 59% of the urban housing stock and 64% of the total state-owned stock, while the remaining 36% were under the administration of the local soviets. 1.29 The same legislation that called for the centralization of control over the existing stock under the jurisdiction of local soviets, initiated a similar centralization policy for the development of new housing construction. This policy aimed at the concentration of municipal, enterprise, cooperative, and all other building activities under a "one zakazchik" system, 8 Chapter 1 whereby all state housing construction projects would be processed through one client -- an executive committee of a local soviet -- which in turn would use only one designer/planner and one building contractor -- a residential construction kombinat. The zakazchik rights were granted to local soviets by union legislation of 1957 and 1971, and then reinforced by several local decrees. This policy has also been carried out with a varying degree of success across cities but have functioned through 1980s with little change. The Cooperative Sector 1.30 The cooperatives, banned in 1937, were reinstated in 1958. The reason for their return was the ambitious housing program launched by the government in 1957 with the goal of eliminating mounting shortages within ten to twelve years. The cooperatives were legally reinstated in 1958, but the legislation had some serious shortcomings and the cooperative movement did not take off until 1962, when credit facilities were finally offered to cooperative members. However, their annual contribution to the housing stock over the years remained below expectations, rarely exceeding 10%. Even though the 1964 amendments allowed for cooperatives to be set up on state farms and rural areas, they remained a predominantly urban form of tenure. The Private Sector 1.31 The shifts in housing policy that marked the end of private sector's expansion throughout the 1950's came in 1962 and 1963. Restrictions on access to credit and land for private builders culminated in the 1963 legislation explicitly prohibiting private housing construction in cities with over 100,000 inhabitants. This law marked the beginning of the sector's decline which lasted through the mid-1980s. This downward trend was not arrested by the several attempts made by soviet legislators in 1960s and 1970s to revitalize private house building. In particular, the legislation failed to enlist the support of local governments, who made no effort to accommodate the prospective private builders. The sector's contribution to new urban construction dropped from about 32% at the beginning of 1960's to 7.9% in 1980. The Housing Situation by the mid-1980s 1.32 The volume of housing investment continued to increase beginning with the 1950s, but housing's share in total capital investment declined steadily, falling to a low of 13.4% in 1980. The increased level of investment did improve the overall housing standards as measured by the amount of space per person, which rose from 7.3 square meters in 1955 to 14.6 square meters in 1985. These global numbers, however, conceal large regional disparities in housing conditions. While there were areas with excesses of housing space, severe shortages persisted in many urban centers, where the waiting period for the allocation of a dwelling kept lengthening. Chapter 1 9 E. The Search for a New Housing Policy, 1985-1990 Economic Developments Under Perestroika, 1985 to 1990 1.33 Several piecemeal reforms introduced in the late 1970's and early 1980's failed to confront major weaknesses of the economy and arrest its secular decline. By 1985, the Soviet government began to outline the major restructuring of the economy which came to be known as perestroika. However, it took another two years of continued deterioration of the economic conditions for the actual systemic reforms to get underway. The initial effort was centered on the enterprise and foreign trade sector reforms. The administrative price system and the role of the Gosnab, the state distribution agency through which most of the material resources were allocated, remained unchanged. A two-tier banking system was created in 1988, but no major market-oriented reforms of the financial system had followed; interest rates on deposits and loans remained low and fixed. After 1988, both the domestic and external imbalances increased rapidly. The "Accelerated Solution to the Housing Problem " (Uskorenie) of 1986 1.34 In 1986, the 27th Congress of the Communist Party set forth an ambitious and -- given the country's economic situation -- unrealistic program for the acceleration of new construction and the elimination of housing shortages by the year 2000. This program, much as the initial perestroika campaign, was based on the restructuring and improvement of the existing model without major systemic changes. Its execution relied on municipal governments, which were instructed to carry out local needs assessment and subsequently develop local strategies. The program had some initial impact: the output increased both in 1986 and 1987, by 6.5% and 10.3%, respectively. The following year, however, the overall economic decline had reversed this trend. The Shift from Direct Government Investment to Enterprise Funds 1.35 The main change in the housing sector during the 1987-1990 period was the shift of investment financing from the state budget resources to enterprise profit-based funds. The shift was an aftermath of the 1986 Law on State Enterprises, which granted enterprises partial autonomy in allocation of their internally generated funds. While in 1987 about 8% of the new construction was financed by enterprise housing funds, by 1988 this share expanded to 36%. The Prvate and Cooperative Sector Legislation of 1988 1.36 By 1988, when the fiscal deficit reached 11 % of GDP, the housing sector started to receive more attention as a major contributor to the worsening budgetary imbalances. Consequently, the government initiated a switch in housing policy reminiscent of NEP. The strategy focused on private and cooperative sectors, through which the population's savings, some Rbs 283 billion, could possibly be tapped for new construction. The legislation enacted from March through December of 1988 gave a new impetus to both sectors. The facilitating 10 Chapter 1 regulations spanned all relevant inputs such as finance, land and infrastructure, and building materials. Loan conditions were improved, with increased loan ceilings and extended maturities. Loans could also be granted for purchase of individual homes. Local soviets were instructed to provide serviced plots to people who were interested in construction of own houses and would surrender their state-owned dwelling. Finally, credit lines became available to enterprises intending to start or expand production of building and finishing materials. The legislation also defined a new form of housing cooperative, one which is not concerned with construction. Members of such cooperatives could acquire existing housing through purchase of new or renovated buildings from either local soviets or enterprises. Th7e First Privatization Law 1.37 The decrees enacted through March of 1988 stipulated -- for the first time -- that residential buildings owned by local soviets or enterprises can legitimately be passed into private or cooperative ownership. These properties could be transferred with the initial payment of no less than 20% of assessed value to cooperative members and 50% to employees of enterprises, with the balance to be paid in installments over 25 years. By December 1988, the USSR Council of Ministers approved the privatization law whereby sitting tenants in both local soviet and enterprise housing could buy their flats as well as unoccupied flats in buildings undergoing capital repairs. The response to this first privatization law was very small. For example, in Russian Federation only 10,000 and 43,000 apartments had been sold in 1989 and 1990, respectively. III. BASIc FEATURES OF THE RUSSIAN HOUSING SYSTEM 1.38 At the time of the 1917 revolution, Russia was the least urbanized and most backward European economy with a level of urbanization of 16 percent. Today Russia's urbanization is essentially completed. Its system of cities has developed without any reference to private individual property, market mechanisms, private financing, and without the institutions associated with them. Compared to the urban systems found in market economies, the Russian housing system is extremely distorted. In fact, Russia has one of the most distorted housing systems, even among socialist systems regarding ownership, financing, rents, and maintenance, state monopolies over production, and the uniformity and quality of the stock. Economic Restructuring, Urbanization and Migration 1.39 Because Russia experienced its highest rates of urbanization after World War II, a high proportion of the housing stock is of recent vintage compared to European or US cities. However, this urban growth has been quite different from market economies since Russia has a relatively lower degree of urban concentration in large cities. The period of economic and political adjustment which Russia is now undergoing will cause significant flows of migration. Some residual rural-urban migration could also be expected if agricultural productivity increases to Western levels. However, city to city migration will dominate. However, because Russia Chapter 1 11 has a mature urban system, the emergence of new towns is not likely to be significant. Most housing and urban investment efforts during the 1990s should be directed to raising the international competitive capacity of existing Russian cities. Yet, there is considerable interest in Russia in using population control and distribution policies to favor small town development. This interest is motivated by deep environmental concerns. However, urban decentralization policies would be economically very inefficient and inconsistent with market-based growth, free mobility, and employment generation.4' The dachas, on which many urban Russians families lavish so much care and energy are not part of the regular permanent housing stock. They are seasonal residences only and are regulated accordingly. Their conversion to year-round use is also prevented by a lack of utilities, no social services such as schools or health facilities, and usually poor access to work with extremely long travel time requiring private means of transportation. Legal Framework 1.40 Certain aspects of housing policy in Russia have shown a remarkable amount of continuity over the past several hundred years. In particular, Russia has never had a strongly developed notion of individual land ownership. The second decree of the new revolutionary government in October 1917 abolished the private ownership of land. Before the end of 1917, all large residential buildings in cities had been nationalized. Also, Russia had long limited household mobility with institutions ranging from serfdom in medieval times to the current "propiska" residency permit system. Ownership Structure 1.41 Russia has the most distorted urban ownership structure among the main socialist countries. In Russian cities, 83% of the housing stock is under state control, by comparison with 67% in China, 56% in Poland, 33% in Romania, and 25% in Hungary. Cities like Moscow and St-Petersburg had almost 100 percent under state control in 1990.5' Shares of public housing in western countries are found at the opposite end of the ownership spectrum. In 1992, Russian state enterprises managed about 44% of all existing urban stock and dominated new production, despite a decades-old policy of encouraging transfer of enterprise stock to local governments. Much of enterprise housing has proven significantly more costly to operate than municipal housing and is often in a worse state of disrepair, which vary according to the profitability, scale and sector of the enterprise or work organization. 41 Note of the ussian Editor: The critical remarks of the author regarding the policy of small town development seem debatable. The unregulated concentration of population in very large cities leads to a deterioration of the environment, more expensive engineering and transport infrastructure, the growth of crime and drug abuse, as well as some other negative factors. 5/ Currently in Russia 52% of the housing stock is privately owned by citizens and legal bodies. 12 Chapter 1 Rents and Housing Prices 1.42 The Russian Federation also has some of the most -- if not the most -- distorted housing prices in the world in three ways. First, housing rents have been frozen since 1928 and are extraordinarily low. Second, the free market prices observed on the new auction markets of major cities do not bear any relation to the purchasing power of the average population. Third, the supply price of housing also appears to be severely distorted and does not reflect the true economic cost of the resources involved. Subsidies involved to support the present housing system are very large, untargeted, and very poorly measured. As a result of the extremely rigid rent control system, rent-to-income ratios are now below 1 %, by comparison with about 20% in typical market economies. By contrast, house-price-to-income ratios (PIR values) in the emerging urban markets are extraordinarily high compared to the purchasing power of ordinary households -- about 20 times average household incomes. Balanced and well-functioning housing markets have PIR values ranging between 2 and 3.5. Building Industry and Housing Maintenance 1.43 By any measure, the residential building industry in Russia is now in crisis: (a) In terms of total housing stock, in 1990, floor area per person in Moscow was 17.8 m2 and in Russia it was 16.4 m2, compared with typical floor areas per person in developed Western countries of 30 to 45 m2; (b) Looked at through the flow of new housing, production of new dwellings has decreased from the peak of 72.8 million m2 in 1987 to only about 28 million m2 in 1992; (c) Construction delays are endemic because of misplaced incentives to start new projects rather than finish existing works (see Chapter 8). In 1988, officially work-in-progress represented 84% of annual housing output; by 1990 it had reached 103%; while the estimate for 1991 had reached over 300%; (d) Construction costs have experienced explosive increases with price liberalization partly because the monopolistic system of production, distribution, and supply of materials has continued as before; (e) Housing finance, in the market sense of banking services, but has instead been mixed with state and enterprise budgets. Up to 85% of new building is financed directly from the budget or state enterprise; these budgets are now being drastically reduced; (f) The housing product itself is primarily large, high-rise, heavy, reinforced-concrete, panel apartment blocks. This assembly line technology is not liked and is just tolerated by most occupants as shown by surveys. It is of low quality, high cost, and energy inefficient. Development of alternative technologies, designs, skills, and materials have been neglected; (g) Repair and rehabilitation of the existing stock have been seriously neglected to the point where there may be a permanent loss of some of this stock unless corrective actions are taken soon. Land Use and Urban Efficiency 1.44 Under seventy years of socialist rule, city planning took on a distinct character that distinguished the modern Russian city from its market-style counterpart. Under the socialist system, ministries were given primary responsibility for industrial development; socio-economic planning considerations dominated over physical planning. Five concepts came to dominate Russian urban planning models: (1) the nationalization of all productive goods including real Chapter 1 13 estate and land; (2) normative rather than market-determined land use; (3) standardization of provision of urban services (intended to reduce segregation and increase the role of public transport); (4) dominance of cities in controlling social and economic change, and (5) centralized economic planning, implemented by numerous economic ministries. Because central-level and sectoral planning has dominated over spatial and local planning, urban infrastructure development and urban investment have been poorly coordinated. As a result, Russian cities have a lower level of economic efficiency and livability than could be achieved at the actual level of urban investment. IV. CURRENT CONDImrONS IN THE HOUSING SECTOR Effect of the Economic Crisis on the Housing Sector 1.45 The economic crisis which had been evolving since 1985 has now led to an accelerating of deterioration of housing conditions from an already unsatisfactory level along three dimensions: new housing production has dropped dramatically, maintenance of the existing stock has been severely cut back, and local government deficits related to housing have sharply accelerated. Decline in Housing Output 1.46 Housing production has been declining at an increasing pace between 1990 and 1992. The 1992 output was about 28% of the 1987 levels, because of inflation and major cuts in public outlays. There has also been a significant increase in the volume of unfinished construction. Structural Adjustment in the Production of New Housing 1.47 The structure of the new housing stock completed during the first half of 1992 reflects changes in construction financing that began in the mid-1980s. The main component of this change is the shift of state investment funding away from direct budget resources of all level of government to enterprise profit-based funds, and -- to a lesser degree -- to resources of the non- state investors. Structural changes in the sources of residential construction financing are expected to lead to a shift away from the large panel, high-rise buildings towards diversified technologies, such as traditional brick and wood technologies, and small pre-fabricated elements for low-rise and individual housing construction. Destabilizing Fiscal Effects of Housing Subsidies 1.48 On-budget subsidies and transfers to the housing sector have increased significantly during 1991 and surged after the liberalization of prices in January of 1992. In view of the extremely high cost of housing and the declining output, there is at present a great pressure on the Government of Russia to further increase budgetary support to the sector. However, new 14 Chapter 1 subsidies can seriously threaten the implementation of the Government's macroeconomic stabilization program. Housing Affordability and Effective Housing Demand 1.49 Under current economic conditions, the transition from a predominantly state-financed housing to housing markets where the great majority of household will pay full price for their housing, will be extremely difficult. The issue of who can afford housing at full cost and who could afford housing at reduced costs with the help of subsidies, needs to be addressed as early as possible. Moreover, there is a considerable amount of uncertainty with regard to all major factors that affect demand for housing. It is for these reasons that the Federal Government has developed its Special Housing Program in 1993. m:\rhsector\green.eng\chapters\chap I x.v9 lOlOamAugust 2, 1995 PART II A STRATEGY FOR HOUSING REFORM CHAPTER 2 THE ROLE OF PRIVATIZATION IN RUSSIAN HOUSING REFORM Table of Contents 1. INTRODUCTION . ........................................ 15 H. WHY PRIVATIZE HOUSING? ............................... 16 A. Pricing Distortions and Shortages ........................... 17 B. Ownership Distortions and Household Immobility ................. 20 m. HOW TO -PRIVATIZE? .......... .......................... 22 A. Specificity of Housing Privatization .......................... 22 B. Sell Housing or Give it Away? ............................ 24 C. Transfer State-Owned Housing Quickly or Gradually? .... .......... 26 IV. THE EXPECTED BENEFITS OF PRIVATIZATION . .27 A. Economywide Benefits of Privatization .27 B. Housing Sector Benefits .30 C. Fiscal Considerations .32 D. Factors Shaping Household Privatization Decisions .32 V. WINNERS AND LOSERS: THREE PERSPECTIVES ....... ......... 35 A. Households and Their Different Tenure Status ................... 35 B. Local Governments ........... ......................... 37 C. The Central Government ................................ 38 VI. CURRENT STATUS OF HOUSING PRIVATIZATION . .38 A. Characteristics of the Housing Stock to be Transferred .38 B. Legislative Developments on Housing Privatization .39 C. Speed of Privatization .42 D. Regional Patterns .42 VII. MANAGING THE TRANSITION ............................. 44 CHAPTER 2 THE ROLE OF PRIvATIzATION IN RussIAN HOUSING REFORMS I. INWRODUCTION 2.1 Since the mid-1950s, the Soviet Union had been the largest producer of housing in the world, with an annual output of about 2.2 million units.' Russia produced the largest share of this output. Yet, housing in Russia is widely considered to be unsatisfactory in quantity and quality by both the public and policy makers. Indeed, housing is the only sector in which there has been early agreement among broad segments of the population that privatization is desirable. 2.2 However, privatization has many meanings in Russia. It can mean developing a sense of "ownership" among those responsible for existing economic assets, or transferring the assets to 'better owners." In housing, privatization commonly refers to the transfer of ownership of the existing stock from state enterprises, local governments, and even state-controlled cooperatives to private individual households. The privatization of housing construction is an integral part of the process of restructuring the housing system but it requires its own rules. The public and private debates on housing reforms in Russia and in the other transition economies of Europe and Asia revolve around several key questions.2 Why privatize? Should the state-owned housing stock be distributed for free or should it be sold to individual households? How should rents be raised? How can new social assistance programs be developed, financed, and targeted to the poor? What will happen to the housing system during its transition from the administrative system of central planning to markets? 2.3 This chapter outlines the multiple effects of the housing system on Russia's economic performance and social welfare to show that housing reform cannot be disassociated from overall reforms. Accordingly, two important links will affect the coherence and consistency of housing reforms. First, privatization of the existing stock and rent reform are functionally linked and will support one another. Second, and quite new to the old administrative command system of Russia, the critical relationship that exists in housing markets between cost recovery (and the rate of return) "1 By comparison the U.S. housing output peaked briefly at about 2.0 million units in the early 1970s and is currently about 1.3 million housing units per year. Russia produced about 60 percent of the total produced by the Soviet Union. Its peak output was about 1.3 million units in 1987. By 1992, housing production had collapsed to about 450,OOOunits. 2/ For an analysis of the systemic housing problems encountered in transition socialist economies in a comparative perspective, and the framework of reform, see Bertrand M. Renaud. Housing Reform in Socialist Economies, World Bank Discussion Paper No. 125, Washington, D. C., June 1991. 16 Chapter 2 from the existing housing stock and decisions to invest in new housing compared to channeling funds to other activities.3 II. WHY PRIVATIZE HOUSING? 2.4 Debates on housing privatization in Russia at the national and city levels have largely focused on "how" to privatize rather than "why." The specific goals of housing privatization have received little explicit attention. Ranking the goals according to their importance within the framework of housing and macroeconomic reforms have not been matched with the privatization methods under consideration. In particular, the debates have not placed housing privatization in the context of sequencing scenarios for the national economic transition to a future Russian market system. Yet, housing is not only an issue which affects every Russian life but the housing system must also be seen as a major component of the national wealth whose successful reform and privatization is a major element of the overall transition.4 2.5 Two core economic reasons for housing privatization are to remove the large pricing distortions and to eliminate most of the pervasive "principal-agent" failures in a sector where the degree of capital intensity and specificity is low and sound contractual relationships are paramount. The housing reform is not primarily a production issue. Good institutions, good laws, and sound incentives produce good buildings and stimulate the production of the right building materials, not the reverse. Privatization of the existing housing stock is much more important in the short-term because in a good year new production amounts to about 5 percent of the existing stock. Moreover, in a market economy, expanded supply of housing services resulting from the upgrading of the existing stock is important in any year. The national accounts of industrial market economies show that about one-third of the annual funds expended on housing investments goes to maintenance and renovation, what some refer to as "increased supply" from the existing stock. This renovation share against new construction tends to increase during economic slowdowns. This is not happening in Russia because housing under state ownership suffers from acute "principal-agent" or "agency' problems where the state as owner is an ill-defined representative of the population, and local governments or state enterprises, as the state's agents, have strong incentives to pursue their own interest rather than maintain buildings and preserve their capital value. Private ownership would encourage better maintenance by eliminating principal agent problems in the housing sector. 31 The critical analytical concept of 'economic opportunity cost" was absent from the Soviet theories of central planning until very late and found only limited operational use given the nature of administrative decision making. This concept was even less well applied to an activity like housing which was considered a .non-productive" social investment and often treated as a residual activity in the planning process. The rate of return to housing investment compared with other activities could not be determined. 4/ An overview of the basic housing problems of Russia can be found in Chapter 13 "Distortions in the Urban Economy and Housing Reform Priorities" of the World Bank report on Russian Economic Reform, Crossing the Threshold of Structural Change, Washington D.C. September 1992. Sectoral details are provided throughout this report, and in the annexes and the statistical appendix. Chapter 2 17 BOX 2.1: The Economic Value of Socialist Tenant Rights When considering the cost of renting state housing to tenants in TSEs, it is necessary to understand accumulated socialist rights and to consider the economic value of implicit property rights afforded to them. These include the right to permanent occupancy of a unit, and implicit inheritance rights. The effective costs of renting are even lower than those expressed solely in terms of low rents: socialists tenancy rights have greater economic value than the personal ownership of a unit. The value of the tenancy rights is explicitly recognized by the payment of "key money" upon obtaining a unit in some countries. The occupancy rights are often sold in black or grey markets. In Hungary, local governments have offered to buy back the occupancy rights from households, by paying 3 to 10 times the initial key money. A recent rent reform proposal in Hungary attempts to address the problem by compensating tenants for the loss of permanent occupancy rights. Tenants are offered 20 percent of unit value in cash or bonds; they cannot sell or bequeath the unit. Given low rents and implicit property rights, the state rental housing appears to be more attractive than individual ownership. However, there are costs involved in restricted mobility: many households find it difficult to adjust their housing consumption to changing financial and family circumstances and are under or over-housed. Furthermore, the state supply in socialist countries has typically meant wrong designs, wrong locations, and poor quality (of which Russia is one of the extreme examples). In Russia, the need for exchange of housing units are very strong within cities, and across cities. For instance, in Moscow one of the new housing exchange "cooperatives" created after 1988 was maintaining a computer list of over 65,000families looking for an exchange. However, until the middle of 1991 exchanges were officially restricted to barter; cash compensations for differences between units were prohibited. Such a prohibition gave additional arbitrary powers to housing bureaus which approved the exchanges. These exchanges usually required absurdly complex chains of simultaneous moves due to the bureaucratic nature of the process and the fact that vacancy rates are practically zero in the system. In major cities like Moscow monetary compensation has been used since 1991 particularly after the passage of the first federal housing privatization of July 1991. 2.6 Reduced to its shortest possible form, and overlooking the numerous operational problems that will need to be addressed, the long-term logic of housing reform in Russia is that a change of ownership from state to private entities. This is necessary in order to raise rents to full cost-recovery levels and to restore direct control of income implicitly confiscated from the households to pay for the huge financial subsidies for state controlled housing back to them. It is essential to the success of housing reform to be clear that reform involves a three-way change in ownership, rents, and labor incomes. A. Pricing Distortions and Shortages 2.7 Figure 2.1 represents the main elements of current demand and supply conditions in Russia and illustrates the three-dimensional relationship between ownership, rents and incomes. The downward-sloping line DD represents the aggregate purchasing power of households based on labor 18 Chapter 2 productivity. The curve DD slopes downward to reflect the trade-offs between the demand for housing and for other goods and services: the higher the resource cost of housing, the less income will be available for other consumer demands in the economy. The more resources the building sector can conunand (the higher the real resource price it can charge), the more it can produce; thus the curve SS slopes downward. In a market economy the dynamics of demand and supply are transparent. Prices that guide individual decisions are numerous, detailed, and constantly adjusted. They are rich in economic information. The centralized administrative command-system has obscured this process by focusing on quantity rather than price so that it is hard to know the true resource cost and economic value of most decisions in the sector. 2.8 Under the administrative-command system, production decisions have been based on annual estimates of needs without consideration of the value that final users might actually ascribe to various units. The current rents for municipal housing and enterprise housing (13.2 kopecks per square meters) have not changed since 1928. They cover only a fraction of the true resource cost of a unit (point 5 in figure 2.1). Since Russian households spend more on vodka than on housing it is clear that even under the low-wage system they could devote more of their own resources to housing. The encouragement of state-controlled cooperatives since the mid-1980s had exactly that objective. Instead of spending 2.5 percent of their income on housing, cooperative households spent 10 percent to 20 percent. The low-wage constrained rent could, therefore, be much higher (point 4 in figure 2.1). Yet, even under cooperative housing a large proportion of the supply cost remains unrecovered from residents (Point 3 in figure 2. 1).5 That part of production costs has been financed in a round-about way through the low-wage system. Such a system was bound to maximize transactions costs at every step and to break the links between final users and builders, thereby generating massive principal-agent problems. 2.9 Figure 2.1 shows the two main causes of housing shortages. The largest cause is the underpricing of housing. Since housing is free but valuable, waiting lists are long (the gap between Qd and Qs in figure 2.1 is exceptionally wide in Russia). Figure 2.1 also shows that the cooperative housing system shortened the queue: those willing to pay more or without the connections to get housing allocated quickly had little choice. It can also be seen that raising rents from its nominal level at point 5 to the "low-wage" level of point 4 will continue to keep the Russian housing system in place, unless and until the full wage has been reconstituted across the economy. 2.10 The second cause of shortages is linked to Russia's systematic underinvestment in housing. Russia has underinvested in housing because savings extracted through low wages and not fully returned to households in the form of housing were redirected to priority industries (bread and housing were the inputs and steel was the output). The squeeze on the civilian economy was more severe in Russia than in any of the other TSEs to finance military expenditures (guns were preferred to butter). The massive volume of production initiated under Khrushchev represented a stock-adjustment process designed to catch-up for the destruction from wars and the suppression of 5/ For instance, a law subsidizing 70 percent of the production costs for housing cooperative units approved or under construction was passed in 1992. In order to limit its budget impact, the subsidy in applicable to only those households waiting in the cooperative housing queue prior to a specified cut-of date. Chapter 2 19 Figure 2.1: The Russian Housing System Before Reforms 0 p S (1) Market Rent | (2t) Equilibrium Rent Ps- _ - - (3) Supply Cost Rent Supply /o / /UDr!t/ // \ Fr.nm RcsiAg 2 . z - _ - B - (4) Low Wage Coopera / B Constrained Rent IThusing / \ Housig(5) Current __ _ _ S _ _ _ 7 _ low Rent Ubicg C2§ D ° 0 QD) Q Administriely EXCESS DEMAND DISTORflON: Determined Supply Housing shortage when ret of Housing is constL3ned by the t'low-wage" system 20 Chapter 2 investment in the sector for decades. Housing standards in 1950 were as low as in 1914. In contrast with Central and Eastern European TSEs, Russia was experiencing the fastest rate of urbanization of the world. Figure 2.1 suggests that the largest proportion of the shortages can be eliminated with ownership transfer and realistic rents. Rent adjustments are further discussed in Chapter 3 as part of the reform strategy. Operational recommendations to manage rent reforms that should prove acceptable to the Russian population are provided in Chapter 4. B. Ownership Distortions and Household Immobility 2.11 The former Soviet Union had the most distorted ownership structure of all the socialist housing systems. It had the highest rate of public ownership of the urban housing stock, with more than 78 percent Union-wide compared to 67 percent in China, 56 percent in Poland, 33 percent in Romania, and 25 percent in Hungary. By contrast, public ownership in market economies at the end of the 1980s was 2 percent in the US, 7 percent in Germany, 17 percent in France, 30 percent in the UK, 38 percent in Sweden, and 42 percent in Holland. Among the republics of the Former Soviet Union, the system of centralized state housing ownership had been pushed the furthest in the Russian Federation, Belorussia, and the three Baltic states. Housing in Russian cities above 100,000 people is almost entirely under public ownership. State pressures to suppress individual ownership of housing were maintained until 1985, when changes were made for cooperatives, partly as an opportunistic way to raise private funds for state construction enterprises. As a result, the two dominant forms of tenure in Russian cities are municipal housing (37 percent) and state-enterprise housing (41 percent). Cooperative housing in Russia is still a very limited form of tenure (6 percent) compared with other TSEs. 2.12 "Private" housing (16 percent) is found mostly in smaller cities. This type of tenure is not directly equivalent to private property in market economies. Under Soviet law "personal" property cannot be sold, it is difficult to exchange and rental rates cannot be charged above the symbolic state rent.6 In 1990, individual housing represented 0.2 percent of the total floor space in Moscow and 1.4 percent in St. Petersburg. For decades, individual housing was marginalized in every sense: politically, geographically, and in the provision of public services. As a result, Russians until now have equated individual housing to slums in total contrast with market economies. The quality of individual housing is extremely poor: 6/ This is not quite exact. According to Soviet legislation, houses privately owned by persons could be sold or rented, although these procedures were quite complex due to the existing laws. The possibility of exchanging privately owned housing for housing in public or municipal stock was not contemplated in the law. TABLE 2.1: Russian Housing Stock by Ownership,' 1990 Total National In% Total In % Total Urban In % Housing (total National Housing (total floor space, Housing floor space, min:m:) (units in 000) min: m:) Total housing stock 2,272.4 100.0 45,110.03 100.0 1,606.2 100.0 State-Owned stock 1,471.1 64.7 30,294.2 67.2 1,246.9 77.6 Local Government 607.8 26.7 12,285.1 27.2 591.5 36.8 Enterprises & Organizations (own-budget) 846.2 37.2 17,654.1 39.1 644.7 40.1 Enterprises & Organizations (budget 17.1 0.8 354.9 0.8 10.7 0.7 financed) Other Enterprises & Organizations 2 68.6 3.0 1,271.6 2.8 8.0 0.5 Housing Construction & Housing 92.0 4.0 1,934.5 4.3 91.6 5.7 Cooperatives Housing (Non-Building Coops) 0.9 0.0 20.4 0.0 0.9 0.1 Privately-Owned stock 640.7 28.2 14,816.0 3 32.8 259.7 16.2 'Excluding hostels and dormitories 2 These include, among others, cooperative-type enterprises and kolhozs 3 Rural as of January 1, 1991 Source: Ministry of Economy 22 Chapter 2 RUSSIA: Ownership and Quality of Urban Housing Units (1990) (Percent of units with service connections) State-owned Private (personal oroDertv) Piped water 91.9% 17.9% Sewerage 89.9% 11.1% Central heating 89.9% 31.2% Bath 85.2% 6.5% Hot water 76.8% 6.4% The state-owned housing stock of best quality creates an additional impetus for privatization. Even under a socialist regime, the margin for an adjustment toward private ownership in Russia would be considerable compared to Poland, Hungary and the former Czechoslovakia (table 2.2). 2.13 Housing appears to be the easiest and the most immediately satisfying subject of privatization, since the right of transfer gives ownership of a potential asset to most urban households, 84 percent of whom live in state-owned dwellings or state-controlled cooperatives. A consensus in favor of ownership transfer can also be reached swiftly. The notion of private ownership of housing, well established in the collective consciousness as a "non-productive" asset, is more ideologically palatable an the private ownership of the means of production. Decision-makers are likely to be winners in the housing privatization process and there is, at present, no clear vehicle for those likely to be losers, to express their concerns. Finally, since everybody is somehow housed in Russia in spite of the waiting lists, the initial distribution problem is far less thorny than the privatization of state enterprises and other state-owned assets. III. How To PRIVATIZE? A. Specificity of Housing Privaization 2.14 Privatization is an integral part of the transition to markets in the former socialist economies. However, the historical experience of countries such as Poland and Hungary shows that liberalization, if pursued without concurrent privatization, brings only temporary improvements and interacts perversely with behaviors inherent in the un-altered, state-dominated ownership structure. While most transitional socialist economies (TSEs) favor privatization, they actively debate over the proper means. Housing is one of the four tvnes of privatization and represents about one-fifth or more of total assets of the national economy. Each area requires its own specific strategy: a. major state-owned industrial enterprises - "large scale privatization"; b. small to medium-scale activities where the required capital is non-sector specific and entry is relatively easy - "small scale privatization'; Table 2.2 Ownership of Existing Stock: Russia versus Other Countries I2 Russia Poland Hungary Czechoslovakia USA FRANCE Total Urban Total Urban Total Urban Urban Total Total (Budapest) Other Cities Total housing stock 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 State-Owned stock 64.7 77.6 32.6 39.5 24.8 42.4 28.9 35.0 2.3 17.1 Non-prof Local Government 26.7 36.8 - 27.7 - 30.0 - 33.3 2.3 16.5 (HLM) 3 9.5 HLM p 7.0 HLM-SA Enterprises 43.0 40.1 - 11.8 - 10.0 - 1.8 _ 0.6 (others) All Housing Cooperatives 4.0 5.7 23.9 36.7 - 9.0 - 18.9 1.9 Privately-Owned stock 28.2 16.2 . 43.5 23.8 75.2 48.6 71.1 46.1 95.8 82.9 Private Owner-occupants 61.5 Rental stock 21.4 Russia: 1990; Polal: 1989; Hungary: 1987; Czechoslovakia: 1988; France 1990 2 Percentages are related to number of units, not economic valucs HLM - Public and HLM - S.A.: managers of rent-controlled housing, but HLM S. A. is a commercial corporation 24 Chapter 2 c. state-owned rental housing stock and cooperative-owned stock - "housing privatization"; d. the privatization of "agriculture." Some housing privatization programs have preceded privatization in the other three areas where no attempts were made until the fall of socialist regimes in the region. Some housing privatization programs were initiated more than a decade before the serious debates on the privatization of goods-producing sectors started in the late 1980s. 2.15 In Russia the concept of privatization on demand to sitting tenants has been widely endorsed since the late 1980s. Debates concentrated on methods of privatization by exploring possible scenarios between selling the stock and giving it away. Public debates took place at every level of government. The discussions usually converged on four scenarios:7 a. "Free Transfer". The stock would be given away, with discounted prices charged for floor space in excess of the fixed norm; b. "Full Price Sales". The stock would be sold at full assessed price, with few or no discounts; C. "Socially Just". A fixed amount of housing would be given away, with high price charges for any floor space over the norm; d. "Compensatory Justice". It would be based on fully transferrable vouchers for a fixed amount of housing distributed to all households; vouchers would be exclusively used to purchase units. B. Sell Housing or Give it Away? 2.16 The best economic strategy under present economic conditions in Russia is a free transfer of housing to households. With inflationary pressures, most households would have little available savings to buy housing assets. Free transfer also bypasses the thorny problem of establishing market valuations for assets. Yet four objections to free transfers are often raised. Two are based on conceptual errors and have little economic validity. Two are practical operational problems that must be addressed. 2.17 Objection 1 considers that the free transfer of housing will generate large windfalls given the extremely high prices observed for free market transactions in cities like Moscow.8 This emerging 7" See Kosareva, Nadezhda B. and Natalya V. Kalinina (1990, 1991, 1992). 8/ Recent prices in Moscow for apartments are extremely high for central locations -- $17,000to $20,000 for a single room, $25,OOOto $32,000for two-rooms, and $30,000to $l00,OOOfor three-room apartments. These prices are reported to be stabilizing. In St. Petersburg apartment prices were reported to be $440 to $470 per square meter of total floor space. This market is priced or indexed to hard currencies, revealing its limited nature. (See, Commersant, March 31, 1993, pp. 6-7). Chapter 2 25 market has two components. (See Figure 2.1.) Some buyers in major cities no longer receive a socialist low-wage but a full market wage. These buyers are able to afford a full market rent, which is more than 15 to 20 times what the average Russian could pay, especially when real wages have fallen by about 45 percent in 1992 alone. (Compare Point I with Point 4 in Figure 2. 1). The second component is foreign demand for office space and staff housing based on purchasing power magnified in three ways: the high per capita income of the country of origin, allowances that raise expatriate incomes above their national level, and a greatly undervalued ruble exchange rate. These disequilibrium prices are magnified at the initial opening of the real estate markets. Large scale privatization will bring current high real estate prices to much lower levels. The new prices will settle between the high, central-city hard currency prices and the low ruble prices in peripheral locations. 2.18 A difficult aspect of objection I is non-economic. It relates to the traditional Russian acceptance of standing in line as the fairest solution to shortages and the tendency to reject price increases because they are seen to favor the rich. Yet with proper public education such attitudes should also support a rapid and large-scale transfer of housing: the larger the proportion of housing transferred, the closer the system will move to balance (point 2 of figure 2.1), and the larger the number of people who will be able to afford the new prices. Current opportunities for arbitrage windfalls between a strong demand for good units and the artificially limited supply of private units would disappear. (The housing price level would move to Point 2). Monetary stability will also be a powerful positive factor for equitable access to housing since today a large population is scrambling for a very small supply of "assets of refuge" like housing or building materials. 2.19 Objection 2 is that free transfer will impoverish local governments, which should collect badly needed resources from sales. The old system of municipal housing was financially balanced even though the cost recovered from residents covered about 40 percent or less of operating costs. The cash shortfall from residents was covered through cross-subsidies from commercial rents and budgetary transfers. Thus municipal housing is a liability to local governments. Arguing that under free transfer local governments are missing the opportunity to sell at market prices shows a misunderstanding of the initial stage of Russia's transition to a market economy. High market rents and housing prices (point I of figure 2. 1)--reflect a minority of Russian wages and high foreign wages. A broadly-based real market price increase can only happen if most of the population enjoy a market wage. This could only be achieved by transferring as much housing to occupants as possible. Then local governments will have to develop effective property taxes based on market prices that can provide adequate revenues. Chapter 7 on land use provides initial analyses of emerging prices on the Moscow housing mass market which show that these prices remain low and little differentiated because wages are low. Free transfer bypasses the need for valuation (see Box 2.2). However, subsequent free trading will generate market valuations required for mass assessments and property taxation. Households and local governments will ultimately benefit. 2.20 Objection 3 is that waiting lists are not purely generated by bad pricing, but that part of the housing shortage is genuine. The socialist rights of those who have waited in the queue must be compensated. For housing policy to succeed, even under present unstable conditions, fairness is important. Three ways to mediate or fully solve the problem exist. First, the best units are or could be going to the best connected people. The concept of a socially guaranteed minimum has been introduced in the law on the basic federal principles of housing reform of December 1992. This 26 Chapter 2 concept leads to a two-part transfer where a basic uniform amount of housing is guaranteed to everyone free of charge. Any amount above the guaranteed minimum would be charged. Each city would have flexibility to select the guaranteed minimum based on local conditions. Second, compensation to families unable to obtain housing could be made in the form of vouchers or in-kind transfers. For instance, the privatization vouchers issued for large-scale enterprise privatization could be used for housing. The operational design of such vouchers systems will be very important. Poorly designed vouchers could lack credibility, be ineffective or generate inordinate administrative costs.9 Another kind of compensation has been the free distribution of garden plots to people on waiting lists in Moscow and St. Petersburg. However, the distribution of land assets are likely to have negative urban development and ecological effects that remain to be fully evaluated. Third, free trading of units will resolve important rental stock misallocation. It is a rule of thumb of public housing everywhere that 25 percent of the residents have too little housing (young families) and 25 percent have too rnuch (the old and the retired). Analyses done on some large Chinese cities by World Bank missions suggest that the economic benefit of large scale reallocation through voluntary trading could be equivalent to two years of new production. 2.21 Objection 4 is that housing reform is being carried out during a depression and that it is not advisable to implement a free transfer of housing to households who could not possibly maintain it. The cause of this problem is technical rather than institutional or economic. The type of industrial housing built and its location (with high rise towers in suburban locations distant from employment) has a high resource cost for operation and maintenance by Western standards. There is considerable concern that past investment in housing was misled by land that had no price, energy that was priced well below world prices, and capital that carried no interest. Today, significant sections of Russian cities may have a negative value added; this is being revealed as domestic prices are adjusting to world prices. The value of the services provided may be below the resource cost to produce them. Germany is experiencing this with part of the East-German housing stock. The British and French experiences with the type of industrial mass housing so dominant in Russia led the two countries to abandon the state-financed, industrial approach to solving housing problems in the late 1950s and early 1960s. With the rapid fall in real wages in 1991 and 1992, the Russian housing stock is not aligned with the purchasing power of most of the population. No broad strategy has emerged to solve such problems. Individual solutions will be required at the city level, housing estate by housing estates. The problem also suggests that most of the housing stock might well remain under state ownership or require public resources until a significant recovery of household incomes takes place. C. Transfer State-Owned Housing Quickly or Gradually? 2.22 The argument for a strategy of free transfer adjusted to achieve as fair an allocation of housing as possible also supports a rapid, rather than a gradual, transfer of the stock. The sooner distortions can be corrected, the better it will be for the economy, the housing sector and the households. The sharp contraction of the Russian economy and two-digit inflation per month reinforce the need for a rapid transfer of housing assets to all the households wishing to take advantage of these programs. 91 In practice, this fear tumed out to be justified. Chapter 2 27 IV. THE EXPECTED BENEFITS OF PRIVATIZATION A. Economywide Benefits of Privatization 2.23 Housing reforms are central to successful structural economic reforms because they provide: (1) corrections in macroeconomic imbalances, (2) macroeconomic stabilization; (3) economic efficiency for enterprise and labor market reforms, and (4) greater equity and social stability. The need for reform comes from the large distortions in the sector caused by the administrative-command system. A glaring economic paradox of the Soviet housing system has been its large-scale asset misallocation and the consequent loss of efficiency. The state owned the physical assets and the households the liquidities and savings. During their lifetimes, households accumulated increasing amounts of savings which could not be stored in the form of housing, and the state could not organize itself well enough to produce attractive units. Because housing has been managed as a social need, the broad effect of the sector's efficiency on total economic performance during transition has often been misunderstood. Now economic reforms cannot bypass the housing sector because it accounts for such a large share of the overall economy. 2.24 Correction of macroeconomic imbalances and of housing's contribution to economic decline. The poor performance of socialist housing systems originates in the management of housing as a social issue, rather than as a major segment of the economy. Due to decades of poor capital cost recovery, rent controls, and subsidized operating costs, the rate of return on housing assets is negative. Despite the fact that Russia has chronically underinvested in housing compared to market economies, the share of housing in national wealth is still significant and the housing stock may be about 20 percent of total reproducible assets. Adding the value of urban land to buildings further raises the share of housing in total national wealth. Thus, the housing sector and its related infrastructure have played a significant -- though misunderstood and overlooked-- role in the slowdown and eventual decline of socialist economies, and of Russia in particular. Better management of the housing sector through privatization will be critical to Russia's economic recovery. 2.25 Budgetary control and macroeconomic stabilization. Macroeconomic stability is a primne requirement for a successful transition to a market based economy. Macroeconomic stabilization must be achieved by controlling inflation and reducing state deficits, including housing subsidies. The evidence from other socialist economies in Eastern Europe and China suggests that housing subsidies in Russia could easily range between four and nine percent of GNP. However, an accurate estimate of the variety of subsidies in the sector is difficult to make under current inflation and the disruption of the former administrative system. 2.26 Revival of household savings. The rate of growth of aggregate wages had been considerably higher than the rate of growth of output during perestroika (1985-1990) in Russia. This imbalance created strong pressures on an anemnic consumer goods sector that was released during the price liberalization of 1992, which eliminated most household financial savings. At present, double-digit inflation per month and the dynamics of relative price adjustment are further eroding confidence in the ruble. Encouraging households to accumulate wealth through housing ownership as an asset of refuge against economic instability would mobilize sector resources and improve the macroeconomic balance. 28 Chapter 2 BOX 2.2: Obstacles to Privatization Through Sales 1. Valuation of units. In Western housing privatization programs, a purchase price is established on the open market value of the unit, from which applicable discounts are subtracted. The direct transfer of this approach and other market techniques is not very meaningful in TSEs where the valuation of units is considerably more complex in cities where prices are poorly documented and are shifting rapidly. In market economies three basic methods are used to value a residential or a commercial property: | * Valuation based on market prices of comparable properties.There are little guideline data on property values in Russia because real estate markets are in an early stage of development. It is very difficult to assess the market value without fully functioning markets. Current high prices are based on a very limited supply of housing units possibly sold for future commercial, and not residential, use. Such prices provide a distorted picture. * Valuation based on current replacemeiu costs. The construction cost of new units in Russia is not a very good indicator of value, because it reflects past inefficiencies and distortions in production methods. Replacement costs do not address the site valuation problem. * Valuation based on future income streams. The value of social housing, which under market conditions would be calculated as the present value of the future stream of rents less operating costs, is now negative in Russia and clearly bears no relation to open market value. Instead of using actual rents, this valuation system could be based on notional target rents (to be in turn based on projected incomes) which would be charged at some point in the future. However, given the circumstances, making long term forecasts of real incomes in former TSEs is hazardous. In Russia, most cities are trying to established synthetic property values with mathematical models in order to develop the basis of a fiscal cadastre for local taxes. Tests carried out in Russia and in Poland have shown that mass appraisal techniques based on adequate samples of market transactions can provide better information on values, faster and cheaper than such artificial models. These tests strongly suggest that comparative valuation will dominate TSE markets. 2. The Purchase Price. The effective price at which a unit is sold reflects various discounts on the assessed value of the unit. Discounts typically depend on the type and condition of unit, and the occupancy period. 3. The Liquidity Problem. An alternative to privatization through sales is the "rent-to-mortgage" scheme. Under this scheme, the rent a tenant is paying is transformed into a mortgage payment. The local authority retains a share in the property which must be redeemed when the property is sold. The program allows the tenant to maintain the level of his effort ratio and realize a part of capital gains. Chapter 2 29 2.27 Improvement of labor force mobility and motivation. One conspicuous flaw of traditional Soviet housing is its extremely rigid allocation system through waiting lists which impede labor mobility. A flexible housing system will have major labor market efficiency and equity benefits. Access to housing has become the dominant labor motivation. Residency permits (propiska), and lack of housing prevent workers from increasing their contribution to society by moving from jobs with a lower productivity to jobs with a higher productivity. Since housing is by nature immovable, housing and wage reforms are required to improve labor conditions. 2.28 Freeing enterprisesfrom housing issues. Housing reforms and the supply of housing through open markets can make important contributions to the industrial and services sectors. They can free enterprises from the burden of financing and managing housing systems for which they have no comparative advantage. To achieve successful housing reforms, the current system of social funds must be reintegrated with the cash wage of households. However, this will create serious transition problems for unprofitable firms operating with strict financial autonomy. Freeing the enterprises from direct responsibility of financing housing will contribute to stabilization efforts by ending the diversion of investrnent funds away from strategic enterprise investrnents into direct, inefficient housing investments produced by state construction companies. 2.29 Correction of consumption spillover effects. In Russia, citizens's rights to housing are guaranteed by the Constitution, but this guarantee does not mean the right to free housing for all households. These rights were reaffirmed in the recent housing reform laws passed by the Russian Congress in December 1992. For efficiency, price stability, and welfare reasons it is important to correct the present consumption spillover effects caused by the extraordinary underpricing of housing. Under the present housing system, Russian household expenditures on alcohol and tobacco have been larger than those on housing. Between 1987 and 1989, the share of housing in total household expenditures by workers and employees declined from 3.0 percent to only 2.5 percent while the share of tobacco and alcohol consumption rose from 3.3 percent to 3.4 percent of total expenditures. In 1992, the household contribution to housing practically ceased with the decline of housing expenditures to 0.9 percent of total expenditures, and real wages fell by about 45 percent. One major objective of the reforms is to raise the household contributions to financing the production and operation of housing. Housing rent and ownership reforns are needed to encourage households to move away from less essential consumer goods toward housing, which is still in great shortage partly because of such poor pricing. 2.30 Well managed housing reforms could become a useful lever for economic output stabilization and economic recovery during the economic transition. These reforms need to promote an efficient housing industry and eliminate the severe housing shortage. Indirect evidence suggests that increasing housing production will have a high rate of return in the Soviet economy. However, the lack of precise and realistic pricing information has made comparisons between the economic efficiency of alternative investments extremely difficult in Russia. 2.31 Revival of the small business sector. Operating in an unstable economic environment, the emerging small private businesses in TSEs encounter serious problems with access to loans, even short-term loans. This is also the case in Russia. Laws on collateral are currently being developed to help small entrepreneurs overcome these constraints while providing adequate protection to 30 Chapter 2 lenders. Given the acute shortage of capital, the possibility of using privatized real estate as collateral may greatly facilitate the revival or emergence of the small business sector. 2.32 Protection of household balance sheets under inflation. In a highly inflationary environment, households which privatize their housing become owners of an asset that will be a hedge against inflation. Savings can be quickly invested in purchase and in rehabilitation. With privatization, housing units are the most accessible assets of refuge for the majority of the population. For the past three years, the increase in housing prices in the small segment of the market where trading have taken place, has outpaced general inflation. It can be expected that privatized housing will at least maintain its real value. Meanwhile the cash savings of households have been devastated by inflation. Sberbank, which has monopolized household savings and retail banking in Russia, pays negative real interest rates on deposits. New commercial banks offering better rates do not carry deposit insurance, and are not prepared to venture into retail banking. 2.33 Moving away from the combination of low wages and "distribution goods". The socialist economies operated on the principle of low cash wages from which the state removed the purchasing power for services such as housing, transportation, health services, and education. These services were provided either free or were heavily subsidized as distribution goods controlled by the state. The standard efficiency analysis of public economics suggests that such a large implicit wage tax is highly distortionary and is a hidden drain on the efficiency of the economy from which nobody gains. The reconstitution of a full wage will give more power to households to make faster and better economic choices than a distant and poorly informed or motivated bureaucracy. Given the size of the housing sector in the economy, the positive effect on aggregate resource allocation will be major. 2.34 The benefit to households resulting from the difference between the current nominal rent and what would be a market rent, represents the return on the capital spent in the past for housing investment. The restoration of control over the flow of housing funds to households can be provided through a wage reform or the direct distribution of this differential flow by the transfer of housing assets. The latter is preferable because reform would cause further adjustment complications in labor markets, and macroeconomic disruptions. This reconstitution of a normal wage through housing might be done over time through a rental allowance, or as a lump sum through the transfer of housing units to the ownership of its occupants. B. Housing Sector Benefits 2.35 Improving the quality of the existing stock. In Russia, low rents, in the face of high real operating costs, have led to widespread deferred maintenance and rapid depreciation and deterioration of residential buildings. In 1992, the Russian Ministry of Construction estimated that about 68 percent of the country's housing stock was in a bad state of disrepair. Better maintenance would slow or halt this deterioration process. The national accounts of industrial market economies show that about one-third of the annual funds expended on housing investments goes to maintenance and renovation -- what some refer to as "increased supply" from the existing stock. Conversely, housing in Russia suffers from acute "principal-agent" problems: the state as owner is an ill-defined representative of the population, and local governments or state enterprises as the state's agents have strong incentives to pursue their own interest rather than maintain buildings and preserve their capital value. Private ownership will encourage better maintenance. However, the improvement of Chapter 2 31 maintenance and an end to the disastrously high rate of depreciation of the housing stock are contingent on the development of an effective condominium law. Such a law is absolutely necessary to permit the withdrawal of the state from housing maintenance and operations. 2.36 Gains from trade and increased value of housing assets. Much more important than the improved quality of housing which should result from its privatization are the gains which will result from trading units voluntary and freely. Given the long tradition of state allocation and the weak state of the economy, these gains from trade may currently seem to be the most abstract of all benefits to be expected from housing privatization. Because housing is typically misallocated through the family life cycle and cannot be exchanged, the aggregate value of the housing stock is depressed. As noted earlier, even the one-time benefits allowing residents with very different needs and preferences to trade housing units can be very large. Dynamically, because the economic value of housing will rise, its price will also rise. This new wealth in the hands of the households will provide them with the resources to finance activities of their choice whether they are new real estate investment or other business activities. Such activities will benefit the entire urban economy. 2.37 Revival of new construction and private rental sector. Privatization can potentially jump start urban housing markets, turning housing consumers into housing investors. The volume of new construction can be increased, as households resell their units and build or buy new dwellings. Privatized apartments can serve as collateral for loans to finance new housing. Moreover, the private rental market (thus far marginal and operating in the black or grey economy) can legitimately expand and meet a broad variety of household needs. An increased supply of units for purchase and rent would stabilize downward the current extremely high prices. However, these potential benefits of privatization cannot be fully realized as long as actions in other areas of housing policy, in particular housing finance, are delayed by monetary instability and institutional constraints. 2.38 Shift to more efficient, less energy intensive urban development. Russian cities often have large, inefficiently utilized energy infrastructure. They are also highly energy intensive. In a decade when domestic savings will be extremely scarce, housing reforms can improve the use of the existing stock and lead to a more efficient type of urbanization that will be necessary during the severely resource-constrained economic transition. An entirely new approach to the urban regulation of land use, which is directly linked to economic activity, is needed for efficient trading mechanisms and the development of a diversified and competitive housing production industry. 1 (For a full discussion, see Chapter 7). IO/ Efficient commercial and residential real estate markets have mnajor benefits for the internal efficiency of cities. The space and location needs of families change significantly over time. Jobs relocate in cities as the economy grows. Yet, Soviet urban planning has been static, inflexible, and mostly arbitrary for the lack of sound economic information. In a rapidly modernizing urban economy the annual rate of employment mobility in a city is significant. International studies show that job relocation caused by new or relocating enterprises can represent from 3 to 5 percent of all urban jobs every year. Without markets, Russian urban centers, which form the core of this highly urban economy, have become increasingly inefficient (see Chapter 6). 32 Chapter 2 C. Fiscal Considerations 2.39 Budgetary savings. Privatization is likely to be considered a substitute policy for fiscal restraint if large rent increases are politically difficult to implement. In view of sharply declining real incomes and the changing structure of housing expenditures, only small rent increases would be possible and might have to remain bureaucratically quite uniform, thus leading to the continuation or expansion of operating subsidies. Privatization can cut a substantial part of these subsidies, shifting the responsibility for maintenance and repairs to new owners. In addition, even if the currently considered property tax rate of 1 percent is very low" , some revenue from these taxes will accrue to local governments once units are privatized. Implicit in this fiscal rationale is the expectation that the better-off households would privatize, and they could bear the full cost of housing maintenance if they had to. 2.40 Restructuring of the subsidy system. Privatization should set the stage for restructuring the entire subsidy system, forcing the targeted and transparent use of scarce budgetary resources. A large transfer of wealth to occupant households will generate pressure on the government to continue and expand housing subsidy programs, where individuals on state and cooperative waiting lists are among the first prospective claimants. But where are the fiscal resources to meet these claims? There is also a pressing need for development of rent assistance programs to accompany rent adjustment in the remaining state stock. Three major policy issues of subsidy restructuring are: (1) how should subsidies be allocated between the existing stock and new production? (2) how should subsidies be allocated between the producers and consumers of housing? and (3) which households, depending on income and "housing needs" should receive the subsidies? D. Factors Shaping Household Privatization Decisions 2.41 Russian tenants will be making their privatization decisions with very poor information on factors affecting the future costs of owning and of renting. The privatization decision should be based on an understanding of the potential future changes in the sector, which few households have. The decision to choose between ownership and rental tenure is new. Regional and cultural differences may be as strong a factor in making a choice as any rough and ready economic appraisal. Box 2.3 presents a concise analysis of a family's decision to own or to rent in a market economy. None of the information presented here is available in Russia. If Russian households are unprepared for a tenure decision, and the uncertainty about future prices and costs are so great, many will be risk adverse and prefer the status quo. 2.42 Future maintenance and repair costs. Despite being deeply subsidized, current maintenance levels in state housing are insufficient and have resulted in the significant decapitalization of the stock. The only available information on the current (unsubsidized) maintenance costs comes from housing coops, which contract state maintenance organizations (REU or Remontnoye y II' The household property tax in Russia constitutes 1% of a house's estimated value. However, significant groups of the population, pensioners in particular, our entirely exempt from paying this tax. Chapter 2 33 Ekhsploitatsionoye Upravleniye) for services.'2 Inflation of maintenance input costs was high throughout 1992 and 1993. It may remain so, especially as energy prices increase. The costs of capital repairs and renovations necessary to halt the continuing physical deterioration of the stock is unknown. Since the designs and locations are inconsistent with market pricing, operation and maintenance of many units will be unaffordable. For many units with unfavorable locations, the costs of accumulated deferred maintenance could be high enough to imply that a privatizing household obtains an asset with a negative value. 2.43 Condominium law and maintenance responsibility. The two uncertainties about future maintenance costs are (1) unknown prices of services after subsidies are removed, and (2) unclear financial responsibilities for joint-ownership, specifically under mixed ownership arrangements (owners and tenants in building). These uncertainties are likely to prevail for some time; the condominium law, which will clarify some (but not all) of these uncertainties, is not yet implemented.13 Yet this law and its regulations are absolutely critical to an orderly, sustainable, and successful privatization. Good models for such laws which could be adapted to Russian needs are readily available, experience is also available from other TSE's further ahead in their housing reforms. 2.44 Capital Gains. How high are the expected capital gains for households that privatize?" Outside of Moscow, St. Petersburg and a few other cities, housing markets are very limited, and little information on open market prices exists. Under economic restructuring, many regions face economic depression and high unemployment. The situation is threatening in many company towns with only one or very few large firms, where employment is highly concentrated typically in defense- related production. Capital gains may not be realized if households have difficulties borrowing against the privatized property. There is also some uncertainty regarding the possible future attempts to redistribute or otherwise contain the windfalls through the capital gains tax or other measures. The early drafts of privatization laws embraced restrictions on reselling privatized units. Such restrictions exist in the UK and in Poland, where reselling the property before a specified time involves repayment of discounts or punitive taxation. 2.45 Property taxes. The redistribution of privatization benefits could also occur through the property tax system. The current bill stipulates a low flat rate of 0.1 percent assessed on the value 12/ Until 1973, the state subsidized the maintenance costs of the cooperative housing stock. Now only heating and hot water are subsidized. Cooperative maintenance fees are based on actual costs of communal and repair services. Households pay amortization fees into the cooperative capital repair fund. The effort ratio (rent/income ratio) of cooperative households is, therefore, much higher with debt service payments ranging from 10 to 20 percent more of income than that of tenants of state housing. IN/ The Presidential Decree entitled 'Temporary Regulations on Condominiums" has been in effect since December 1993. 14/ Data on the distribution of capital gains with respect to income was collected in Hungary. For units resold in Budapest, 40 percent of the total capital gains accrued to households in the highest income quartile. The average gain of households in this quartile is 46 percent higher than the gain of households in the lowest quartile. (see Kosareva and Struyk, 1992). 34 Chapter 2 of property of physical persons. There is a considerable uncertainty about the future level of property taxes and their differentiation across localities. Equity concerns on the outcome of privatization are unlikely to be the main driving force behind the possible changes in property tax legislation. Upward adjustments will be sought by local governments mainly to enhance their revenues. In market economies, the property tax is often the main local tax and the chief contributor to the local revenue base. 2.46 Changes in tenancy rights. Households that wish to remain tenants must accept a great deal of uncertainty about the future rent levels and a possible termination of some of their strong occupancy rights. The recent rent increases proposed in St. Petersburg (10 times) and Moscow (48 times) indicate that local governments intend to exercise their rights to increase rents, and there will probably be major differences in rent adjustment schedules across the country. 2.47 Clarification of land property rights, legally and in the records. Land is not included in the current version of the privatization law. The December 1992 law on private ownership of land grants the right to physical persons only, and limits the use of land and excludes construction of residential or commercial real estate for sale or rent.'5 Property rights would also need to be clarified for the inclusion of land in a technical sense. Frequently, boundary lines cannot be easily determined. Nobody knows where property limits are and various agencies are already fighting.'6 If no legal restrictions on land markets were present, adding land to the privatization package would have a strong effect on the pace of the process. The inclusion of land would affect the value of transferred assets and the distribution of windfalls. In many instances, the site value of centrally located but dilapidated units greatly exceeds the value of the structure itself. 2.48 Declining real incomes and changing household expenditures. Since 1990, real incomes of many social groups in the reforming TSEs have stagnated or declined. The magnitude of real income losses are somewhat difficult to measure, because estimates do not take into consideration shortages that formerly prevailed in consumer goods' markets, and many people hold more than one job, earning income not accounted for in official household budget surveys. Some Russian experts estimate that these second economy transfers are within the 30 to 50 percent range of the reported incomes. The Goskomstat has estimated a 40 percent decline in real incomes for 1992. Changes in relative prices brought on by price liberalization have affected the structure of household expenditures throughout the region, significantly raising the share of food in an average household budget. In Russia, according to the Goskomstat surveys, the share of food in expenditures of working urban households increased from 28 percent in 1990 to 40 percent in the mid-1992; pensioners spent 70 percent of their incomes on food. 151 The Law 'On the Right of Citizens of the Russian Federation to Own and to Sell Land Plots for Individual Housing Construction," December 1992. 16/ Many local governments are involved in economic ventures by contributing their land (and other real assets) to partnership with other investors. As long as land could not be privatized, such contributions could be made at low costs. Chapter 2 35 V. WINNERS AND LOSERS: THREE PERSPECTIVES 2.49 The federal governrment, local governments, and households have different views on housing reforms and often have conflicting interests. In implementing reforms these differences should be resolved satisfactorily. This section takes a brief inventory of possible outcomes. A. Households and Their Different Tenure Status'7 2.50 Municipal housing. A certain percentage of tenants will receive a large transfer of wealth. Since there are major uncertainties about factors affecting future costs of owning and renting, and the regional distribution of the ratio between the two, it is difficult to predict how many of those who privatize will be winners. Large windfalls will be generated through privatization programs in selected, tight markets of large cities, where well located units can be resold easily and command high prices. In those locations, the return on investment in renovation and modernization of units will be high. 2.51 Cooperative housing. Members of cooperative units who have borne a much higher-than-average burden of housing expenditures will not benefit as much from privatization." Yet, it can be argued that the asset was originally established with implicit taxes levied on incomes of the entire population. In 1991 and 1992 building cooperative members received subsidies equivalent to 70 percent of construction costs to allow completion of projects in progress. 2.52 Individual housing. Owners of individual housing under Soviet "personal" ownership also will stand to benefit from privatization because it will force a clarification of the ownership of their housing lot and its registration. A significant proportion of these residents are economically weak and belong to the vulnerable groups who should be supported by the safety net. Given their marginal status and their weak bargaining power with urban administrations, special attention will be needed to insure that the property registration process is carried out fairly. 2.53 Tenure and waiting lists. It is difficult to estimate how many households are enlisted in housing queues. According to Goskomstat statistics, in 1990 approximately 26 percent of all households (including single-person households) were waiting for allocation of a separate dwelling. Other data based on population show that the share on waiting list has risen from 18 percent in 1988 to over 23 percent."9 Data may not be reliable because of double-counting; in many localities one 17/ Annex 2 provides more details on the four major types of tenure inherited from the soviet system in Russia: municipal housing, 'departmental" or enterprise housing, cooperative housing, and individual housing. la/ Surveys indicate that households living in cooperative apartments do not, on average, enjoy higher incornes than tenants of the state-owned stock (see Kosareva, 1992). 19' At the beginning of 1992 in Russia, 10 million families and individuals were on the waiting list for improved housing. By the end of 1994 this number had dropped to 9.1 million. 36 Chapter 2 household may sign up for more than one housing list. Municipalities, enterprises, and housing cooperatives all have separate housing queues; marginally different criteria for signing up may apply. Box 2.3: The Decision to Own or to Rent in a Market Economy * In market economies, household decisions on the tenure choice can be analyzed within the framework of the expected costs of housing services to owners and renters. The expected cost for a homeowner reflects the owners's joint role as a consumer and an investor and is defined by equation: (1) E(uc) = c + d + (I-g)(t+m+Ei) - (1-4)PH with the expected values of the following variables: c - the operating costs excluding property taxes, d - the nominal cost of physical depreciation, g - the owner's marginal tax rate, t - the property tax m - the financing cost (mortgage interest), Ei - the foregone interest on homeowner equity E at rate i, PH - capital gains from appreciation in a unit's price, and f - the tax rate on capital gains. Tax systems in market economies contain many tax preferences for housing. Specifically, different systems have distinct treatment of housing costs such as financing costs, property taxes, and capital gains. The first two are not necessarily exempt from taxable income as the equation presented implies. This equation must therefore be adjusted to the specific tax and financial rules in force in the market under analysis. * The expected user cost for a tenant is R, i.e. the rent. With the perfect housing (and capital) markets, the expected user cost for a homeowner would be the same as the expected rent, so that households would be indifferent between owning and renting: (2) R = E(uc) * At any given time, for a specific household, the two user costs differ. Within the same local market the relative costs of owning and renting change, causing shifts in tenure preferences. In particular, considerable research has gone into investigating how the user cost is affected by the combined impact of tax concessions, inflation and the alternative mortgage instruments since fiscal and financial policy instruments are the tools which government use to regulate housing market indirectly. The type of analysis presented makes a direct link between the use of capital in housing and in the rest of the economy. Chapter 2 37 B. Local Governments 2.54 New responsibilities but no new resources. In December 1991, administrative raions and cities became owners of buildings, housing, urban infrastructure facilities, consumer service enterprises, and other properties within their jurisdictions. Many municipal organizations have large and growing operating deficits, particularly housing maintenance and repair organizations and the enterprises providing local public goods and services. With the extremely low and falling cost recovery already noted, housing is a negative asset, and its privatization is equivalent to large savings. In the context of enormous future liabilities, the gains achieved by acceleration of the process afforded by a shift to an uncompensated transfer will almost certainly offset the revenues generated in previous scheme. The argument of foregone revenues in the Russian context is not meaningful. 2.55 Benefits of housing privatization. The potential benefits of privatization for local budgets are obvious. In addition to a decline in operating subsidies, some revenues will accrue from property taxes. However, the actual situation may easily turn local governments into losers first and foremost because of the current maintenance arrangements for new owners. Under the law, local housing maintenance organizations remain service providers, and no higher maintenance fees can be charged to owners. Thus for an unspecified period of time, owners and tenants will be subsidized, and the reduction of fiscal deficits will be achieved only through rent increases, which can then be extended to owners' service fees. There is another important financial and social concern. Typically, the privatization process results in adverse selection whereby the best units get privatized quickly and local governments are left with the worst properties. These units are expensive to maintain, and are inhabited by the poorest households with a host of social problems. 2.56 Fast privatization. If the shift to the uncompensated transfer accelerates the process and a large percentage of stock is privatized quickly, local governments would be winners assuming that they can avoid subsidizing the maintenance for new owners. At the same time the central budget (and, to some extent, budgets at lower levels) will be pressured for capital investment grants for new construction because: i. The rental stock will be depleted. As long as there is no enforceable eviction law without the obligation to provide substitute housing, few private investors will put capital in new rental housing. For local governments, it means a decreased number of units repossessed through turnover and decreased possibilities of unloading the queue. ii. The total stock may be depleted due to increased demolitions as the deferred maintenance leads to the abandonment of buildings. Many households which privatize are likely to find their increased maintenance and repair costs unaffordable if unemployment increases and persists. 2.57 Slow or stalling privatization. If few units are privatized, local governments will be losers and will attempt to pass some costs either to the budgets of higher levels of government or to the population through further cuts in maintenance and repair services. The flow of housing services 38 Chapter 2 from the existing stock will decrease rapidly. The stock is likely to be depleted through increased rate of conversions to commercial use. C. The Central Government 2.58 In 1992, the government managed to reduce the central budget deficit by pushing many social obligations down to subnational and local levels. Since the new responsibilities and resources of local governments do not match, there are significant budget shortfalls in many areas. The pressures for increased interministerial transfers are strong. In November 1992, the Law on Subventions was passed, allowing ear-marked grants from the federal to oblast budgets, and from oblast budgets to cities and raions. Such transfers were negotiated among various levels of governments, but now they are established by law. Housing -- including the operation of existing stock and new construction -- is likely to become one of the targets for transfers as local governments are unable to meet their financial responsibilities in this area.20 In terms of direct fiscal impact, privatization will reduce the pressure for transfers from higher levels of govermnent to the extent that it will reduce maintenance subsidies. The total picture is complicated due to the unclear role of different levels of government in providing housing subsidies and various social safety net provisions. Ultimately, the central government should be responsible for the adequate social protection of those most in need. It must ensure the provision of basic services in economically weak regions. VI. CURRENT STATUS OF HOUSING PRIVATIZATION A. Characteristics of the Housing Stock to be Transferred 2.59 Potentially massive scale of ownership transfers. The scale of potential housing privatization in Russia is larger than in any other TSE in absolute value and as a share of the stock to be privatized.2' Although the share of housing in national wealth of the TSEs is lower than in market economies at similar levels of development, housing privatization in Russia entails a potentially massive transfer of assets. For example, housing represents about 18 percent of net reproducible assets in Hungary and about 20 percent in Russia. Only a negligible share of the total housing in Russia (asset value) is privately owned. The 1990 Russian estimates indicate that total household capital assets (including housing) constitute only about 3.6 percent of total net reproducible assets, and most of these household assets constitute housing. 20/ The economic policy of the government provides for the apportionment of federal budget resources for construction or acquisition of housing for strictly limited groups of the population (military; retired military; victims of accidents, natural disasters, and military conflicts; northerners; and others). Central government aid to the most needy will be put implemented through tax breaks and subsidy laws. 21/ The only possible exception might be China owing to the 7.5 to I ratio between the population of the two countries. However, the value of China's urban housing stock in state ownership may be lower because China's per capita income of $400 is one-fourth and its level of urbanization less than half that of Russia. Chapter 2 39 2.60 Relative uniformity of the urban housing stock. The Russian housing stock is physically uniform. The Russian housing stock comprises 48.4 million units (excluding vacation homes) and an additional 8.7 million beds in hostels and dormitories. Approximately 74 percent of this stock is urban. The predominance of large panel, high-rise apartment buildings in the urban stock produces the monotonous uniformity of Russian cities, especially in the larger ones. This uniformity extends to the characteristics of units themselves. In state-owned stock, 45 percent of units are two-room apartments with an average total space of 46 m2. 2.61 Recent vintage of the housing stock. The distribution of the stock by the age of construction is highly skewed towards the younger stock. The bulk of urban 78 percent and rural 70 percent of the housing stock was built after 1960. Over a quarter of urban stock (27 percent) is less than twelve years old. Only 7 percent was constructed before 1940. Even though age distribution is similar, there is a major dichotomy between urban and rural stock in terms of presence of basic amenities. While units in cities generally have hot water (78 percent) and bathrooms (85 percent), 52 percent of houses in rural areas lack piped water, and 64 percent do not have modern sewage facilities. 2.62 Combination of low construction quality and insufficient maintenance. The use of shoddy materials and the lack of quality control during construction cause the unduly fast onset of physical deterioration of newly completed buildings. Deferred maintenance has greatly accelerated this process. The Russian Ministry of Construction estimated that about 68 percent of the entire stock was in unsound technical conditions, of which at least one-third urgently needed major repairs. The retirement rates for housing in all former Soviet republics have been growing during the last five years. During 1986-1989 approximately 1.7 percent of the existing housing was retired, about 50 percent was demolished.22 Within the state-owned housing, the enterprise stock is reportedly in worse disrepair than municipal housing, but significant differences in the upkeep exist and are related to enterprises' sector or branch affiliations. B. Legislative Developments on Housing Privatization 2.63 First privatization legislation of 1988. The first housing privatization laws were enacted in 1988. The February 1988 resolution of the USSR Council of Ministers stipulated that residential buildings owned by local soviets and enterprises could legitimately pass into private ownership. The properties could be transferred at a maximum of 50 percent discount from the assessed value, with a down-payment of 20 percent and the balance to be repaid in installments for 25 years. Shortly afterward, another resolution granted ownership rights to members of housing cooperatives who paid off the outstanding balance on their loans. 2.64 By December 1988, the USSR Council of Ministers approved the first housing privatization law whereby sitting tenants in municipal and enterprise housing acquired a right to buy (at full assessed price) their flats at full assessed price. Unoccupied apartments in buildings undergoing capital repairs could also be purchased. Some high quality apartments in selective markets were 22/ According to some Russian researchers, most of the five-story apartment buildings built during 1956 to-1970 would not be worth maintaining for more than 50 years. 40 Chapter 2 purchased despite steep assessments, but low prices failed to stimulate demand for privatization of under-maintained, low quality units. The response was meager, and might have been contained further by local governments' attempts to control the sales. 2.65 Between 1989 and mid-1991, only about 128,000 apartments in Russia were sold. This small number was due primarily to insufficiently clarified and guaranteed property rights. The 1988 laws preceded the enactment of legislation establishing ownership and use rights in housing. Until 1990 regulations restricting private ownership to one dwelling were not yet revoked.23 2.66 The RSFSR Privatization Law of July 1991. The Law on Privatization of Housing in the RSFSR was passed before agreements were made on housing privatization by the Union government. It established the right of a duly registered tenant occupying a state unit to become its owner with fully guaranteed property rights. Initially, the law set the following transfer terms as guidelines for implementing regulations of local authorities: (1) an applicant's entitlement to a free-of-chargee transfer was 18 m2 of total floor space per person, plus 9 m2 per household, and (2) an applicant paid the difference between the value of the unit and the entitlement (assessed at average price of square meter in the locality). The right to privatize a unit on these terms can be exercised only once. The law stipulates that during the transition of unspecified length the housing allocation system will remain in effect in its present form and implies that those allocated a unit can privatize it under the same conditions. 2.67 In this July 1991 version, the law places restrictions on the housing stock subject to privatization. It excludes dwellings that does not meet health and safety standards. Apartments in buildings in urgent need of capital repairs can not be privatized until repairs are completed by municipalities or enterprises. New owners pay maintenance fees determined by tariffs established for operation of state-owned stock, that is, owners are effectively subsidized alongside tenants. The law encourages owners to form associations which will have the right to choose a management company when the entire building is privatized. 2.68 The 1991 privatization law is not very clear on time limits for future claims. It appears to imply, however, that those currently on waiting lists will have a right to privatize upon being allocated a unit. Clearly, new construction for giveaway privatization is economically unfeasible. What, if anything, can be done to address the problem? An extensive review of housing lists must be done locally and should address some key points: 231 Previously, the category of personal -- not private in the market sense -- property was employed in legislation. Personal property could not be used for the production of income, only for the owner's own consumption. The 1990 Law on Property in the RSFSR established the right of citizens to hold private property in housing. Chapter 2 41 - How are households in queues presently housed? Some live with relatives in overcrowded units that can be privatized. If a unit can be used as collateral for a loan, then a family may opt for individual construction. In this case, construction grants should be made available. Generally, localities need to examine costs and demand for options involving a combination of vouchers and land plots to compensate households for leaving the queue. This approach has been used in a Polish program.24 Many individuals or groups (who can form building associations) interested in house building are likely to take advantage of the offer. Moreover, construction grants could also be used as a down-payment for purchase of new municipal units. The importance of getting a housing finance system in place cannot be overestimated: all these schemes rely on the introduction of mortgage financing. Compensation schemes for waiting lists need to be approached in the context of the whole housing subsidy system. Offers to leave the queue would be taken up by households with the resources to match construction grants or incomes to support debt service. - The problem of low-income households on waiting lists remains. Only low-income households should be able to sign-up for municipal rental households. 2.69 Implementation by local governments. In 1991 and 1992, subnational and local governments followed the blueprint of the national privatization law to develop their own versions.' The chief difference was the amount of housing transferred free of charge. Many governments increased the national norm significantly; the oblasts of Smolensk, Amursk, Tulsa, Rostov and the city of Moscow (and some other regions) decided on free transfer. This was largely regarded as gross injustice. Transfer costs were perceived to be fairly high to some populations (smaller households on low or fixed incomes, and those in relatively bigger flats). This concern could have easily been addressed by local governments, which were encouraged by the law to establish financing schemes including long-term discount credit and installment plans. The average effective cost of privatization (for transfers including cash payments) in the spring of 1992 was estimated to be only in the range of Rubles 1,000-10,000, or one third to three times the average first quarter household income. 24/ Poland has attempted to deal with its waiting lists through a program in which households are offered preferential conditions for access to land and given a construction grant. It is not known how many households have taken advantage of this offer. 25/ For example, the early proposal put forth by the City of Moscow attempted to accommodate the claims of several groups of inhabitants who were either ill-served or would not benefit from the national privatization law through a voucher program. This proposal included occupants of small units and households ou, waiting lists. The city vouchers would have made these persons eligible for free apartments as they became available. This proposal would have been a legal commitment creating a large liability to an as yet unspecified number of future claimants. 42 Chapter 2 2.70 December 1992 amendment to the Federal Privatization Law of July 1991. In response to these concerns, the Supreme Soviet sought to amend the July legislation and moved to switch from the "free norm plus residual payment" formula to a giveaway transfer. There were also other smaller changes. Transfers of some categories of dwellings previously excluded from privatization is now permitted (para. 68). A reportedly large number of applications came from tenants residing in buildings which did not meet basic health codes or which needed major renovations. The amendments clarified the status of enterprise housing in case of ownership change or liquidation of the enterprise. In these cases, housing is to be transferred to legal successors of the firm or to the municipality. This change came in response to many instances where enterprises blocked privatization or abandoned their housing (together with social facilities).26 To simplify and accelerate the processing of applications, the amendment removed the requirement of notarial authentification. C. Speed of Privatization 2.71 According to the Ministry of Economy, as of January 1993 about 2.5 million apartments with a floor space of 125 million square meters had been privatized in Russia. This constituted approximately 6 percent of the total state-owned stock.27 The pace of privatization accelerated greatly in the second half of 1992. By the end of 1991, only 113,000 apartments were privatized, and another 70,000 were transferred between January and April of 1992. Of the 200,000 apartments privatized as of April, half were in the city of Moscow because the enactment of local privatization laws and the actual availability of administrative services lagged significantly behind the national July 1991 legislation. For example, Ekaterinburg and Novosybirsk enacted their own local decrees in January 1992, while Moscow did it in February 1992, and many other cities even later.28 D. Regional Patterns 2.72 The regional data for transfers completed until mid-1992 (including sales before the enactment of the July 1991 privatization law) shows no consistent patterns. The rates appear higher in regions and cities with free transfers, but other factors are also at work. In the selected markets like Moscow, widely publicized high market prices affect the rates. The rates are higher in regions with better natural and climatic conditions. For example, Northern Caucasus privatized 4.4 percent of its social stock while the Northern region 0.4 percent; the rate for the whole country was 1.3 percent. There appears to be a positive correlation with the percentage of privately owned urban housing in the region. More widespread ownership as an alternative to state-provided housing before the privatization programs began may have facilitated household decisions. 26/ See comments on the amendments to the privatization law, in a Russian language article by N.Lopatkin, Moscow, December 1992. 27/ Expressed as percentage of total residential space in state-owned housing stock. 28/ The pace of housing privatization sharply accelerated in 1993. At the end of that year more than 8.5 million apartments had been privatized, or 24% of the aggregate number of state and municipally-owned apartments. Subsequently, the pace of privatization slowed. Chapter 2 43 BOX 2.4: What Privatizatlon Pace Can be Expected? The experiences of either the UK or other TSEs indicate that, irrespective of large price discounts, privatization does not necessarily happen overnight. Beside the purchase price, several other factors directly affect the pace of privatization: the physical characteristics of the stock, tenancy rights, and the housing subsidies provided to renters and owners. The following section summarizes some of the key facts about privatization programs in the UK and Eastern Europe: * The UK "Right-to-Buy'Program Between 1979 and 1991, nearly 25 percent of the 6 million public sector units were sold to sitting tenants. As a result, the share of public housing in total stock fell from over 30 percent to slightly over 20 percent. Most units sold were houses rather than flats in multi-story buildings. Discounts on market value increased during the life of the program and are currently from 32 to 60 percent for houses and 44 to 70 percent for apartments. Discounts cannot be turned into cash. They must be repaid (on a sliding scale) if the privatized unit is resold within the three years. After three years, the unit can be sold with no restrictions and no capital gains are recaptured by local authorities. Normal capital gains taxation applies. * The Bulgarian Experience One of the most successful housing privatization programs in Eastern Europe is that of Bulgaria, which privatized 50% of state-owned rental stock within two years. Bulgaria already had an extremely high share (90%) of owner-occupancy by any standard. While this initial situation is significant, privatization was no doubt accelerated by the sharp nine-fold public rent increases in March 1991. * The Albanian Experience Starting from a situation of total state control two years ago, the greatest proportion of the Albanian urban and rural housing stock has now been transferred to private owners. The direct relevance of Albania to Russian privatization would appear quite limited given Albania's limited economic development, urban development, and its low industrialization. What is relevant to other TSE countries in the Albania case is that a good condominium law was passed by the new parliament prior to privatizing the housing stock. It was clearly understood that without such a law clearly assigning responsibilities for the maintenance of apartment units and common space, the state might be trapped into continuing maintenance of much of the housing stock. Another relevant point is that in order to go very fast Albania decided to privatize apartment by apartment and not building by building, which would have been much better, as shown by the Western experience. The Albanian condominium law allows the state to be a member of the condominium association for the units it still owns. This should permit a future regrouping of state owned apartment units in their own separate buildings, which is advisable. 2.73 At least two factors have affected the regional privatization patterns, but the degree cannot be established. The local privatization laws have been enacted at different tirnes between January 1992 and mid-1992. The economic base of a city has been important. Many enterprises, 44 Chapter 2 reportedly, have refused to comply with or obstructed the law. Several ministries (including the Ministry of Defense) and federal industrial associations have issued orders suppressing privadtzaion of housing under their control. These orders have since been rescinded. Finally, the federal data reported completed transfers rather than the number of registered applications in all processing stages. For example, the May privatization data directly obtained for Moscow, Ekaterinburg, and Novosibirsk indicated that the applications in these citieswere equal to 114 percent, 175 percent, and 409 percent of the number of units transferred.29 VII. MANAGING THE TRANSITION 2.74 Privatization involves trade-offs between efficiency and equity. Unfortunately, the two cannot be easily reconciled, in the short term. There will inevitably be losers, but how much of the temporary imperfection can or should be tolerated? The current system of general subsidies to the population regardless of income is inefficient, inequitable, and must be altered. The safety net protection must be provided for the poorest households. 2.75 Windfalls are unavoidable during conditions of deep disequilibrium and extensive quantitative shortages, and will persist throughout the transition. They are difficult to accept politically because the initial housing endowment has been inequitable. Well-housed families, members of the former nomenklatura, will win again. There will be public pressure to contain or redistribute windfalls through administrative regulations or fiscal tools, but these would be counter-productive and costly. For example, restrictions on transfers of privatized units and heavy, progressive capital gains taxes would stall privatization. Ultimately, the transition period would be prolonged. The development of housing markets, bringing the general improvement of housing conditions, would be delayed. Because it is not possible to voluntarily privatize all housing instantly, good management of state- owned housing will be imperative. Chapter 5 explores the management of state-owned housing during privatization in more detail. In one possible model of the future housing delivery system, subsidies are directed solely towards consumers. Market rents are charged throughout the sector and the rates of return to all owners of housing converge. Once the rents in state-owned rental sector are raised to market levels, the rationale for the sector's existence becomes questionable because renter households can move freely between the publicly-owned and private rental sectors. m:\rhsector\green.eng\chapters\chp2x.v4 August 8. 1995 29/ Regional variations in housing privatization subsequently diminished. By the middle of 1994, the percentage of privatization fluctuated from around 40-50% in the southern regions to 4.7% in Tatarstan and 8.8% in Yakutia. CHAPTER 3 FLOW OF FUNDS THROUGH THE HOUSING SECTOR AND EMERGING ROLE OF RENTS Table of Contents I. DYSFUNCTIONAL AND DISRUPTED HOUSING FLOWS OF FUNDS .... 45 H. THE CURRENT RENT SITUATION IN RUSSIA ................... 47 A. Minimal Rents, Low Utility Charges and Strong Tenancy Rights ... ..... 47 B. High Maintenance Subsidies and Pressures for More ............... 47 C. Property Transfers, Budget Cuts, and Effects on Housing ... ......... 49 m. UNDERSTANDING THE STRUCTURE OF A REAL ESTATE ECONOMY 51 A. The Property Market and the Use of Space ..................... 52 B. The Asset Market and Decisions to Invest ...................... 53 C. The Stock Adjustmnent Process ............................. 53 D. The Function of Rents in Housing Sector Performance .............. 53 1. Central Planning and The Effects of Recent Economic Instability . 54 2. Stabilization Strategy: Improving the Flow of Funds Through The Housing ...................................... 58 IV. MOVING TOWARD RATIONAL RENTS ......... .. ............. 61 A. Definng the Full Cost Recovery Rent ........................ 61 B. What Could be the Full Cost Recovery Rent in Russia? ............. 64 C. Feasibility of Municipal Rent Increases ........................ 65 D. Five Principles for Establishing Public Rents .................... 68 E. Annual Rent Reviews and Stock Valuation: Historical Cost Versus Replacement Cost ..................................... 70 F. The Case of Enterprise Housing ............................ 71 G. Rent Regulations for the New Private Sector ..................... 72 V. RENT REFORMS AND VULNERABLE GROUPS ....... .. .......... 72 A. The Rapidly Changing Household Income Distribution of Russia ... ..... 72 B. The Distorted Socialist City Structure Under Market Pricing ... ....... 74 C. Will Housing Allowance Programs Work in Russia? ............... 75 VI. MANAGING THE EXISTING HOUSING STOCK AFTER PRIVATIZATION ................... ..................... 76 A. Mixed Private and Public Ownership and Condominium Law .... ...... 76 B. Importance of New Housing Management Firms ................. 77 CHAPTER 3 FLOW OF FUNDS THROUGH THE HOUSING SECTOR AND EMERGING ROLE OF RENTS I. DYSFUNCTIONAL AND DISRUPTED HOUSING FLOWS OF FUNDS 3.1 There are two leading causes behind the inordinate inefficiency of the Russian administrative- command system of housing. First, there are the principal-agent problems and the consequent high transaction costs created by the total separation of households from all key decisions supposed to benefit them. As discussed previously in Chapter 2, rapid privatization of housing, which has taken place since mid-1992, provides the key correction to this first group of problems: housing is being put in the hands of better owners. 3.2 Second, there is the lack of accurate price information to guide all decisions large or small, for new construction or maintenance. The details of the flow of funds through the housing sector are remarkably poorly known for a system where all decisions were centralized. There is no link between the cost of providing housing and the value of housing services. Russia lacks knowledge of the real resource costs of existing state-owned housing. State investments in new housing are not amortized through rents and continue to be treated as a one-time cash expenditure. Because there are no direct links between financial inflows and outflows, meaningful financial plans for state housing construction projects do not exist. It is only since the 1992 reforms that prices are beginning to play a leading -- rather than secondary -- role in resource allocation. 3.3 The most conspicuous indicator of a dysfunctional flow of funds are the housing rents themselves which bear no relation whatsoever to the user cost of housing capital in Russia. Under central planning, rents have by design played no role in the allocation of resources and households choices. These housing rents could be thought of as some kind of management fee or real estate tax. Rent reforms, which must now be carried out by the various municipal, enterprise, and cooperative owners of the housing stock, are the necessary complement of privatization. They form the most critical part of the restructuring of the flow of funds through the Russian housing system that is currently taking place. 3.4 The rapid collapse of the administrative-command system means that the traditional flow of funds has been profoundly disrupted, and that the total volume of state funding has been sharply cut back. ' Under central planning, housing was financed through a series of implicit taxes, particularly through the low wage system. As the volume of implicit taxes shrunk and central planning was dismantled, the share of these resources going to the housing sector began contracting rapidly. Stabilizing the housing sector means achieving greater levels of cost recovery, raising rents, and mobilizing new resources. This must be done in a way consistent with the emergence of the market- based housing system. Pressures for maintenance subsidies from various budgets have been rising sharply. These pressures are partly due to inflation, but mostly due to adjustment in relative prices I/ For a presentation of the traditional flow of funds for new construction under central planning refer to Chapter 6, in particular to Figure 6.1 46 Chapter 3 which are imperative such as energy price increases. These new levels of high subsidies are unsustainable, particularly for local governments. The share of direct household contributions to the housing sector must rise if the flow of housing services from the housing stock is to be maintained anywhere near its recent levels. For the existing housing stock which dominates the housing system in terms of the value of resources, these contributions will come from higher rents for those who remain renters, or direct out-of-pocket costs for new owners. Funding new construction is an additional problem. There also, cost recovery and repayments will take place through rents, or their equivalent for new home-owners. 3.5 Deciding not to raise rents would be equivalent to deciding that the total flow of funds through the housing system should be permanently cut back. A much lower volume of housing services from the housing stock will rapidly match this lower volume of funds. Housing standards will fall to match the rent-to-income ratio that households will be willing to pay. This downward adjustment will take the form of housing stock losses resulting from deferred or zero maintenance. Current estimates of the rate of depreciation of the housing stock are not available in Russia. However, by reference to depreciation rates in market economies, they are probably of the order of 4 or 5 percent per year in Russia, which is equivalent to one year's worth of new construction. In addition, the deep pricing distortion of low rents would continue to block the development of new housing construction markets. 3.6 For public policy, the immediate priority is to stabilize the flow of housing services coming from both the existing stock and new construction. The Russian economy has been contracting over the last few years and the strategic question facing central and city governments alike is how to deploy their scarce resources among alternative choices to achieve the greatest possible return. Such a question would be best addressed through an explicit financial plan tracking the dynamic and interactive flows of public and private resources going into construction and maintenance. 3.7 As an initial step toward such financial plans, this chapter presents an aggregate model of the real estate economy. This model focuses on the essential features of the real estate economy. It shows the relationship between property markets where existing floor space is sold among competing users, and asset markets where decisions to invest are made against alternative opportunities in other sectors. It offers a concise representation of a market based housing system. Multiple housing reform actions are required in Russia, and they may at times appear difficult to put in perspective. Within this analytical framework, it is possible to show where individual components of reforms have an impact on the housing economy, and where they relate to each other and interact within in a coordinated reform strategy. Then the chapter discusses the problems to be solved in establishing more rational rents. It examines also the complementary reforms in construction and maintenance that should accompany rent reform. Eventually, the chapter returns to the difficult social, political, and managerial problems of raising rents under present Russian conditions. To provide the context of the analysis, the chapter first outlines current rent conditions in Russia. Chapter 3 47 H. THE CURRENT RENT SITUATION IN RussIA A. Minimal Rents, Low Utility Charges and Strong Tenancy Rights 3.8 Significant changes in rents only began in 1993. So far renters of the state-owned housing stock have paid extraordinarily low rents, which have been frozen since 1928. The basic rate per square meter of living space has remained at 13.2 Kopecks for over 60 years. Best quality units conmmanded a 25 percent surcharge, or 16.5 Kopecks per m2.2 The state also maintains price ceilings on residential utilities. Until the end of 1991, residential tariffs for heating and hot water remained at 1967 levels, ranging from Rbs. 1.58 to 5.78 per Kcal. Between 1967 and 1991, wholesale energy prices increased twice, but residential tariffs remained unchanged. The first residential increase came in January 1992, when the tariffs were raised by 200 percent. Additional increases are now being implemented in various cities. 3.9 Like all renters in the publicly-owned housing of TSEs, renters in Russia enjoy strong tenancy rights (see box 2.1 in Chapter 2). The occupancy contract does not specify a time limit. The occupancy right is permanent; it is transferrable to family members registered in the unit. The first important breach to this entitlement was made by the December 1992 Law on Principles of Federal Housing Policy.3 Implementing regulations, however, have not been developed and it is unclear whether the procedure could be enforced. This law does not address other situations in which tenant eviction is an issue, such as existing workers occupying enterprise-owned housing after their employment is terminated.4 A Goskomstat-World Bank survey of 1992 wages and benefits shows that, in half of enterprises which own housing, non-employees constitute over one-third of all tenants. B. High Maintenance Subsidies and Pressuresfor More 3.10 Massive impact of price liberalization. Large deficits were incurred in the operation of state- owned rental housing, but they did not become a problem until price liberalization. In 1990, a recorded Rbs. 83 million maintenance subsidy to municipal housing organizations constituted a negligible share (below 1 percent) of total local expenditures budget. In 1992, this share was estimated to increase to at least 5 percent. In 1990, approximately 57 percent of municipal 2/ Under the old Soviet system, several categories of renters were entitled to living space exceeding the social norm (12 square meters per person), and to significant rent rebates, (up to 50 percent off the flat rate). However, charges for additional living space were higher. The square meters above norm were priced at three times the regular rate for the floor space under basic social entitlements. 3/ The new housing policy law permits eviction for non-payment of rent after a 6-month grace period. It specifies that the altermative dwelling to be provided must only meet standards acceptable for hostel-type accommodations, making the possible penalty significant for the first time. 4/ Under the Soviet housing laws and central planning, the Council of Ministers specified a list of priority industries and branches. The list determined which enterprises were entitled to reallocate their tenants to other dwellings after the labor contract was terminated. This limited eviction right would only apply if a contract were terminated by an employee without sufficient cause, or if the separation was the result of a disciplinary action. 48 Chapter 3 organizations incurred minor deficits. Deficits have been fueled by high inflation in the construction and municipal service sectors. In 1991, Goskomstat reported an almost threefold increase in prices for housing repair services, followed by another in January of 1992. Since rents remained practically frozen until 1993, cost recovery on the municipal stock has fallen dramatically under inflation rates of 15 to 20 percent per month (see figure 3.3). Residential rents covered approximately 20 percent to 30 percent of the stock operation and current repairs in 1991; this range has now dropped to an average of 2 percent to 5 percent.5 (For details on trends in operating subsidies, see the statistical appendix, section 6.) The effects of price liberalization on enterprises is not well documented. Their housing programs involve large implicit budgetary subsidies in the form of foregone taxation. For instance, the 1991 tax regulations exempted from the profit tax the share of retained earnings used by enterprises for housing. On the other hand, the impact on municipal housing is clear: the ability of state owners of housing stock to absorb the inflation of housing costs has declined dramatically with price liberalization. Rather than increasing subsidies further, state owners -- especially municipal governments -- are sharply cutting maintenance. 3.11 Fragmented Budgets and Chronic Undermaintenance. The expansion of the supply of housing through existing stock, which is created through capital repairs and renovation, has been falling sharply. In 1990, this "supply from the existing stock" measured by total renovated floor space was only 60 percent and 50 percent of the 1980 level for municipalities and enterprises, respectively. The outlays for capital repairs have dropped even more significantly over the last three years. Regardless of these trends, the levels of current repairs and capital repairs have been chronically too low, resulting in the premature physical deterioration of the stock. The Ministry of Construction estimated in 1992 that about 68 percent of the housing stock is in "unsound technical condition". One key incentive behind this disturbing trend is that the administrative-command system makes no allowance for the amortization of capital costs under a the total separation of budgetary responsibility for new investments on one hand and maintenance on the other. Needless to say, concepts of life-cycle costing of buildings were absent from Soviet practice. Furthermore even within maintenance budgets there is a sharp division between routine maintenance operations and capital repairs. To make matters worse, in 1992 the central government has passed on responsibility for capital repairs and renovations to local governments who lack the resources to carry this burden. 3.12 Minimal yet still falling household effort ratios. The combined burden of rent and utilities is very low for tenants in the Russian departmental and municipal rental stock compared to other TSEs. The average household effort ratio (the ratio of rent plus utility and other housing payments 51 Many enterprises are resorting to barter as a new version of the former system of state-orders to maintain viability. The dynamics of inter-enterprise arrears and barter trade, which rapidly developed with high inflation in 1992 do not augur well for the future of municipal housing. Barter trade allows enterprises to meet obligations. Municipalities have been following similar tactics. To handle their budget deficits off-budget, municipal governments have often transferred losses to their municipally-owned enterprises with separate budgets. Among these, municipal housing administrations have few goods to barter because they manage the occupied housing stock. Being at the end of the arrears chain, rental housing enterprises are accumulating deficits faster than other enterprises and are in very poor financial situations. Chapter 3' 49 to income) for urban households6 remained stable at 3 percent until 1987. Nominal incomes rose but rents and utility tariffs remained frozen or controlled. In 1991, the effort ratio was down to 1.4 percent. By mid-1992, the total rent effort ratio including utilities fell below I percent; the share of rent proper was barely equal to two-tenths of one percent. (See statistical appendix, table 1.6) Therefore, for all practical purposes, the household contribution to cost recovery for the existing housing stock fell to nothing in 1993. 3.13 Multiplicity of maintenance subsidies. On-budget maintenance subsidies include stock operation, current and capital repairs, and utility subsidies. Large off-budget, unaccounted or imnplicit subsidies are also present throughout the sector. Accounting for all subsidies would be a complex task because the three main forms of Russian housing tenures (departnental, municipal, cooperative) receive funds under different rules through different channels. 3.14 Enterprise versus municipal housing. The operation of the enterprise stock appears to be much more costly than that of municipal housing. In 1990, operating subsidies per m2 of the total enterprise stock were reported to be Rbs. 5.4 compared to Rbs. 0.14 for municipal housing. This subsidy differential implies large inefficiencies in the enterprise housing management system. Greater inefficiencies may arise because enterprises by law must maintain extensive housing administrations and maintenance service units for a stock that consists of one or two apartment buildings. Accounting practices designed to disguise diversion of funds to other uses also contribute to the difference in operating subsidies between the two types of tenure. 3.15 Energy-related subsidies. What remains of budget and enterprise resources for housing is concentrated on utility subsidies, especially energy subsidies. Estimates for 1992 made by the Ministry of Finance placed the total figure for the subsidies to the existing stock at approximately Rbs 154 billion, or 12 percent of all local budget expenditures. Over half of these transfers are used for residential heating and hot water, the largest operational subsidies. Heating and hot water subsidies have escalated since the energy price increase of 400 percent in May 1992. C. Property Transfers, Budget Cuts, and Effects on Housing 3.16 The system of interministerial commission fiscal relations is being totally restructured.7 Already, in 1991 and 1992, several legislative acts altered the rights and responsibilities of entities managing state rental housing stock. Following the Law on Property in the RSFSR and the Republic's Supreme Soviet's decree on the division of state property, local soviets (previously managers of municipal housing located within their jurisdiction) became owners of state property. 6/ Russian household surveys traditionally used the category of 'employees in non-agricultural sectors' not .urban households". Regarding housing expenditures, the data is biased upwards because it includes households residing in cooperative housing who constitutes about 6 percent of urban residents and owner households. The effort ratio for cooperative households is higher than 10 percent and may include debt servicing on housing loans from Sberbank. 7/ See "Russia: Interministerial commission Fiscal Relations in the Russian Federation", Report No. 11302-RU, The World Bank, December 1992. 50 Chapter 3 Housing ownership was also granted to financially autonomous enterprises and organizations, but not to budget-financed entities, which retained their management role. The major change in 1992 was the transfer of financial responsibilities for housing from the republic's budget to the oblast level and below. In April 1992, a decree issued with the Budget Law empowered local governments to increase rents for the first time in over 60 years, as well as utility charges. Box 3.1: Insuring a Sound Aggregate Return to Housing The Gennan Rent of Reference (Vergleichmiete") Rents in the private rental sector of the Federal Republic of Germany are set freely in an individual contract between a landlord and a tenant. Both parties can agree on phased rent increases during tenancy, which are then recorded in the contract. Otherwise a landlord can demand annual rent adjustments. These rent adjustments are subject to regulation under the "rent of reference" system which applies to approximately half of the private rental stock. Rather than control rents, the system purports to disseminate market information and to promote "fair "pricing, i.e. similar rents for dwellings of comparable quality and to prevent erratic or unwarranted price increases. 'Comparability" is not explicitly defined in the Federal Law, only the process to be used to determine it. Municipalities are free to develop their data base and analytical methods to monitor rents across their entire urban area. Generally, rents are adjusted according to the rule of 'three times three": landlords are expected to locate three comparable dwellings and adjust the rent they demand accordingly. In addition, the system imposes a 30% cap on rent increase in three years. Such a rule, which is suitable in an economy with stable prices, would need to be modified in Russia and other TSEs. The "rent of reference" system avoids the most serious negative effects of rent controls based on "normative" or indexed rents in that it depends on market signals. It protects the tenant, while still allowing landlords to earn a reasonable return on their capital. Another important benefit of the "rent of reference" system relates to social housing and may not be readily apparent. The municipal data on market rents is kept current and can be used to determine the cash housing assistance for a needy family to be able to rent a specific unit. In this way, full cost recovery requirements are separated from the need to protect the excess rental burden of a poor family. As a result, considerable more options are open to rents in terms of units they can rent. Instead of being forced to dive in specially-designed, low-income public projects, social ventures have access to a considerably broader range of public and private units. Thus, much greater economic consistency is achieved across the entire system. The benefits to the economy of the combination of the "rent of reference" and the housing allowing are important. This approach reduces the need for the direct production of public housing, which, as a rule, is about 20% more expensive to produce than a private unit of comparable quality due to bureaucratic procedure and regulation. In West Germany, the public social housing stock was 7% of the total housing stock. Chapter 3 51 3.17 The new laws have burdened the local governments with extensive mandatory responsibilities, but do not prescribe a stable and predictable revenue base. Interministerial commission finances are in transition; the restructuring of fiscal relations and municipal finance reform has only just begun. Cities are barely coping with increased housing costs. If the problem of covering deficits incurred in stock operation is bad, it is worse for housing investment. Local governments funds are expected to increasingly replace the central budget's shrinking contribution to new housing construction. In volume of new housing, the central budgets' share was expected to fall from 74 percent in 1987 to approximately 13 percent in 1992, or from 975,000 to 82,000 new units per year, and was expected to remain at a similarly low level in 1993.8 3.18 Rent and tariff increases by local governments are legally permissible, but politically and economically infeasible. In January 1992, only the St. Petersburg government made minor rent adjustments. Local governments will incur increasingly large deficits for housing maintenance because they cannot pass on cost increases to renters. In recent years, commercial rents have been used to cover part of the shortfall in residential revenues, but because most renters are public agents, cross-subsidization is limited. The revenues from commercial rents in some cities such as Moscow were being claimed by other agencies. (see figure 3.3) Most city executive councils are now preparing major increases in rents and utility charges.9 3.19 Coping strategies used by local governments could be detrimental within and beyond the housing sector. Cutting the volume of current repairs and rehabilitation causes an accelerated deterioration of the already poorly maintained stock. Deferring all but the most essential payments to utility companies and other urban service enterprises appears to be increasingly common and seriously damage these organizations. III. UNDERSTANDING THE STRUCTURE OF A REAL ESTATE ECONOMY 3.20 There are strong affinities between ownership forms, economic coordination mechanisms, and government structure.'" A contributing cause of distortions in the Russian housing sector is the total segregation of the regulation of new housing construction from the operations and maintenance (O&M) of the existing stock. The Russian Federation continued in 1993 to maintain this flawed approach. The Committee for Architecture, Planning, and Construction is responsible for housing production and other construction activities. Meanwhile the Committee for Housing and the 8/ Official figures are in square meters of "construction" floor space. Estimates of unit numbers used 55.5 m2 and 62 m2 respectively for units completed in 1987 and 1991. 9/ For instance, in late 1993, the Moscow city administration approved a sharp increase in rents for state- owned property, whereby, the rent per square meter of living space would rise from 10 kopeks to 24 rubles on January 1st and would reach 101 rubles by December 1994. Major increases were also planned for central heating, water, and sewage, but not for gas charges. These rent reform plans were subject to the approval of the new Duma elected on December 12, 1993. IO/ See for instance, Janos Kornai, "The Affinity Between Ownership Forms and Coordination Mechanisms" Journal of Economic Perspectives, Vol. 4, No.3, Summer 1990. 52 Chapter 3 Communal Economy regulates housing operations, maintenance, and other urban services. This government structure was consistent with the administrative-command system and the direct involvement of the state in every aspect of the real estate sector. Today, such a structure is inconsistent with the indirect regulation of the housing sector in a market economy. " The production and the subsequent operation of real estate assets are not economically independent. Changes in one market are functionally related to changes in the other, and attempts to direct and regulate them separately can lead to severe distortions and costly inefficiencies because in a market the flow of funds between the two activities are linked. For instance, attempts to keep rents artificially low to suit popular views will insure that little new housing is built by owners who know they will bear the true cost of consficatory regulations. A viable housing reform strategy must be based on a sound understanding of a market-based housing and real estate economy. 3.21 This section describes the basic structure of the housing economy which consists of two basic markets: (1) the property market where the allocation of available housing and real estate space takes place among competing users, and (2) the asset market where investment decisions are made in competition with alternative investments elsewhere in the economy. Through such a decomposition, it is possible to see more clearly the factors that determine the flow of funds through the housing economy. This conceptual two-market analysis is also applicable to commercial and industrial real estate markets as well. It provides a much clearer view of where in the system each of the individual reforms needed to stabilize the entire housing system will have an impact. It shows the centrality of rents in allocating resources and in influencing most decisions in housing markets. In the current environment of contracting national output, this conceptual framework would also form the starting point of the flow-of-funds analyses that would be highly desirable to evaluate the best use of scarce budgetary and other funds consistent with market development. Such analyses should be carried at the national level and at the level of individual cities to facilitate local decisions. A. The Property Market and the Use of Space 3.22 This market allocates existing floor space for residential and non-residential uses. The factors affecting this market are the distribution of the population within cities, the composition and growth of employment (linked to the growth of enterprises and their profitability), and the composition and distribution of the existing property stock. Different users bid against each other for space and location until the effective demand for space matches the stock of property. This process is information-intensive. The outcome determines the rent level, which reaches equilibrium when the demand for space balances with the available stock of properties. Differentiated sub-markets reach their own rent level and should be related to the overall rent level in each market if bureaucratic or regulatory interference are curbed. II/ In 1994, based on Gosstroi Russia and Roscommunkhoz, the Ministry of Construction was established, charged with the management of housing construction and operation of the housing/communal economy. Chapter 3 ' 53 B. The Asset Market and Decisions to Invest 3.23 The rent level in the property market determines the decision to invest in new construction. The key function of the real estate asset market is to place a value on properties. The valuation of residential and commercial properties compares the rent level to capital markets and financial returns possible on other investments. Key factors affecting this asset market include inflation, monetary policy and its effect on interest rates, fiscal policy and its effect on the taxation of housing, and real ;,state and other investments. In the real estate asset markets, land and buildings are bought, sold, and exchanged along with other investments. The outcome is the valuation of each property; the price of a property is a function of the rents it can generate and the capitalization rate as dictated by the cost of investment funds in the economy. i2 Administrative concepts of priority sectors or priority investments cannot come close to the efficiency of the decentralized and project specific analyses that take place daily on investment markets. 3.24 Once property valuation has taken place, decisions to build are based on comparisons of the market value of existing properties with construction costs for similar ones. A new property is built if the property valuation is greater than construction costs. These construction costs are raised by bottlenecks such as general inflation, scarcity of serviced urban land, costly and inappropriate regulations, shortages of building materials, lack of financing, labor shortages, and inappropriate technology. C. T7he Stock Adjustment Process 3.25 Key factors affecting new construction on the property market are the existing stock of space, its depreciation rate, and annual removals from the existing stock. The quality of maintenance has a double effect. There is the 'supply of housing services from the existing stock". For instance, if the water supply and heat in a 22-story building of 11,000 square meters of space did not reach past the 9th floor, the true supply of services available from this building might be closer to 4,500 square meters. Secondly, maintenance affects the rate of removals of unusable space from the stock. D. The Function of Rents in Housing Sector Performance 3.26 An analysis of the property and asset markets as they operate today and as they could evolve under alternative scenarios clarifies the relationship between rent and housing reforms. Box 3.2 summarizes the two interrelated markets in their four key activities. Figure 3.1 provides a graphical representation of these markets and the means to trace the current dynamics of the housing markets 121 The main failure of the administrative-command system was the lack of an operational method to determine the opportunity cost of capital resources among alternative investments. This could be done only for coarser, more aggregate and more obvious decisions. In the early stages of central planning, major gains could be achieved from relatively simple decisions. However, as the development of the economy began, secular decline set in for lack of effective cross-sectoral and intra-sectoral information. High rates of investment were not matched by innovation, as in market economies. This pattern is clearly evidenced in the urban sector where engineering skills are not matched by adequate economic and financial information. 54 Chapter 3 and policy options available. The system's dynamics can be traced through the four quadrants of figure 3.1 in a counter-clockwise direction. These four quadrants match the contents of the four sections of Box 3.2. 1. Central Planning and The Effects of Recent Economic Instability 3.27 Figure 3.1 refers to market mechanism and cannot directly represent the old administrative- command system. However, it permits an interpretation of the forces at play during the transition to a market economy. Until the mid-1980s, the four parts of the housing system were working together through the rigid mechanisms of the central plan as a substitute for allocation through private property and prices. In its inefficient and distorted ways the system was sustainable and the flow of funds followed the path marked by the light dotted line ABCD across the four quadrants of figure 3. 1. - Quadrant 1 represents rent setting in the property market (the market for space). The aggregate rent level i.e. the total cost recovery level was stabilized at point A. Rents recovered from households were about 40 percent of operations and maintenance costs. However, the financing gap was covered by cross-subsidies and budget transfers. The space available may have been inefficiently allocated, but there was a basic administrative resource as well as an ex-post accounting balance. - Quadrant 2 represents property valuation in the asset market. Line OP represents the link between rent and property valuation (price P) based on the flow of rents generated and the cost of capital in the economy [P=f(R, l/i)]. The slope of line OP depends on the cost of capital in the economy, and will rotate as this cost increases or decreases. For all practical purposes, Quadrant 2 did not exist in the administrative command economy since: property valuation did not exist in the old soviet system; interest on capital funds was not recognized; there was no way of knowing the opportunity cost of new housing through an analysis of its rate of return compared to other investments. - Quadrant 3 represents construction decision. Line MC defines the construction volume in square meters, as a function of the price of property in Rubles. The volume produced, is associated with property valuation. The difference between the market valuation of existing properties and the cost of building new ones will determine the total volume of construction. The location of the construction curve is affected by production bottlenecks and the dominant choice of technology, such as large-panel, reinforced concrete industrial housing, modular manufactured housing allowing builders to balance on-site and off-site assembly flexibly, or low-rise brick buildings. The line ends at M, which is the point below which property valuations would be too low to justify new construction. Under the old system, Gosplan would make construction decisions based on estimates of social needs, technical norms, resources available through material balance analyses, and the politics of the budgetary process. Gosplan itself replaced the asset market represented by quadrants 2 and 3. - Quadrant 4 represents the housing stock adjustment process which is directly proportional to the annual volume of new construction C, and inversely proportional to the rate of Chapter 3 55 economic depreciation of the existing stock D. This process is defined by line OS or [S= f(C, l/d)]. At point D, the volume of new construction balances with the economic depreciation of the stock. In Russia, the decline in use-value of a building cannot be measured in price terms without property valuation. Estimates can be made through engineering and economic surveys. The annual rate of removal of housing units from the stock is easier to know. Out of a total space of 2,425 million square meters, an estimated 9 million square meters have been removed in recent years. This low removal rate of 0.4 percent per year establishes a floor for the depreciation rate of the stock. In the balanced housing systems of industrial economies, the annual aggregate economic depreciation rate is about 3 percent per year. Given the poor maintenance of the Russian housing stock, the total rate of depreciation has risen sharply and is expected to be around 4% to 5% per year. 3.28 The effect of the administrative and economic reforms, which started withperestroika in 1985 and accelerated in 1991 and 1992, can be interpreted with figure 3.1. These reforms led to a rapid decline in the implicit taxes used to finance the entire sector. This process was analogous (not identical) to a sharp decline in the aggregate flow of rents throughout the system. The sharp contraction of the economy since 1991 and the lack of alternative sources of funds to maintain the housing stock and to build new housing is leading to housing contraction. The effects are most visible in new housing construction. The production of new units -- around 1.2 million in 1976-1989 -- slowed to 0.985 million in 1990, 0.775 million in 1991, down to a dismal 0.45 million units in 1992. The 1992 level represents about 28 million square meters -- barely three times the annual floor space removed from the stock when the system was stable. As a result the waiting lists have been increasing steadily since 1987.'3 13/ For a detailed description of the various waiting lists see annex 11. 56 Chapter 3 BOX 3.2: The Two Interrelated Markets of Real Estate Asset market (investment) Property market (space) 2. Property valuation 1. Use of space and rent level Function: Function: Valuation of properties linked to capital markets Allocation of existing space for residential and and financial returns on other investments. non-residential uses. Setting rents (and extent Key factors: of full cost recovery.) -inflation Key factors: -monetary policy: structure of interest rates -spatial distribution of the population -fiscal policy: tax laws affecting investments -structure and growth of employment -foreign exchange policy: foreign investments -household income levels -returns on real estate versus other assets -enterprise growth and profitability Activities: -composition and spatial distribution of the Land and buildings are bought, sold, and existing stock of properties exchanged in comparison with other investments Activities: Key outcome: valuation of property (P) Different users bid against each other for space P =RI i and location until the demand for space (Price) = (flow of rents)/(capitalization rate) matches the stock of properties i reflects the cost of capital in the economy Key outcome: The rent level (Ruble/m2) will reach equilibrium when the demand for space balances with the property stock 3. Investment decision to build 4. Annual stock adJustment Function: Function: Construction decisions based on comparison of The annual flow of new construction is market valuations of existing properties with converted into a long-term stock of space. This construction costs for similar ones, if: Asset price leads to its expansion or contraction. (P) > Replacement cost (C). Key factors: Key factors: -Existing stock of space: S Construction costs affected by bottlenecks: -Annual rate of depreciation: d -scarcity of serviced urban land -annual removals from the stock: S.d -costly or inappropriate regulations -annual flow of new properties: C -shortage of building materials Key outcome: -lack of financing Growth or shrinkage of the total stock of -labor shortages property space. Stability is reached when: -inappropriate technology Key outcome: [Annual change in S] = C - S.d = 0 Production of new real estate properties: C= f(land, materials, finance. labor, regulations, (N.B. In the 4-part diagram the slope of line technology) S=C/d reflects the speed of depreciation of the stock, and the quality of maintenance.) Chapter 3' 57 Figure 3.1: Recent Shocks to the Traditional Housing System 2. ASSET MARKET: 1. PROPERTIY MARKET: PROPERTY VALUATION UE OF SPACE Rents (Rb/m2) P =R/ji D =S \ A _ A , > 0 Property Stock Property Prices 4 M \ TSt SO (millions of m2) (Million Rubles) I /1 1nDownward Stock Adjustment - / __ _ _ _> _\ | lAfter Loss of Rent Subsidies New Construction C = f(construction costs) (million m.2) S F(C /d) 3. ASST MARKET: 4. PROPERTY MARKET: CONSTRUCT1ON DECISION STOCK ADJUSTMENT 58 Chapter 3 2. Stabilization Strategy: Improving the Flow of Funds Through The Housing Sector 3.29 Several important implications can be drawn from the analyses of figure 3.1. If nothing is done to correct the rapid decrease of funds flowing through the housing system, the supply of housing from the existing stock and from new construction will continue to shrink and Russian housing standards will fall. The share of funds coming directly from the household sector is likely to rise over time, although the reform process will differ in each segment of the housing system according to each tenure form. For instance, the international or hard currency real estate markets of Russia exhibit the opposite dynamics of domestic markets: rents are rising (quadrant 1), property valuations have been rising very quickly even when adjusted for inflation (quadrant 2). The willingness to build for that market has been high (quadrant 3). So has the willingness to improve maintenance, to rehabilitate or convert buildings (quadrant 4). However, this market is only a very small part of the total urban system. The municipal housing segment is the most exposed, while the enterprise system has more adequate resources but requires extensive privatization. Given its marginal position under soviet housing policies, the individual housing segment shelters a high proportion of vulnerable groups who often require direct housing and non-housing assistance through the new social safety nets. 3.30 A coherent reform strategy of privatization and rent reforms will entail different tactics for the different segments of the real estate economy. Stabilizing rents in the aggregate flow of funds in the property market must be supported by consistent policy actions in the asset market. These policies must be differentiated for each housing segment, and must respond to the various economic shocks received by the housing system. Figure 3.2 represents transition shocks and the elements of a full transition strategy affecting the space market and the investmnent market quadrant by quadrant. Figure 3.2 offers a graphical mapping of the complete set of policy actions needed for the housing reform and privatization strategy of the Russian Federation. - Property market (quadrant 1: space allocation) Rents must be recovered to achieve stability in this market. Those who are privatizing must pay full rents, but they must also protect themselves against inflation. Rents in all remaining state-controlled housing must rise above operations and maintenance costs. The policy of uniform rents for all must be abolished. Rents on state owned property should be differentiated according to building quality, neighborhood amenities, and city location. This will be easier to achieve than to measure the actual income of occupants. It is also the appropriate approach. Rent schedules must be developed city by city. The rent schedules can be developed from observing property values in the private market and prices paid for trades and exchanges in most cities. Chapter 3 59 Convergent but differentiated rents may be needed for each type of housing: the newly privatized housing, the remainder of enterprise housing, the remainder of municipal housing, and cooperative housing. Financing programs will differ from city to city depending on local conditions. - Asset market (quadrant 2: property valuation) With the disruptions and risks in the economy, and the fall in domestic savings, the real cost of capital has been rising sharply. The property valuation line P=f(R, I/i) has been rotating adversely against the real estate sector. Unless inflation-adjusted rents rise, which has happened in the hard currency market, prices per unit will fall relative to other activities. Housing reform policies can do little to change these macroeconomic conditions; they must adapt to them. - Asset market (quadrant 3: housing construction) Much can be done in the construction sector to increase efficiency and significantly lower the unit cost of housing (that is, to rotate the construction line in the right direction). These strategic areas for action, as identified in Box 3.2: - Improve access to serviced urban land. - Change the regulatory system that is heavily biased in favor of expensive and unattractive production technologies. - Demonopolize the construction industry. - Develop new, bank financing mechanisms. - Demonopolize the building materials industry and modernize the supply of building materials to match the new type of housing demanded. - Property market (quadrant 4: housing maintenance) Housing maintenance policies can help stabilize the sector. A real burden on Russian housing policies is the industrial housing that dominates the housing stock. These housing units are much more expensive to maintain than alternative units. The under-financing of maintenance and poor institutional arrangements exacerbate the high rate of depreciation of the housing stock. There is considerable scope for lowering the depreciation rate of the stock and losses in the supply from the stock (which is equivalent in the analysis of figure 3.1 to rotating the stock adjustment line S =f(C, l/d)). These actions must be taken: - Privatize the stock and implement condominium laws. - Demonopolize and restructure the maintenance organizations. - Develop new contractual arrangements for maintenance. - Reduce the large energy losses resulting from housing operations. - Implement large-scale rehabilitation programs jointly with rent increases. 60 Chapter 3 Figure 3.3 Stabilization Strategy for Housing 2. ASSET MARKET: 1. PROPERTY MARMET: Rising Cost of Funds Privatize the Housing Stock Rising Cos oFud Reform the Rent System Few Options, Dependent on R MvIacroeconomic Stabilization P=RIi \;:= B \B A V~~~~~~ C ~~~~~~L.... ……D~~~~S F ld C f(construction costs) \ 3, ASSET MARKET: 4. PROPERTY MARKET: Compensate Increased Capital Costs Cut Depreciation Rate and Stock L( With Improved Production Efficiency With Improved Maintenance And Different Buildings Large Rehabilitation Programs Life Costing of New Buildings Chapter 3 ' 61 IV. MOVING TOWARD RATIONAL RENTS 3.31 Now that privatization seems to be speeding up, the time has come to restructure rents. This section analyses the rationalization of rents, Russia's current experience, and restructuring subsidies on state rental housing (a topic which is revisited from a management viewpoint in chapter 6.) 3.32 Once the option to privatize is offered to tenants, the pace of privatization depends on several factors: the current and anticipated rent levels, the property tax, the focus of housing maintenance responsibility, and the method chosen for privatization. In turn, the pace of rent reform, which depends on gains in real incomes, is also contingent upon the pace of privatization. Fast privatization facilitates funding of housing allowance programs to accompany real rent adjustments by reducing the population to be served. Administrative and market rents can also converge faster. Economic logic argues that at least real (inflation adjusted) rent increases should be carried out in parallel with privatization because the perceived higher value of owning a unit is likely to increase demand for privatization. Decreased subsidy levels will make state tenancy less attractive. 3.33 Successful housing reforms leading to a household-based housing demand depend on rents that recover the full resource cost of a housing unit. The components of this full economic rent include: (1) site value; (2) capital value of housing, which is used to calculate interest and depreciation; (3) maintenance; (4) management, taxes and insurance; and (5) profits that generate the resources for further investments. Box 3.3 presents the format for calculating full economic rents, and the various incremental steps that could be taken to raise rents. A. Defining the Full Cost Recovery Rent 3.34 Private owners have clearcut incentives to find their full rent, but it is public ownership which overwhelmingly dominates Russian housing. To manage the public housing stock, a balance must be established between revenues from rents and expenditures. Expenditures can be divided into three categories: (1) management (security, taxes); (2) minor and major repairs; (3) loan repayment contracted for capital investment (major repairs, construction). The equation "rents = management cost + repairs + repayments" is a valid principle applied in practically every country with a public housing policy (see box 3.2). Rents often remain moderate because construction cost is carried out by the social owner with partial subsidy of the total price (site + building), or of the financing applied to this price. 3.35 The achievement of financial balance in public housing is quite complex. It can be attempted on housing estates of varying size. A single proprietor may wish to break even on each apartment 14/ The format to analyze the full economic rent presented in box 3.2 was developed for China. The Chinese urban economy is faced with rent reform and privatization problems comparable to Russia, including the exclusion of land --and therefore the value of location-- as part of project costs. Buildings must now be privatized with the land underneath but site valuation is very difficult. 62 Chapter 3 block, various apartment blocks, or on all his property.'5 Several proprietors may break even through revenue and expenditure sharing, using various mechanisms to partially cross-subsidize rents from the rich to the poor. This can be done with direct payments, rent allowance systems (which cover a wider field than any housing stock, no matter how large), and income redistribution through taxes with some tax revenues used for public housing. 3.36 Cost recovery rent varies according to the age of the housing stock. Proprietors who fiance new apartment blocks through loans must devote a major proportion of rent revenues to loan repayments (but often rents are slightly higher), in the same way as a proprietor who needs to finance major repairs to old or low-quality buildings. Intended maintenance standards are crucial. This single factor can cause the break-even point to vary considerably. Management can be of variable effectiveness, and taxation can play a role. If real estate taxes are equivalent to one or two months' rent, tenants will have to pay more than if the public housing sector were not taxed. 3.37 The financial break-even point depends on the subsidy system. Capital investment subsidies enable costs to be reduced for investors and lead to lower rents. If new construction is free of charge, rents should be lower than if construction was funded through loans. Operating subsidies could be allocated to compensate for low investment subsidies, or to add to their effect. It is better to subsidize capital investment and attempt to reach a break-even point on operating costs. Major repairs can always be considered eligible for subsidies. If the rent allowances program is large, rents can be higher and the initial investment assistance can be lower. Everything depends on the limits within which family subsidies are funded and distributed: will they cover a single portfolio of buildings or an entire local housing system? Will the housing subsidy system operate independently or will it be included in the total social safety net system? 3.38 Attempts should be made to recover costs on apartment blocks, including ground-floor shops, but not including buildings with different purposes such as department stores, offices, and government premises. Many cities and neighborhoods will not break even. It might be more effective to depend on housing rents and rents for commercial premises in the same building to balance expenditure. Several factors complicate the definition of cost recovery rents: uncertainty about the future of new construction and the system by which' it is funded; uncertainty about the construction and repair programs to be implemented; and the speed and method of privatizing housing stock. 3.39 Permanent monitoring of the financial balance within the housing sector and the composition of the local flow of funds should be maintained city by city. The immediate objective is to define an economically sound rent level that covers management, maintenance, and, if possible, major repairs. This should continue after the housing stock is divided between new proprietors, some buildings are privatized, or units are retained as public housing in each property. Monitoring will help determine the economically c,.rrect rent level. This level will be affected by the age of the housing stock, the willingness tk. carry out small or large-scale repairs, the contribution of non-residential rents, and other sustainable sources of funds for low-income subsidies. 151 Taking into account the financial treatment of buildings scheduled for demolition. Chapter 3 63 Box 3.3: The Components of Economic Rent Rents to be charged in units owned by public (local authorities), social (housing associations) or private landlords can be calculated differently, depending on the owner's objectives. China has been concerned with the destabilizing macroeconomic effect of its state- owned housing system since 1988. That year it issued a housing reform plan that centered on rent reform and privatization of the stock. Efforts were made to provide local governments and enterprises with guidelines for rent adjustments. The following rent categories were defined as a step ladder of rent increases until a full cost recovery 'commercial rent' has been reached. This scale clarified the magnitude of the distortion associated with alternative rents. 1. BFR = maintenance fee + administration fee; basic fee rent 2. CR = BRF + depreciation + insurance fee; cost rent 3. LIR = CR + low interest rate; low interest rate 4. RIR = LIR + rational interest rate; 5. CMRI = RIR + profit; 6. CMR2 = CMRI + housing tax; 7. CMR3 = CMR2 + land cost, where; with: 2. CR = BFR + depreciation + insurance fee; 3. LIR = CR + low interest rate; 4. RIR = LIR + rational interest rate; 5. CMRI = RIR + profit; 6. CMR2 = CMRI + housing tax; 7. CMR3 = CMR2 + land cost, where: l * The first four calculations are commonly used in China as a basis for rents charged to occupants of public or social rental dwellings; these rents involve explicit and/or implicit subsidy. In addition, a ceiling on the actual level of rent paid by the household may by set. This maximum household burden ratio, i.e. the share of rent in household income, is usually 20 percent. Privately-owned rentals command rents that cover full economic cost. * The choice of interest rate, based on the opportunity cost of the capital, is of crucial importance and has the largest impact on the rent level. An investor may decide upon the current long term loan interest rate or the replacement interest rate. * The actual market rent, i.e. the rent which prevails in a freely functioning rental market, can differ from equilibrium rent, which is a theoretical concept and denotes rent that would prevail when the supply of rental housing can fully respond to demand (Compare Points (1) and (2) in FIGURE 2.1). Sour: Yukun WANG (1990) 64 Chapter 3 B. Mhat Could be the Full Cost Recovery Rent in Russia? 3.40 Frozen rents for 60 years combined with three years of extremely high inflation of 150 percent in 1991, 2,400 percent in 1992, and about 1,000 percent in 1993, mnake it obvious that rent must be raised manifold in nominal amount. Raising them in real terms will be a difficult process which will be best carried out at the local level. What could be the required increase? Two simple approaches can be used. One way is to look at the experience of housing management organizations. The other is to estimate the current replacement cost of an apartment unit. Given the high inflation rate in Russia, the relative prices used here were based on April 1992 data, and 1992 prices. The price numbers are no longer relevant but the conceptual approaches remain applicable. a. Survey of housing management organizations. According to housing administration officials in Moscow and St. Petersburg, the appropriate rent level to offset expenditure including major repairs (but excluding future construction), was between 4 and 15 rubles per square meter of living space per month in April 1992. This equals 150 to 400 rubles per month (excluding utility expenses) for a standard housing unit of 50 square meters, with usable living space of 32 square meters. Large state enterprises managing their own housing reported even higher figures between 450 and 575 rubles per unit per month. b. Construction replacement cost estimates. A new public housing unit built in the spring of 1992 cost about 300,000 rubles. (Various sources reported housing auction sales ranging in price from 100,000 to 1 million ruble for apartments of exceptional value.) If a very conservative return of 2 percent is accepted (I percent to reconstitute the capital, I percent for administrative costs, taxes), a 300,000 ruble housing unit should have been rented for 6,000 rubles per year or 500 rubles per month (15 rubles per square meter of living space). Because average rents before utility payments paid by unit (not by square meter) were only 5 rubles per unit per month these estimates lead to the conclusion that rents should be multiplied 25 to 100 times in inflation adjusted terms.16 Is this conclusion economically correct? What is the meaning of such very rough numbers? 3.41 The first and obvious conclusion is that by the end of 1992, state-owned housing with its rent at 5 ruble per unit inherited from the past had become totally free in Russia, except for utilities. Second, housing actually being a very valuable good, its rapid free privatization is the best strategy for all state owners under current circumstances. Third, with the price liberalization of January 1992, the data shows the very first signs of a demand-driven housing economy where it will be the household's capacity and willingness to pay which determines what and how much housing is built. What is the ability to pay of Russian households in the municipal housing stock? 16/ The 1992 rent for an apartment of 32m2 of living space was 5 rubles per month. Raising the rent to 15 rubles per square meters would raise the total rent to 480 ruble for a standard apartmcnt. Chapter 3 65 C. Feasibility of Municipal Rent Increases 3.42 Russian household surveys for 1992 show that the national share of total housing expenses for rent including utilities -- the total rent effort-- had fallen to the lowest national level ever recorded of 0.9 percent of household incomes. Since household incomes adjusted for inflation were themselves estimated to have fallen by at least 40 percent, the flow of funds originating from household to maintain the existing housing stock has dried up. A race is in progress between the rate of disappearance of the housing stock and increases in all rents. The housing system is, therefore, in deep disequilibrium and is moving towards a lower equilibrium level where the flow of funds through the housing system will be in balance with the necessary full cost recovery on a smaller housing stock. More buildings would deteriorate and be abandoned, forcing household crowding into smaller amount of floor space per person until the effort ratio per square meter finally reaches the balance. As already indicated by figures 3.1 and 3.2, this lower housing equilibrium depends on the ability to raise rent and improve maintenance, the speed of recovery of the economy, the ability to produce more efficient housing, and also the ability to mobilize resources to supplement rents during this transition. 3.43 The rent increase problem is most severe for municipal housing. Could the present uniform low rents be raised uniformly with cross-subsidies financed internally? The following exercise is to a great extent redundant since a negative answer has just been provided with the very low housing effort ratio of 0.9 percent of income. What follows is therefore just an illustration in terms of 1992 prices of the municipal rent increase problem. 3.44 Starting with rents and utilities, and the approximate range of incomes observed in April 1992, we can test the effect of uniform rent increases combined with moderate increases in utilities.'7 The test is designed to get to the financial break-even point while providing family subsidies to low-income households. The figures are computed on a monthly basis. In this simple linear simulation summarized here, incomes are divided into twenty levels. Initial rents are taken to be slightly proportional to incomes and to range from 4 to 8 rubles per housing unit. Similarly, utility charges range from 10 to 30 rubles. Every household is assumed to earn the median income within an income bracket. Four rent simulations combine rents increases from 10 to 100-fold with utility increases from 1 to 4-fold: Rent Resulting Utility Resulting multiplier rent (Rbs) multiplier expenses (Rbs) Case 1 10 50 1 15 Case 2 20 100 2 30 Case 3 50 250 3 45 Case 4 100 500 4 60 17/ The housing payment-to-income ratios selected as benchmark are based on other TSE countries. They assume that each household pays its monthly housing fees directly to the rental agency. TABLE 3.1: Combining Uniform Rent Increases with Housing Allowances Impact of various hypothetical increases in rent (R) and utility charges (UC) (Rubles for month) Monthly Rx 10 R x 20 R x 50 R x 100 Results in April UC x 1 UC x 2 UC x 3 UC x 4 1992 Average rent (in rubles) 5.07 50.70 101.41 253.52 507.04 Average utility charges (in rubles) 15.35 15.35 30.7 46.06 61.41 Average total expenditure (in rubles) 20.42 66.06 132.11 299.58 568.43 Expenditures to income ratio 0.61% 1.98% 3.97% 9.00% 17.08% (Monthly income = 3,329 rubles) percent households with gross effort rate >5% 0 17.9% 54.0% 92.1% 99.3% percent household with gross effort rate > 10% 0 6.0% 17.9% 61.7% 88.7% percent household with gross effort rate > 15% 0 0% 6.0% 44.6% 73.2% percent of rents required to be redistributed to: Limit net expenditures to income at 10% 0 1.8% 7.5% 27.3% 52.5% Limit net expenditures to income at 15% 0 0 2.8% 14.7% 35.1% Limit net expenditures to income at 20% 0 0 1.8% 8.5% 24.3% Financial results after rent redistribution to limit net expenditures to income at 10%: Net rental revenue per housing unit 5.07 49.8 93.8 184.2 241.0 Percent of the gross rent recovered 100% 98.3% 92.5% 72.7% 47.6% Chapter 3 67 3.45 In these four cases, the effect of the rent and utility increases on the average level of new housing payments-to-income ratio and the percentage of households reaching various thresholds can be easily calculated. We can also find the net level of financial cost recovery achieved after the cross-subsidies have been calculated. Financial assistance to vulnerable families can be administered with equivalent financial effect. For instance, if the policy goal is to limit total housing expenditures to 10 percent of income, it is possible to: (1) pay the households an appropriate sum of money to bring their level of expenditure to this level; (2) credit their account with this sum, and demand that the difference be paid; or (3) set the rent at a certain level that will be cut back to a payment equal to 10 percent of income if the rent rises above that level. 3.46 The results of the four cases which are presented in table 3.1 can be interpreted as follows: Case 1: Rents increased tenfold, utility charges unchanged: The average monthly rent is 50 rubles and utility charges are 15 rubles. The average household expenditure rises to 2 percent. Only 6 percent of all households face an expenditure level in excess of 10 percent of income. If they are to remain below the 10-percent ceiling, the amount of rents to be redistributed (or not collected) is a minimal 1.8 percent of total rent revenues (not including administrative expenses). Large-scale subsidies to municipal housing organizations remain necessary. For the administrative authorities the situation is barely different from the initial one. Case 2: Rents increased twentyfold, utility charges increased twofold: The average rent is 100 rubles and utility charges are 30 rubles. The average household expenditure rises to 4 percent. Now 18 percent of households face expenditure in excess of 10%. If they are to remain below 10 percent, the amount to be redistributed (or not collected) is 7.5 percent of rent revenue. In this case the municipal company remains far from the break-even point. Case 3: Rents increasedfiftyfold, utility charges increased threefold: The average rent level rises to 250 rubles and utility charges rise to 45 rubles. The average household expenditure rises to 9 percent. Now 65 percent of households face expenditures in excess of 10 percent of income. To bring them back down to 10 percent, 27 percent of the total rent revenues must be redistributed (or not collected). After payments are made to utility companies and family subsidies, the net average rental revenue per housing unit is 184 rubles (rather than 250). Subsidies to the housing companies remain necessary if they are to break even financially. Case 4: Rents increased one hundredfold, utility charges increasedfourfold: The average rent level is 500 rubles and utility charges are 60 rubles. The average household expenditure rises to 18 percent. This time, 88 percent of households devote more than 10 percent of their income to housing payments. To bring them down to 10 percent, 52.5 percent of rent revenues must be redistributed (or not collected), before utility companies are paid. The scale of the revenue redistribution (non payment) brings the average rent income per housing unit to 241 rubles, less than half the average gross rent figure. Subsidies will be required to break even. 68 Chapter 3 3.47 The higher the rent, the higher the proportion of revenue devoted to helping low income households. As a result, when the rent doubles from 250 to 500 rubles, with utility charges increasing from 45 to 60 rubles, the total rent revenue available after redistribution increases only by 31 percent. For housing companies to break even on their operating expenses based on these assumptions, rents of 600 rubles and a minimum payment to income ratio for all households of about 15 percent will be necessary. 3.48 This is a simplified simulation, but it illustrates the key problems and yields several provisional conclusions. Under the present conditions of the housing stock and given rent levels, a move to 50 or 100 rubles per housing unit per month would help housing management agencies without solving their financial problems. Uniform rents, unalleviated by allowances, can only be low. The rent system freezes up as soon as high or even medium-level uniform rents are considered. Low income households cannot pay unless assisted by inordinate family subsidies. If high rents are applied to high-income households they will demand higher quality maintenance and location. This occurs in the market economy, and can be partially achieved by adjusting gross rents in the public housing sector. Thus concept of uniforn rents corrected by rent allowances finance internally from cross-subsidies appears very difficult to implement. Rents should be differentiated according to building quality and especially location. 3.49 The municipal housing system as described above has difficulty surviving on its own. The net rental income cannot cover expenses even if rents paid by richer families are partially redistributed to limit the expenditure of poorer families. Other resources must be found: from subsidies, funds from small scale privatization"8. Though difficult, a balance must be found between the sustainable public subsidies, the rent increases demanded of households, the shape of the rent schedule, nd resources from paid privatization, loans, and other sources. 3.50 When housing prices begin to reflect the true costs of resources within the economy accurately, users of housing can then carry the full costs of the units they have. The rent they pay can then cover all investment and operating costs as outlined in box 3.2. Accordingly, the provider of housing can operate in a sustainable environment and in the case of groups that are unable to afford this full economic rent, subsidies can be more intelligently applied to preserve accountability and cost tracking throughout the system. In such a difficult environment, financial plans tracing the flow of funds through the housing system and their dynamic interactions can make a major difference in the task of sorting out politically acceptable strategies that are financially viable. D. Five Principls for Establshing Public Rents 3.51 Major wage adjustments would have serious effects on macro-stabilization, and would result in serious distortions in labor markets. If incomes cannot be restored to a full mnarket wage through wage reforms, how can rent reforms be implemented? Analyses of the Russian situation lead to five conclusions on rent adjustments for municipal housing stock. These conclusions apply directly to la/ As a basic financial rule, funds originating from the sale of assets should not be used to finance consumption and ordinary maintenance. It is economically sound to restrict any allocation of revenues originating from privatization asset sales to investment expenditures such as major repairs and rehabilitation. Chapter 3 69 the 38 percent of the entire housing stock under municipal control. As already noted, enterprise housing which constitutes another 40 percent of the total stock is much more heterogeneous and the enterprise sector had done relatively well economically in 1992, especially compared to municipalities and individual households. Yet, these five conclusions appear to be relevant to enterprise housing, even if implementation differs among enterprises (profitable, money-losing, or bankrupt, large or small, company town-firms). 3.52 The core of any rent reform strategy will be to limit subsidies exclusively to socially vulnerable groups and lower the subsidy per unit because this will result in a more efficient use of the existing stock. Relocations would occur between the underhoused and overhoused families; those who cannot afford steeper rents for the extra space would seek smaller units or sublet. Here virtue will be made out of necessity. Housing subsidies must be lowered because high subsidies can not be sustained at their present level without increasing inflation and eventually greater decay of the housing stock. 3.53 Uniform rent increases must be avoided. The average rent level should be raised through differentiated rent adjustments. Since cost recovery from residents is low, significant rent increases would mean increases by a factor of 25 to 100. Given the declining real incomes and the rising share of food in household expenditures, high increases can not be enforced without implementing a housing assistance program. Otherwise non-payments on a massive scale would be inevitable.'9 Income data and maintenance costs analyzed for Moscow during first quarter of 1992 showed that rent increases sufficient to cover half of the full cost of housing services would absorb the entire cash income of Moscow households in the lowest 25 percent of income distribution. Such an imbalance also suggests major deficiencies in the physical characteristics of the housing stock that are suddenly revealed by price liberalization. 3.54 Rent differentation should be based on the size of benefits provided. What makes housing reform in Russia more difficult than in other countries is that the "right to housing" has been translated into a "gift" from the state. The size of the gift must be reduced to a minimum. Tenants residing in the social stock are entitled to living space determined by a social norm of 12 m220 per person, plus 6m2 for a family. According to the 1989 census, over 31 percent of Russian families (excluding one-person households) lived in units with living spaces between 5 and 8 m2 per person. About 11 percent lived in units with 17m2 or more per person. Designing a strategy that will lower the subsidy per unit must include: (1) a much steeper rate increases for living spaces exceeding the norm; (2) revising the norm so that the highest subsidy would only be paid for the absolute minimum of living space; 191 The rate of arrears on municipal housing was already reported at 17 percent overall in Ekaterinburg and up to 30 percent in some areas of Moscow in 1991. However, clarifications are needed on how arrears reports differentiate between non-payments and late payments, (some Russian households' payments coincide with bonus payments from employers). Similar patterns appear in housing loan repayments. 20/ In the new draft housing codex this norm was increased to 15m2. 70 Chapter 3 (3) targeting a percentage of top standard units for faster rent adjustments. 3.55 Because local housing conditions vary, the net loss resulting from differentiating between a social minimum and additional space may exceed additional revenues. Concurrently with the two- part adjustment in rents based on the social minimum, local governments should differentiate rental rates to reflect market valuation of units. Rapid, broadly based housing privatization will help by providing such benchmarks for the first time. Price differentiation must be based on the three factors that define the value of housing units anywhere in the world: the building's quality, the neighborhood's quality (the social and economic amenities it provides), and location within the city. These adjustments should account for the value of location; households in better locations must pay more. The means exist in Russia to design a rate scale simulating market valuation. These citywide rent schedules would provide a maximum and minimum rent per m2 for a given category of housing. The rent within this range would be determined by each public sector owner. 3.56 The imrplementation of housing rent reforms should be decentralized to the lowest possible government level. (1) The Federal government should define the process through which appropriate rents should be established, and the rules for basic remedies when problems arise. Ideally, it should refrain from dictating local prices and quantities. (2) City or metropolitan wide governments should set rents and establish rent schedules covering the entire local housing system. They would also establish the monitoring procedures to track rents and correct financial imbalances if necessary. (3) New autonomous local housing organizations responsible for specific buildings and housing estates should calculate rents based on their operating experience (see Chapter 6). The more directly (public or private) decision-makers are responsible for solving a problem, the better they will see the alternatives, the less ideological they will be, and the less likely they will be distracted by other agendas. E. Annual Rent Reviews and Stock Valuation: Historical Cost Versus Replacement Cost 3.57 Looking ahead, rents must reflect the true resource cost of a housing unit. In setting policies for annual rent reviews in the remaining public housing stock, current replacement costs, not the historical costs of providing the housing, provide the appropriate basis for calculating rents. If historical costs are used, problems will develop in the housing stock. Permanent funding shortages will develop in the housing system, resulting in chronically dilapidated housing stock. Marginal pricing, or pricing at replacement cost, will bring all rents in line with the true cost of housing service provision. There will usually be a mix of units of different vintage. With varying construction costs, rents in otherwise comparable units constructed more recently will be higher than those in older buildings. Chapter 3 71 3.58 The distortions in the social rental sector caused by historical cost pricing can be extensive. As cities grow and residential construction extends to the suburbs, rents for similar dwellings increase with distance from the city center; the resulting rent gradient is the opposite of that normally observed in the market economy. Inefficiencies arise through black or grey market rentals in the center, and high vacancy rates in the suburbs. Such is the case in Sweden, despite rent 'pooling", which averages historical costs over one social owner's entire stock. Such "rent pooling" adjusts relative rents within the stock of one company, but spatial discrepancies remain. F. The Case of Enterprise Housing 3.59 Enterprises will play a major role during the housing transition because they controlled most of the 40 percent in the category of departmental housing and employers are now producing the major share of the flow of funds going into new housing. Moreover, as already noted, aggregate flow-of-fund analyses for six broad sectors of the national economy show that the enterprise sector did remarkably well as a whole in the year 1992 considering the precipitous contraction of national output. There are, therefore, three broad reform issues for this segment of the housing system: privatization, what should happen to the residual enterprise stock, and the role of enterprise fnancing in new construction. 3.60 Rapid privatization should be the first line of reformn in enterprise housing. Giving housing free to households is like asking them to pay 100 percent of operation and maintenance and zero percent of capital cost recovery. This usually is an attractive prospect, especially considering that housing is also one of the few real assets available to households to protect themselves against inflation. The housing privatization laws apply to enterprise housing, and as already noted recent surveys show that about 30 percent of the stock is occupied by residents not or no longer working for the enterprises which own it. In the case of the enterprise housing not transferred rapidly to households, rent behavior will continue to parallel the problems of the municipal housing stock. This is most likely to happen to enterprises remaining in state ownership. To the extent that such continuing enterprise ownership of housing then becomes an inportant vehicle for labor unions to extract more compensation in kind from enterprises, specific policies may be in order to contain such behavior, possibly by mandating progressive ownership though mechanisms comparable to the 'rent- for-mortgage" used in the U.K. as a form of lease-purchase. Case studies of the financial impact of housing on selected privatized and non-privatized enterprises would be very helpful in cutting the socialist gordian knot of low enterprise productivity, labor market rigidity, non-market wages, and housing. 3.61 Enterprises are likely to be the prime source of financing during the early stages of economic stabilization and recovery. Given the leverage of many enterprises in their local communities this apparent constraint on enterprise financing should be used to foster the emergence a strong and competitive building industry. Enterprises should be discouraged from financing housing from their own account. Any financial assistance that enterprises provide to their employees should be used only for direct employee ownership. Housing funds should be channeled to local developers through competitive bidding. Independent and influential enterprises will have a vested interest in seeing their staff well housed. They will often be a in position to stimulate local competition and pressuring the local governments to dismantle rapidly the remnants of monopolies over access to land, to building materials, and to finance. As is the case in quite a few countries, enterprises can also act 72 Chapter 3 de facto as agents for mortgage lenders in making loans to individual employees by grouping loan requests and insuring timely repayment collections. G. Rent Regulations for the New Private Sector 3.62 Rents should not be controlled in the new private sector. This is particularly important now in Russia when the housing sector is in disequilibrium and should settle down as rapidly as possible. The evidence from market economies is overwhelming on that point: a healthy private rental market acts as shock absorber for the sector, and the national economy in case of macroeconomic shock. Yet in some market economies, the private rental sector of provinces or cities is subject to government regulations that place ceilings on rent levels and often make it nearly impossible for landlords to evict tenants. Rent controls are inefficient and inequitable and result in removal of private rental units-due to abandonment, disrepair, demolitions, conversions, unfilled vacancies, and the discouragement of investment in the construction of new rental dwellings. They restrict mobility and interfere with households' adjustment of housing consumption according to income and family circumstances. Subsidies are often provided to households who do not need them. However, rent controls can be popular with politicians because the controls favor sitting tenants who vote against future occupants. Unfortunately, rent controls also raise the cost of housing above national average over the long-term. These two outcomes can be encountered in otherwise competitive market economies such as New-York, San-Francisco, or Boston in the United States, or the Province of Ontario in Canada. In case public pressures were to build up for some form of action, a Federal Law in Germany provides a good alternative to the devastation of rent control, and a means to introduce consistent rent levels across segments of the housing system (see box 3.3). V. RENT REFORMS AND VULNERABLE GROUPS 3.63 This section focuses on vulnerable social groups. It establishes two points on social policies in Russia. The resources of the housing sector are too low to provide the major share of social protection. External resources will be required to stabilize living conditions. If housing is integral to the social safety net programs, as it must be, the program cannot be the net provider of resources because the resources are not there; otherwise, the rate of depreciation and building abandonment in the sector will be accelerated. Given the scale of the population to be reached, relatively simple administrative procedures will be needed. Three issues are examined briefly: the rapidly changing income distribution.of the Russian population, how housing allowances might work in Russia, and the unusual problems posed by the internal structure of Russian cities inherited from the Soviet administrative-commnand system. A. The Rapidly Changing Household Income Distributon of Russia 3.64 A complicating factor in restructuring housing rents is the rapidly changing income distribution in Russia under the effects of price liberalization, shifting relative prices, and inflation rates bordering on hyperinflation. The income distribution in Russia and the states of the former Chapter 3 73 Soviet Union was less well documented than for other socialist republics of Europe.2' The highest and the lowest income groups tended to be under-represented in income and expenditures surveys. Large countries like the RSFSR have more unequal income distribution than smaller republics. In 1986, the estimated decile earnings ratio for full time workers for the RSFSR and selected other republics was:22 Russian Federation 3.36 Ukraine 2.97 Belarus 2.88 Georgia 3.35 Armenia 3.46 Poland 2.77 Hungary 2.64 Czechoslovakia 2.45 Great Britain 3.23 3.65 A decile earnings ratio measures inequality as the ratio of earnings of the ninetieth percentile (D9) to the tenth percentile counting from the bottom (Dl). Earnings data differ from income data, but the two measures are closely correlated. Atkinson and Micklewright report a ratio D9/DI of 3.16 for the Russian Federation in 1989 for an average household size of 3.1 persons. At the beginning of Perestroika the earnings distribution was more unequal in the Russian Federation than in Central Europe. Russia's income distribution was comparable to the United Kingdom, which is known the be more equal than that of the United States. 3.66 The rapidly declining income distribution causes serious problems for the social dimensions of housing reform. Preliminary analyses of survey data for the June-September 1992, collected under the joint Goskomstat-World Bank project monitoring income trends, indicate that about 37 percent of individuals lived below the poverty line (47 percent were children under 15 years of age). Inequalities had increased sharply. The income ratio of the top quintile (DIO+D9)/(D2+Dl) appeared to be 16.7. If this ratio is confirmed, Russia's income distribution would be comparable to Brazil (with a ratio of 16.7 in the early 1970s), and no longer to the U.K., whose quintile ratio is 6.0 or the United States whose ratio is 11. This ratio suggests the need for differentiated rent reform and for the close integration of housing reform with social safety net issues. Suitable, quality housing surveys should be developed and should combine operational data on housing characteristics with occupant information. 21/ For the most complete recent analyses of income distribution in the Former Soviet Union, Central and Eastern Europe, see Anthony B. Atkinson, and John Micklewright, 'Economic transformation in Eastern Europe and the Distribution of Income, Cambridge University Press', U.K. 1992. 22/ See Atkinson and Micklewright, Table 4.3 page 103. 74 Chapter 3 B. The Distorted Socialist City Structure Under Market Pricing 3.67 Russian cities have been built with grossly distorted prices for three critical urban inputs: raw land or site value which had no price, capital for which no interest was charged, and energy which was priced at less than 2 percent of the world price until 1992. These prices have led to a misallocation of resources and an economically inefficient city structure, which is now interfering with price liberalization, housing privatization, and future urban investment. The core outcome, described and analyzed in chapter 8, is that Russian cities have inefficient land use patterns and populations and building densities that rise as one moves away from the center. This tends to maximize transportation and energy costs." This kind of socialist urban investment creates large sections on the periphery of cities like Moscow with a negative valued-added under realistic pricing aligned to world conditions. Suburban households are faced with sharply escalating operations, maintenance and transportation costs, and a declining standard of living. The mechanisms to restore balance are not those that the population would choose if it had a choice. A balance between the resources used and their cost will take place through a rise in the price of housing per unit of space, abandonment of the most inefficient and most poorly located buildings, and the production of a substantial amount of efficient smaller housing units in the better locations. A low cost, efficient urban transport system will play a major role in minimizing social housing problems and the size of the negative value-added housing stock. 3.68 With price liberalization and the opening of the Russian economy to world trade, urban prices are adjusting sharply. For instance, energy prices are now at one-third of world prices. Under the wrong policies, these price adjustments could lead local governments to ever-higher levels of subsidies to housing and other urban sectors. Moving rapidly to market pricing in the urban sector could cause two problems. Adverse selection will occur during housing privatization as the real estate price gradient rotates and rises sharply near the center. Citizens in centrally located apartments may realize substantial capital gains, but those located in the periphery may receive an asset of negative value. The second problem is the shortage of capital for the transition to markets. 3.69 One little appreciated problem in Russia is that households are willing to trade off space for location and travel costs when they are free to make their own decisions. For a middle-income country with an income level comparable to Russia, households spend about 15 percent of their income on housing payments and about 4 to 5 percent on transportation if they do not own a car, 8 to 9 percent of income if they own a car. To stay within a total budget constraint of 20 percent they will choose smaller, more expensive, centrally located units if they wish to cut down on commuting time. But in Russia, apartment units do not vary in size based on their distance from the city center.24 23/ The analysis presented in Chapter 8 and its implications are developed more fully in Alain Bertaud and Bertrand Renaud, Cities Without Land Markets: Lessons of the Failed Socialist Experiment, World Bank Discussion Papers, Number 227, January 1994. 24/ The only clear correlation is between the date of the housing project and unit sizes. Chapter 3 75 C. Will Housing Allowance Programs Work in Russia? 3.70 When designing assistance systems for vulnerable Russian households, one must understand that housing problems for the Russian poor are exactly the opposite of those of the Western European or American poor. In Western industrial countries, the main problem of the poor is not inadequate housing, but exceedingly high rental payments. In Russia rent payments are trivial, but housing quality is very low. As a sound rent setting develops the situation will reverse itself. This poverty issue is complementary to the housing problems in cities where the supply response is inadequate and demand-side subsidies are rendered less effective in solving low-income housing problems. A third structural difference with Western social policies is that housing allowances are given to minority of the population; in Russia they would be required for the majority, especially given worsening trends in income distribution. 3.71 In the search for effective, but administratively manageable social safety net measures that will maximize the use of scarce public resources, the administration of rent reforms should be separated from the delivery of income maintenance support. Of course, one policy should not ignore the other. Rather these interdependencies should be managed autonomously. 3.72 Administrative costs. Housing allowances are widely used in market economies. Housing allowances and other consumer-oriented subsidies channel public support to those most "in need". Since housing allowances are not restricted to public housing, tenants spend their subsidies freely between the social and private rental sectors. However, the administrative burdens of housing allowance programs are heavy. Rapidly changing incomes place the recipients in different categories of need, thus ceilings have to be revised constantly. 3.73 Housing allowance programs (HAP) in Russia will be a major administrative challenge. The social rental stock comprises approximately 78 percent all urban stock; in large cities, this percentage is often over 90 percent. The average size of stock administered to local soviets is large. As detailed simulations for a Moscow HAP indicate, the percentage of tenants receiving housing allowances can vary from 60 percent to almost 100 percent, depending on the pace of rent increases.25 The potential numbers of program participarits could translate into staggering implementation costs. The possibilities of local governments to administer the programns efficiently are questionable given their other responsibilities. They must invest in technical equipment and staff training. Housing allowance programs implemented in Poland and Hungary are, in comparison with the potential in Russia, small and simple.26 25/ See Struyk, Ray, Nadezhda B. Kosareva et al. 'Implementing Housing Allowances in Russia: Rationalizing the Rental Sector", Washington D.C. The Urban Institute, (Moscow), and the Economic Reform Working Center of the Russian Federation, 1992. 26/ Since 1990, Hungary's program has excluded certain categories of households from rent increases. In Poland, households become eligible for rent assistance if the combined share of rent and utilities in household income exceeds 8 percent which is low compared to the payment-to-income ratios for cooperative housing in Russia, or less distorted housing systems like in Bulgaria. 76 Chapter 3 3.74 Income reporting. Housing allowance programs rely on accurate reporting of household incomes. A large percentage of the working population holds at least one extra job beside the official salaried job for which income is reported. The administrative-command culture is such that extensive resources have been expended to circumvent the workings of the system. The magnitude of second economy earnings in Russia is not known. Common estimates of 30 to 50 percent simply convey the scale of economy activities. Because the program's scale is dependent on income verification, the misreporting of household's size and composition could be costly. In Russia, as in other socialist economies, there has grown a deep cultural aversion against all forms of income reporting to any state organization 3.75 The net budgetary savings under HAP. Revenue gains from increased rents will be offset by the combined costs of housing allowance payments and administrative costs. The three year sirnulations for Moscow's prospective HAP show net revenues in the third year cover 18 to 28 percent (versus 4 percent in March) of total maintenance expenditures. However, the calculations assume constant real income when a decline in real incomes is distinctly possible, and do not account for the administrative costs. Simulations assuming 10 percent unemployment did not effect net revenues greatly, but unemployment may reach much higher levels in cities or areas where employment is concentrated in one or two industries or enterprises. 3.76 Are western-style housing allowances useful in Russia? Western countries that use housing allowance programs have reasonably stable economies and functioning housing markets. Given the macroeconomic and housing sector's conditions, are housing allowances an efficient policy choice for Russia? Participation by households that do not need housing subsidies may not be the most important source of inefficiency. The major issue is the net effect of subsidy distribution. The most efficient use of scarce resources may be the subsidy policy that will have the largest net effect on restoration of the annual output levels. 3.77 The competition between housing allowance programs and subsidiesfor new construction will be strong. Redirecting the bulk of subsidies to middle-income households willing to match them with their own savings is likely to have a much larger effect on housing investment and on the emergence of housing markets than targeting all available resources to the neediest households. An increase in output will lower the housing costs for all households. Assistance for the poorest households should be addressed through the safety net prograrns. VI. MANAGING THE EXISTING HOUSING STOCK AFrER PRIVATIZATION A. Mixed Private and Public Ownership and Condominium Law 3.78 As privatization progresses, many more properties will be held under mixed private and public ownership. Since most of the state stock consists of multi-story apartment buildings, newly privatized units will coexist with rental apartments belonging to a municipality or an enterprise. The experience of Eastern and Western European countries alike shows that such a co-ownership is a highly inefficient solution. In Russia, because of the scale of the problem and the severe undermaintenance of the stock, the issues are likely to be much thornier. The outcome could be that the state will continue to subsidize the new owners indefinitely, and both parties the state and the Chapter 3 77 owners will shun financial responsibility for capital repairs, and as a result many properties will deteriorate. 3.79 Yet because privatization has been so rapid in Russia mixed ownership is a widespread fact. Can the occurrence of mixed private and public co-ownership situations be reduced? The privatization law does not empower municipalities to take actions that would interfere with households' right to privatize (or not to privatize). However, in situations where most renters opt for ownership, the municipality will be well advised to attempt (but not enforce) reallocation of residual tenants by providing comparable dwellings in other buildings. 3.80 The law encourages formation of owners' associations in privatized buildings. These associations will need a good condominium law to provide them with guidelines for dividing financial responsibilities, su'ch as maintenance costs for common areas, assessments for repairs and funds for future repairs. The 1993 condominium law of Albania makes provision for the state to be a member of the association on an equal footing with the private owners of individual apartments with identical rights and obligations for every apartment owner in the maintenance of the property. Its effectiveness remains to be tested.27 B. Importance of New Housing Management Firms 3.81 Of equal importance to a good condominium law for private housing, is the emergence of new housing management firms for public housing. In former CPEs, management of public housing stock has been provided by highly inefficient monopolistic state-owned management companies. These organizations, like all other state enterprises in Russia, have lived in the environment of "soft budget constraint" with accountability based on fulfillment of plan targets and no interest in cost control. There is a sizable potential for cost reduction. For example, in forrner Czechoslovakia, per-unit management costs in self-managed cooperative housing are about half of those in state housing. In Russia, REUs (the state housing maintenance organizations) have no competitors, and manage both municipal and cooperative housing.28 Enterprises' housing management structures are similar to those in municipalities, but they operate even more inefficiently. The privatization law does little to end the monopoly of state housing management companies, but endorses the emergence of competing non-state management entities. 3.82 The need for improvement of housing management is urgent. The ownership status of future management firms is a lesser issue; they must, however, have financial autonomy. Such non-profit agencies may be built on the basis of the existing structures, but their regulations and accounting 27/ Mixed ownership has ben a problem in Poland. For decades buildings privatized nearly 100 percent have been maintained (and thereby subsidized) by local authorities. Organizations managing public housing in France, after decades of problerns in managing buildings with apartments in mixed ownership, allow privatization of entire buildings only. 25/ In Moscow, a few administrative rayons are beginning to experiment with contracting quasi-private organizations for repair and maintenance of municipal housing. 78 Chapter 3 framework must be codified. Optimal stock size and composition will make the management economically efficient; this may mean regrouping of the stock of several REUs or enterprises. m:\rhsector\green.eng\chapters\chap3x.v8 16:43August 2, 1995 PART III PROGRESS OF HOUSING REFORMS AND SECTORAL ISSUES CHAPTER 4 PROGRESS AND LIMITS IN PROPERTY RIGHTS REFORMS Table of Contents 1. ENTRODUCTION ........................................ 79 H. RECENT LEGAL REFORMS ................................ 80 Im. RUSSIA'S HOUSING LAW FRAMIEWORK ....................... 80 A. The Old Constitution: Earlier Conflicts with Reform Laws. ... ....... 81 B. Civil/Housing/Land Codes: Need for Updating and for Implementing Regulations .. 82 C. Local Government Laws: Centrality of Clarifying Central-Local Relations . 82 D. Land-Use and Spatial-Planning Acts ......... .. ............... 83 E. Property-Registration Law ............ ................... 84 F. Building-Industry Law .............. .. .................. 84 G. Housing-Finance Laws .............. .. .................. 84 H. Condominium Law ............... .. ................... 85 I. Landlord-Tenant Law .............. .. .................. 85 J. Housing Privatization .............. .. .................. 86 K. Division of State Assets .............. .. ................. 86 IV. THE LAW DRAFTING PROCESS IN RUSSIA ...................... 86 V. CONCLUSION ............................................ 87 CHAPTER 4 PROGRESS AND LIMITS IN PROPERTY RIGHTS REFORMS I. INTRODUCTION 4.1 Over the past years, the Russian Government has made important progress in developing market-oriented urban laws. Recent laws introduce key concepts to begin housing privatization and promote the development of constituencies for further improvements. However, additional substantial developments in basic legal rules, implementation of regulations, and administrative and judicial institutions at the federal and local levels are needed to create a fully functional urban legal system. Transition from a system of well-established socialist rights to a market-oriented housing system will not be a simple or linear process. 4.2 There remains a wide gap between Russia's socialist property rights system and a new legal system able to support competitive housing markets. The old system remains based on bureaucratic controls with unclear property rights that make legal private transactions difficult; while a market system requires transparent, verifiable rights, a carefully delimited sphere of public regulation, and competent judicial processes to clarify private rights and enforce private contracts. The most difficult task for Russia will be to achieve an appropriate balance of regulatory intervention. One danger in the process of dismantling the bureaucratic and administrative structure of central planning is that Russia may not put in place the indirect legal and regulatory tools necessary for development of well- functioning housing markets. 4.3 As noted in the Special Program for Housing, the Government's new role will not be to produce housing, but rather to regulate markets: under this indirect role, the legal system should create a reasonably determinate set of property rights and institutions; enforce rules of competition; intervene to ensure adequate protection of health, safety, and the environment; and protect vulnerable groups consistent with social norms. Such a legal framework includes, for example, clear land ownership rights and efficient property registers that promote urban land markets and help rationalize urban land uses; condominium forms of ownership that encourage private management and rehabilitation of multi-family buildings; simple foreclosure procedures that allow families to use their housing as collateral for loans; appropriate land use and building standards that encourage private production of new forms of housing while conserving urban amenities; balanced landlord-tenant rights that lead to emergence of private rental markets; and clear tax and subsidy rules that combine fiscal stability with protection of needy groups. 4.4 The balance of the chapter notes briefly some recent legal reforms, sets out a simple legal framework for tracking progress of housing reforms, and discusses aspects of the law-drafting process. 80 Chapter 4 II. RECENT LEGAL REFORMS 4.5 In December 1992, the Supreme Soviet took major steps to create the basic legal framework for housing markets. Key among the new laws passed is the "Law of the Russian Federation on the Basic Principles of Federal Housing Policy," (the "Housing Law"). This Housing Law is intended by the Government to be a "Housing Bill of Rights" that provides the foundation for the move to a market economy. According to its stated goals, the law aims: To ensure social guarantees for the right of citizens to housing; to accomplish the construction and rehabilitation of state, municipal, and private housing; to create conditions to attract non-budget sources of financing . . . ; to develop private property; to ensure protection of the rights of entrepreneurs and owners in the housing sector; to promote competition in the construction, repair, and maintenance of the housing stock, and the manufacture of building materials, articles, and goods to furnish houses. 4.6 Equally important, during December 1992, Articles 12 and 58 of the Constitution were amended to permit ownership and free trading of land plots for housing construction and to redefine the right to housing in terms consistent with a market economy. In addition, a "Law on the right of citizens to acquire private property and to sell, land, dachas, and individual housing units" introduced private property of land in urban and rural areas. Finally, a new draft law was introduced that would modify the earlier "Law on the Privatization of the Housing Stock" of July 4, 1991 to allow the free distribution of housing, simplify privatization procedures, broaden the types of housing stock that can be privatized, and establish the right for condominium owners to choose the maintenance companies of their choice. III. RussIA's HOUSING LAW FRAMEWORK 4.7 Recent reforms introduce, but do not yet create, a viable framework for market-based housing. This section sets out a simple framework of housing law and discusses current issues within each box of the matrix. The framework is intended to assist the government in tracking its broader program of sector reforms. While the enactment of the legal program will be ad hoc to an extent, the government should ensure that, over time, progress is made across the entire framework. Each of the elements of the housing law framework appears to be essential in reasonably well- functioning urban legal systems. Failure to progress in any area -- through a combination of policy decisions, legal drafting, and institution building -- will limit progress in the others. 4.8 Broadly put, Russia has a hierarchy of legislation from the Constitution to laws on the principles governing areas such as land and housing, down to specific codes. At a level down from these laws and codes are the administrative regulations, both federal and local, which give content to public and private rights and which constrain the institutions charged with implementation. Finally, between private parties there are standard contracts and informal regimes of property rights allocation. Within this hierarchy, different laws allocate decision-making authority among levels of government; define the relationship of private actors to government authority; and prescribe rights and responsibilities among private actors. Chapter 4 81 4.9 Russia can be expected to build a civil law framework for housing made up of a dozen key elements that are briefly summarized in Table 4.1: (1) The Constitution; (2) Civil, Land and Housing Codes; (3) Local Government Laws; (4) Land Use and Spatial Planning Acts; (5) Property Registration Laws; (6) Building Industry Laws; (7) Housing Finance Laws; (8) Co-ownership Laws; and (9) Landlord-Tenant Law. As an economy in transition, Russia has two additional areas in its legal reform framework: (10) Housing Privatization Laws, and (11) Rules for the Division of State Assets. Because, in market systems, housing is the central asset of most households and intersects a complex set of relationships, a final area of reform can be succinctly summarized as (12) Other. These other areas, which will not be discussed separately here, include rules on eminent domain, nuisance and trespass, family law governing concurrent owners, bankruptcy law, environrmental law, and natural resources law. Finally, unlike the experience of Central and Eastern Europe, Russia has been spared the debate over restitution of expropriated property because it appears land and housing were seized long enough ago that there is no effective lobby for direct compensation. A. The Old Constitution: Earlier Conflicts with Reform Laws. 4.10 The constitution provides basic guarantees to rights in land and housing. In Russia, the old RSFRS constitution had remained an area of serious concern: several provisions appear to conflict with reform laws already passed. Until these ambiguities and inconsistencies were clarified by the new 1993 Constitution," the potential benefits of the reform laws could not be fully realized. Two areas stood out and deserve continuing attention in the development of new laws and decrees: a. Land Ownership. Perhaps the most serious conflict reflects a genuinely unresolved issue in Russian law: private rights to own and transfer land. Article 11 of the Constitution, which still prohibits full private land ownership, may conflict with the new Housing Law as well as with the December 27, 1991 Decree on Urgent Measures to Implement Land Reform in the RSFSR. The newly revised Article 12, para. 3 now permits the free trade of land plots for housing construction, as long as there is no change in land use patterns. In other words, land use reallocation remains blocked. b. Housing. The Russian Constitution provides a "right to housing" in Article 44, and newly revised Article 58, which could be interpreted so broadly as to prevent implementation of the foreclosure and eviction provisions of the new Law on Pledge. Even when the economic situation stabilizes, bankers will not lend for housing if there is a substantial possibility that they cannot realize the collateral value of housing in cases of default. More precisely, the discussion concerns the December 1992 Constitution of the former Russian Supreme Soviet. Currently, the Constitution adopted by popular referendum on December 12, 1993, is in effect. 82 Chapter 4 4.11 These two areas illustrate a broader concern in the transition process: recent laws and decrees are often passed without explicitly revoking or superseding prior related legal rules. While these ambiguities and contradictions are unavoidable during the reform process, the resulting uncertainty may substantially restrict emerging housing markets and will certainly increase transaction costs. B. Civil/Housing/Land Codes: Need for Updating and for Implementing Regulations 4.12 The Civil Code governs rights in contract and in real property in more detail, including rights to own, mortgage, transfer, and lease land and housing. Thorough revision of the Civil Code is a long-term project, to be resolved after key bottlenecks are addressed, such as basic issues of land ownership, use, and transfer rights. Partial revisions may appear in Land, Housing, and Commercial Laws or Codes.2 4.13 The recent Housing Law is intended to guide development of the more detailed Housing Code at the federal levels and to provide enabling legislation for local implementing regulations. As noted above, this Housing Law represents a step towards, but not the achievement of, a framework for viable housing markets. By defining real estate in land and housing, the Housing Law increases formal rights in private land ownership. At present Russian law still does not allow unrestricted freehold ownership of land, even though several laws before the Housing Law and the 1991 Decree on Land have extended private rights, for example the Law of the USSR on Property (March 6, 1990) allowed individuals "lifelong inheritable possession" rights in land for construction of houses; the Fundamental Legislation of the USSR and the Union Republics on Land (February 28, 1990) granted ownership rights and protection against uncompensated expropriation; and the Fundamental Legislation of the USSR and the Union Republics on Leasehold (January 1, 1990) established fairly broad leasing rights in land. 4.14 Without further Constitutional reform and workable regulations to secure land ownership rights -- such as the property registration systems discussed below -- housing market development will be impeded. Instead, less efficient alternative systems of land trading will emerge, such as systems that use complex leaseholds or multi-party land exchanges. C. Local Government Laws: Centrality of Clarifying Central-Local Relations 4.15 Local Government Laws define the division of law-making authority among the different levels of government -- Federation, Republic, Oblast, Krai, Districts, and Cities. Clarification of these rights and responsibilities will have a pervasive effect on the development of further housing reforms. At present there is a complex mosaic of relationships, but the main legal statement in this area is the "Federal Agreement" of March 13, 1992, which sets out basic principles of Central- 2/ This first part of the new civil code was adopted by the State Duma in October 1994 and went into effect on January 1, 1995 Chapter 4 83 Republic relations.3 A similar Law on Administrations sets out central relations with other independent, non-Republic jurisdictions such as Oblasts and Krais.4 Finally, the July 6, 1991 Law of the RSFSR on Local Self-Governments delegates substantial authority in the area of land use and housing to local governments such as cities, townships, districts, and settlements. 4.16 Under these rules, the Russian Government may enact fundamental principles of law while the Republics enact administrative and implementing regulations. Under this Agreement, disputes between levels of government are now to be resolved by the Constitutional Court -- an arrangement that appears to increase local power by giving them recourse against federal incursions into their legislative domain. The distinction of competencies among these levels of government is important because law reforms by Federal legislators may now be challenged by local authorities. Yet, the boundaries among different levels of government are currently untested, and Federal legal drafters do not appear to have clear guidance on the scope of their power to introduce reforms or monitor local compliance.5 D. Land-Use and Spatial-Planning Acts 4.17 Land-use controls at the federal level must balance central and local authority to determine land use procedures for residential infrastructure, conversion of agricultural land, and zoning and building standards. As discussed in Chapter 7, Russia will require a substantial re-orientation of its land use and planning procedures and institutions at both the local and central levels. 4.18 The August 1, 1992 Law on the Principles of Urban Development in the RSFSR still adheres to rigid normative and administrative concepts of urban planning that international experience has shown to be flawed. Legislation in this area demonstrates the need to clarify quickly the scope of the legislative authority of the central government. Under the old system, the federal government had substantial responsibility for town planning and construction across the country and down to the most local level. Today, even the most basic powers of the federal government are unclear: whether it can, under the Federal Agreement and Law on Local Government, set out mandatory frameworks for land-use and master planning for local governments. There is concern that many local governments are not fully committed to the new market-oriented approaches to land-use planning in general, and to privatization of public lands in particular. If the Ministry cannot use the planning process as a tool for reform -- either directly through legislation or indirectly through fiscal controls -- local governments may become a substantial obstacle to creation of functioning housing markets. 3/ This agreement and law was superseded by the new Constitution, adopted in December 1993, which defined the Russian Federation and its Republics. 4/ See previous note. 5/ See note #3. 84 ' Chapter 4 E. Propenly-Registration Law 4.19 Clear titles in land and housing spur development of real estate markets, emergence of housing finance, and creation of property taxation systems. A workable title registration system for land will require, and contribute to, continued clarification of property rights. At the federal level, enabling legislation is required that will ensure the integration of land and property registers at the local level, and the establishment of the basic procedures for registration. 4.20 Russia will have to decide between a registration system where the government guarantees an instrument's validity and recordability, or a registration system where private parties insure against the risk of faulty registration. In addition, Russia will have to decide the requirements for registration; consequences and liabilities for failure to register or erroneous registration; a priority rule among recorded documents; and rules for resolving disputes among parties. Another basic issue will be to decide how the property registration system should be integrated with a property-tax cadastre. 4.21 Improving and integrating the institutions of property registration should be a high priority for local governments in Russia. Creating the necessary legal infrastructure and institutions to implement abstract legal rights will be a difficult task. Practical issues such as the level of fees, the accessibility of registration offices, delays in registration, and perceptions of integrity and transparency in administration, all affect the system's ability to support market development. For example, high transfer taxes would encourage people to sell their homes without recording the transfers. F. Building-Industiy Law 4.22 Building industry law in a market economy includes a range of bidding and procurement rules that encourage competition; building standards and codes allow developers to have wide flexibility to respond to market pressures; legal forms such as subcontracting, performance bonding, completion guarantees, and liability insurance protect relationships. No major legislation has recently been passed in this area.6 G. Housing-Finance Laws 4.23 Russia's new Law on Pledge (Aug. 1992) introduces basic concepts of secured transactions, including the real estate mortgage. The law needs to be complemented with workable regulations and standard procedures, especially in the areas of registration, foreclosure and eviction, and mortgage work-out rules. These additional rules are necessary before lenders will value land and housing as the secure collateral that it can be. Alternative procedures, such as third-party guarantees and wage-garnishment procedures are usually a less efficient form of collateral than enforceable mortgages, but such alternatives should be considered in Russia during the transition period. 6/ In 1993 and 1994 the Russian Government and Minstroi Russia adopted a number of legislative acts and standards on this issue. Chapter 4 85 Cooperative Law can also be modified to allow cooperative housing units to be used as collateral to secure loans. 4.24 Additional areas in the legal framework for housing finance depend on the resolution of broader decisions regarding financial sector development. This framework includes banking supervision, mortgage forms, credit reporting, consumer protection, liquidity and reserve requirements, and other laws. H. Condominium Law 4.25 Russia does not have a developed legal framework, such as condominium laws, regulations, and charters to govern individual ownership in multifamily buildings. Nevertheless, under the 1991 Housing Privatization Law, housing units are being privadzed without having clearly determined what property the new owner owns, what management structure governs common property, and which level of government has the authority to determine these rules. 4.26 At present, the legal framework for multifamily buildings is contradictory. The Federal Agreement and the Housing Privatization laws appear to make local governments responsible for implementing detailed regulation in this area, but this presumes a national enabling legislation for condominiums which does not exist. Similarly, the October 18, 1991 "Model Regulations" for privatization of the housing stock does not appear to be binding at the local level. More recently, draft legislation states that individuals may form condominiums, joint stock companies, or other associations in privatized buildings. Such open-ended options do not necessarily help either local governments or households. While there are many possible forms of common ownership of multi- family buildings, including cooperatives and joint-stock companies, the condominium form of ownership generally has the most flexibility in meeting residents' ownership and self-governance needs. Joint stock companies, for example, do not deal with the complex issues of property management. 4.27 Condominium laws can also take various forms. In Russia, such laws will have to address the problem of ensuring that individuals pay their assessed shares of rehabilitation costs. They will also have to resolve management responsibilities in buildings that remain partly owned by local governments. L. Landlord-Tenant Law 4.28 Tenant rights under Russian law are so broad - including lifetime occupancy rights, rights to inherit, and near-impossibility of eviction - that households' incentives to participate in an emerging real estate market according to their needs are diminished. In addition, tenants' rights in Russia are often quite vague and federal authority to act is unclear. Unless the balance between landlord and tenant rights is readjusted and clarified, the privatization process will be severely hampered, local governments will be burdened with unmanageable liabilities of unsold units, and a private rental market will not emerge. 4.29 An effective landlord-tenant law has significant consequences for the functioning of the overall housing market. While reducing rental regulations will be difficult, they should be broadly 86 Chapter 4 curtailed especially in the private rental market. Subleasing should be allowed, and conversion of dwellings to office or commercial use should be allowed subject to limited regulation. Bulgaria successfully lifted many of these regulations recently. A clear, speedy, and sure eviction procedure should also be instituted, perhaps in association with explicit social protection. Without workable eviction procedures, private rental markets will not emerge, and housing finance systems will not develop. J. Housing Privatization 4.30 Housing privatization is discussed in detail in Chapters 2 and 3. This area interacts strongly with reforms in other areas such as landlord-tenant law, land law, and condominium laws. Uncertainty in these other areas tends to slow down or thwart housing privatization goals. For example, the length of time and changing terms available to privatize units can become a difficult policy issue. In addition, the residual rights and responsibilities of municipal owners can pose a substantial problem, particularly in the areas of renovation and rehabilitation of dilapidated housing stock. Another key area of contention is ownership of the valuable ground-level retail space and other commercial space in multi-family buildings. K. Division of State Assets 4.31 Not only must ownership of assets be clarified, but incentives must be carefully structured so that new public owners do not use their new assets to paralyze emerging markets. Russia should be explicit about which level of government controls particular assets in real property and which has law-making authority over land and housing. In some reforming socialist countries, unclear allocation of property among levels of government slowed privatization as state, municipal, and state enterprises competed for control over land assets. Alternatively, excessive fragmentation and decentralization of housing assets to a district level, coupled with reductions in central government subsidies, can put local governments in a fiscally difficult situation. Across Central and Eastern Europe local governments have begun to play disruptive roles in local property markets, either as speculators or hoarders, rather than as market regulators. IV. THE LAW DRAFTING PROCESS IN RUSSIA 4.32 Under Russia's existing system of administrative control -- inherited from central planning - - there is presently a tendency to organize drafting of laws affecting urban property and housing investment along geographic and administrative units. It would be much better to focus on the functional continuity of legal rights in real estate. For example, the basic legal principles that apply to private property in land are cormmon to both agricultural and urban land: the legal concept of land is unitary, but the legal reform process so far is not. Similarly with pledge, mortgage, lease, transfer, registration, and the remaining basic legal framework, the basic legal concepts and tools are more generally applicable. 4.33 In the first phases of property rights reform, the current incremental approach to law drafting is understandable. However, to the extent practical, drafters should create legal tools of general applicability, rather than confining their work to a narrow sectoral focus. What is special to housing Chapter 4 87 are policy issues, rather than the legal tools used to govern the sector. When the housing sector is viewed as a whole, the legal tools necessary for its management do not have -- nor need to be given -- a special or separate character. Rather, they are integrated in a systematic legal structure. 4.34 The current process of law-making, with partial, sometimes inconsistent and even conflicting provisions, parallels the legal-reform experience in other socialist countries in transition. Along with the issues discussed above, Russia also faces three practical issues necessary to make newly legislated rights enforceable and tradeable: a. New Laws Should Be Widely Publicized. At present, new laws and decrees are not published in a systematic way at the federal or local levels. Lack of widespread publication impedes market development because private actors lack basic information about their rights and responsibilities. Also, without widespread publication, local officials might not fully engage in their responsibility of implementing the new legal framework. Basic laws about property and privatization should be promptly circulated to local officials and be made widely available to private citizens. b. Inconsistencies Among Laws Should Be Reduced. Partly as a result of the difficulty in publicizing the current legal framework, many inconsistencies are emerging among laws and decrees. A particular area of concern is the status of land tenure and the land development process where local laws are not always written in accordance with the federal laws, and federal laws are not always consistent with each other. c. Legal Administration Should Be Improved. The institutions of legal administration are an important part of a well-functioning housing market. Accessible and efficient legal institutions -- such as courts, notaries, registration offices, and land use commissions -- provide credibility to the new rights created by federal and local institutions. Creating these institutions is an important part of the reform process. Another important priority is to clarify quickly the competence of different levels of government to legislate in key areas of housing law and to establish an efficient arbitration mechanism where there are conflictirig interpretations. V. CONCLUSION 4.35 The most striking aspect of the draft legislation on housing reforms taking place at the Russian Federation level is the relative paucity of international legal assistance available to the drafters. Drafting committees are responsible for producing a staggering range of basic reform laws across the spectrum of the urban legal framework. At present, law drafters are mostly policy and technical staff acutely aware of the limits of their access to international comparative legal experience. Without exception, officials contacted expressed strong interest in increasing the range of technical cooperation available in the law-drafting area, particularly by introducing best legal practice in existing market economies and transition legal strategies in formerly centrally planned economies with similar legal problems. Drafters are attempting to reinvent many of the basic legal rights and practical legal tools already available in market economies. TABLE 4.1: Legal Framework for Russian Housing Reforms (1993) HOUSING LAW RECENT REFORM LAWS COMMENTS FRAMEWORK 1. Constitution Law on Chanees and Additions to the Constitution (Dec. 1992) Unrestricted private ownership of land is still not allowed. Art. 10 provides equal protection to private and state property and limits Also, the right to housing may conflict with rights to confiscation. Art. 12(3) now permits free trading of residential land plots foreclosure and eviction necessary for housing finance. as long as no change in land use. Art. 58 redefines the right to housing. 2. Local Federal Agreement (Mar. 1992) Clarifying the legal competency of different levels of Government Law Sets out basic principles of central-Republic relations. government is essential to creating functioning local land and Law of the RSFSR on Local Self-Governments (July 1991) housing markets. One step is to identify legal mechanisms Delegates substantial authority in the areas of land use and housing to that the federal government can use to spur local-level local governments. reforms. 3. Civil Codes Law on the Basic Principles of the Federal Housine Policy Revisions to the Civil, Housing, and Land Codes are and Basic (Dec. 1992) required to bring them in accord with the principles of the Housing Law (1) Defines government responsibility in insuring private right to housing, new law. Implementing regulations now are required to (2) defines owners and tenants relations, (3) defines private property in provide practical methods to implement the rights granted. housing sector, (4) defines social guarantees and right to evict from state- Republic and local governments will need federal guidance owned property, (5) reinforces right to access to land, and (6) promotes regarding their role in creating procedures and institutions to competition in construction, rehabilitation, and maintenance. support the law. 4. Land Use and Law on the Rinht of Citizens to Obtain Land Plots for Private Ownership (1) Land ownership remains an important area for further Law of Urban and Sale for the Purpose of Conducting Personal Subsidiary and Dacha rights development. Procedures for acquiring and Development Farming, Gardening, and Individual Housing Construction. (Dec. 1992) registering land under this law need to be speedily This law allows private property of land in urban and rural areas, implementing. Restrictions on uses should be regulated by although it still places restriction on changes of uses. local zoning laws. Law on the Principles of Urban Development of the RSFSR (AuR. 1992). (2) The role of the central ministry remains unclear. It is a The Law still relies on rigid, normative, and administrative concepts of high priority to divide responsibility for procedural and urban planning. International experience has consistently shown such substantive rules of land use planning between the federal concepts to be flawed. A Law on the Fundamentals of Town Planning is and local levels. A modern land use system would allow in draft. flexible conversion of agricultural land, provide affordable standards, and ensure speedy resolution of disputes. 5. Property No comprehensive legislation has recently been passed in this area, General legislation in this area is a high priority. Land and Registration although draft legislation is pending. Property registries are divided property registers should be integrated into a single system. according to the type of property and are not linked through an overall Such a system clarifies ownership and provides a basis for a land parcel map. Considerable technical work appears needed to support housing finance system and for property taxation. viable legislation in this area. HOUSING LAW RECENT REFORM LAWS COMMENTS FRAMEWORK 6. Building No major legislation has recently been passed in this area. Bidding and procurement rules for public projects need to be Industry Law revised to promote competition in the building industry. Regulation to promote subcontracting, performance bonding, completion guarantees and liability insurance is also important. 7. Housing Law on Pledee (Aug. 1992) The Law requires workable regulations and procedures. Finance Laws The Law sets out the basic principles for secured transactions, including especially in the areas of registration, foreclosure and real estate mortgages. A separate Law on Mortgages is in draft. eviction, and mortgage work-out rules. Broader legislation is still required to establish a housing finance system. 8. Law on No major legislation has yet been passed in this area, although Arts. 3 A national enabling law for condominiums is an important Condominium- and 21 of the Housing Privatization Law appear to provide sufficient priority to guide local implementing regulations. In Cooperative authority for local governments to enact condominium regulations and the addition, the existing laws on housing cooperatives will need new Housing Law allows, but does not define, condominium ownership. to be revised. 9. Landlord- No major legislation has recently been passed in this area. Federal authority to determine landlord-tenant rights is Tenant Law unclear. Nevertheless, federal legislation may be necessary to clarify and restrict tenants' rights under rental contracts for state and private units. 10. Housing Law on Housing Privatizadon (July 1991) Implementation of the Law has been slowed by the absence Privatization The Law provides allows for privatization of state rental units. of implementing regulations, including property registration, condominium rules. Lack of clarity on rent increases and maintenance responsibilities has also slowed implementation. A draft Decree to Accelerate the Privatization was being prepared in late 1992. 11. Division of No major legislation has recently been passed in this area. Not only must ownership of state assets be clarified among State Assets levels of government, but also incentives must be structured so that public owners do not use assets to paralyze markets. 12. Other Other areas of housing law include eminent domain, nuisance and Creating a market system for housing will require attention trespass, family law on concurrent owners, bankruptcy, environmental to seemingly unrelated areas of law that indirectly affect liability, and natural resources law. incentives in the housing sector. 90 Chapter 4 4.36 By gaining access to international experience, Russia could incorporate the best practices of well-functioning housing law systems. Such best practices incorporate modern legal principles that attempt to miniimize the regulatory costs of transactions. In addition, Russia can learn from the transition legal issues that have already been addressed by other reforming socialist economies. To date, international assistance has been of sharply varied quality, with many private companies advocating individual agendas. Technical assistance could be provided to provide rapid reviews of draft urban legislation, expert seminars, and model codes and standard forms from other countries. m: \rhsector\grecn\cng\chapteu\chap4x.v 10 August 1, 1995 CHAPFER 5 HOUSING MANAGEMENT AND PRICING OF THE SOCIAL HOUSING STOCK Table of Contents THE TRADMONAL FINANCING OF HOUSING MANAGEMENT AND MUANTENANCE ........................................ 91 A. The Administrative System of Financing ........ .. ............ 91 B. Orders of Magnitudes for Management and Current Maintenance Costs Until 1991 ................... ...................... 92 C. Share of Total Housing Subsidies in Total Local Public Expenditures ... . 92 D. Disruptions of the Traditional Financing of Rental Housing .... ....... 94 II. PRIVATIZATION AND MANAGERIAL PRINCIPLES FOR REFORM ..... 97 A. Leading Issues in the Management of the Public Housing Stock ... ..... 97 B. Pricing the Existing Housing Stock: Basic Managerial Principles ... .... 98 III. IMPLICATIONS OF THE NEW MANAGERIAL PRINCIPLES ..100 A. Reorganization of the Supply of Urban Services .100 B. Transfer of the Ownership of Social Housing to Autonomous Organizations . 100 C. Not Every Building Is Suitable for Privatization .101 D. Rationalizing the Structure of Housing Payments. 102 E. The New Rents .103 F. Systems of Direct Subsidies to Individuals .105 G. Revision of Waiting Lists and Their Functions .106 H. The Problem of Fragmented and Incomplete Financial Management .107 I. Taxation of Housing ................................... 108 CHAPTER S HOUSING MANAGEMENT AND PRICING OF THE SOcIAL HOUSING STOCK 5.1 This chapter elaborates on the general housing strategy presented in Part I for the entire housing sector. It focuses on the reforms needed in the management, maintenance, pricing, and privatization of the existing state-owned housing stock, and provides managerial recommendations. It is not a status report on housing privatization across Russia nor on the current financial conditions of municipal housing organizations or enterprise housing. Operational data on housing privatization can be found in the annexes to this report. Illustrative, but fairly detailed data on the financial problems faced by the cities of Moscow and Ryazan until late 1992 are also presented in the annexes. I. THE TRADITIONAL FINANCING OF HOUSING MANAGEMENT AND MAINTANCE A. The Administrative System of Financing 5.2 The traditional Soviet administrative system of financing housing is becoming rapidly unbalanced. Until 1991, investment in new housing and the management of the existing stock had been totally disassociated. This disassociation was primarily financial, as public-sector construction was carried out with subsidies from municipal, state, and enterprise budgets, but without the use of loans for even a part of the investrnent. This disassociation also had a technical basis, as different companies were responsible for construction and subsequent repairs. It also had an administrative basis, as the construction and management services were administratively separate. In such a system, rents bore absolutely no relation to housing construction costs or financing costs. 5.3 Three broad categories of financing can be distinguished in all housing systems: new construction, major rehabilitation, and current management and maintenance. In market economies, whether it is a purchased or a rental unit, the third category (management and maintenance) can be easily covered by a usually modest share of total rents and monthly payments. In Russia, on the other hand, rent payments for residential premises do not even cover basic maintenance. Until 1991, housing rents provided a third of the necessary revenue. The full coverage of management and basic maintenance costs was dependent on the availability of other sources of funds: - municipal subsidies (in the enterprise sector, enterprise subsidies); - rents received for commercial premises on the ground floors of apartment blocks; - fees for urban service networks; - additional management fees in the case of cooperative apartment blocks. 5.4 Such a system created a strong financial dependence of housing on income which varied in time and space: commercial premises could vary in number, as could cooperative apartment blocks. Subsidies could be threatened by budgetary difficulties, while levels of housing rents were presented as politically untouchable. However, this system was at least sustainable as long as the entire local economic system remained stable. 92 ' Chapter 5 B. Orders of Magnitudes for Management and Current Maintenance Costs Until 1991 5.5 Subsidies provided by the municipal authorities for housing management services represented an average of 40 percent of maintenance and management costs in 1991. Commercial rents contributed an additional 21 percent to 27 percent. In total, rents and various contributions paid by occupants covered less than a third of current expenditure, excluding any amortization of the capital invested to build the apartment blocks. Before the economic and institutional reforms took effect, the financing of current housing maintenance was, therefore, profoundly unbalanced. There was no link between the usage of dwellings and the cost of running them. Operational budgets for Moscow and St Petersburg were as follows: Operational budgets for municipal housing, 1991 (in millions of rubles and as a %) MOSCOW St PETERSBURG Rbs. % Rbs. % EXPENDITURES - Current repairs 218 26.2 137 38.7 - Maintenance 178 21.4 74 20.9 - Salaries 290 34.9 77 21.8 - Miscellaneous 145 17.4 58 16.4 Total 831 100 354 100 REVENUE - Residential rents 136 16.4 58 16.4 - Commercial rents 228 27.4 76 21.5 - Cooperatives fees 19 2.3 32 9.0 - Miscellaneous 117 14.1 44 12.4 (inc. utility network maintenance) - Subsidies 331 39.8 144 40.6 Total 831 100 354 100 C. Share of Total Housing Subsidies in Total Local Public Expenditures 5.6 What was the scale of public subsidies for new construction, major repairs and management and maintenance? At first sight, it was extremely large. On the basis of the documents collected it was about one-third of local budgets in 1991. Detailed analyses should be carried out in a variety of cities and enterprises across Russia. Basic data based on the situation in several major cities in 1990-1991 leads to the following broad conclusions: - Housing, in the narrow sense, could represent about 10 percent of municipal budgets. This percentage relates to new buildings and major repairs. Management and maintenance only represent 20 percent of that total, or 2 percent of local budgets. Chapter 5 93 Subsidies to cover operating costs represent 40 percent of the total required balance. Rents paid by tenants cover only 16 percent. The remainder is drawn from commercial rents and various other revenues. 5.7 Given the accounting system, and the nature of administrative pricing, it is impossible to say whether housing subsidies were too high or too low in the local economy of cities. Perhaps the subsidy level was too low, considering its limited importance in budgets, and the notorious inadequacy of construction maintenance. On the other hand it might have been too high considering the sector's dependence on various sources of income, and the almost insignificant contribution of residential rents. Municipal Budget and Housing Expenditures in Selected Cities (in millions of rubles) Subsidies for Total housing and % budget communal services Moscow 1991 12,600 3,633 28.8 Saint Petersburg 1991 6,600 2,200 33.3 Nizhni Novgorod 1991 852 346 40.6 Ryazan 1990 114 39 34.1 5.8 The "communal economy" as defined by Soviet terminology covers extremely varied types of expenditures. Most of these are subsidies to achieve a break-even balance with various companies responsible for urban services (metros and other public transport services, urban heating, health clinics, etc...). Some of the expenditures are subsidies to reduce the cost of food and pharmaceutical products. Others are capital grants to carry out urban improvements. By isolating the budget lines strictly corresponding to housing expenditure in these different budgets, far smaller orders of magnitude are obtained: Importance of housing expenditure in 1991 city budgets (in millions of rubles) Moscow Saint Nizhny Petersburg Novgorod Total budget 12 603 6 600 852 Housing expenditures - Major repairs 694 33 29 - Maintenance Subsidies 48 110 12 - New construction 883 178 34 Total 1,925 327 75 (Share of City Budget) (15.3 %) (5.0 %) (8.8 %) 94 Chapter 5 5.9 These figures are only illustrative of the old system since they predate the major price liberalizations of 1992. Moreover, inflation was already rising. Also, while the figures concern the same year, the budget figures of Moscow and Nizhny-Novgorod are drawn from budgets which were adjusted during the year, whereas those of St. Petersburg were drawn from the budget estimation prepared at the beginning of the year. Housing maintenance subsidies in St. Petersburg were much higher than initially expected (148 million rubles versus the forecast of 110 million). Furthermore, these data cover only part of the expenditure for housing. For instance, the city of Moscow paid a subsidy of 128 million rubles in 1991 to companies producing construction materials, of which only a proportion is destined for the housing sector. D. Disruptions of the Traditional FYnancing of Rental Housing 5.10 This administrative system of financing has now been thoroughly disrupted, and the financial imbalances experienced by municipal housing systems are the cause of de facto insolvency. The housing sector is suffering the repercussions from the redistribution of power and resources between local authorities and the federal government. This redistribution of responsibility has progressed rapidly, yet the general principles adopted leave a large margin of uncertainty. Many new responsibilities have been given to cities, without it being possible to evaluate these new burdens precisely. For instance local authorities are now responsible for subsidies for basic necessities which are increasing rapidly under accelerating inflation. 5.11 The redistribution of responsibilities and the sharing of tax resources are apparently being negotiated in a piecemeal, disjointed manner, without any clear attempt to reach a balance between the transfer of burdens and resources. The sharing of fiscal resources between federal and local government is often subject to protracted negotiations between the federal, the oblast and the city levels. In the large cities, the process does not stop there but carries into the relationship between city governments and individual districts. 5.12 The sharing of resources between various public authorities is not clearly defined. Since 1992, a proportion of the taxes collected within the jurisdiction of a local authority to provide funds for the state has been given back to cities and regions. However, such sharing is not subject to consistent rules across cities that are stable over time. It is the result of negotiation which may be repeated by each municipality every budgetary year. Nevertheless, this situation seems to be changing fast, as the central government is now proposing a redistribution of taxes rather than a sharing of tax income, with each level of authority receiving the entire income of a range of taxes. The proposed distribution would be as follows: - Central government: VAT, excise duties, taxes on unearned income, insurance, banking, and share issues. - Oblasts: taxes on profits; on personal revenue; on transport; on inheritances and gifts, on enterprise property, and on forestry revenues. - Municipalities: taxes on personal property, land taxes, and 21 other local taxes. Municipalities will have some freedom to fix tax rates and grant tax reductions to some categories of taxpayers. Chapter 5 95 5.13 In this climate of uncertainty, the evaluation of public housing expenditure in a given city faces several difficulties: competition for funds, inflation (which rapidly renders recent budgetary data outdated), the many departments involved, and problems in getting budgets voted. For a single budgetary item, financial and technical departments provide divergent evaluations which could only be clarified by a complete budgetary process. All parties concerned feel that their figures are ephemeral. Credits authorized by financial departments at the beginning of the year are at first strongly underestimated, then "extensions" are granted as tax revenues come in. Rents Remain Stable while other Pikes Rise 5.14 The liberalization of prices and extremely high inflation has placed real estate management in an impossible situation. The price increases, which have also affected construction materials and energy, have increased maintenance costs and require either higher rents and household expenses, or higher subsidies. Utility payments have increased, at least partially, but rents have remained stable based on the argument that food and clothing have become more expensive. Housing has not been judged a priority in applying real prices, partly because low rents are a tradition that is difficult to break, and also because the economically vulnerable groups may be able to cut back on clothing and food, but not on housing. Authorities also fear large-scale protests and a sharp increase in payment defaults. As a result, rather than making richer citizens pay more, decision-makers chose not to infringe on the principle of equal rents for all. Financially balanced management is not possible under these conditions. Access to Housing Organizations, Access to Commercial Rents are Compromised 5.15 Commercial rents have been used by housing organizations (the REUs) to compensate for low residential rents, but this traditional source of income is at present being lost or partially compromised. Unlike housing rents, rents for non-residential premnises located on the ground floors of apartment blocks were fixed more freely by the municipality or the enterprise which owned them. For instance in Moscow, the average annual rent in 1991 was 18 rubles per square meter of total surface area compared with 1.4 rubles for housing. In St. Petersburg, it was 19.2 rubles. Commercial rents varied from five to 100 rubles per m3 according to type of tenants and the profitability of their activities and location. Such rents thus brought in a considerable proportion of revenue, and there remained a wide margin for possible increases. At the beginning of 1992, the system was modified in Moscow, St. Petersburg and other cities. Commercial rents are no longer paid directly to the housing management department, but into the municipal budget. With this change of procedure, however, commercial rents no longer contribute to the management of apartment blocks, and their collection is less well enforced. A further adjustment has been considered to return funds to housing organizations, but in a less centralized way. For commercial premises of less than 150 square meters rents will be collected by prefectures, whereas the municipal authorities will collect rents from premises of larger size. 5.16 The privatization of small-scale enterprises is another reason for a rapid restructuring of the financing of social housing. With the rapid sale of shops and other commercial premises cross- subsidies between coninercial and residential rents are under pressure. A fundamental flaw of the present privatization system is that municipalities use part of the proceeds of the sale of long-term 96 Chapter 5 real estate assets to finance operations and maintenance. Sound financial policy dictates the proceeds from sales be used for purchasing better assets. Nominal Subsidies and Budgetary Problems Increase Significantly 5.17 Subsidies have had to be increased in order to continue the management and minimum maintenance of rented housing. This is due to higher expenditures caused by inflation, diminishing revenues as residential rents remain unchanged, and a rising proportion of lost commercial rents. As rents in Moscow and St. Petersburg remain legally fixed at the 1928 levels, the REUs' budget at the beginning of 1992 was subsidized by more than 80 percent, compared with between 40 percent and 60 percent a year earlier. This is an average figure, as accounts can vary from one REU to another, but the scale of subsidies appears to be similar elsewhere. The same problem arises for housing owned by unprofitable enterprises. For instance, the department responsible for maintaining housing owned by the ZIL car enterprise in Moscow (9,000 housing units) calculated in 1992 that the rent level to break even on management costs would be almost as high as 600 rubles for a three- room apartment. That figure was about 35 rubles at the beginning of the year. Double-digit inflations rates make it difficult to provide budgets for operating long-term assets like housing. Rapid Decline in Maintenance and Major Repairs 5.18 Faced with rising costs and a lack of funds, administration departments are helpless. They carry out their tasks on a day-to-day basis without any guarantees concerning the public funds they might receive each year to operate their departments. They make an effort to continue work, and to motivate employees who are paid late and treated badly. Municipal authorities are seeking solutions in administrative reforrns. In Moscow, the lowest level housing units (the REUs) are legal identities with autonomous accounts. Their budgets are prepared after negotiations with the prefectural level organizations (the PREOs). The PREOs allocate their budget for maintenance among the various REUs, and fix a level of service and the corresponding costs with them. 5.19 Such devolution measures adopted in the context of budgetary crisis have increased confusion and worsened public deficits, at least temporarily. Until 1992, the construction and rehabilitation program was prepared every year in Moscow and other cities by the housing department and covered the entire city. This program made provisions for the major rehabilitation of several buildings, major repairs for others, as well as urban network (water, sewage, electricity, etc..) rehabilitation. Even in the absence of credit allocations at levels which match their needs, the specialized rehabilitation construction enterprises (UKKh) have nevertheless started construction programs which exceed officially authorized expenditure limits. The enterprises take the risk and provide the municipality with liquid assets by financing the construction work. Each expects a hypothetical budgetary extension to resolve the situation. Municipal Governments are Resorting to Expedients 5.20 Municipal authorities are searching for expedients to cope with these difficulties. The traditional remedy, which is continuously gaining in importance, is to increase non-residential rents. However, access to the cash-flow from commercial properties must be directly or indirectly retained. This will not be the case everywhere with privatization. The use of loans is envisaged, but with Chapter 5 97 double-digit inflation rates cities have very limited access to loans. Privatization is increasing in popularity because it carries the freedom to sell real estate at higher market prices. Yet a coherent view of the real estate sector is often lacking. The authorities expect very large profits from the sale of a few buildings. At the same time they are ready to privatize all their housing by selling it to occupants for nominal sums or free. Meanwhile they are hostile to higher rents on the largest and most important urban real estate assets, the residential stock. Heavy Rehabilition and Construction are in Deep Crisis 5.21 The continuation of new construction and major repairs for the benefit of tenants and potential tenants is threatened by the inability of budgets to subsidize the considerably increased construction costs. The enterprise sector may be doing marginally better than municipal or cooperative construction. Where inflated costs leave households unable to pay for their accommodation, yet again requiring increased subsidies. H. PRIVATIZATION AND MANAGERIAL PRINCIPLES FOR REFORM A. Leading Issues in the Management of the Public Housing Stock 5.22 Current reform of housing policy, and the improvement for the sector which should result, are adversely affected by three weaknesses: - a lack of both public and private institutions responsible for organizing the transition to a private housing economy. Such a transition should not come down to an unstructured confrontation between individuals who have become new co-owners and the administrative bodies which currently manage the housing stock and urban services; - the absence of a legal framework which would clearly define not only the role of these new institutions but also the rights and obligations of owners, renters and enterprises; - the absence, not only of institutions and mechanisms for financing the rehabilitation work required for the housing stock as a whole, but also of a stable housing sector financial plan (including full cost-recovery by the public landlord after taking into account the direct subsidies targeted to low-income renters). 5.23 Current housing reform in Russia is taking initial steps towards various form of privatization that offer all renters the possibility of becoming owners of the housing unit in which they reside. Beyond such privatization, many plans for economic, institutional, financial, fiscal, and administrative reforms are being discussed across the country. But they have not yet been adopted or specified in detail. As discussed in Part II and Chapter 4 of Part III, the lack of basic legal changes and clear policy directions until late 1992 have been impediments to reform. In such a policy environment, privatization cannot by itself resolve the difficulties experienced by the housing sector. 98 Chapter 5 5.24 Privatization, moreover, is still operating selectively. It has accelerated in major cities like Moscow which may well have privatized one third of the municipally owned housing stock by mid- 1993. Many renters preoccupied with short-term employment and income problems who are used to the nominal rents of the old system, fail to appreciate what privatization has to offer them (improved service, better usage of their savings, prospective capital gains), nor do they understand risk they incur if they remain renters (rent increases, deteriorating level of service, eviction for defaulting on rent payments, etc...). Another problem is that the administrative rules and the actual staff necessary to actually implement privatization and transfer ownership are at different degrees of readiness. For these reasons, across Russian cities, the housing stock is still mostly owned by local authorities and enterprises which are powerless to prevent the increase in maintenance costs arising from inflation and the poor condition of buildings, and the stagnation of resources resulting from the long-lasting freeze on rents. 5.25 Adverse selection during privatization has not been taken into consideration by most local governments. A change in attitude on the part of renters occupying the better types of housing would represent a risk for the government, leaving government with management of the most run- down, poorly-situated housing i.e. housing which consumes the most public assistance. The ongoing process can also result in a fragmentation of tenure within individual buildings which can lead to serious and lasting management problems. 5.26 Finally, the conditions under which privatization of the housing stock is being carried out are also perceived as a source of injustice: Privatization is free in certain places but not in others. It is considered as a gift to renters in comparison with the price that members of cooperatives must pay for their housing -- an administratively fixed price which reflects neither the real value nor the location of the housing. B. Pricing the Existing Housing Stock: Basic Managerial Principles 5.27 The old administrative housing system and the emerging market system will coexist during the transition period. The Russian housing system will progress gradually from an urban housing stock totally dominated by the public rental sector to a more balanced situation combining three sectors: the low-rent public housing sector, the private rental sector, with market-driven or only lightly regulated rents, and the owner-occupant sector. Major economic distortions in the sector will be removed when the resource cost of housing in these three different subsectors has converged to true full cost recovery by both the private and the social owners of the housing stock. At that time, the public subsector will no longer be favored at the expense of the other socially more desirable forms of ownership. 5.28 It will also be essential to deal separately with problems of poverty and unemployment on the one hand, and housing on the other. The socially underprivileged must be given assistance. However, it would not make sense to determine the overall rent level by reference to the lowest- income households and the most underprivileged renters. A policy of managerial differentiation is imperative to avoid costly, random, and wasteful subsidization of the sector. The experience in Western Europe and North America shows that such a goal can be achieved. Chapter 5 99 5.29 The long-term principles on which housing reform in the existing stock should be carried out are as follows: 1. Transfer the management of the public housing stock from the government or enterprises to bodies which are autonomous as regards management and financial decisions, and are independent legal entities with a mandate to balance their accounts within a specified and reasonably short period of time. The accounts of municipal housing should be totally distinct from those of the municipalities, and those of enterprise-owned housing should also be distinct from those of the enterprises themselves. Even non-profit organizations must achieve full financial cost recovery and respect the equation 'income = expenditure'. This does not mean that rents for low-income families cannot be lowered where controlled and sustainable subsidy sources are identified. 2. By means of a gradual rent increase, provide financing for the upkeep of the housing stock, which takes account of service costs and which progressively becomes totally independent of the annual public budget, except in the case of the sustainable subsidy mechanism mentioned above. 3. Introduce a system of direct personalized subsidies to protect the lowest-income households from the effects of this increase and make the reform socially acceptable. Such assistance should, however, be granted very selectively. 4. Initiate a vast program of rehabilitation in order to reduce heating costs and to make viable the positive aspects of the reform. This will make the additional financial effort required of households more palatable if rent increases are associated with visible improvements in the quality of the dwelling units. 5. Differentiate clearly between all matters concerned with housing maintenance on the one hand, and the other urban services (water, sanitation, trash disposal, urban heating, electricity, etc.) produced and billed by specialized, autonomous institutions, on the other. 6. Distinguish clearly between three categories of expenses: individual household utilities (gas, power, telephone) billed according to family consumption; ordinary housing operating costs paid by the occupant of the housing unit; repairs, management costs, taxes and loan repayments paid by the owner. Such financial and accounting clarity is indispensable since the three types of occupancy can sometimes be found in the same building. 7. Specify the taxation framework for housing to reassure investors and possible candidates for privatization. It is fundamentally unsound to simultaneously privatize the housing sector and to think that this private stock can be used as an easy target now and in the future to cover public deficit shortfalls as they arise. 100 - Chapter 5 8. Provide for specific and workable foreclosure rules (in the case of mortgage holders) or expulsion proceedings (in the case of renters) in order to penalize defaulting payers. These provisions will obviously need to be implemented very carefully, but it must be absolutely clear to the willfully delinquent payer that he/she runs the risk of losing his/her housing. m. IMPLICATIONS OF THE NEW MANAGERIAL PRINCIPLES A. Reorganization of the Supply of Urban Services 5.30 Reorganizing the housing system requires that a distinction be nade between the management of the housing stock and the provision of other urban services. There should be separate billing for the individual household consumption of various urban services and housing service consumption. The current undifferentiated management of the "communal economy" is the cause of multiple problems. The managerial principles proposed are as follows: (a) Autonomy for the enterprises responsible for supplying individual household utilities (water, power, gas, heating, telephone, etc.) with direct payment to the enterprises for such utilities. Several different types of legal status for these enterprises could be envisaged: government enterprise, concession or contracting out to a semi-public enterprise or to a private enterprise, etc.' The central point is the need to separate the provision of housing services from that of urban services. During the transition period, the municipal REU (Maintenance and Repair Administration) may function as a billing center for each of these new enterprises until they are able to take over this function themselves; (b) financing by taxation of the services for which individual users could be charged directly (street cleaning, street safety, possibly household trash disposal, etc.); (c) financing of capital amortization, major repairs, and current maintenance from rent collections. B. Transfer of the Ownership of Social Housing to Autonomous Organizations 5.31 This restructuring of the 'communal economy" which is imperative if housing quality is to improve in Russia, would involve transferring ownership, or assigning management of public housing to agencies with broad-based autonomy. These agencies could be non-profit bodies whose statute should be defined by the law. Their management regulations and accounting framework should also be codified. They are presently set up on the initiative of the local governments and placed under their policy control. Their real estate assets come from the allocation of city-owned buildings -- which may mean a regrouping of the stock of several REU or enterprise-owner buildings. A housing 11 Refer Annex 10 on 'Private Sector Participation in Municipal Services' for further details on the wide range of contractual and managerial arrangements that could be considered by a modem city. Chapter 5 101 management enterprise will not necessarily have to be defined on a geographical basis. It could manage buildings anywhere in the city. This is already the case with property belonging to enterprises. 5.32 These new bodies must progressively achieve a financial balance between: Expenditures: management costs, operating costs (covered by the payment of charges), current maintenance, ordinary or exceptional repairs, taxes, and - if they have borrowed - loan repayments. Income: rents2, fees for services, balancing subsidies (linked to the low-income status of households such as housing allowances or quasi-capital: possible loans, privatization sales, other forms of subsidies). 5.33 With regard to making the reforms sustainable, the responsibilities of these agencies are would be to: make an inventory of their housing stock, highlighting its economic and technical characteristics. Such an inventory will be useful in at least four areas requiring specific and detailed evaluation: the prices of various privatized housing units, new rents which must better relate to the services offered, determination of required rehabilitation, and tax assessments for local taxes. The technical elements needed to establish such consolidated inventory exists within separate services, especially BTI (Bureau for Technical Information) for the appraisal of real estate and architecture, and town-planning services for land evaluation; determine and negotiate their repair priorities with residents. Such repairs are the required trade-off for rent increases. These rents linked to specific units would remain within the range of the rent of reference for each individual city; submit the schedule of a privatization prograrm which would involve transferring some of their assets to the private sector, while at the same time maintaining a balanced public stock with a diversity of location and type of building; iimplement their privatization and rehabilitation programs in accordance with the methods and with the assistance of the forms of financing described further below. C. Not Every Building Is Suitable for Privatization 5.34 The policy perspective that not every building is suitable for instant privatization derives from two principles: 2/ Including rents derived from the non-residential use of ground-floor premises in residential buildings. 102 Chapter 5 - To insure that there will be a public rental sector that is sound and viable; - To avoid management difficulties by scattering throughout the housing stock privatized housing units which might represent only a small fraction of each building. Consequently, privatization should preferably not begin everywhere at once in a random way. In parallel, a housing unit privatized by a household need not be the one it currently occupies. Trading and exchange mechanisms should be developed. Buildings should, therefore, be specialized with some remaining undivided, public property, and others being sold off unit by unit. 5.35 The selection of buildings for privatization should respect the following three principles: - There is a de facto privatization of buildings already under way today, but, in the future, there should be agreement on privatization from a majority of tenants. Technical and social analyses should be carried out to help identify buildings where residents are capable of self-management and self-maintenance. Social housing as a public service should be linked to anti-segregation: it would be harmful if only well-maintained and well-located buildings were privatized, with the public sector keeping only "problem" buildings. As soon as the privatization of a building is underway (at the request of more than 50% of its occupants), the managing body should encourage privatization of the entire building by proposing exchanges of housing units for the remaining renters. 5.36 The implication for the new non-profit companies owning the public housing stock is that they should quickly develop an "asset management plan" identifying the buildings to be privatized, those which they would keep, with the possibility that the fate of certain buildings might remain undecided. The choice of buildings to be privatized should be made in agreement with the municipal authorities. 5.37 In privatized buildings, renters not wishing to buy their units would remain as tenant. Their landlord would be the public authority which in this case would be a co-owner, since it would not own all the units. However, these households should be encouraged to trade their units (within the same neighborhood and the same housing stock) with other households wishing to privatize, the objective being that buildings would eventually be either entirely rental, or entirely co-owned. In this case the occupants will generally be the new owners, but some housing units could be occupied by a tenant, under contract with this owner. D. Rationalizing the Structure of Housing Payments 5.38 Three major groups of expenses must be differentiated: (1) individual utilities (expenses payable by individual households); (2) ordinary building utilities; (3) management, repair and possible loan repayment costs. A management distinction must be made between what is to be paid Chapter 5 103 by the occupant and what is to be paid by the owner, which could of course be the same person in private housing, but clearly not in social housing units. Paid by If rental A. Individual utilities: water, gas, power, occupant occupant telephone Minor domestic repairs Insurance (partial) B. Building-wide utilities: power, owner direct billing to renters collective heating, common space, etc. Current maintenance, cleaning C. Management costs owner much the same as rent Minor or major repairs (enhanced by possible Loan repayment or capital charges future forms of assistance) Real estate taxes Insurance (partial) _ 5.39 These categories are not always the sarne in different Western countries or even cities of the same country (e.g. according to whether heating is billed on an individual basis, by building, or by city district). But the principles are clear: - The occupant owner should pay Groups A, B and C. - The tenant should pay Group A (all apartment utilities distinct from the management of the building), and Group B (common operating costs of the building paid in proportion to bills). The tenant should not pay expenses listed under Group C, but the rent he/she pays should permit the owner to cover these costs more or less in full. If the rent is set voluntarily low, targeted housing allowances should complement it, varying according to the households. Global balancing subsidies might possibly be used to meet the absolute necessity of financial equilibrium for the non-profit owner. - The same system should apply if the tenant's landlord is an individual who has privatized his housing unit. The tenant should pay the expenses under Groups A and B, while the owner should pay those under Group C. In this case, however, the rent will be higher and the owner will not be entitled to any balancing subsidy beyond the housing allowance. E. The New Rents 5.40 It is not efficient to mix the management of residential buildings with that of commercial buildings because the clientele and their goals and behavior are totally different. Predominantly, commercial or office buildings belonging to the city should be managed or sold by specialized 104 Chapter 5 organizations. Their rents or sale proceeds should be transferred to the municipal budget. Policy regarding their use should be designed in the overall context of municipal finance reforms rather than on an ad hoc basis. Rents from non-residential premises located in predominantly residential buildings, on the other hand, could go to the body responsible for the management of this part of the housing stock. 5.41 The central problem today is the very low level of public sector housing rents. It is essential that these be increased, even though low-income (and only genuinely low-income) households will need to receive assistance if they are to bear this new cost. An attempt must be made to calculate the full cost recovery rent (even if it is not to be charged in full). Full cost recovery rent should allow for the long-term payment of management charges, current or special repairs, and loan repayments (if any). 5.42 The extremely high inflation rates make the calculations of a monthly rent per square meter (excluding charges) difficult. Nonetheless, the price to be paid for the failure to carry out rent adjustments is the accelerating deterioration of the public housing stock. The rent could, of course, be lowered if the local community finds it feasible to partially subsidize social housing management and decides to use other assets to do so. 5.43 Rents should be differentiated. The uniform rental rate per square meter currently applied is bearable only because it is very low and, by now, economically meaningless. A realistic rent cannot be uniform. The rental rate must take account the following factors: the cost per m2 is uniformly higher in a small housing unit than in a large housing unit; those in better locations must pay more as a function of the new transport costs; those occupying quality housing should pay more than those occupying mediocre housing. The newly available market-based data should not be applied mechanically, but used flexibly, with a concern for justice. 5.44 A general social rent schedule could be drawn up as a guideline based on studies carried out in Moscow, St. Petersburg, and other Russian cities -- on the quality of buildings and on space allotment. This schedule could include a series of ranges determined by the municipal authorities. For a given category of housing (location, technical quality, size) a maximum and a minimum rent per m2 could be published3, the actual rent within this range being determined by each of the new public sector owners. 31 An alternative would be to have a single scale but to consider not the real surface area of the housing unit (rooms alone or total) but a 'corrected' surface area where positive and negative factors are taken into consideration. But in this case each housing unit would have to be described separately, which is unnecessarily rigid. Chapter 5 105 5.45 Rents calculated in this fashion would be indexed on general inflation and on the miimum salary; a revision should be applied only following a certain increase (rents cannot be recalculated on a monthly basis). It is essential to stop the reduction in rental resources caused by inflation. The increase in rents can be expected to bring back on the market unutilized or under-utilized housing units being kept by households only because of their insignificant price and a lack of bureaucratic administration. F. Systems of Direct Subsidies to Individuals 5.46 The principle of housing allowances for households economically at risk is by now accepted as the best practice in the affluent and well-functioning markets of Western Europe and North America. It is the conclusion of a broad range of experiments over decades. It is, therefore, a strategic direction that should be constantly taken into account in the design of Russian housing reforms. However, the implementation of such a practice on a large scale in Russia today is impaired by four major factors: rising poverty levels, low housing quality, administrative inefficiency, and generalized housing shortages that go beyond what is caused by poor pricing. 5.47 First, there is the very sharp deterioration in the income distribution of households caused by extremely high inflation. In 1992, about 40 percent of the population were below the poverty line. A major proportion of households would not be able to afford the full rent increases; nor could they afford to buy housing units or pay private sector rents. Second, the standards of housing construction in Russia have been so energy intensive and public construction quality so mediocre that the true operating cost of the existing stock is out of balance with the falling purchasing power of the population.4 Third, the administrative structure of Russian cities and knowledge of official and unofficial incomes are such that implementing generalized housing allowance schemes does not seem feasible in the immediate future. It is therefore likely that a substantial share of total housing subsidies will continue to flow through housing organizations owning the stock rather than being directly linked to individual household needs. 5.48 A uniform national policy of housing allowances for a country that is geographically twice as large as the Unites States -- with very differentiated ethnic, social, and economic conditions across cities -- does not seem appropriate at present. In addition to the three factors already mentioned, local shortages (and supply inelasticity) are a fourth important consideration. When designing assistance systems for vulnerable Russian households, it will be essential to understand that the initial problems of the Russian poor are exactly the opposite of those of the Western European or American poor. In Western industrial countries, the main problem of the poor is not inadequate housing but exceedingly high rental payments. In Russia, the problem is just the opposite: rental payments are trivial, but housing quality is very low. This poverty issue is different from but 4/ It is important to keep in mind that most of the housing stock was built when energy prices in the Soviet Union varied between one-hundredth and one-twentieth of world prices. As discussed in the chapter on the building industry, both the construction and the operation of the housing stock in Russia is highly energy intensive. In a large closed economy like the Soviet Union, this was not obviously damaging. Now that the Russian economy is opening up and energy price adjustments are a national priority, the large impact on housing costs (and urban transport costs) is finally visible. 106 Chapter 5 complementary to the housing problems of cities where the supply response is very inadequate and demand-side subsidies are rendered less effective in solving low-income housing problems.5 5.49 The best short-term strategy appears to be one of highly selective direct subsidies linked to overall safety-net programs. To the extent that various regions and cities may initiate policies of direct subsidies to households -- with support from the federal Government -- some general principles can be outlined: Level of assistance The assistance should be higher if the rent is high; income is low, and the number of occupants is high. A ceiling should be placed on the rent to be covered in order to avoid an endless race between rents and assistance. This ceiling should be consistent with the general ceiling for the purchase of social housing and with the upper limit of the rent range defined for the specific municipality.6 Mode of payment The allowance can actually be paid to households directly or net rents can be calculated in such a way that beneficiary households are clearly required to pay a lower sum, with the difference being received by the owner. Flnancing This personalized assistance could be financed in part by intergovernmental transfers, and possibly by a general levy on rents (for example, 10% on all rents and 30% on those exceeding a certain level by m2, so as to have some cross-subsidization between central and peripheral neighborhoods) that would be managed by the financial agency referred to below. G. Revision of Waiting Lists and Their Functions 5.50 Because shortages are worsening, there will still be waiting lists. However, these waiting lists must be drawn up in line with new principles. The public rental sector should progressively be reserved for low-income households.' A ceiling on household resources must, therefore, be 51 For a recent discussion in the United States about housing allowance experiments and possible differentiated results in cities where the supply elasticity of housing was high like in mid-western, medium- size cities and cities like New-York, San Francisco or Boston, see Mahlon Apgar "Which Housing Policy is Best? in Housing Policy Debate, Vol. 1, No. 1, 1990. 6/ In a very large country like Russia, considerable variations in housing costs, rents and prices will evolve across the range of cities and municipalities. 71 This should not affect current residents: the introduction of a ceiling should not be retroactive. Chapter 5 107 established. Initially, until home ownership or private rental alternatives are developed, this ceiling may be relatively high. 5.51 There must be a removal of restrictions on home-buying cooperatives until it results in home ownership at a normal economic price. In principle no cap on household resources should be introduced unless the cooperative is subsidized and the purchase prices are well below market prices. 5.52 Each new public owner body should have its own waiting list, although households should not be able to be included on several lists. It will soon become clear that it is easier to find an apartment if it is slightly less well located or, for units in good locations, if they are somewhat more expensive. 5.53 What should be the criteria for allocation? Applicants will still need to be treated according to a certain hierarchy. The system proposed would combine seniority of enrolment and personal factors such as: - income - proximity to work place - over-population - a family event (divorce, birth) 5.54 In the case of housing stock belonging to enterprises, workers at one of the funding enterprises could receive priority consideration. Dwelling unit allocations should be carried out by the organizations of new social owners, with a right of inspection or even a municipal quota (to avoid a situation where households are refused everywhere). H. The Problem of Fragmented and Incomplete Financial Management 5.55 When discussing financial management, it is particularly important to keep in mind that different segments of the housing stock will evolve differently. The approval of the principle of condominium ownership in December 1992 makes it possible for the first time for the state to withdraw from the direct management of housing. Given the fact, that a very large segment of the population is unable to pay the full maintenance cost of their units, it remains impossible to change abruptly everywhere from the present uniform, centralized management into a series of newly created independent housing companies. A system of cross-financing will remain necessary. Profits from privatization of various state real estate assets should also be reinvested in a vast rehabilitation program to limit financing by public budget resources. 5.56 The dual function of pooling of revenue sources (to be further identified) and the provision of financial services for specific rehabilitation or other operations, should be entrusted to a financial agency or agencies. Such agencies could provide loans to local non-profit enterprises managing the public housing stock and to owner associations created after privatization. It would also manage social housing benefits. The cash flow sources of these agencies investment resources would be: income from privatization of the real estate stock, a capital grant from the city, national and international loans, and loan repayments. These resources would be used to make loans to rehabilitate the public and private housing stock. 108 Chapter 5 5.57 Loan repayments by the new owner bodies should be possible if the rents are raised. In turn higher rents will be seen as legitimate because of an improvement in the services offered and operating costs will be lowered through greater efficiency (in particular for heating). Condominium owners would also have incentives to rehabilitate their building due to the possibility of tax cuts. 5.58 During the transition period, these financing agencies could play a role of centralization and allocation of subsidies to non-profit owners, based on their income and expenditures, to achieve financial balance. Their financial conditions in turn will be linked to the quality of their stock, their level of rents, their works program, and the rate at which privatization progresses. L. Taxation of Housing 5.59 During the years 1991 and 1992, the tax system has undergone a radical transformation. Several types of taxes, either new or drastically modified, are directly or indirectly related to the housing sector.8 The primary goal of these taxes is to finance public budgets but they can also foster or impede the progress of housing sector reforms. For instance, in Moscow, the introduction of a property tax which would primarily affect owners of real estate is often presented as an alternative to paying for privatization. Some people tend to consider this tax as a revenue source for the housing sector which will make it possible to continue deep subsidies. To make things worse, the lack of clarity as to how this tax will be calculated is dissuading households that would potentially privatize their units. 5.60 Tax ambiguities should be dispelled and the taxation system should be clarified in the following areas: - personal property tax: the purpose of this tax, the method for selecting tax rates, and determining values must be clarified. At first, the administrative evaluation of the assessment of the tax base might help avoid false declarations; - site value tax: this tax should be coordinated with the property tax; - income tax: define the rules for taxation of income from real estate and provide possibilities for tax incentives to encourage households to invest in housing (such incentives would cover both home ownership and major repairs); - tax on real estate transfers: the rate should be pegged so that this tax does not become an obstacle to the transfer of assets; in this area, as for estate duties, so long as the number of transactions remains limited it would be better initially to apply the tax rate to an administrative evaluation of the asset in question. m: \rlecctorXgreen.eng\chapters\chap5x.v7 16:52August 2. 1995 S/ For a comprehensive overview of taxation issues refer to 'Russia: Intergovernmental Fiscal Relations in the Russian Federation", World Bank Report No. 11302-RU, December 18, 1992, 301 pages. CHAPTER 6 HOUSING FINANCE AND BANKING SERVICES FOR HOUSING Table of Contents I. ENTRODUCTION ................. 109 II. THE TRADITIONAL SYSTEM OF HOUSING FINANCE .110 A. Financing of Housing Investment Under Central Planning .110 B. Sources of Funds for Housing Investment .113 C. Use of Funds Allocated to Housing .115 D. Allocation of Housing Units Constructed ...................... 116 E. The Banks Resulting From Central Planning .116 III. THE RUSSLAN BANKING SYSTEM IN TRANSITION .116 IV. A BANKING SYSTEM FOR THE RUSSIAN REAL ESTATE INDUSTRY . . 120 A. Housing Services, Housing Prices, and Housing Finance .120 B. Macroeconomic Impediments to Housing Finance in Russia .123 C. Construction Finance in Russia ............................ 124 D. Long-Term Real Estate Financing in Russia .127 V. CONCLUSIONS ......................................... 129 CHAPTER 6 HOUSING FINANCE AND BANKING SERVICES FOR HOUSING L. INTRODUCTION 6.1 The privatization of housing, including the right to sell or rent properties, is a pre-condition for the emergence of a housing market and the development of housing finance. Until privatization started in 1990, less than 5 percent of housing assets in Russia were privately owned." By December 1992, about 2.5 million housing units were already privatized throughout Russia representing about 8 percent to 9 percent of the state housing stock. In December 1992, the housing privatization law of July 1991 was amended to allow free transfer of housing. In many cities now, privatization is being done by giving away the property to those who presently have the right to live in it. Therefore, the problem of financing the sale of the existing stock of housing does not arise in any significant way. Presently the main issue in housing finance is the development of banking services and new instruments that will enable the financing of new housing, and more generally, the use of equity in housing properties as the basis for collateral in borrowing for other purposes. Problems in developing an efficient banking sector are compounded by the unstable macroeconomic environment which is particularly hostile to the forms of long-term finance required by the housing sector. 6.2 A housing finance system represents the set of economic and financial structures through which resources are allocated to the housing sector. A system may include the following components: Sources of savings: which provide the investment capital for housing construction and purchase. Housing investors: who purchase housing units, either for owner occupancy or to rent to others. Financial intermediaries: which expedite the transmission of funds from the savers to the investors. Financial instruments: which are used by intermediaries and other agents to transfer savings to housing investors. 6.3 In practice, we observe a wide range of alternative systems. In very simple systems, housing investors accumulate the required savings capital themselves, thus avoiding the need for financial intermediaries and instruments. Of course, this delays the construction date. In more complex systems, a wide range of depository intermediaries and mortgage-banking firms determine the most efficient mechanisms and instruments with which to transfer resources from savings sources to housing investors. I/ In the beginning of 1991, individuals owned 26% of the entire housing stock, as opposed to 15.7% of the urban housing stock. 110 Chapter 6 6.4 The benefits of an efficient housing finance system extend beyond the housing sector. In most developed market economies, housing assets represent more than one-fourth of tangible capital wealth, and mortgage debt exceeds one-fourth of total financial debt. Housing is, therefore, a key real sector of the economy and mortgage debt plays a major role in the banking and financial markets of these countries. There is a complex interaction of beneficial externalities -- with well-functioning housing and housing finance markets stimulating the real economy and financial markets, and vice versa. 6.5 The transition to banking services away from the financing mechanisms of central planning represents a major change in Russia. Considerable work is necessary to develop a safe and sound system of banking for the housing and the building industry. Yet this is the most critical element for the development of a demand-driven, competitive housing system in Russia that will increase the share of housing investment mobilized from households. The development of this housing finance system itself is an important part -- but only a part -- of the total development of commercial banking in Russia. Proposed housing finance reforms will be shaped by the strategy adopted for the entire Russian banking system, particularly the financial policies regarding Sberbank which has so far been the "bank" of the household sector.2' 6.6 A full technical analysis of the resources, institutions and instruments for a new housing fmance system goes much beyond the scope of this report on the overall housing reform strategy. However the direction of housing finance reform can be presented by addressing the following questions: how was housing financed under central planning? What kind of new Russian banking system is emerging? What is the link between housing services, housing prices, and housing finance in a market economy? What are the macroeconomic impediments to housing finance in Russia today? What are the directions to take to develop a banking system for the housing and building industry of Russia? II. THE TRADITIONAL SYSTEM OF HOUSING FiNANCE 6.7 In Russia, housing finance has been synonymous with the financing of new investments, most of it by state-controlled organizations. The need to finance the purchase of existing housing was a non-issue since only exchange was permitted and sales were prohibited. The financing of housing under central planning, which has been in force for more that five decades, is a necessary starting point of reference for the development of housing finance reforms. Witi privatization and the emerging banking service for housing, the total separation of the financing of housing investmnent from the financing of housing maintenance in the flow of funds characteristic of central planning will gradually disappear. A. Financing of Housing Investment Under Central Planning 6.8 The system which was used to finance housing in the former Soviet Union often served as a model for other centrally planned economies. An administrative planning structure was responsible 2/ In particular, the analyses and recommendations of this chapter 5 take as a starting point the report 'Russia: The Banking System in Transition", World Bank Report No. 11818-RU, 1993. Chapter 6 111 for determining investment, output and prices. Each year, the specific investment allocations were developed through a top-down, bottom-up negotiation process. First, Gosplan would determine the housing investment budget, including non-state resources. Gosplan would distribute the program for allocating the total housing investment budget to the Union and Republican Ministries, the local governments of each region and sub-region responsible for housing construction, and the housing cooperatives. In response, these "clients" would demand a greater allocation of resources for constructing housing for their constituents. After several iterations, a final allocation would be reached. 6.9 Housing investment was classified as a "non-productive investment" and certainly was not a "priority sector". As a result, it received only 15 percent to 17 percent of total investment during the last two decades. This share fell even below the 15-percent level between 1974 and 1983. It rose only after the start of perestroika to cross the 17-percent level in 1987 for the first time since 1968. 1987 also marks the peak volume of physical output in over two decades. This decreed rise in investment share was an attempt at correcting the chronic undersupply of housing. In spite of such efforts, the ratio of households to apartment units continued to deteriorate and increased from 1.13 in 1980 to 1.21 in 1990.3' After 1990, the rapid dismantling of the central planning system has led to a sharp decline of output, which fell in 1992 to less than 40 percent of what it was only five years earlier in 1987. These lower investment rates are leading to rising housing crowding ratios and a lengthening of the waiting lists. 6.10 Under central planning, Gosplan was operating under the guidance of the Central Committee of the CPSU and the Council of Ministers. Every year, Gosplan developed a budget for allocating national income. It would work out investment plans with other state commnittees -- especially Gosnab which allocated materials and supplies -- the Union-level ministries, their industrial associations and their enterprises. This system of allocation and the basic flow of funds through the administrative system in 1990 is shown in Figure 6.1. That year, roughly 77 percent of USSR income was allocated to current consumption, while capital investment received the remaining 23 percent. Of the capital investment budget in 1990, "nonproductive investrnents", which included housing, education, and health, received 31 percent of the total. The remaining 69 percent went to "productive" investments such as industry and agriculture. The total USSR housing investmnent was approximately 37 billion rubles and represents 54 percent of all funds allocated to "non-productive investments". The RSFSR housing investmnent funds amounted to 22.9 billion rubles or 62 percent of the Union total. Figure 6.1 also shows how a great share of investmnent funds was controlled by Union ministries and operated independently of the decisions of the Union republics and lower-level soviets. This vertical system of investrnent has often had a very deleterious impact on the quality of Soviet urban planning and led to a very low spatial and economic coordination of local investments (see Chapter 7). It has been the subject of major internal debates in Russia for many decades. 31 Deliberately or not, Soviet statistics tended to be difficult to interpret. In particular, crowding ratios must be used with care. Some statistics refer to 'households' and include both one-person and families as households. Others refer to "families" and count only households with two or more people. 112 Chapter 6 Figure 6.1 USSR Central Planning System for Housing Investment (1990) I ; - ~~~~~~~~~................ .. . ConumtioCNATIONAL INCOME: ,Investment Fund .Consmptio Fun IOA.NOE- _= 23 Consumption Fund ~7~2 23% (Accumulation) "Non-Productive" "Nonversdctivent "Productive" Investment i Other [HougInvestment SOta ISpheres (3S.2 Billion Rbs) Other Sources of 78% x~~22% ; 78% v 22%,Housing Investment State Capital Financing ! Investment i 37o'% Centralized 41°' Decentralized Republican Ministries ________--/___Y__/_ and Departmental I Union Ministries , Union / Organizations and Departmental 65% -- Organizations ReulisAgro-industrial Complex 35% (APK) Enterprises and Organizations 19% Local Soviets ,Rr (a) Social funds Tax in i (b) Other funds kind? Ura Cities and _ -Urban Settlements ----------------- Chapter 6 113 6.11 It must be stressed that, under the central planning process, monetary resources were neither the only -- nor always the most -- critical resource for housing investment.4' The allocation and procurement of material resources done by Gosnab has always been equally central to the success of a construction project. In the high inflationary environment of 1991 and 1992, it had become even more important. Indeed, the banking system existed merely to disburse credits against works in progress for authorized construction projects, a point discussed again later. B. Sources of Funds for Housing Investment 6.12 While the process of allocating total housing investment was largely controlled by the Central Government -- with input from local governments, enterprises and other entities -- the sources of funds for housing investment are varied. The main sources of funds for housing investment and their contribution to actual investment in 1986, 1991, and those expected for 1993, are shown in TABLE 6.1 in Rubles. Three features of this financing are important. First, the majority of housing investment funds have always been from the State under the planning process. Second, enterprise funds played no role in financing housing until the enterprise reforms of 1987 which gave more leeway to enterprises in using their investmnent funds. Third, the contribution of the population has remained very low. Raising the population's share is a priority objective of the Government Housing Reform Program of 1993. 6.13 The comparison between the 1986 results and the financing plan for 1993 also shows that major changes are taking place in the financing of investments. The state's share was about 84 percent in 1986 and is expected to decline by a modest amount to about 80 percent in 1993. However, the composition of this state financing was dramatically different and greatly more decentralized. The share of enterprise funds had skyrocketed from zero in 1986 to over 50 percent in 1993. The local government share has risen from zero to a more modest share of 6 percent. Defense budgets -- at least for 1993 -- were expected to play a significant role for housing and to fimance 15 percent of total housing investment. The share of fnancing from the population (including housing cooperatives) remained static around 7 percent. The Russian-style private sector enterprises (business cooperatives) and other organizations rose also from zero in 1986 (when they were still prohibited) to over 10 percent in 1993. The dominant change in housing finance is the extremely rapid decentralization of funding. By now the role of ordinary state central budgets has shrunk to the same share as that financed by the population. The dominantfinanciers of housing are now the employers -- both state enterprises or new emerging enterprises. State wages have been falling in real terms by 55 percent in 1992 leaving very little or no savings for housing finance. Pending further wage reforms and economic recovery, the direct role of households seems destined to remain limited by the rate of growth of the grey or second economy. 4Q The dual monetary system of the "credit plan" for investment and the "cash plan" for household expenditure is well known. "Credit ruble" values were assigned to transactions, but only to balance the books, not allocate resources. The credit rubles could not be exchanged for the "paper rubles" used for the consumption purchases of households. Credit rubles remained the main unit for bank lending to enterprises. Since investments operated under the credit plan, the accounting prices of the "credit plan", the allocation of materials and resources was as important as the allocation of credit. It was this Joint-allocation of funds and physical resources which formed the core of the old housing finance system under central planning. The distance from this system to pure barter under today's high inflation is very small indeed. TABLE 6.1 RUSSIAN FEDERATION: Housing Investment by Sources (Milliards of Rubles) 1986 1991 1993 (Plan) 1993(percent) Total Investment 18.63 37.00 1,372.9 100.0% of which: State Investment of which 1. Central Government 15.59 30.80 114.5 8.3% 2. Enterprise Funds 0.00 19.30 688.8 50.3% 3. Local Governments 0.00 0.00 84.0 6.1% 4. Defense Budget Funds -- 206.0 15.0% 3. Cooperatives 0.69 1.10 ---- 4. Collectives/ Kholkhoz 1.62 20.00 37.8 2.7% 5. Population 0.59 9.00 96.6 7.0% 6. Social Organizations 1.45 3.00 ---- 7. Other Organizations 0.00 20.00 145.2 10.6% Source: Ministry of the Economy Chapter 6 115 6.14 The rising role played by the enterprises in fmancing housing construction in the late 1980's would not have been possible without the passage of the Enterprise Reform Law of 1987. This law lowered the tax burden on enterprises, increasing their retained earnings and, thus, their ability to finance housing construction for their workers. This trend underlines the convergence of changes brought out by various forms of privatization. The remaining financing sources for housing investment were minor with respect to their historical contribution. Added together, they represented just 17 percent of total housing investment in 1991. However, both cooperatives and the population at large represent potentially a much greater source of financing a market-based housing finance system. C. Use of Funds Allocated to Housing 6.15 The state allocated housing investment resources to three main categories of clients: Union ministries and other agencies of the Union; Republic ministries and other republican-level agencies; and the local Soviets or Councils. However, resources earmarked for housing would flow through several layers of government and public entities before reaching the end-users, or "clients". For instance, some of the funds allocated to both the Union-level ministries and agencies and the Republic-level ministries and agencies would be shared with local councils through a variety of complicated sharing arrangements (see Annexes 1 and 2). The basic final distribution of funds for housing investment in Russia between the Union ministries, Republican ministries, and Local Councils is shown in FIGURE 6.1 for 1990. The allocation between rayons and selected oblasts is omitted for the sake of simplicity but constitutes an important and potentially contentious local step. 6.16 As FIGURE 6.1 also shows, the majority of the housing investment budget was allocated through the state. Recently, an increasing percentage of resources has been allocated to cooperatives and collectives, reflecting the larger percentage of total resources mobilized for housing investment that they represented. In 1990, cooperatives and agricultural collectives received 22 percent, or approximately 8 billion rubles, of the total resources invested in housing. However, a large portion of this sum was in the form of allocated material resources. These resources would, in turn, flow to the local soviets and the rural areas. 6.17 In 1990, of the remaining 29 billion rubles, 60 percent was allocated to the Republican governments and the remaining balance of the 40 percent was allocated to the Union ministries and other central agencies. The governments of the Republics then allocated the funds earmarked for housing between several different types of clients. Lower levels of government, specifically, the housing construction departments which reported to the local councils at both oblast and city levels, received approximately 35 percent of these funds in 1990. The remaining 65 percent was allocated to the Ministries of the Republic and to the powerful agro-industrial complex. The local councils would then negotiate with the Republican Government how much of the funds they were to receive from the agro-industrial complex. 6.18 The Union ministries and other agencies of the Union allocated their resources simply to enterprises which were under their jurisdiction. However, these Union enterprises would then allocate their funds via an arrangement called "partial participation" to local councils. In 1990, this participation amounted to about 18 percent of the funds allocated to these enterprises for housing. The remaining funds earmarked for housing were channelled through the ministry's own construction 116 Chapter 6 group (trest or trust), to an enterprise construction group, or, in rare cases, to a construction cooperative. D. AUocation of Housing Units Constructed 6.19 The eventual allocation of the housing units which were constructed by the enterprises (both Union and Republic-level enterprises) depended on their source of financing. For instance, if the funds were allocated from the central government, then enterprises would give up between 48 percent and 60 percent -- sometime up to 70 percent -- of the units constructed to the local soviet. However, if the funds were from the enterprise's own housing funds, then the enterprise was required to give up only up to 8 percent of the units to the local government. In all cases, approximately 10 percent of all the units constructed were given to the builder/contractor who could use them as a means to attract labor in a sector which was notorious for poor working conditions throughout most of the Union. E. The Banks Resulting From Central Planning 6.20 Banks have not played the traditional role of a financial intermediary to mobilize funds and allocate them among competing projects based on the banks evaluations of risks. The banking system resulting from central planning existed merely to disburse credits against works in progress for authorized constructions. Worse, most project financing, even for very durable goods like commercial or residential real estate, was done on a cash basis. As a result, the administrative housing finance system has been extremely disjointed in terms of who disburses, guarantees, receives, and supervises the use of credit. The only very minor exception was Sberbank (the Russian National Savings Bank) whose deposits represent most of Russia's household savings deposits. Sberbank records since 1981 shows very small amounts of housing lending for garden plots, cooperative housing and individual housing. With the political winds of reform, Sberbank's lending pace rose after 1986. However, the Sberbank housing loan business is very marginal, amounting to about one percent of its total deposit base. With the economic reforms a new banking system is emerging in Russia, but it does not yet have a sound and dynamic housing-finance component. III. THE RUSSIAN BANKING SYSTEM IN TRANSITION Central Bank5' 6.21 The Central Bank of Russia (CBR) has a discount window at which banks can, in theory, borrow under certain conditions. The interest rate on CBR credits to commercial banks (the discount rate) was raised from 40 to 80 percent in June 1992, and to 100 percent in March 1993. Clearly, with inflation running at over 1,000 percent, a discount rate of 80 percent or 100 percent cannot be expected to ration the use of CBR resources. In practice, the discount window serves almost solely as a channel for the directed credit programs. In 1992, the CBR disbursed about 2.8 trillion Rubles 51 This section is based on excerpts from RUSSU: The Banking System in the 7ransition, World Bank Report No. 11818-Ru, 1993. Chapter 6 117 in directed credits, which represented over 95 percent of CBR's credit to commnercial banks (and over 50 percent of the expansion in the monetary base) in that period. Almost all of them were disbursed under four programs: agriculture (46 percent), industrial enterprises (18 percent), fuel and energy (14 percent), and Northern Territories (11 percent). Commercial Banking System 6.22 The Russian commercial banking system has existed for a little more than five years. Both the structure and the purpose of the banking system are still changing very fast. Rapid change is also occurring within most individual banks. As the magnitude, the character, and the speed of these changes is unprecedented, it is extremely difficult to analyze it or to compare it to experiences in other countries. One of the main characteristics of the Russian banking system is the split that exists between the role of Sberbank (the Savings Bank) and the role of all other banks. Sberbank is geared to raising household-sector deposits, which until recently were automatically channeled to financing the government deficit. The other banks raise deposits from and provide loans to enterprises. 6.23 There are more than 1,700 independent commercial banks in Russia. While this number may seem relatively high, most of these banks are very small. More than 75 percent of the banks (1,295 banks) have authorized capital of less than 50 million Rubles, and less than 5 percent of banks (65 banks) have an authorized capital of over 200 million Rubles. In August 1992, the CBR raised the requirement on minimum authorized capital to 100 million Rubles (from the 5 million Rubles established in 1991), and ruled that all existing banks will have to increase their capital to that level by July 1993. With continuing inflation, the minimum authorized capital for new banks was raised to 2 billion rubles in January 1994, with a target of 5 billion ECU (or about $5.6 million dollars) in 1999. The largest 65 banks account for about 70 percent of total assets and loans in the system. The five largest banks hold about one third of total loans in the banking system and a similar proportion of total assets (Rosselkhozban - 15 percent; Sberbank - 8 percent; Mosbiznesbank - 5 percent; Promstroibank - 3 percent; and Moscow Industrial Bank - 2 percent). 6.24 There are about 43,000 bank branches or offices in Russia, or about one branch per 3,500 inhabitants. In theory, this branch density is in line with the situation in many market economies (higher than in the U.S., lower than in Japan). However, only two banks have a network of branches that extends over most of Russia: Sberbank, the savings bank, with about 40,000 branches; and Rosselhozbank, the agricultural bank, with more than 1,000 branches. Together they account for more than 95 percent of total branches in the system. Most other banks have no branches. Only a few have more than 10 branches or branches in more than one city. 6.25 Almost all banks are joint stock companies and have been created within the last two years. About 700 banks are spin-offs of the former Soviet specialized banks, including most of the larger banks. The remaining 1,000 banks were created by their shareholders after 1990. These banks are often referred to as zero-banks as they tend to be quite small. The ownership structure of these two groups is very different. Large banks are often owned by hundreds or even thousands of shareholders. The state (through GKI, the CBR, and other agencies) retains partial ownership in many of the larger banks, including Sberbank and Rosselkhozbank. On the other hand, ownership in most zero-banks tends to be concentrated, with some banks owned by a single or a few shareholders. 118 Chapter 6 A Taxonomy of Russian Banks 6.26 The following taxonomy classifies banks according to their main activities, but also takes into account other criteria such as ownership structure and management sophistication. This taxonomy is useful as an organizing tool to analyze banks' activities and identify problems. In practice, however, many banks perform activities linked to more than one of the suggested categories. Moreover, some banks may change the nature of their main activities over time. Sberbank. Sberbank constitutes a category by itself. Its structure and activities are discussed separately below. "Channel" Banks. The main objective of these banks is to funnel resources from directed credit programs from the CBR or the GOR to state-owned enterprises to which they are associated with. Typically, state-owned enterprises own a larger share of these banks' stock than of other banks. These banks account for a large share of total lending, since directed credits amount to over 50 percent of the total amount of outstanding bank credit. The former "specialized" banks, of which Promstroibank and Rosselhozbank are the largest, are clearly the largest channel banks. "Agent" banks. These are banks were created by an enterprise or a group of enterprises to manage their cash flows and to perform payment system transactions on their behalf. These services are presently more efficient and safer when performed by "agent" banks, rather than unrelated banks. In market economies, the treasury departments of enterprises provide many of the services provided by these banks. Shareholders, depositors and borrowers are often the same entities in agent banks. Emerging "good" banks. There is a core of 20-30 leading commercial banks in Russia that are developing in a direction similar to that in market-based economies, and are seemingly quickly evolving into real banking institutions. The number of these banks is increasing as banks from other groups transform themselves. While this group still comprises only a small number of banks, it includes some of the largest independent banks. This group is characterized by management that is more or less independent from the enterprise- shareholders, and that tends to be more sophisticated than in the channel banks. Most loans in these banks seem to be secured in some way (collateral, third party guarantees, or loan insurance). A substantial portion of their loans goes to "private" commercial structures and to joint stock companies which are either private or in the process of being privatized. Sberbank 6.27 The three largest specialized banks are Sberbank (the savings bank), Rosselkhozbank (the agricultural bank), and Promstroibank (the bank for industry and construction). Their names reflect their specializations under the former Soviet regime. Presently, the three banks are joint stock companies and are chartered to operate as universal banks. Sberbank is the most dynamic of these three banks. Historically, Sberbank raised household deposits, which were automatically channeled to the government to finance its deficit. In the last several years, GOR allowed it to expand into other activities, and granted Sberbank's management greater independence. Sberbank is rapidly Chapter 6 119 developing new types of activities, such as lending to enterprises and households, and developing a deposit base from enterprises. It has helped create the interbank market, where it is the main lender. It has over 100,000 shareholders, the majority of them employees, but its shares are not yet tradeable. The CBR is the largest shareholder and its chairman is also the chairman of Sberbank. 6.28 Sberbank still retains its near-monopoly on raising household ruble deposits, over 90 percent of a total of 570 billion rubles. It has retained this position, although all banks are now authorized to open household deposits because: Its network of over forty thousand branches and offices accounts for more than 90 percent of total bank branches, making Sberbank the only bank in most of the Russian territory as well as in most neighborhoods in larger cities. It has about 200,000 employees. Sberbank is the only bank that has an explicit GOR guarantee on deposits. Sberbank offers many unique services such as transfer of payments for utility fees, taxes, and pensions. -It is commonly assumed that GOR will compensate Sberbank depositors for the erosion in the value of deposits due to inflation, since this has occurred in the past. 6.29 Sberbank interest rates paid for household deposits are still determined in close consultation with the CBR and MOF. Subsidized housing credit are a problem for Sberbank. In 1993, the Ministry of Finance had allocated 60 billion rubles for interest rate subsidies on Sherbank's mortgage loan. by early 1994, these subsidies had actually risen to 400 billion rubles which MOF has refused to repay, thereby exposing Sherbank to significant losses. The Current Role of Banks in Housing Finance 6.30 Some commercial banks are already carrying out housing finance activities, ranging from simple construction loans to the management of large projects in which they integrate development, financing, and construction activity. To date, however, these activities have been sporadic and quantitatively insignificant. That is, no commercial bank has focused on housing finance. On the other hand, within the last year, so-called mortgage banks have been chartered with the goal of specializing in building projects, to cover development, financing, and construction activities. None of these mortgage banks is yet operating actively, although their proposed activities are using known financial techniques (see BOX 6.2). 6.31 At this stage in the development of the Russian economy, housing finance could appear to offer an especially attractive set of mutual benefits for the commercial banks and the Sberbank on the one hand and the housing sector of the economy on the other. However, with high macroeconomic instability this is far from being the case and most banks have so far no interest in retail mortgage finance. To the benefit of housing finance, the banks could provide both a large pool of funds for investment and expertise for evaluating project profitability and borrower creditworthiness. To the benefit of the banks, real estate lending has the potential to provide positive 120 Chapter 6 real rates of return on comparatively safe debt. In addition, real estate loans may be organized as inflation indexed assets, allowing the banks to offer positive, real rates of return to their depositors. Presently, risk-adjusted returns from mortgage finance simply do not meet these ideal conditions. IV. A BANKING SYSTEM FOR THE RUSSIAN REAL ESTATE INDUSMRY A. Housing Services, Housing Pices, and Housing Finance 6.32 Housing finance could be described as a form of retail banking. It is therefore affected by the expectations of the population. A new financial culture is developing rapidly in Russia, particularly in metropolitan centers like Moscow and St Petersburg, yet there remains considerable confusion regarding the status, objectives, and future of the Russian housing finance system. The following is a short list that illustrates some sources of this problem: - Housing is not yet considered to be a economic sector of the Russian economy. Instead, it is treated as one -- and at that, an economically unimportant one--of the outputs of the investment goods industry. In other words, housing output has often been just a residual element of the Russian central planning system.6' - The term "housing finance" is often misinterpreted in Russia to mean "housing subsidies". This immediately places the discussion in the wrong department, conceptually and sometimes literally. - Even when the discussion is properly directed to issues of finance rather than subsidies, the connection of housing finance to banking institutions (or financial intermediaries more generally) is only vaguely understood. Indeed, in many cases there is not a precise understanding of the process of financial intermediation. - Discussions of the short-term problems of housing finance are inevitably dominated by the effects on the housing sector of the macroeconomic problem of hyperinflation. These housing sector effects include a severe fiscal crisis for the government units that maintain the existing stock, as well as the frustration that arises when government agencies are unable to create even the appearance of action -- let alone actual activity -- regarding solutions to the inadequate quantity and quality of the Russian housing stock. - Discussions of the medium-term problems of Russian housing finance are also frustrated by the absence of accounting structures that could provide a useful framework. There is a need to cover both flow of funds tables and sectoral balance sheets that highlight the housing stock as an asset. 61 This in not exactly the same as 'Housing Construction" and was previously considered to be an independent sector of the national economy. Chapter 6 121 Thus the framework for discussion housing finance reforms is a critical prerequisite to practical and meaningful discussions. This framework has three key analytical elements: housing services, housing prices and housing finance. (see BOX 6.1) Housing Services and Housing Prices 6.33 The distinction between housing services (the use of space) and the housing stock (the asset) is central to the development of a market-based housing system in Russia. A family renting a flat, a traveler using a hotel room, a shopkeeper renting some business space, a political party renting a theater are all obtaining comparable if different real estate services. The rental rate is the cost to be paid for such services. As already shown in Chapter 3, the valuation of a property is directly based on the flow of rents expected in the future. A more explicit analysis is now given in BOX 6.1. Control policies which interferes with the setting of rents are likely to depress the value of a property to a point where it cannot be maintained and might even be abandoned. Housing Prices and Housing Finance 6.34 Housing finance is the means by which an individual can obtain the resources to pay the price of a housing unit. The reason why housing finance is very important is that the price of a housing unit is very high compared to the annual income of a household. In a balanced market economy the ratio between the price of a housing unit and the annual income of its occupants is usually 3-4. The development of housing finance in Russia is severely impeded today by two types of major disruptions: the old central planning distortions due to the low-wage system and shortages, and the current macroeconomic instability. Free transfer of housing can greatly correct the old distortions. However, macroeconomic stability is an absolute necessity for the development of housing finance. What the population needs is a housing price that is moderate compared to its purchasing power and a cost of housing finance that is affordable i.e. which lead to moderate monthly payment to income ratios. Current Russian macroeconomic policies do not permit that to happen. Housing FYnance and Housing Subsidies 6.35 Housing finance concerns the means by which resources are accumulated to purchase housing. There is no direct or necessary link to questions of government subsidy. Indeed, generally speaking, a well-functioning housing finance system must provide a positive return to housing, and therefore the housing sector will be self-financing. In brief, the best way to increase housing production is to create a private and efficient system of housing finance. Of course, there will be circumstances in which subsidies for housing are desirable, either for socially needy people or related political reasons. But housing subsidies are generally best treated as elements of the income distribution problem to be solved through the fiscal instruments of tax and transfer payments. Housing subsidies are generally not efficiently achieved through housingfinance. The reason is that the main source of housing finance funds is household savings. It may take the savings of 20 families to finance one housing loan; to decide to subsidize one loan is like deciding to penalize 20 families to help just one. This can be done by politicians wanting to promote short-term production, but it is usually not a good decision for the growth of housing finance. Soon families will take their savings somewhere else and the volume of finance available will stagnate or decline. 122 Chapter 6 BOX 6.1 Housing Prices and the Role of Housing Finance 1. Housing Services and Housing Prices. It is critical to distinguish housing services from the housing stock. Housing services are derived from the use of a housing unit. For example, a family renting a flat is obtaining housing services. Rental rates are the cost paid to obtain housing services. The housing stock refers to the capital asset representing a housing unit. In a market system, house prices represent the price of the housing stock. House prices and rental rates are related by the following formula: N R (1) p = - t=1 (1 +i)' where R = the annual rental rate, P = price of the housing stock, i = the capitalization rate (the rate which transforms rental rates into house prices). N = longevity of the housing stock. As a simplification, we can assume that the housing stock can last forever, instead of for just N years, and then equation (1) simplifies to the relation used earlier in BOX 3.1 and FIGURE 3.1: R (2) P= i 2. The Unique Role of Housing Flnance. The distinction between rental rates and house price is important because housingfinance applies mainly to house prices. That is, housing finance is the means by which agents are able to obtain the resources to pay the price P to purchase a unit of the housing stock. The distinction between housing services and the housing stock is also relevant to the form of tenure; that is, the difference between owner occupants and renters. In a renter-occupied unit, one agent -- the landlord -- owns the unit, while another agent -- the consumer of housing services -- rents the unit. Housing fmance applies directly here only to the owner of the unit. The owner can be a government unit, an enterprise, or just an individual. In an owner-occupied unit, the same family owns the unit and obtains the housing services. So the family acting as the owner pays the rent to itself, acting as the renter. Here housing finance applies to the consumer of the housing service. We now see that housingfinance is the means through which an economic agent purchases a unit of the housing stock. There remains the question, however, why housing finance is such an important topic. 3. Housing Fiuance and the Hl1gh Price of Housing. The answer is that a unit of the stock of housing provides a large and valuable flow of housing services over many years. This means that a unit of the stock of housing is an important item in any economy, and the price of a unit of housing is going to be high. For both of these reasons, housing finance is an important area of policy. Due to its long-term and bulky nature, the price of housing is always high relative to family income. As a rule of thumb, in balanced market economies, the price of a family's house tends to be about 3-5 times the family's annual income. We can use the equation introduced earlier to do some 'back of the envelope' arithmetic that illustrates this result. First, let us assume that a family's annual rent R equals about 30% of its annual income. As an equation: R = (.30)(Y). Second, assume that the capitalization rate is 10%. As a result, we have: (3) P = R/i = R*(10) = (.30)(Y)(10) = (3)(Y) Chapter 6 123 B. Macroeconomic Impediments to Housing Finance in Russia 6.36 In Russia's unfolding transition to a market economy, macroeconomic issues are a major obstacle to the development of a sound housing finance system. It is not an exaggeration but a mere fact of financial development to state that macroeconomic stability is a necessary condition for the establishment of market-based long-term finance for the Russian housing system. High and Volatile Inflaton 6.37 Uncontrolled inflation is the most visible result of macroeconomic instability. The tenfold increase in prices during the first quarter of 1992 could have been a one-time adjustment, after which prices would have stabilized. The continuing increase in prices during the second and third quarters of 1992, however, belies this interpretation. Russia now appears to be threatened with a high rate of inflation arising from high rates of money supply growth which are required to finance large government budget deficits. 6.38 A major cost of hyperinflation in Russia is its impact on real interest rates. In some markets, such as the inter-bank loan market, nominal interest rates tend to track changes in expected inflation, so the implied real rates of interest are positive. This has required annual nominal rates as high as 100 percent.7' Of course, actual inflation may either exceed or fall below these nominal rates, causing either the lender or the borrower to face an unexpected loss. These losses can cascade through the economy as one group of agents after another fails to fulfill its obligations. 6.39 The effect of high rates of inflation on real interest rates becomes even more distortionary in loan markets in which nominal interest rates fail to respond to changing inflation. As one example, the investment portfolio of the Sberbank (Russian Savings Bank) is dominated by loans with low, fLxed, nominal rates of interest. As a result, even if it wished to, the bank could not pay positive real rates of interest on its deposits, which naturally creates a strong disincentive for consumers to deposit funds in the bank. Within limits, real estate loans provide one potential solution to this problem. Since real estate property is likely to appreciate in value at a rate approximating the overall inflation rate in the economy, borrowers may be willing to negotiate mortgage contracts which provide lenders with nominal interest rates that imply positive real rates of return. However, real estate markets are very thin in Russia and show a slight degree of price volatility. Output and Real Income Contraction 6.40 A major contraction in output -- an overall economic decline approaching 50 percent from previous peaks -- is another result of macroeconomic instability. A breakdown in the pattern of wholesale trade has been an important cause of the output decline. A well-functioning, decentralized, market system requires an established medium of exchange to enable firms to buy inputs from low- cost suppliers while selling output to high-priced demanders. In Russia today, however, lack of 7/ A continuation at this rate and then a reduction would have been desirable, but the already high level of inflation in 1993 and 1994 led to an increase in percentage rates to 200% and higher. 124 Chapter 6 confidence in the ruble forces wholesale trade to continue to rely on the barter methods developed under central planning. Guide indexing mechanisms have also been developing in 1993. Other factors such as the breakdown of trade with the newly created states, and export sales on which the hard currency receipts are retained outside of Russia also contribute to the problem. 6.41 This major decline in output creates an equally severe decline in per capita real income. In a market economy, most housing would be rendered unaffordable by such a severe decline in real income. In Russia, this is certainly true for newly produced units that are priced at market levels. However, since rents on most existing housing are negligible, these units can remain affordable as long as the subsidies continue. Of course, this system creates the budget squeeze on local governments discussed above. One bright side is that these problems could greatly ease if output recovers to its previous levels. Domestic Saving 6.42 Little domestic saving will occur in Russia, as long as budgetary explosions, high rate of inflation, negative real rates of interest, and massive declines in output continue. Furthermore, the institutional infrastructure creates strong disincentives to save. The legal system does not yet deal adequately with land ownership, bankruptcy, and other aspects of a commercial code. Also, strong social taboos regarding eviction make foreclosure proceedings difficult to carry out. All of these factors limit the supply of equity funds for housing construction. The body of new housing related laws passed in December 1992 can be seen as directly favorable to housing finance. C. Construction Finance in Russia 6.43 By 1992, new units were being privately constructed and then sold directly or through public auctions, while existing housing units were being privatized and sold through real estate brokers. There is also private activity to rehabilitate existing units and to complete unfinished building projects. However, the absence of an organized market for construction finance creates an inefficient system in which the volume of private construction activity is severely limited. The Ineffciency of Construction Finance 6.44 Inefficiency in construction finance can be measured by the ratio of the market price of existing units to the construction cost of new units."I When the ratio exceeds 1, profitable investment opportnities exist, since new units can be sold at prices above their construction costs. In efficient markets, new construction forces the ratio back toward 1. This has not yet happened in Russia. In mid-1992 prices, construction costs were approximately 20,000 rubles per square meter or 1 million rubles for a standard unit of 50 square meters in total space. Auction prices for completed units of this type, however, were rarely less than 1.5 million rubles and may approach 2 million rubles. Thus the Tobin Q value is between 1.5 and 2.0, which points to unused investment opportunities. a/ This ratio is sometimes referred to by market analysts as Tobin's Q which is a general measure of the disequilibrium in a variety of asset markets. Chapter 6 125 Industrial Organizaton Sources of Inefflciency 6.45 This disparity between construction costs and market prices reflects factors that make private construction difficult. Two of these factors represent issues of industrial organization. Local authorities control most of the available land as well as building permits, which creates high transaction costs, including the need for long-standing contacts or side payments. Little effort had been directed to the development of modem housing products in the newly emerging markets. Instead, the expertise of most developers arises from their close relationships with local government officials. In the thin high income markets, high construction costs are caused by the high cost of imported construction materials as well as monopolistic trends in the domestic production of building materials. Financial Sources of Inefficiency 6.46 Construction requires a substantial period of time. This creates two major risks for construction lending, which increase the disparity between construction costs and market prices: cost increases during the construction period, and "agency problems' in construction contracts. 6.47 Within the last 12 months, construction costs in Russia have risen by a factor of 10 or more, and there is no accurate gauge for measuring the likely increases during the next 12 months.9' As a result, it is impossible to form reliable estimates of the ruble cost of completing a given building project. The problem can be dealt with in two fundamental ways. Construction materials can be purchased and stockpiled at the start of construction. This requires that the funds for material costs be fully expended at the start, a costly activity in an economy with interest rates at the level of 100 percent per year. It also does not protect the developer against unexpected increases in the cost of labor. Alternatively, construction funds can be invested in high-yielding financial instruments that compensate the investor for ongoing inflation. This leaves the investor open to the credit risk of the investment securities. Also, the investor is not compensated for changes in construction costs that are uncorrelated with changing interest rates.'0' 9' Average construcion costs were 16,000 rubles/m2 in 1992; 300,000rubles in 1993 and 700,000rubles in 1994. 10/ Another variant is to maintain the construction funds in hard currency investments, exchanging them into ruble as needed. The risk here is that the exchange rate depreciation of the ruble may not closely reflect housing cost inflation. 126 Chapter 6 BOX 6.2: Financing Construction Under Hligh Inflation (Mutual Real Estate Investment Trusts) There is a severe shortage of good properties in Russian cities today, and their prices are rising above inflation rates. Innovations are emerging to deal with the problems of construction lending. The focus of the plan is a mutual real estate investment trust adapted to current conditions in Russia. The assets of the trust would consist of construction projects, in the specific form of inventories of construction materials, buildings under construction, and working capital invested in financial instruments yielding market rates. The liabilities of the trust would consist primarily of ownership claims providing investors with their prorated share of the trust's assets. The trust could also use debt financing in order to create further leverage for its investors. In its simplest form, the trust would follow a closed-end format, such that all of the shares would be sold in an initial offering in an amount equal to the total capitalization required to finance the intended projects. Investors could sell and transfer their shares to other owners, but the fund's capitalization would be unchanged. Mandatory liquidation of the trust would occur as each building project was completed. Investors would thus receive a return based on the value of completed projects relative to the amount of capital invested. The expected return on an investment in the trust could be quite attractive since the margin between construction costs and the value of completed buildings is currently 50 percent to 100 percent in Russia. Moreover, this return would be well indexed against inflation since the fund's asset would represent either real goods (construction materials and buildings in process) or short-term securities invested at market rates. Additionally, investors could be provided an option to take their investment return in kind, namely in real estate constructed by the trust. A trust constructing apartment flats might, for example, attract investors whose goal was to purchase such a unit. The trust would be operated by paid managers who would act as project managers for all aspects of the construction projects. These managers would work closely with the material suppliers and construction firms to control the agency problems described above. Indeed, it would be useful to make a substantial share of the payments to all of the involved parties -- trust managers, material suppliers, and construction firms -- in the form of trust shares which would become liquid only as projects were completed. The proposal would thus deal with the two primary problems facing construction activity in Russia today: 1. The agency problems that arise between lenders, final investors, construction firms, suppliers of construction materials, and project managers (or developers) who must cooperate during the 6 to 18 month period of construction. 2. The need to provide a positive rate of return to savings capital invested in the project. The initiative to create such entities would best come from the trust managers. Groups in St. Petersburg and in Moscow have already started to develop plans following such basic principles. The investors could be future owner-occupants of the housing produced, owners for others, or owners of commercial real estate for business operations. Chapter 6 127 6.48 "Agency problems" in construction contracts are significant in Russia today. Given the time needed for construction activity, there is a risk in any economy of non-performance by one or another of the parties to a construction contract. The current inflation in Russia magnifies these problems, since someone may abscond with the valuable stockpile of building materials, or the investment funds intended for the building project may disappear or be diverted to other uses. In addition, the enforcement of private contracts is new in Russia, and therefore remains much more problematic than in other countries. Agency problems of this sort can be reduced by creating - in one way or another -- close connections between the various parties to the transaction: the developer, the construction firm, and the investor (or final demander). In the extreme, some of the parties might become vertically integrated. The solutions to these agency problems are likely to provide a unique character to the Russian housing finance system. An illustration of solutions that may develop in Russia in parts of the real estate sector is given in BOX 6.2. D. Long-Term Real Estate Financing in Russia 6.49 Long-term lending in Russia today faces serious problems arising from inflation, default risk, and affordability concerns. Long-Term Lending with High and Volatile Inflaton Rates 6.50 Volatile inflation rates create uncertainty for the real rates of return on mortgage instruments. For example, fixed-rate contracts are not currently viable in Russia, since invariably the contractual rate will not accurately reflect the inflation rate that actually occurs over the contract period. Variable rate instruments -- where the interest rate on the loan is frequently reset (for example, quarterly) -- provide one potentially attractive alternative. Price-level adjusted mortgages (or more practical alternatives such as dual-rate adjustable mortgages) provide other solutions. Whatever the specific solution, adjusting the mortgage rate to reflect the ongoing conditions of inflation necessarily subjects the borrower to "payment shock" as the size of the payment responds to changing market conditions for inflation and interest rates. In this case, the lender must take care not to succeed only in trading an interest rate risk for a credit risk. Default Risk on Long-Term Mortgage Loans 6.51 A borrower may become delinquent and eventually default on a mortgage contract for two different reasons: (1) The borrower may find that the value of the property is less than the outstanding mortgage obligation, in which case default becomes a strategic decision; (2) Delinquency will arise immediately if the borrower has inadequate income to meet the scheduled payments. Default may also occur if the real estate equity is negative after deducting the transactions costs of selling the property. 6.52 The current Russian situation is unique because severe limitations are placed on the remedies available to lenders once default does occur. In this regard, it should be recognized that given the lack of vacant housing units, eviction is tantamount to making a person homeless, and, therefore, 128 Chapter 6 is rarely carried out."' Although the legal aspects of this problem may be rectified by the new mortgage law (or subsequent improvements to it), fundamental issues remain regarding how the courts will judge eviction cases. It is, therefore, likely that prudent lenders will continue to design loan contracts to minimize the likelihood that default, foreclosure, and eviction will actually occur. For example, Russian lenders are likely to continue to require a substantial list of co-signers who are required to make loan payments when the primary borrower fails to do so. 6.53 In many countries where credit risks are considered significant due to economic conditions - - but not due to deficiencies in property registration or inadequate foreclosure laws and practices -- the practical solution is to insure that the loan-to-value ratio at the time of lending is a relatively low 60 percent or 70 percent. Such a practice has the dual benefit of lowering monthly payments and insuring that a borrower's equity in the property is high enough for him not to want to lose it. Such an approach, however, has no merit when the quality of the collateral is weak as it is today in Russia. Affordability Issues for Long-Term Mortgage Loans 6.54 The ratio of average housing prices to average annual family incomes in Russia today is at least 15 to 1. If the house purchase is to be financed with subsidized loans at a 20% annual interest rate, the debt service to income ratio is still 3 to 1, obviously an impossible situation. In the U.S. and many other countries a ratio of 0.25 would be considered normal. Even using price-level adjusted mortgages, with real interest rates on the order of 5 percent, borrowers would need to allocate most of their income to housing. 6.55 Two observations are relevant to this unfortunate situation. First, the high ratio of house prices to income is an aberration, based on temporarily high house prices and low incomes. High house prices reflect the structural problems of the construction sector as discussed above. Low incomes reflect the temporary decline in Russian industrial production. Thus, within a few years, a major decline in this house price to income ratio should occur. Second, non-subsidized housing production is currently available only to households at the very top of the Russian income distribution. Nevertheless, housing construction still provides benefits at all income levels as the result of a trickle-down process. That is, if we assume that each household which purchases a new home also vacates a less expensive existing unit, then the existing unit becomes available for sale to households lower down the income distribution. This process continues sale by sale, until it reaches the lower reaches of the income-distribution chain. Long-Term Lending Through Depository Intermediaries 6.56 Advanced market economies provide a variety of models for long-term housing finance systems on which Russia's system could eventually be based. In the short-run, however, investment funds in Russia are scarce, which limits the feasible sources of long-term funds for real estate loans. Indeed, for most of the existing banking institutions, long-term real estate lending has little appeal II/ It was not uncommon, however, for people to be ordered to change housing, but the new unit was specified prior to the move. Chapter 6 129 relative to the attractions of short-term investment banking opportunities. Among these institutions, the Sberbank (Russian Savings Bank) stands out as the one bank which simultaneously has access to a large pool of funds, has indicated interest in long-term real estate lending, and, if necessary, could be further motivated by the government to focus on such lending. Indeed, as mentioned earlier, the bank already has developed some experience and expertise in real estate lending. 6.57 The potential for acquiring price-level indexed assets could make long-term real estate lending a better deal for all banks. For Sberbank it would be better than the mandatory lending it is subjected to. In mid-1993, the Sberbank paid 60 percent (annual rate) on its retail deposits, reflecting the allocation of a large part of its portfolio to assets yielding low nominal interest rates compared to monthly inflation rates between 15 % and 20% per month. Long-term real estate loans, in contrast, could reasonably be indexed against inflation (measured either by housing prices or a consumer price index). Based on such earning assets, the bank could offer depositors -- at least on long-term funds -- a positive real rate of return. The financial sector policies followed in Russia and for Sberbank in particular will have a very significant impact on the development of its housing finance system. 6.58 However, Sberbank is the only bank mobilizing households deposits so far in Russia. Its liabilities are guaranteed by the Government. Its role should therefore be evaluated from the broader perspective of the development of the Russian financial system, and narrowly with reference to the financing of housing. The primary role of Sberbank should be to provide households with a safe window to deposit their savings, access to the payment system, and a limited source of credit. At present, housing finance services are limited to a marginal volume of financing by Sberbank under very negative real interest rates. In order not to jeopardize Sberbank's financial soundness, lending to households should be limited to a small fraction of its total deposits until macroeconomic stabilization is durably achieved. Mortgage lending to households should be allowed only for a small share of the asset portfolio in order to allow Sberbank to develop its loan origination and loan servicing capacity. Sberbank should lend only at variable interest rates and at a level high enough to insure full loan recovery in real terms after adjusting for inflation. If the Government wishes to develop a sound housing finance system capable of growth, it should not provide housing subsidies mandated to the financial system, but only from fiscal resources. V. CONCLUSIONS 6.59 A full treatment of housing finance covering resource mobilization, housing investors, financial intermediaries and instruments would require a separate report. However, several key strategic issues can already be emphasized. First, the development of a housing finance system is the most critical element -- the leading edge -- of a market-based housing system. Second, macro- economic instability makes the development of market-based, long-term housing finance currently impossible. Third, when macro-economic instability will be controlled, the development of a safe financial system in Russia will be a high priority. In the early stages of recovery there will be few reliable financial assets in which household deposits can be invested. Well structured residential lending will be among these few assets. What should be started now on a limited basis is the development of a loan origination and servicing capacity, as well as training of bank personnel of the asset/liability management problems inherent in residential mortgage lending. 130 Chapter 6 6.60 Construction and long-term lending techniques can create value by promoting the benefits of a housing finance system for the rest of the financial system. Most importantly, real estate investments and loans may represent inflation-indexed assets -- highly useful instruments given that inflation is among the major risks facing the Russian economy today. In addition, with proper underwriting standards and safeguards (such as co-signers), mortgages also provide relative safety as investment instruments for bank portfolios. This should, eventually, enable the banking system to attract savings capital, whether the funds are allocated ultimately to real estate or business lending. m:\'hcto\gmren.eng\cbhaptenchap6x.v7 6:57August 9. 1995 CHAPTER 7 ACCESS TO URBAN LAND: CITY EFFICIENCY AND URBAN LAND REFORM Table of Contents I. INTRODUCTION: WHY URBAN LAND REFORM? ................ 131 II. LAND ALLOCATION IN CITIES WITHOUT MARKETS ..... ........ 132 A. Major Spatial Differences Between Russian and Market Cities ... ...... 133 B. Dynamics of Housing and Residential Development in the Socialist City . . . 137 C. The Socialist City Compared with the Market City ................ 138 III. EMERGING REAL ESTATE PRICES .......... .. ............... 140 A. Synthetic Land Price Gradients and Normative Prices ............... 140 B. Housing Privatization and Rapidly Emerging Land Price Gradients ... ... 141 IV. MANAGING THE TRANSITION: IS THE SOVIET CITY SUSTAINABLE? . 143 A. Market prices and Affordability of Land Currently Occupied by Enterprises ......................................... 143 B. Impact of the Transition to Markets on Housing and Services Areas ... ... 145 V. COMPONENTS OF URBAN LAND REFORM ..................... 149 A. Land and Property Tenure ............................... 149 B. Trading of Urban Land and Market-Oriented Information Systems ... ... 152 C. Property Taxation, Valuation and Registration ................... 154 D. The New Professions: New Role of Urban Planners in Market Cities ... . 158 1. Overview ..................................... 158 2. The Current Urban Planning Process .................... 159 3. Direction of Reform ............................. 159 4. The New Role of Urban Planners in Russian Cities .... ...... 161 CHAPTER 7 ACCESS TO URBAN LAND: CITY EFFICIENCY AND URBAN LAND REFORM I. INRODUCTION: WHY URBAN LAND REFORM? 7.1 In an open economy, the competitiveness of a country is affected significantly by the internal efficiency of its cities. In a vast country like the Russian Federation, cities are the nodes along which most economic, political, and social activities are structured. Urban efficiency is linked to low urban operating costs including the reliability of urban infrastructure and services, the high quality of the telecommunications systems, energy efficiency, and transportation efficiency. Urban efficiency includes also the ability of commercial and industrial services to operate without interruption, and, when necessary, to relocate according to changing technologies and new relative prices. The internal organization of cities and their enviromnental quality define the quality of work and of life. 7.2 Except for the old historical centers, almost all of Russia's urban growth has taken place during the socialist era. The fact that urban development took place in a period when land was nationalized and administratively allocated rather than sold on an open market for a price has had a very profound impact on the internal organizations of Russian cities. The inability of the administrative-command system to evaluate even approximately the value of a land site and its opportunity cost -- its site value according to highest and best use -- has generated striking spatial anoinalies and urban inefficiencies. The objective of this chapter is to show that the development of urban land markets, far from being an ideological or doctrinaire prescription, is the only way to remedy past urban distortions and inefficiencies in an incremental and organic fashion. If the creation of a decentralized housing finance system is essential to the demand side of the housing system, on the supply side the development of soundly regulated urban markets is critical to housing reform. The central point of this chapter is that due to a lack of urban land markets the socialist city has inordinately high capital-output ratios. As a result, the socialist city spends more resources for less urban development than its market-driven counterparts. The current allocation of industrial land also accentuates environmental degradation. 7.3 To demonstrate the problems of the socialist city, the chapter addresses four questions: (1) How do Russian urban land-use patterns differ from those in market economies; do these differences generate major inefficiencies? (2) What issues may arise once market land pricing is applied to Russian cities previously developed under a command model? (3) Will long-term market forces correct existing inefficiencies or should Russia adopt specific transition strategies? (4) What changes in existing laws, institutions, and professions will be needed to operate sound urban land markets? 132 Chapter 7 7.4 These questions are central to the urban economy. During the transition toward a market economy, urban infrastructure and housing investments may be an engine to restart the construction sector. Depending on the geographic pattern of future real estate market values, these transition investments might have a negative economic rate of return or might perpetuate land use distortions. Failure to carry out land use reforms may lead to even worse land-use distortions as partial market forces collide with distorted existing uses. By contrast, understanding land market values might help direct investments to high return areas that could quickly reduce some of the worst land-use inefficiencies. In short, the spatial distribution of investment in the urban areas is a matter of substantial relevance to policy decisions during the transition. 7.5 This chapter begins with a spatial analysis of Soviet cities that shows what has happened to resource allocation and the spatial structure in these cities without land markets. This analysis shows the outcome of administrative decisions about what to build and where to build when they are made without the guidance of market prices. The resulting Soviet cities have a structure strikingly different from market cities. Their land use is fragmented and, perversely, the density of population rises away from the city center. Such a spatial organization tends to maximize commuting costs and infrastructure requirements. Today, site and property valuation have become a major operational issue for local governments. Over the last few years of transition, active real estate markets have been emerging in major cities like Moscow. Early analyses of such voluntary trading are already possible. They show the extent of land misallocation, as the emerging price pattern is exactly opposite of the current urban density profiles. Such a complete contrast between the new price gradient and the old density gradient is a cause for concern in managing the transition to land and real estate markets. Is the distorted Soviet city economically sustainable when key internal price,s such as energy prices and capital prices, have adjusted to world prices? The following section discuss the impact of the transition to markets on enterprise, residential areas, and the services sector before discussing the components of urban land reform. 7.6 The chapter then highlights four major elements of urban land reform: land ownership and property rights; mechanisms for the trading of land; information systems and market needs for timely, accurate and easily accessible information; and the critical issue of property valuation. In the context of property valuation, the present Russian land tax is also examined. There should be no misunderstanding about the requirements of urban land markets. Markets for short-lived consumer goods like pencils, tomatoes, or vodka do not require much regulation to operate well. However, markets for perpetual goods like urban sites cannot be operated without appropriate regulations and well-trained professionals. Finally, the new role of urban planners in Russian cities is examined. II. LAND ALLOCATION IN CITIES WITHOUT MARKETS In Russia, administrative decisions based on "needs" and "norms" governed the use and quantity of land consumed. By contrast, in a market economy, land price differentials constitute one of the most important factors determining quantity and location of land consumed. These divergent principles governing land allocation and land use could be expected to produce different spatial and efficiency outcomes. A quantitative land use analysis of Moscow and St. Petersburg reveals that there are indeed important differences between Russian cities and market-economy cities in the Chapter 7 133 distribution and consumption of land. (See BOX 7.1). Inspection of land-use maps or satellite photos of other Russian cities confirms that these are systemic features of the socialist city. A. Major Spatial Differences Between Russian and Market Cities 1. Absence of Incentives to Recyck Land in Soviet Cities 7.7 As their economy and their population grow, cities expand through the progressive addition of concentric rings, similar to the process for trees in successive growing seasons. Within each ring, land use reflects combined effects of demography, technology, and the economy at the time when the ring was developed. While this organic incremental growth is common to all cities, in a market city changing land prices exert their pressure simultaneously in all areas of the city, not just at the periphery. Changing land prices exert a powerful influence to recycle already developed land in the inner rings when the type and intensity of the existing use is too different from the land's optimum economic use. Thus, changing land values bring a built-in dynamism: Continuous variations in land prices trigger land-use changes by putting a constant pressure on the existing uses of land. 7.8 By contrast, under Russia's command economy, the absence of land prices removed all incentives to redevelop built-up areas. Once land was allocated, it was almost never recycled. Without price signals, it was administratively simpler to respond to current land demand pressure by developing at the periphery than to redevelop well-located areas with obsolete land uses. While the city expanded outward, land use in already developed areas remained unchanged. One striking illustration of this phenomenon is the persistence and uniformity of housing types in successive rings around Moscow. Each type is usually designated by the period in which it was built. Thus, driving from the center of Moscow, one passes through rings of Stalin, Khrushchev, and then Brezhnev flats. 7.9 This socialist land use process creates sizable enclaves of "fallow" or "dead land" -- areas which combine low levels of economic activity with negative environmental qualities. Following this process, the Soviet command economy has generated an urban development process with two characteristic features of large land-use inefficiencies: (1) Areas where obsolete land use occupy large amounts of the total city area. (2) Households tend to be concentrated in the periphery with increasing densities further from the center and "historically" low densities in central areas. This pattern tends to increase transport costs and pollution by requiring higher energy expenditures without providing better amenities such as larger plot size or a better environment that would be the normal trade-off for increasing commuting distance in a mnarket economy. 2. Spatial Structure of Socialst Cites: Rusdng Factories in Prime Locations 7.10 The failure to recycle land occupied by old activities of little value -- this "dead land" syndrome -- yields several spatial outcomes: centrally located industrial belts, a large total amount of urban industrial area, low job density in the industrial belts, and central land areas fragmented by dense railway networks. 134 Chapter 7 BOX 7.1 SOCIALIST ClTIES WITHOUT LAND MARKETS: St Petersburg's Land Use Pattern The pattern of land use distribution in St Petersburg within a radius of 25 kilometers from the city center at the intersection of Nevsky Prospect and Sadowa Street, shows the features typical of a planned urban economy where site value was not priced, energy costs were heavily subsidized, and the cost of capital was not recognized: | A low percentage of residential area of 35 percent out of the total built-up area because land was allocated in priority to non-residential use. In market cities a share of 50 percent to 65 percent is common for residential areas. Very few residential areas between 5 and 8 km from the city center where most of the land is used by old land-intensive industries. Because land is not priced, it cannot be recycled when the city grows. Wasteful old users have no incentive to release any of their holdings. New residential areas have to "leap-frog" these obsolete industrial areas rather than push industries toward the outskirts of the city. A spatial discontinuity of residential areas showing three density bumps caused by a supply-driven housing system where projects are planned with the objective of rationalizing large-panel industrial construction technology. The result is residential areas without continuity with the existing city. Yet, there are no significant topographical constraints and a large amount of land is available for expansion. The pattern of population density shows four distinct concentric zones: - The pre-socialist historical core with high population densities similar to the ones encountered in Paris intra muros. - The industrial belt showing a sudden drop of residential density in the immediate vicinity of the city center. - The "socialist' residential belt where land use is dictated by uniforrn urban planning norms independently from the distance to the city center. - Suburban areas where a mix of individual housing, dachas, and apartment blocks somehow eventually lower the average density. Under market conditions, such brutal discontinuities in population densities would be unlikely to occur. Households in St. Petersburg are pushed toward suburban areas by administrative fiat, not because they are making a trade-off between the convenience of the city center and the better environment of the suburbs, i.e. between commuting time and housing space. With the absence of market prices, land consumption per person is similar in the city center and in distant suburbs. The same residential density of 400 persons per hectare is found at 2 km and at 15 km from the center. This is symptomatic of the absence of differentiated housing products. Actually, average apartment sizes tend to be smaller in the suburbs than in the center, and residential densities are similar or even higher than in the center. Such land use patterns lengthen commuting times, increase infrastructure requirements, and greatly intensify energy costs. Moreover, the old industries at the center have a greater polluting impact on the residents surrounding them. There is also a significant shortage of space for services activities which were under-planned by the Soviet system. With land market prices to reveal trade-offs, these features would correct themselves over time. Chapter 7 135 7.11 Of these pathologies, the most startling are the old industrial belts that ring Moscow and St. Petersburg. Developed during the 1930's and 1950's, these belts are still spread between 4 and 8 kilometers from the city centers. These industrial land-use bottlenecks have never been recycled, even though the land values would have been prohibitively expensive for the enterprises had market land prices been used. The absence of market signals resulted in a land use freeze that pushed residential areas further toward the city periphery than in market cities. Meanwhile, obsolete and low density activities have remained as enclaves on accessible and well-serviced land. 7.12 The absence of land prices and the dominance of industrial planning in govermnent thinking and policies explains the second phenomenon. Not only are Moscow and St. Petersburg characterized by centrally located industrial belts, but also the total industrial land area within these cities is extraordinarily large. For example, in Moscow, 31.5 percent of the total built-up area is used by industries, compared with 5 percent in Paris, 6 percent in Seoul, and 5 percent for Hong Kong. In the industrial belt from 7 to 8 kilometers from the center of Moscow, 67 percent of land is used by industries. (See FIGURE 7. l.a) The extensive use of prime centrally located urban land for industries is particularly inefficient in Russia because of the socialist industrial organization which requires most industries to hold large inventories of materials in order to survive in the socialist system. These industries therefore use large areas of land for warehousing and heavy transport infrastructure -- a peculiar constraint on industrial land use that results in a low ratio of jobs per unit of land. In a market economy, such a low job-to-land ratio would be incompatible with the central location of these industries. 7.13 Third, the distribution of jobs by distance to the city center shows that both Moscow and Saint Petersburg are still monocentric cities with a high concentration of jobs in the city center, a feature common with most market economy cities. (See FIGURE 7.1 .b) As the transition to markets progresses, many industrial jobs will disappear and more service jobs will be created. The majority of these jobs will be located in the city center, further reinforcing the monocentric characteristics of these cities. The histograms of the geographical distribution of jobs for Moscow (shown in FIGURE 7.1.b) and Saint Petersburg (not shown) confirm that the industrial zones do not significantly increase the number of jobs to justify their prime location so close to the city center. No data were available to conduct a more detailed analysis of present land use and floor space. But the very high spot prices reached by new office space in Moscow and Saint Petersburg are indicative of an acute supply constraint for land and floor space dedicated to services in the city center, a typical shortage in socialist economies in transition. 7.14 Fourth, the land of the industrial belt of Moscow is serviced by a dense network of railways which have the effect of further fragmenting the land and making land on the exterior side of the industrial belt expensive to service. Only a small part of the volume of traffic on the rail network within Moscow Municipal boundary is used for passenger and commuter traffic; most of it is used for freight. This fragmentation further reduces the usability of land adjacent to centrally-located industrial areas and increases significantly the cost of the primary infrastructure network which has to be developed to service it. 136 Chapter 7 Figure 7.1 Industrial Land Use and Job Density Patterns Figure 7.1.a MOSCCW- LAND USE Percntage of inctusau Lana wtmin Built-up Area 70% 40% 3 0% I aI20%I 10 1 2 3 4 5 6 7 a 9 1011 12 1314 15 16 17 18 19 20 21 oem _ ._ eo nm c * _ Figure 7.1.b MOSCOW. LAND USE ANALYSIS Job Density 250, 1 3 5 7 9 t 1 13 15 1 7 19 21 23 OMO two coy O- q S--e at wvo .on .w 99 Saa: ktauo d Maa Plan of Mosw 1 992 Chapter 7 137 B. DYNAMICS OF HOUSING AND RESIENTIAL DEVELOPMENT IN THE SOCIALISr CITY 7.15 The prevalence of unrecycled, large-scale industrial belts in Moscow and St. Petersburg is a subset of a larger set of spatial distortions found in Russian cities. The development of housing projects under the administrative-conmuand system and the activities of real estate developers in market cities follow different motivations and yield totally different outcomes. Understanding these larger distortions provides a tool for designing policies that reduce inefficiencies. In a market conomy, housing developers are value maximizers, while in a supply-driven command economy bureaucratic housing builders are cost minimizers. They have little interest in final user satisfaction since administrators, rather than users, are their direct clients. 7.16 In a market economy, private developers compete for the same location. The winning bid will go to the activity estimated to be most profitable at that site. Land prices exert their pressure on the whole supply of land, including the already built land. This is the key to efficient cities. As the city expands, land prices tend to rise throughout the city. Land prices stay the highest in the most accessible areas around the city center and along transport corridors. This triggers rising density in those areas. The rise in density triggered by relative price changes is due to the compounded effects of two phenomena: (1) Floor-to-land area ratios (FAR) increase in central locations because of land recycling through demolition and reconstruction. (2) The consumption of land space per job or per resident decreases because the more efficient land users outbid less efficient land users who then move to more peripheral locations where land is cheaper. 7.17 Over time, the interaction of these effects produces a population density profile that is negatively sloped from the high-population center to the sparsely-populated periphery. The driving force behind this density gradient is not master planning by city planners, but the individual decisions of real estate developers who want to maximize the difference between production costs and the market value of the final product. As a city grows larger and richer, recycling land in already built- up areas offers the opportunity to maximize this difference. This is an incremental and decentralized process but it is not slow. In advanced industrial economies, about 2 percent to 5 percent of all urban jobs within an urban area relocate every year, depending on economic-growth conditions. In a country like the U.S., famnilies relocate every five years and 80 percent of their moves are within the same urban area. 7.18 By contrast, in Russia under the administrative-command economy, housing construction organizatio -- the housing kombinats -- respond to very different incentives. A kombinat's performance is measured by its ability to reduce input costs while meeting quantitative production targets. The costs have to be minimized while the "value" of the final product is irrelevant. Land may be free, but it must be allocated from what is available. Due to the lack of incentive for land recycling, the supply of land is limited to the new areas developed that year in the outer fringe. As a consequence, kombinats have to meet their production targets using land that is almost exclusively at the periphery. The density of the newly built area (defined as the unit of floor space divided by 138 Chapter 7 unit of land) will then reflect the ratio between the developed land available and the amount of floor space to be built to meet the production quota. 7.19 As the Russian city expands, the land at the periphery becomes less and less desirabi and more expensive to develop because primary infrastructure -- and metro lines in the case of Moscow and St. Petersburg -- have to be expanded. But in a command economy, housing is entirely supply- driven and, if the supply of serviced land is lagging behind the floor space production target, the building density in the outer rings will tend to rise. Over time, housing kombinats have been stacking up more floor space on the more distant land. The failure to price land is compounded here by artificially low energy prices. Such a system does not tend to preserve resources, unlike the more efficient, negative-density gradient of market cities." C. The Socialist City Compared with the Market City: Moscow versus Paris 7.20 The comparison of density profiles between Moscow and Paris is revealing (FIGURE 7.3.a). Both metropolitan regions have a population of about 9 million. They are strongly radio-concentric, and have similar peak densities. However, the way densities are distributed geographically is strikingly different. Paris shows the typical density profile of a market economy city, with a negativety sloped gradient. In sharp contrast, Moscow has a positively sloped density gradient. The net density of Moscow at 15 kilometers from the city center is twice as high than in the center. The density of Moscow suburbs at 15 kilometers from the center is the same as in the center of Paris. One should note the drop of density at 6.7 kilometers from the center in Moscow. This drop in density is due to the unrecycled industrial land use producing the enclaves of "dead land" in the city fabric. 7.21 The degree of population dispersion can be measured in a rough manner by comparing the median distance to the center per person. FIGURE 7.3.b shows the cumulative population distribution curve of Moscow, St. Petersburg and Paris. The cumulative curves of Moscow and Paris intersect each other at 14 Kilometers, corresponding to a population of about 6 million people. This means that within a circle of a 14 kilometers radius, Moscow and Paris serve the same population, and as a consequence share the same average density. But because of the difference in the density profile between the two cities, the median distance per person to the center is 7 km for Paris and 10 km for Moscow, a 42 % greater dispersion in the case of Moscow. 7.22 Are the land use and the density profiles of socialist cities like Moscow or St-Petersburg a mere curiosity for land-use specialists? Emphatically not. It matters a great deal to the Russian urban economy -- where three-fourths of the population lives, for the following reasons: (1) Average densities being equal, the population of a city with a positively sloped density profile is more dispersed than one located in a city with a negatively sloped Note also the compounding distortion of the socialist low-wage policy. All behavioral studies in market cities show that urban residents tend to value their time travelling to work as a significant proportion (about one- third) of the hourly- wage equivalent of their salary. Therefore, the distorting effects of the lack of land prices are further masked by the artificially low value that urban residents are placing on their time. Chapter 7- 139 Figure 7.2 The Socialist City Compared to the Market City Moscow Compared to Paris Figure 7.2.a COMPARATIVE POPULATION OENSIrY GPAOIENT IBetween Moscow ana Pans Built uc Area 300 250 Scum: instA of Mart P!gn ct M oaw 1n92 Figure 7.2.b MOSCOW * LAND USE ANALYSIS Comoaravve Poculamon DlstnD,mon 9.000.000 S 000.000-4- ' h 17.0010.000.4- 4 .000000* 1,.OOOwbw, , 0 1 3 5 7 9 11 13 15 17 19 21 23 2s 27 2s 31 33 35 2 4 6 S 10 12 14 16 18 20 22 24 26 28 30 32 34 0 ._ m -. uo aM *. Mra@ww -w"U -a- we Soa minUm ct Maswr PIwn ot Mo00w Im St Peurou Insuwm d# Urbaruce Th.oryj Pari Census 1990 140 Chapter 7 profile. This implies for Moscow higher transport costs, higher primary infrastructure costs, higher urban operating costs, and a greater share of labor time wasted in travel. These distortions are paid for in the form of lower levels of economic development. (2) A large amount of floor space has been developed where there is little demar. for it, that is, in Moscow suburbs with less accessibility. When transport subsidics are progressively removed and full wages restored, demand -- and consequently land prices -- for this type of high density housing far from the city center will drop even further. Prices could drop well below replacement costs and trigger abandonment. (3) The fully serviced, underused land close to the city center has a high opportunity cost. 7.23 Russia has used its great natural resources to build an urban system of doubtful efficiency and sustainability for lack of adequate and up-to-date economic information about the opportunity cost of its urban land. The evidence support the earlier assertion that the socialist city has inordinately high capital/output ratios and requires more resources for less urban output than market cities. m. EMERGING REAL ESTATE PRICES A. Synthetic Land Price Gradients and Normative Prices 7.24 During the late 1980's Russian local government resources became severely constrained. Local mechanisms to finance the production of serviced land had to be found to complement inadequate resource transfers from the central government. It was, therefore, decided to create a land-use tax to finance local infrastructure. In the peculiar logic of an administrative-command system, land officially has no value in construction projects, yet it was agreed that different locations had very different economic values. The solution chosen was to estimate normative land prices on which taxes could be based. Various research institutes developed models to calculate synthetic land- price maps from which land-price gradients could be calculated and according to which taxes might later be raised. These land price-gradients could also become helpful for privatization and the location of urban public investments. 7.25 In a market economy there is a strong correlation between the density profile of a city and the land-price gradient. This is true because prices drive locational choices. While the density profiles of Russian cities can be readily estimated, Russian cities are not yet at a stage where land- price gradients can be simply derived from land markets -- in part because such markets are operating in a stage of significant disequilibrium. Research institutes have attempted to map anticipated land-market values based on location characteristics. The normative value of land was calculated using a number of weighted coefficients representing amenities such as transport, infrastructure, environmental quality, etc. Typically demand factors were not included and price estimates were based on very distorted late-1980 accounting prices. However, land-value maps were produced and from the data they contained it is possible to build the city's normative land-price gradient. Chapter 7 141 7.26 The resulting normative land-price gradients of Moscow and St. Petersburg are negative. Moscow's gradient is somewhat flatter than St. Petersburg's. The normative price variation between the center and the periphery in Moscow is only 2.5 to 1 (from 4,000 rubles at km 0 to 1,600 rubles at 22 km). Based on what is known of urban land prices in market cities, both curves are much too flat. In the absence of major topographical and legal constraints, the ratio between the land price in the central business district and the one at the fringe of the built-up periphery is usually on the order of 10 to 1. The profiles of the curves are highly arbitrary, as we do not know the high and low points. However, the direction of the slope is correct. Such normative prices might improve the traditional urban master plans made in Russia but would be of little value for activity-specific individual choices of location. B. Housing Privatization and Rapidly Emerging Land Price Gradients 7.27 Normative prices may be of interest for research purposes, but they are fundamentally flawed for actual decision-making because they attempt to infer individual land values from flawed models and simplistic normative ratios based on partial data and past distorted prices. It is worth restating again the fundamental rationale for reviving urban land markets in Russia. This rationale is that the allocation of land in cities should be driven by its current opportunity-cost. This "opportunity-cost" is commonly referred to as "highest and best use" by market analysts to stress that current land use may be inefficient. In practice, the value of a specific land parcel in its highest and best use can prove difficult to estimate even in a stable, fully developed urban land market. The next best price is based on current actual market transactions, which are the result of private valuations of investors looking at the future and risking their own resources. (Refer to BOX 2.1 on property valuation in Chapter 2). 7.28 With the beginning of housing reforms, actual apartment sales transactions between private parties have been taking place in Moscow since 1991. ' A preliminary empirical analysis of 2,000 transactions carried out in the first trimester of 1992 and of another group of transactions in the fourth trimester of the same year provides an important first look at emerging real estate and land prices. The study analyzed the residuals from an apartment sales model that uses only building- specific variables based on resales of privatized apartments. It is possible to construct a land-price gradient by plotting the residual as a function of distance from the center of the city as shown in FIGURE 7.3. These preliminary results provide some critical information. First, the emerging price gradient is downward sloping from the center. Clearly, housing kombinats are not providing the housing that households value the most. As FIGURE 7.3.a shows, the land-price index decreases from 100 percent in the center to 70 percent at 25 km. -- a negative price gradient -- with the greatest decreases coming in the first 8 km. This model suggests that, at present, inputed land prices are only about 1.5 times higher at the center than at 25 km. This is still a very weak price differential to trigger the urban restructuring that Russian cities need. Various factors can explain 2/ For reference, it is estimated that about 125,000 housing units may have been exchanged or sold in 1992. Since there about 3.1 million apartments in Moscow, this represents a rate of about 4 percent of the housing stock. In a market city, the annual ratio of housing trades is often of the order of 15 percent of the stock. Yet mobility and trading in Moscow are rising significantly. 142 Chapter 7 Figure 7.3 Emerging Market Land Price Gradients in Moscow and Krakow, Poland EMERGING MARKET LAND PRICE GRADIENTS in Moscow and Krakow, Poland 100~ , go5~~~~~~~~~ .. . . .. __ .... .. . ...... _........ . .......... ............ ......... .. ........ ........ .. .... . ... .. .. ... .. ............ .. . .. . . .... .. _. .__ . .... .... _ . . .... . _. .. . .. . . ....... 805i > - - - -. -.-.-.....-. .. '- m U .- Mosow. 1992 I 75t X ....................................... .. . . . . . 70 . ....... ... ..._. .......... . ......... ............. ................. U. . ..... _. . . .. = 7,6 ;X0+ . *3 --. --- ---. .- ---- .- .-- - . - ------j i605 -i.-'- ~-..--. . . ..-.....- -.- ---. _ ......... ,t...... 2 0i - 55_ . -. -.-..... _ _ -.__ !____.. .... .. ..... .................... ..................... ............ .. .. . . _. .... . ..... . _ . . E 50-4 ............................. . ....... .......-............................... ... ......... . ....... j __,,_......... .......... ...... .._. 1 .. 30-_ _ _ .-.-. ..._ ............................ .........._.__..__ _ 4251... ................-- 210 1 . , I . ... ... . . 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Distance from City Center (Km) I (Source: Joseph K. Eckert) Chapter 7 - 143 this flat price gradient, including the collapsing economy, ambiguities about land values, and the state of disequilibrium state in an emerging market. 7.29 What is rather striking and unanticipated is that the land-price gradient seems to be rotating very rapidly during the transition to a market-based system. The analysis for the second period in Moscow shows that the slope of the price gradient has steepened from 100 percent in the center to 58 percent at only 15 km. from the center. This a real adjustment of 20 percent in less than a year. It can be expected that, with new legal clarifications of land ownership rights in December 1992, the gradient will continue to rotate rapidly. This expectation is also fed by a similar analysis of land prices in Krakow, Poland which shows that in that city the land-price differential has already reached a market-city differential of about 10 to 1. Polish urban reforms, in particular the restoration of private land ownership rights, have been more thorough than what has been done so far in Russia. At this early stage in the development of the Russian land market, location values are not yet being fully capitalized into property values. A more normal price differential will only emerge when investors have more certainty about land tenure, when real estate information institutions become more proficient, and when economic and political conditions stabilize. IV. MANAGING THE TRANSMON: IS THE SOVIET CITY SUSTAINABLE? 7.30 The passage to an urban land market is expected to raise the efficiency of the socialist city. But what happens to the cities during the transition? This question can be stated more specifically as what will be the outcome of the interactions between a negatively sloped land price gradient with a positively sloped population density gradient? It can be restated by studying two problem areas. What happens to: (1) the affordability of the land occupied by existing enterprises; (2) the pricing of dwelling units (rents or sale price) after the initial privatization of the housing stock is completed. A. Market prices and Affordabiity of Land Currently Occupied by Enterprises 7.31 The "market value" of land in a given area is a function of the discounted annual return on investment which could be derived from the best alternative use of this land, i.e. the combination of best type of use and best intensity of use. Most of the land occupied by enterprises close to the city center (that is, within a radius of 10 km) will have a high value because of the high accessibility provided by the existing transport network of Russian cities. The best alternative use for such high accessibility areas will probably be a mix of commercial, office, and residential floor space with a high floor-to-land-area ratio. Developers of such projects, willing to pay market value, would be able to bid centrally located land away from the low-value industrial enterprises that currently occupy large areas of centrally located land. 7.32 Land reform administrators are presented with a difficult dilemma: If enterprises are asked to pay the market price (as deflned above) for the land they occupy -- in the form of rent or land-use tax -- most of them would not be able to afford it and some would have to be declared bankrupt. 144 Chapter 7 Alternatively, if the financially weaker enterprises are given a reprieve or a waiver on the cost of land they occupy, this will perpetuate the status quo. The urban community will lose the opportunity cost of the land. New infrastructure would have to be developed elsewhere, while the costly existing infrastructure would remain underused. 7.33 If the objective is to improve land use efficiency as rapidly as possible, one approach for responding to the above dilemma is to grant to existing enterprises explicit property rights in the land they now occupy. Then the enterprise could use this land as equity in planning to relocate to more affordable, appropriate land. For instance, using a current, flat land-price gradient, an enterprise located at kilometer 7 from the center of Moscow and relocating to kilometer 22 around the external ring road would need only 20 percent of the value of the land it presently occupies to acquire a new equivalent site. If the enterprise reviews its land requirements and decides to use land more intensively on the new site, say only half of the present area -- preliminary surveys indicate that this is a reasonable assumption -- then only 10 percent of the value of the present site would be required to acquire a new site. The wealth to be released by the plant relocation is clearly very significant. Under such a scheme, the benefit of relocating land-intensive enterprises to new sites will accrue not only to the enterprise themselves, but also to all urban households. Enterprise relocation would reduce transport time and increase the supply of well-located land for new housing units, which in turn would reduce housing costs. Of course, in some cases, where current industrial areas are heavily polluted, the cost of cleaning up decreases the land's potential market value, and accordingly reduces also the enterprise's incentive to move. 7.34 The value of the land resources involved in industrial land recycling -- even under the present socialist low and flat price gradient -- is very large. If we assume that the percentage of industrial land of Moscow could be reduced from the present 32 percent to 10 percent -- still high by international standards -- then about 100 square kilometers of already developed land could be recovered. Using conservative assumptions the total value of the land recovered would be about US$ 2.2 billion, assuming that two thirds of the industrial land recycled is evenly distributed from the center.3' The above evaluation of the value of the land frozen by industries is still conservatively low. Because of the way the industrial areas exist within the built-up area, their total value is not yet sensitive to the location along the price gradient. However the total value of the fallow industrial land will be sensitive to the wider range of high and low land prices that will emerge as the land market develops. 7.35 Following this analysis, the affordability problem of non-residential land can be seen to be a false problem. By definition, the market price of land is affordable to new users. The land may not be affordable, however, to existing users who are asked to pay for it retroactively -- but these existing users are precisely those who are using land in an inefficient manner. The affordability 3/ In late March 1993, the asking price for a 3-room apartment (70 m2) centrally located in Moscow was reported to be range between $30,000 and $100,000. Taking a low estimate of $430/ m2, using a floor-area ratio higher than average (FAR=2.5) and taking the economic value of land to represent 20 percent of building cost, yields a land price per square meter of $27.5/ml. In addition, taking the value at 7 kilometers to be only 80 percent of central locations, yields a unit price for land of $22/m2. Such low assumptions already yield a price per hectare of $220,000. Chapter 7 145 dilemma could be solved by recognizing the land equity interest of present land users and then allowing these users to trade freely the land they occupy. 7.36 This analysis illustrates a crucial point of urban land reform. The recovery of 100 square kilometers of misallocated land will not be obtained through better design or with the help of sophisticated zoning plans or new master plans. Instead, improved outcomes will arise by establishing the rules and mechanisms which would allow the most efficient user to buy land from the least efficient. For each site, it is impossible to identify, in the abstract, the most efficient user or how much land or what floor-to-land-area ratio the most efficient user would consume. A well- functioning land market with a minimum of restrictions on the use of land would allow the most efficient user to obtain the right amount of land in the right place by buying it on the market from less efficient users. In market economies, the role of urban planners is not to design cities, but rather to establish the minimum rules that all potential new land users must meet, and the limits within which the land market will operate. B. Impact of the Transition to Markets on Housing and Services Areas 7.37 The basic price of a housing unit depends on three main parameters: (1) location, (2) floor area, and (3) land area. Households, when shopping for housing, have to make trade-offs between these three parameters. For a given shelter price, suppliers are theoretically able to provide a dwelling unit in any location. This is possible by allocating different combinations of values to these three basic parameters. Thus, the floor-to-land-area ratio of different housing unit types may vary widely within the same city. The net land area required to build one square meter of floor space may vary from 0.10 square meter for high rise apartments to 15 square meters for detached houses. 7.38 Urban regulations and the multidimensional features of housing demand impose a limit to the theoretically infinite number of permutations between location, floor area, and land area. However, in market economies, the clusters of housing types that are built always follow the universal demand rule: an increase in distance from the center should be compensated either by a lower shelter price or by a larger consumption of land or floor space or both. This basic demand rule explains the quasi-mathematical relation which exists in a market economy between land price and density gradient and between land price and total production price. (see BOX 7.2 on the fundamental characteristics of the locational decision of households in market economies and matching empirical evidence). 7.39 A housing market is emerging in Russia during the process of housing privatization. The present occupants are gaining ownership interest in the units they currently occupy. It is, therefore, useful to consider the likely value of the different parts of the housing stock at different locations within each city. The larger part of the housing stock built in the periphery of Moscow and St. Petersburg and the 150 largest cities of Russia (nationally about 55 percent) consists of prefabricated, reinforced-concrete, large-panel, high-rise apartments of 5, 9, 12, 15 and 22 floors.4' The actual economic value of such units will be revealed by household preferences for the first time. This value 4/ For statistical descriptions of the characteristics of the Russian housing stock and the construction industry refer to ANNEX 8 on 'The Organization of the Construction Industry in Russia". 146 Chapter 7 BOX 7.2 LAND USE ALLOCATION IN THE LlARKET CMIY The Fundamental Locational Trade-Off Made by Households The most striking feature of the socialist city is the inability the housing production system to provide households with the opportunity to make trade-offs between housing space and location according to taste, preferences and the life-events of the family life cycle. Housing organizations produce essentially the same unit anywhere in the city, thereby greatly reducing its livability and economic efficiency. In market city about 65 percent of the land is devoted to housing, and the structure of the city and its density are shaped by household preferences. The impact of a multitude of independent household decisions on the basic structure of cities can be explained in a simple and concise way which is remarkably verified in cities around the world. 1. The Two Trade-offs Facing Households When Choosing their Housing In a market economy, households have a wide variety of choices within the constraint of their total income. When selecting their housing, households face two trade-offs. How much of the budget to spend on housing compared to other goods, and second within this housing budget how much space to get and where. Households aim to maximize their satisfaction with respect to the consumption of housing, goods and commuting, subject to their budget constraint. This budget constraint says that expenditures on housing, goods, and commuting must not exceed income. In this budget constraint, income must include the money income foregone as a result of commuting. Part of this income is spent on commuting. Different households will make different choices. But the general pattern of choice can be economically represented in a simple mathematical relationship. The household budget constraint can be represented by three types of expenditures: (I) goods whose prices do not depend on location Q,, (2) housing whose price and size is affected by location Q, (u) and (3) travel costa which are a function of the distance to the center u and a rate t. These must be equal to the wage w. The budget constraint is therefore: (I) PA,Q, + P1(u).Q2(u) + t. u = w The notion of trade-off under a budget constraints also means that when making a choice about its housing, a household may also trade off housing against other goods based on their prices. Taking small variations in mathematical terms trading-off means the relation (where d represent partial derivatives): (2) dQI / dQ, = - ( P, / P2) Equation (2) indicates that the trade-off between housing goods will be invenely related to their respective prices. For instance, if the price of food (Q,) is high there will less budget to spend on housing. 2. The Location Decision and its Impact on City Structure The combination of trading more housing with commuting in equation (1) and housing again other household needs in equation (2) yields the location equilibriun condition which is intuitively appealing and yields. important insights about the structure of cities, and the basic economic forces at play in Russia today: (3) dP,(u)/du = - t I Qz(u) The left side of Equation (3) is the slope of the housing price function. The equation sys that the rate of decline in the price of housing a one moves away from the city (dP2(u)/du) is directly and negatively proportional to the Chapter 7 147 BOX 7.2 LAND USE ALLOCA1ION IN THE MARKET CMTY The Fundamental Locational Trade-Off Made by Households (Part 2) comtnuting cost per kilometer (- t). Housing is more expensive close to the center. Further examination would also reveal that this relation (3) explains the curvature of the price gadimt li1ked to trade-offs, and also why the price curve is steeper close to the center. This relation can also be rerranged to reveal the intuition behind it: (4) Q2(u). dP,(u) / du = -t If du is a move away from the center of one kilometer, the increased quantity of housing available due to housing price at that location wil need to be matched by the increased commuting cost of t! The logic of housing choice under constraint is that suburban residents will consume more bowing than close-in residents. As people locate away from the center, the housing price will fall, but the effect on the budget will be offset by rising commuting costs. Since land is cheaper in suburbs relative to other housing inputs, suburban housing will have lower capital/land ratios than downtown housing. It must be kept in mind that this analysis appiies to two households with exactly the same budget who choose to meet their preferences differently. The fundamental flaw of the socialist city is that housing unit sizes are uniform irrespective of location. The socialist houwing office is implicitly redistributing income to those who get the same space downtown. Housing Diversity and Efficiency in a Market City The preceding formalized analysis is verified very well empirically. In an actual city not only families have different preferences at the same level income, but incomes also vary significantly. In response the housing markets are producing a wide range of units. An actual case study of Malaysia - a middle-income country - shows such a wide choice of units with usable floor space ranging from 20 square meters to 130 m2 and land consumption varying between 30m2 to 500 m2 per dwelling unit depending on location. MALAYSIA.: RANGE OF HOUSING TYPES l c ~500 1 . 400 - / / V C :300 <,"< ' - 4,r ~~'2 'W A INrORUAL ~ f ' 0 20 40 60 60 100 120 140 Square Meters of UJsable Floor/Dwelling Unit 148 Chapter 7 economic value of such units will be revealed by household preferences for the first time. This value will be more strongly affected by the location and the type of dwelling unit than its floor area. For instance, a one-bedroom apartment in the center of Moscow will certainly have a higher market price than a three-bedroom apartment in a high-rise building at 20 kilometers from the center. When households are required to pay for the maintenance of their building -- either indirectly through rent increases or directly because they have acquired ownership of their unit -- the high rise apartments of the periphery will have: (1) The highest maintenance cost -- defined to include the cost of maintenance and operations of elevators and lift pumps, cost of central heating caused by the bad insulation of panel buildings, costs of frequent structural repairs required by the building technology used, and the cost of maintenance of large, common open space; (2) The lowest space standards measured according to room dimensions and height of ceiling; (3) The lowest amenities quality, including distance to shops, variety of services; (4) The highest transport costs currently expressed only in time to work, but soon expressed in financial terms when transport subsidies will decrease." 7.40 Given the above qualities of the typical unit at the city periphery, a potential buyer's choice of an apartment in a suburban high-rise building will not offer a trade-off between different benefits such as getting more floor space or land in exchange for living so far from the city center. The only reason, then, for a buyer to select a unit in a high rise suburban area will be the unit's very low price. The market price, which will emerge as land and real estate markets develop, may turn out to be much below the replacement cost of such a unit. Most importantly, the market price of such units expressed in terms of market rent might not even cover maintenance costs. 7.41 Viewed through the prism of emerging market prices, much of the housing stock in periphery apartment buildings may have a discounted present market value of less than zero -- a sobering insight for privatization policy and for future housing investment programs. In the case of Moscow, in FIGURE 7.2.a, the units at risk would be those located above the density line for Paris between kilometers 9 and 22. Given the current housing shortage, transition policies of preferential treatment in terms of transportation subsidies, higher quality maintenance may ease the burdens on residents. But it will remain a fact that these parts of the housing stock have very low and mostly negative economic value. As the economy of Russia recovers, local urban planners will have to cope with increasing rates of abandonment. Very careful policies encouraging the development of suburban employment centers close to these housing areas may possibly restore some of the 5/ This prediction of the author had already entirely come to pass by 1994. Chapter 7 149 economic value. Strong, carefully thought out and implemented integrated urban programs for these areas is one of the highest urban policy priorities.6' 7.42 It should be clear from the quantitative analysis presented that the suburban housing crisis which is looming in the cities of Russia cannot be attributed to the transition to markets. This crisis is the result of the administrative-command system, which disregarded the practical needs and preferences of the final users over what they produced. The economic value of the housing that was produced did not match the true economic cost of the resources used. This cost was masked by distorted accounting prices which provided no meaningful guidance to decision-makers who had to resort to misleading administrative criteria. V. COMPONENTS OF URBAN LAND REFORM The spatial analysis above demonstrated the predicament that Russian cities face with a built environment that is, in large part, inefficient and unsustainable. Unless an urban land market develops there will be no way to induce obsolete industrial land users to relocate from their prime land and release it for commercial and residential uses. How could new types of administrative orders achieve sound results now, after having failed to do so for 70 years. The analysis suggests a new role for the public sector to support and guide emerging private land markets. This section focuses on four components of the urban land reform: (1) land and property tenure; (2) the trading of land and supporting information systems; (3) land valuation and taxation; and (4) the entirely new role of Russian urban planners in market cities. Each section below provides a brief historical review, describes current practices, and proposes a reform strategy. A. Land and Propery Tenure 1. Overview 7.43 The outstanding features of the history of the Russian land tenure system are: (1) no tradition of individual land ownership; and (2) divergent tracks along which land and property tenure have developed. The absence of ownership rights in Russia can be traced back before the Soviet period through a long history of anti-mobility policies that tied peasants to the land. Even after the Emancipation of the Serfs in 1861, peasants remained tied to their communes which held title to the land. The Stolypin reforms of the early 20th century brought land ownership to only 20 to 30 percent of peasant households. Following the 1917 Revolution, land and structures were collectivized and the "propiska" system of residency permits to control mobility was instituted. (For more details refer to ANNEX 5: "The Russian System of Land Tenure and Urban Development Until 1991"). 6/ Note of the Russian Editor: These extraordinarily interesting views of the author do not entirely account however, for the potential economic and natural-climatic advantages of outlying districts, or other factors, such as proximity and ease of links to dachas or garden plots. 150 Chapter 7 7.44 During the socialist period, the land regime was consolidated around the basic principle of state ownership of land and a complex system of allocation of land-use rights. Management of most urban land was delegated to municipal governments, although central ministries controlled land reserved for industrial uses. Municipal governments allocated land for specific uses to public agencies, enterprises, chartered organizations, or households which then could use the land for the specified purpose for an indefinite period. But the user could not lease or sell the land and the "right of use" could be revoked by the municipal government. "Kitchengarden" plots were typically held in this form of tenure.7' This "revocable right of use" was the only form of land tenure recognized by the USSR. 7.45 It is important to note that unlike land itself, structures on the land were held in somewhat different forms of tenure in the USSR. Enterprises often had "limited ownership tenure" in buildings that had been built especially for their use. They carried the buildings as depreciable assets and could lease but not sell surplus space. "Leaseholds" in buildings owned by the municipality were allowed. Residential rental tenants had a "hereditary, indefinite right of occupancy" paying nominal rents and being virtually immune from eviction. Apartment exchanges were allowed. Housing cooperative members, who supplied the capital to build their buildings, received "cooperative tenure" under which they held joint title to the building, and could lease or sell their apartments through the cooperative association. Finally, a small number of single-family urban houses were held in "full ownership," although the household held only a revocable right of use on the underlying land. 7.46 This divergence between land and structure of tenure has developed because socialist law broke up rights in ways totally different from, and incompatible with, normal market uses. Land and housing law were different branches of socialist law written by different legislative committees; while in market economies, land and buildings are generally considered jointly as 'real estate". In Russia, restricted land tenure rights now impair ownership rights in structures. For exarnple, a factory owner must assume that useful title to improvements will expire at the end of any leasehold period. In addition, separate systems of tenure create real estate valuation and taxation confusion as privatized flats carry valuable but uncertain claims on the underlying land. Also, as discussed in more detail below, separate tenure systems are leading to expensive administrative duplication and confusion as cities create parallel registration and valuation systems for land and buildings. While Article 37 of the Land Code is supposed to ensure that land and building tenures are reconciled when ownership of a building is transferred, in practice such a procedure can create a significant administrative bottleneck. 2. Current Tenure Forms 7.47 During the past three years, tenure confusion has increased as three new forms of land tenure have been created, each limited to certain kinds of owners or certain land uses. The objective of land privatization is to convert the traditional "right of use" to one of these three forms as quickly as possible. 71 Since 1993, the ownership of kitchen-garden plots was transferred to the citizens. Chapter 7 151 (1) Hereditary Life Tenure. This type of tenure was reasonably adapted to single family dwellings or garden plots by providing a legal guarantee of permanent use and the right to pass on the property through inheritance. The main drawback is that the property can not be sold or leased to others. Municipal authorities retain the right to cancel possession rights with compensation for the cost of the dwelling, but not for the land. (2) Lease. Recent legal changes have introduced the leasehold form of ownership with terms up to 49 years allowed under the responsibility of municipal authorities. (3) Ownership of Agricultural Land. Private ownership of agricultural land is now allowed subject to the restriction that it not be resold for 10 years or leased for more than five years. 7.48 These three forms of land tenure are imperfect alternatives to allowing full private ownership of urban land, a reform that has remained a controversial issue until now. Long-term leases remain the main form of tenure for urban development -- a serious bottleneck to further reforms. (FIGURE 1 of the Annex illustrates the high complexity and administrative opacity of the land-leasing process in St. Petersburg). 7.49 In December 1992 The Seventh Congress of People's Deputies passed two amendments to the current Constitution of the Russian Federation which are critical to housing reform, yet do not deal adequately with the full requirements of urban land reform. The Amendment to Article 12, part 3 removes the restriction on the right to freely possess, use, and dispose of land plots owned by individuals. It eliminates previous "anti-speculation" restriction on sales. The amendment remains inadequate since such land can only be sold without any restriction only if it remains in residential uses. The large-scale needs for land recycling across land uses of Russian cities still remain unanswered. An amendment to Article 58, dealing with the rights of citizens to housing has made this more consistent with market-oriented reforms since the state's obligation to provide housing can be considered satisfied through a household's purchase or construction of its own dwelling, the provision of housing through a naym (social housing) contract, payment of housing allowances, or construction and maintenance subsidies. The December 1992 Law on the Fundamental of Russian Housing Policy also creates the possibility of full private ownership of urban "real estate" defined to include land. 3. Directon of Reform 7.50 The key elements of any reform strategy for the Russian government are to: (1) further define rights to full land ownership granted by the 1992 Housing Policy Law; and (2) integrate land and property tenure forms. 7.51 The first step in reforming land ownership rights is to clarify, coordinate, and publicize the rights granted in the various decrees, laws, and codes over the past few years. There are still many restrictions on types of uses and users associated with existing tenure rights that are incompatible with a well-functioning land market. For example, the Land Code allows full land ownership only 152 Chapter 7 for Russian citizens for agricultural or residential use, with restrictions on alienation; the law does not appear to allow development companies or groups of households in joint stock companies to own land for residential development. Enterprises retain traditional "rights of use" until they convert to a land lease through negotiations with the municipal authorities. But, land leaseholds are not necessarily included in property leaseholds from municipalities or as part of apartment property in privatized residential buildings -- a potential source of uncertainty. Presidential Decree 301 appears to allow full ownership by corporations in acquiring land of privatized enterprises; while the December 1992 Housing Policy Law appears to allow full ownership rights in real estate in the market legal sense. In the face of such complexity and ambiguity, prudent investors will not act. The present patchwork may freeze developing land markets by greatly raising transaction costs and unnecessarily raising the level of uncertainty of transactions, with effects reaching far into the future. 7.52 Consistent with this first point, a second priority in land tenure reform is to unify land and property tenure forms in order to simplify trading of real estate. Corporate ownership of land, or long-term leases (such as 99 years) with provisions on the disposition of improvements at the end of lease term, are a prerequisite for residential land development and industrial area redevelopment. Institutional reforms are necessary to establish the procedures, at a local level, so that clear titles to well-delineated land parcels may be obtained. While Russia's land and property codes describe permissible forms of tenure, they are unclear about how to achieve such tenure. It appears that more than half of all land users lack adequate documentation of their claims to title. Many claims predate the 1917 Revolution. Even recent claims to land seldom include a careful parcel boundary. B. Trading of Urban Land and Market-Oriented Information Systems 1. Current Administranve Procedures 7.53 The land information system of the City of Moscow can be used to illustrate several general points about current obstacles to the development of urban land markets: (1) land and property registries are developing separately from one another rather than as a single system; (2) improper incentives discourage those making market transactions from recording accurate sales prices; (3) normative prices for valuation and property taxation bear no reiation to market prices. Because of the size of Moscow, bureaucratic fragmentation and the administrative lack of cooperation are probably more pronounced than in other Russian cities, but the nature of the problems is usually similar. In Moscow, the following are the current parties in the land information system: (1) Geotrust is responsible for all mapping, but has no titling or adjudicatory role. Geotrust provides staff to the Moscow Land Reform Committee for surveying parcel boundaries. (2) The Moscow Land Reform Committee is responsible for granting rights to use land, recording the rights, conditions, and contracts relating to the use of each parcel, inventorying land resources, and establishing a policy for land valuation. Currently, the Committee is undertaking a cadastral survey to fix the boundaries of existing parcels and documenting the initial registration of existing tenure rights. Many boundary disputes will arise and will require mediation or adjudication. In Poland, this process of parcelization has proven quite cumbersome as municipalities, Chapter 7 153 enterprises in the process of privatization, and individuals began to recognize the value of struggling over boundary definitions. New tenure laws seem to require case- by-case privatization and re-registration of these titles, which is a lengthy process. (3) The Bureau of Technical Inventory (BTI) is responsible for the physical inventory of both residential and non-residential buildings. BTI has no mapping information on the buildings it records, although it has a nearly complete register of buildings in the city, including a detailed site map, with measurements of building perimeters. The building dossier or "passport" contains a register of owners and leaseholders that occupy the building with a reference to the document that granted the title. However, this passport is infrequently updated and now quite out-of-date. (4) The (City not GKI) Property Committee is responsible for registering contracts on non-residential buildings only. Individuals or enterprises initiate registration by requesting registration of their rights; and the Committee does not perform on-site verification of information on rights in registration requests. The Commnittee have any mapping information, nor does it send information back to BTI. (5) The Committee on Housing, also known as the Residential Affairs Committee, registers contracts only on residential units -- including municipal, cooperative, or private units -- for a small fee. The actual registrations are performed by a private company, "Mosprivatization" which had registered 135,000 first-time 'privatizations" and 5500 "subsequent transactions," as of end-June 1992. Subsequent transactions of privatized apartments list the reported price paid for rights. Sometimes prices are accurately reported as a means of legitimizing funds, or if a bank is used as an intermediary. Often prices reflect the extremely low BTI book value as a method of avoiding the payment of extremely high transaction tax. (6) Genplana or the Master Planning Institute is responsible for planning city development and keeping track of land usage. In order to get a land passport with permission to build, Genplana's signature is required, along with the requesting enterprise, the raion, and the local architect's office. 7.54 Faced with this bureaucratic structure, what steps are normally involved in a property transaction? First, the seller obtains a copy of the building's technical passport from the local BTI office, which lists the normative price of the building, derived from a non-indexed historical cost. Second, buyer and seller go to a notary who checks the BTI passport, among other documents, and then oversees that the buyer signs a "price-setting" certificate. The seller is then required to pay the transfer fees or taxes, which are set at between 10 percent to 20 percent of declared value -- a strong incentive to under-report the actual sales price. The notary then validates the transfer and the buyer registers the property in the appropriate office, which issues a "ownership certificate." 2. Direction of Reform 7.55 The development of market-oriented information systems for Russian cities has too many legal, technical, institutional, and economic dimensions to treat them adequately within this chapter. 154 Chapter 7 To clarify the scope of the technical work to be done ANNEX 6 on "Market Oriented Land Information and Geographic Information Systems" discusses: (1) Geographic Information Systems and related hardware and software issues; (2) GIS development strategies; (3) prior strategic information systems that cities should develop; (4) outlines the elements of other registration of property interest; and (5) discusses cadastral mapping. C. Property Taxation, Valuation, and Registration 1. Current Conditions 7.56 In 1991, the Law on Land Tax was introduced. This new tax is part of a larger set of taxes, fees and payments associated with privatization and use of land and buildings. Four types of payments could be considered: (1) Payments for privatization of tenure rights to non-residential property have been fairly limited to date, including lease payments for land and buildings based on formula-driven payments. Auctions of rights will presumably become more common. (2) For residential units, the federal Law on Housing Privatization specifies a guaranteed free transfer of up to a certain quantity of space per household member with payments for extra space or amenities to be decided by local governments. Formulas for determining payments have been hotly contested, but are generally based on the depreciated historical replacement values reported by the BTIs, without reference to current construction costs. Article 17 of the Land Code assigns municipal governments the obligation to allocate land to citizens for single family houses and garden plots, but does not specify the procedures or tenure types for such allocation. (3) Property transfers between private individuals require payment of a transfer tax of 10 percent of the transfer price -- a prohibitive tax that encourages under-reporting of actual transaction prices. With under-reported values, it is difficult to establish accurate property valuations. (4) Recurring payments -- in the form of real estate taxes -- are required under the 1991 Law on Land Tax, and the 1991 Law on Taxes Levied on the Property of Natural Persons. The Land Tax requires all owners and users of land to pay taxes, while those who lease municipal land must pay annual land rents. 10 percent of revenues go to the federal government for public works in the city; 90 percent goes to the municipal treasury. Unfortunately, the Law has many flaws. It sets the actual land tax per unit area, rather than allowing local governments to set a rate; it allows cities to vary the land tax by district as long as a citywide average tax is maintained. The law also sets residential tax rates at 3 percent of the general city rate. Finally, the Law introduces the concept of a normative or standard land price -- at 50 times the promulgated land tax -- to govern terms of transfer of land to private ownership, establishment of collective ownership shares, transfer by inheritance or donation, and to obtain mortgage credit. The tax on residential premises is set at 0.1 percent of Chapter 7 155 "assessed value," a term defined in the implementation order to equal BTI's depreciated replacement value. 7.57 In many countries, the payment of property tax has been a first step in defining property rights. In Russia, this may be happening because the tax rates and tax base are quite low, while the incentive to stake out claims to land parcels is high. Enterprises can pay the tax in a simple declaration procedure according to the land area they claim; apartment occupants can pay according to their proportion of total floor area, once the land area of the building is determined. This process will help to define the land area that firms and apartment buildings are using, thus clarifying their holdings or identifying areas of conflicts. On the other hand, the current tax has numerous shortcomings. (1) The law determines an actual ruble payment per hectare, a number that becomes increasingly meaningless in a high inflation setting. A better approach is to allow local governments to set a rate which then allows revenues to track market values. (2) The normative assessments are not based on real transaction prices or actual construction costs, but instead on "depreciated replacement costs," a book value maintained by the BTIs on all buildings. This number could only be a good proxy if related to current prices or real construction costs. Estimates indicate that the June 1992 replacement cost for residential construction was 35 times the official normative value. Assessed value should be based on either the market value of property calculated from actual replacement costs or transactions prices. (3) Specified tax rates are also quite low, so that combined with the low normative assessments, the amounts collected from this tax are trivial for most users. They may even be below the cost of collection. As a collateral issue, the extremely low rate for residential property -- 3 percent of the citywide rate -- discourages local governments from promoting residential construction. (4) A serious drawback of the law is that it allows a high degree of arbitrariness in the value assessment of individual buildings. Article 13 allows negotiation of the value on a case-by-case basis. Also a highly discretionary series of exemptions may be applied for particular taxpayers, including for example, young people, artists, large families, or veterans. Such discretionary power over assessments is prone to corruption and might encourage municipalities to interfere in the enterprise decision- making. Allowing individual negotiations maximizes the transaction costs of administering the tax while encouraging evasion and corruption. 2. Directions for Refonn 7.58 As the above analysissuggests, the key elements of a reform strategy in the land information- valuation-taxation areas are: (1) the establishment of a reliable, public cadastre with incentives for private individuals to report transactions prices accurately; (2) better valuation techniques that move from normative to market prices; (3) the reform of the land tax law to set more realistic, consistent, and non-arbitrary rates at a local level. 156 Chapter 7 Necessity of a Cadastre 7.59 The most urgent step is to create a reliable, transparent, public cadastre that identifies parties to real estate transactions, the land and property rights conveyed, the type of transaction, and the actual purchase price. Land markets require a clear identification and delineation of land parcels. This requirement of markets is reinforced in Russia by the 1991 Law on the Land Use Tax of the Russian Federation which introduced the annual payment of a tax for use of land (analoga). Cadastral information is necessary because land appraisal must be based on current, complete, and accurate cadastral maps that show boundaries, areas, legal constraints, along with identification data. Thus a public, accessible cadastre serves several purpose, such as -- providing information about functioning of the land market, facilitating collection of a land use tax, and providing information for land use planning. Access to such a register should be broadly open to the public, with only a small fee to cover -cadastral administration. 7.60 While a cadastre does not exist presently in Russia, most of the basic information is already available in the municipal BTI offices, which could be compared to the German Grundbuch, or property registry. As discussed above, the key missing element is the lack of a general cadastral map that gives coherence to individual building passports, or allows continuous maps of new subdivisions or land pooling. The second key missing element is a reliable link between land and property titles. Thus, the Land Reform Committees are planning cadastral surveys and registration procedures that would clarify parcel boundaries, identify owners, and document forms of tenure. The Property Committees and BTIs have good building information, but the land and property agencies are not unified. There should be in each city a single, centralized archive of property records that includes both land and property transactions. 7.61 Creating incentives (positive and negative) to encourage parties to report the actual transaction price will require a creative approach. One possibility is to give the municipality the right to preempt transactions that clearly understate the transaction price, by allowing the city to buy the property at, say, a 10 percent premium and then auction off the property. Another mechanism is to require a notarized statement as to the accuracy of the reported price, with stiff penalties for fraudulent reporting, such as forfeiture of the property or voiding the contract. (See ANNEX 6, Part V: Registration of Property Interest). Land and Property Valuation 7.62 Better valuation techniques are a difficult undertaking in the present unstable and high- inflation environment. The paucity and low quality of economic information, which is one of the many legacies of the administrative-command system, could be corrected relatively rapidly considering the extensive size of Russian administrations and the education level of the workforce. It is at the conceptual level that the greatest needs exist since, there is no data collection system with an underpinning analytical and decision-making framework. At present, the information requirements of real estate markets remain imperfectly understood. The problem exists at every level of government. Regarding the price of land in particular, the analysis presented in Part III and the early analyses presented in FIGURE 7.2 indicate that modemn mass-valuation methods to identify the market value of land can be adapted to Russian cities with great benefit. The critical difference Chapter 7 157 between such methods and the current Russian attempts to derive "normative land prices' is that mass valuation methods can embody the concept "highest and best use' which is missing in Russia today. 7.63 The long-term goal is valuation based on actual transaction prices. Professional assessors should be trained to estimate market values based on standard procedures that refer to actual prices of comparable property sales. The assessment procedure should be established in a manner that ensures its relative impartiality, including appeals procedures for property owners. Tax preferences or tax exemptions could then be implemented through differential tax rates and not through preferential value assessments granted on a case-by-case basis."' Improving the Land Tax 7.64 In general, the Land Tax is a good start. It encourages owners to declare ownership of their land and to begin to think about defining their land parcel boundaries. It prepares the public for the concept that along with ownership comes responsibilities in the form of paying taxes. It encourages municipal governments actively to develop and improve their cadastre. And, if assessments and tax rates are made more realistic, it acts as an incentive to use well-located urban land more efficiently by increasing the costs of land hoarding. 7.65 However, there are flaws in the present version of the law. First, it specifies prices in rubles. Inflation will soon require a new act of parliament to modify and update it.9' Prices are elements of managerial decisions which should be kept to the lowest level of government possible. There is substantial economic irrationality to assigning the same implicit economic value to land everywhere. Second, the perspective on taxation should be different. The present law assigns different prices according to current land: two contiguous parcels with different uses could be priced totally differently. This will insure long-term land resource misallocation. The better perspective is to price land according to highest and best use and then select an appropriate tax rate. If certain activities or historical sites need to be encouraged or protected, respectively, then the tax rate can be adjusted accordingly. 7.66 The Land Tax should primnarily be a local tax. It can be one of the few reliable sources of revenue to support infrastructure and public services provided by cities. Municipal governments should be able to set real estate taxes and rates -- indexed to market values -- within their jurisdictions as they deem appropriate for their local revenue needs and local voters' willingness to pay. u1 At this time in Russia, such a structure is in place. 9' Such amendments have already been made. 158 Chapter 7 D. The New Professions: New Role of Urban Planners in Market Cities 1. Overview 7.67 The reality of urban planning and development differed substantially from its principles under the central command system. The basis for socialist city planning derived from decrees on land, home ownership, and nationalization of industry set during the period 1917-1920. Two distinct types of planning emerged from the first five year plan (1928-1932): with "planirovaniia" or socio- economic planning by industrial development ministries dominating over 'planirovka" or physical planning. Key principles of urban planning included: (1) the nationalization of land; (2) normative rather than market determined land use; (3) standardization of urban-service provisions to reduce residential segregation and increase the role of public transport; and (4) centralized economic planning. Despite reform efforts during the 1950's and 1960's, local physical planners and municipalities had little or no power in shaping urban planning, plant location, or housing allocation. The distribution and character of housing followed central industrial planning. 7.68 As was shown in Section II of this chapter, Soviet cities were not planned as entities and their layout hampered rather than enhanced their efficiency and livability. The reasons for the shortcoming of Soviet urban planning throughout the Union were cogently summarized as follows, almost 15 years ago:' (1) Despite voluminous writings on the ideal socialist city, no viable theory or set of principles have emerged to provide a coherent set of guidelines for the future; (2) Although cities since 1971 have been required to produce plans for their orderly development, they have generally lacked adequate staff to elaborate such plans, relying instead upon special contracting agencies in Moscow and Leningrad whose personnel usually have little knowledge or sensitivity concerning local planning problems; (3) Planners, whether from the local governments or from the national contracting agencies, made decisions without adequate data on demographic trends or future investments by central ministries that had fundamental impacts on their communities; (4) Completed plans were not implemented because local authorities lacked their own finances for capital construction. They also lacked political authority to compel industrial ministries and other agencies that had funding resources to build in conformity with their plans; (5) These central bodies had their own priorities for constructing factories, workers' housing, and utilities in a given community. In seeking to balance their own budget 'IO See Thomas M. Poulsen, 'Urban Forms and Infrastructure in the Soviet Union' in Steven A. Grant, editor Soviet Housing and Urban Design, U.S. Department of Housing and Urban Development, September 1980. This work was based on a US-USSR technical exchange agreement carried out in 1979. Chapter 7 159 they felt free to overlook both local planning objectives and even nationally set norms for auxiliary retail and service facilities; (6) The staff assigned by these central bodies to develop factory housing complexes were unfamiliar with urban planning needs and problems and were prone to serious errors in their decisions; (7) Because of a chronic shortage of housing there was a reluctance to tear down existing accommodations. 2. The Current Urban Planning Process 7.69 Currently physical planning is based on master or structure plans, and local plans. Master plans provide the main directions for future development on a scale of 1:10,000 and remain valid for 25 years; while local or site plans, usually very detailed at 1:600, are often prepared for a single project. In practice, master plans are often obsolete by the time they are prepared and local plans are prepared on a case-by-case basis following project completion. Concepts such as floor-area ratios, servitudes and easements does not exist in such planning practice. Modern zoning techniques which focus on local notice and dispute-resolution procedures are entirely absent from such planning processes. 7.70 Second, no reference is made to the notion of infrastructure cost. Infrastructure construction and maintenance are considered to be social services such as health or education. No specific accountability for infrastructure is required of municipal authorities. Nor are costs apportioned among specific projects or between initial investment, maintenance, or improvement costs. There are no procedures for calculating the implicit subsidies being transferred to privatized households or enterprises in well-serviced areas, nor are there procedures to allocate costs and responsibilities for provision and production of new infrastructure between the public sector and private developers. 7.71 Third, there are no clear rights and procedures for conversion of agricultural land to urban uses. Many countries experience severe disruptions in urban land markets because of policies which overly restrict such agricultural land conversion. Cities and oblasts previously negotiated for conversion of oblast-controlled raw land at the urban fringe. Cities compensated oblasts, but not the kolkhozes, for the supposedly free land by making contributions to regional funds for agricultural development under the Ministry of Agriculture. These contributions were implicit prices, which should be made explicit, and paid to current right-holders of the land. Newly privatized farmers at the urban fringe are now in a precarious position because they can not alienate their land for a minimum of 10 years. 3. Directon of Reform 7.72 First, local governments will need to ensure the availability of land for new housing construction in areas where there will be the highest demand. While this new demand has not yet manifested itself, the rough outline of its characteristics can be anticipated: land consumption per unit of floor space should increase from the center toward the periphery. This new trend could be summarized as: high-rise buildings in the center, medium-density structures in the close periphery, 160 Chapter 7 low-rise townhouses and individual houses in the far periphery. As can be seen, most of the rnew demand for land will be located in the existing built-up area. Making this land available will require the following simultaneous actions by local governments: (1) Establishing a legal framework to allow present land users to trade the land they occupy and retain a large part of sale proceeds. This would require streamlining the legal land-registration system; (2) Amending zoning and building laws to allow the maximum of flexibility in land input and land use; (3) Identifying areas which are more likely to be transformed in the near future; inventorying land and infrastructure upgrading required under different density scenarios; and (4) Close monitoring of land use changes and land prices, formal and informal, in order to anticipate infrastructure investment and upgrading needed to support changes. 7.73 Second, better planning practices are not the most important factor for improving land-use efficiency in Russian cities. Rather, the most important factor will be establishing tradabk land property rights. When those rights are established and a real estate market starts functioning, the role of urban planning will again become important. A new role for planning will consist mostly of monitoring and anticipating land use changes triggered by demand, and in designing infrastructure and a new set of urban rules which will allow the new land uses emerging from the market to function effectively. 7.74 Third, the government will need to support new or improved infrastructure and social facilities required by land-use changes under market conditions. Provision of this new infrastructure must be guided by the reference to land market forces, so that investments are made in areas where they will provide maximum benefits in a short period. For example, from the analysis above it appears that the reinforcement of infrastructure and reclaiming of a number of railroad right-of-ways in areas immediately adjacent to the center will provide high economic rates of return. The temptation to run away from urban problems by investing heavily in new peripheral areas and satellite towns should be avoided. 7.75 Fourth, in the area of the urban environment, new regulations will have to be drawn quickly to protect the limited amount of land occupied by historical monuments and valuable traditional neighborhoods from the market. In addition, Moscow and St. Petersburg contain some valuable natural features such as forests, lakes, river, or seashores which should be clearly be protected. The slight decrease in the supply of land involved in the protection of natural environment and historical monuments will increase the market pressure on obsolete land use within the built-up area and, therefore, contribute to the acceleration of recycling land toward a better land-use efficiency. Chapter 7 161 4. New Role of Urban Planners in Russian Cities 7.76 Land-use planners would have to be trained for a completely new approach to their job. Instead of "designing" new areas with the sole supply constraints of a monopolist developer, they will have to: (1) Monitor land use trends brought by households and enterprise demand. (2) Monitor market land prices and rents. (3) Monitor the supply of developable land and the recycling of already developed land. (4) Review the affordability of land-use standards in relation to land prices and construction cost. (5) Relate the cost of primary infrastructure with the value, type and intensity of use of the land it serves. (6) Analyze the spatial, economic and financial consequences of land-development alternatives. 7.77 This new job content of urban planners parallels that of the new professions emerging in Russia such as property valuers, bankers, land developers, and real estate developers. m:\rhsector\green.cng\chaptcrs\chap7x.v6 17:0SAugust 9. 1995 CHAPTER 8 HOUSING AND THE CONSTRUCTION INDUSTRY: PRO-COMPETITION AND PRO-EMPLOYMENT REFORMS Table of Contents . NTRODUCTION: THE NEED FOR CHANGE ................... 163 II. CURRENT ORGANIZATION OF THE CONSTRUCTION INDUSTRY 164 A. The Construction Process .164 B. The Roles of the Parties to the Construction Process .165 The zakazchik Organization .165 Designers .168 Builders .168 C. Building Technologies .170 D. Building Materials ................................... 171 E. Procedures, Documentation and Information .173 m. CURRENT CONSTRUCTION ISSUES ..174 A. Repair, Maintenance and Rehabilitation .174 B. The Energy Problem .176 C. Unfinished Buildings .176 D. Resource Requirements .176 Materials .176 Equipment .176 Manpower .177 Management Training .177 IV. THE TASK AHEAD ....................... 177 A. Restructuring and Privatization of the Construction Industry .................................. 177 B. New Demand for Building Materials and Equipment ............... 181 C. The Changing Role of Government .......................... 183 CHAPTER 8 HOUSING AND THE CONSTRUCTION INDUSTRY: PRO-COMPETITION AND PRO-EMPLOYMENT REFORmS I. INTRODUCTION: THE NEED FOR CHANGE 8.1 The construction industry in Russia has not been functioning well for many years and its performance is deteriorating further. The malfunctioning is evidenced by a whole range of factors on which there is broad professional agreement. The important ones are: * The need for housing and some other construction products has not been met. * The output of housing has actually fallen in spite of the great need for housing. * The housing product - the large, high-rise, heavy concrete-panel apartment blocks -- are not liked by most of the occupants and there has been no mechanism by which occupants of buildings have been able to influence what is built. * There have been shortages of materials; homeowners and cooperatives have been unable to buy materials and other organizations have experienced delays in obtaining them. * There are shortages of some construction skills. - Construction periods for many buildings have been long and the number of unfinished buildings on which no work has been done for a considerable time is substantial and increasing. * The planned costs of construction for buildings have been exceeded several times for many projects for many years. The price reform in January 1992, which was exploited by monopolistic construction materials organizations, created havoc with past price structures and has made completion of many buildings impossible. * The resources used in the construction of buildings appear to be greater than in comparable buildings in Western economies. Not all of these failures are the direct result of failings in the construction industry itself, which has a considerable number of highly skilled professionals. Many flow from the all-pervasive, centrally administrative-command economic system. 8.2 A first requirement for change in the construction industry is for the industry itself to be more responsible for its operations and its products. This process will be greatly assisted by privatization and the development of market relations within the sector. In addition to proposing 164 Chapter 8 concrete directions for reform, a central aim of this chapter is to establish why the construction industry is one of the industries which could benefit the most from privatization of any activities in the Russian Federation. This is particularly true of the building segment as opposed to public works projects. H. CURRENT ORGANIZATION OF THE CONSTRUCTION INDUSTRY A. The Construction Process 8.3 The construction process throughout Russia is substantially under the control of state organizations. The state is the controller of physical planning and the supply of land and functions as the main client, designer, builder, material producer as well as the supplier and owner/operator of the finished product. During the mid-1980s, when there was increasing concern about the productivity of the economy, administrative reforms were promoted for urban construction. These reforms, however, were remarkably ineffective as they aimed to increase existing monopolies in order to"streamline decisions". The concept of "one-client, one-designer, one-builder" was promoted for the 150 largest cities in the hope of improving efficiency and productivity in the sector. Some limited erosion of this monopoly is now occurring with the emergence of housing cooperatives, private companies and joint ventures on the client side and cooperative builders on the construction side. (For a description of the industry please refer to ANNEX 6: The Organization of the Construction Industry in Russia). 8.4 The construction process in Russia is one in which there is a predetermined chain of delegation of powers, allocation of work and orders for delivery. There is very little choice as to the participants in the process at any stage -- unlike the market economies in Western Europe and elsewhere in the industrialized world, where there is choice at every stage of the process, based on price, regulations, and the qualifications of the participants. 8.5 Control of all construction functions by government organizations has three major disadvantages. First, there is no choice as to the organization used for different functions. Second, no importance is attached to the price at which goods or services change hands because it all comes from the same budget; hence any real information on, or control of, costs of the functions is lost. And, thirdly, there is no incentive for efficiency. A structure where the functions of the parties are separated is vital for efficiency and must be created. 8.6 There has, however, been a marked change. Whereas, until 1987, 85 percent of the funds and material resource allocations came directly from the central government, by 1993 less than 10 percent would come from that source, (refer to Table 6.1 in the housing finance chapter). By now more than 50 percent of the funds are coming from various enterprises and new private employers. It can be expected that non-government organizations will be investing for their own use, and that others will begin to act as new developers. Willingly or not, the dominant state organizations will now have to leave room for new, more efficient construction processes. Local governments will have a major impact on how well this transition will managed. Chapter 8 165 B. The Roles of the Parties to the Construction Process The Zakazchik Organization 8.7 The minimum role of the client is to decide what is to be built; select advisers, including designers; brief them on requirements; select builders; arrange for, or provide, finance; and pay his advisers and builder. In market economies, many clients take a more active role than this in making sure they obtain the building they require. In Russia, the client function is delegated to a zakazchik organization which effectively divorces the client from the process and the product. What differentiates the construction industry from all other industry is the central role that the contracting process plays. The difference between the zakazchik organization in Russia and the developer in a market economy represents the most crucial distinction between the construction process in a market economy and under Soviet central planning. From the role of the zakazchik flow some of the most important contrasts in organization between the Russian and Western construction industries. (The central role of the developer in a competitive building industry is discussed in 8.1. The basic interactions between the developer and the contractors who work for him are presented in graphic form in 8.1). 8.8 What is a zakazchik, and what does a zakazchik organization do? The functions and powers of a zakazchik are directly related to the budgetary powers and political process of central planning and the administrative-command system. The verb "zakazat' means 'to order". The function of the zakazchik organization is to be the client's adviser and to be in charge of getting the project constructed and organizing payment. In practice the zakazchik function is broader, virtually taking over the role of the client and controlling the supply of building materials and the construction process.' In Moscow and other large cities, until mid-1992, there was no choice for clients as to the zakazchik organization they could use, either at the functional level or at the level of the sub- departments. The regional organizations in Moscow handle housing and other small-building work within clearly defined geographic areas. Similarly, for larger works the divisions are by types of work -- hospitals, theaters, scientific buildings, industrial and agricultural buildings, community buildings, even for historic buildings, etc. There is no great difference from the management viewpoint in these types of construction, with the possible exception of historical buildings, and very little difference in the construction itself. 8.9 To illustrate the wide range of functions assumed by this core organization, within the offices of the umbrella zakazchik organization of Moscow (Moscapstroi plus its subordinate offices which are undergoing another reorganization) the following functional departments can be found: project documentation and pricing; finance and administration; production and operation control; preliminary investigation; pricing and negotiation; project examination and evaluation; foreign personnel and projects; legal and contracts; accounts and financial aspects; and current affairs. 'I The 13-language Dictionay of Building Terms published in Moscow in 1986 offers translations in various languages which have different meanings in a market economy. A zakazchik is alternatively translated as investor (Czech), issuer of orders (Auftraggeber in German), client (French, Spanish), customer (English), and beneficiary (Rumanian). 166 Chapter 8 BOX 8.1 THE DEVELOPER: A Missing Profession in the Russian Construction Industry A Key Agent of Change in Market Economies The profession of developer stands at the center of change in the evolution of the building industry of market economies. It will be central for the development of market-based housing in Russia. To the developer falls the responsibility to estimate market demand properly, and to make the links between final users and the building industry. This group of decision-makers holds the functional, economic and financial responsibilities of a project. They are critical to the dynamics and well-being of the industry. The profession of developer does not exist in a centrally - planned economy because the essence of development is to aim for a maximum margin between the selling price of a project and its production cost. The developer aims to maximize value, the zakazchik wants to |minimize costs in order to maximize his assigned volume of production. How Does a Developer Maximize Value? In practice, the economic value of a project is reflected in the developer's margin. This margin is determined by: the expected sale price that the market will bear, minus: -the costs of land acquisition -the costs of design, land development, and construction -financial costs -and overhead costs (management, marketing costs, taxes, and insurance). These costs are significantly dependent on the speed and volume of sales. The developer takes the risk that his evaluation of the market is correct. Under central planning, the maximization of this margin did not have any meaning. Moreover the relevant information did not exist. There was no land, nor housing market. Instead of precise contractual arrangements with negotiated prices, prices were derived from administrative tables of standard costs, with the possibility of bureaucratic adjustments. As a result, it was impossible to know the total cost of all the resources mobilized by a development project. Bartering between client enterprises and the building organization further obscured true costs. Profiles of Developers In a market economy, the strategy of a developer varies according to: his capital and his ability to raise additional funds; the functions he chooses to assume in bringing the project to a successful end; and, the type of product and its location. The basic types of developers have already emerged in many transition economies: (1) the developer with only rinancial and managerial expertise but with not special technical expertise; (2) the developer who has a design and engineering capability; (3) the developer who also designs and organizes the project, usually including the delivery of materials and supplies; (4) the developer-builder. Coordination Functions of Developers The critical coordination function of professional developers is outlined in the accompanying 8.1. This figure also shows in summary form all the key participants in the construction process. The initial step is the project preparation, during which access to land, to finance, and the design of the proper project to meet demand shape the entire project cycle. The second phase of the project is the actual construction, coordinated through a complex but effective series of contracting and subcontracting arrangements. This contracting process and the methods of risk-allocation which it serves is described in BOX 8.2. Chapter 8 167 FIGUJRE S.1 THE CONSTRUCTION INDUSY IN A MARKET ECONOMY ROLE OF DEVELOPERS and CONTRACTORS -II OWNERS,PROFESSIONAL DESIGNERS @ OF LAND . DEVELOPER (ARC CRE ----------------------I DESIGN ENGINEERNG . ------ . x XtFINANCE) FINANCL FINANCCG ,INSTITUTIONS ; . PROJE:CIt I ) \ 0 QUAI1Y CONTROL BUREAUS I INSURANCE COMPANIES ';------------------ -------- -BUDLNG EBNTEPPRISES (GENPEAL CONTRACTORS/SPECALI CONTRACTORS) -CIVIL ENGINEERING F1iMS -INDIEPENDANT T.RADES -BULDING MATERLIL EQUIPMENT OTHER GOODS -COMPONENTS AND -EvQUIPMENT SERVICES DEALERS & TRADERS IMPORTEPS _ I]:J~LESING COMPA(NIES PRODUCERS , OF MATERIALS { | EQUPMENT . COMPONENTS PRODUCERS OTHER SUPPLIERS EQUEPMEYr (1) HOUSLNG. COMLERCAl Rr.f £STAT1. ROADS. PtTUC [NCASTRUCTURE(Nrw CONSTRUCTION. ALNTINNCLRERLUABATION CONTRMUTORS TO TRE SECTOR BUT NOT PART OF rr M. .C DA. M WA itZWT 9t 168 Chapter 8 Designers 8.10 Very large public-sector design offices undertake virtually all the design work in Russia. The dominance of such offices is contrary to the structure of design organizations in most countries of Western Europe where public-sector design offices are normally staffed by tens of, or perhaps a hundred, persons and private architectural practices are normally very small, with only a very few employing more than 100 persons. The public-sector design offices in Russia should be split up as soon as possible into much smaller individual units operating as profit centers and independent of central control. The teams within the organizations would seem to be the appropriate units. They should be privatized. In fact, recently architects have begun to establish private practices. In Russia there are 300 architects with a license to practice and in Moscow there are already about 100 firms, most of which are one-man practices, and many of the principals have other employment. A society of independent architects has recently been established in Moscow with around 70 founder members. These firms have very little work, but they represent the beginning of a private design profession which is expected to grow rapidly. These private practices should be encouraged. At the same time, any restrictions on clients as to which design organizations they choose for projects should be removed. Builders 8.11 The public sector construction organizations responsible for work on site are called trests. Trests are grouped together under control organizations (PKUs or Proizvodstvennoe Koordinatsionoe Upravienie and Kombinats) which in turn are under ministries and other superior organizations. Trests undertake general works, specialist trades, or plant hire. In Moscow and in Russia as a whole, they are divided into building departments known as SUs (Stroitelnoemontazhnoe Upravlenie or construction and assembly organizations) for general building organizations and by other names for those having more specialized functions such as working with a kombinat. Trests typically employ a few thousand persons, SUs a few hundred. Trests and some SUs and other subsidiaries could become independent operating units; subsequent privatization should be direct and not through a holding company. The organization of the industry and organizational names vary from city to city. Not surprisingly, Moscow which is the largest city and the seat of government, has one of the most differentiated and complex organizations.2 8.12 Kombinats are organizations which manufacture structural components and erect, and finish housing blocks. In the Russian Federation there are about 2,700 Kombinats , there are only four in Moscow producing 60 percent of the City's housing. They rely on an obsolete technology of large- panel reinforced concrete which is energy intensive and costly during production and assembly, and which produces poorly insulated units that require high levels of energy to operate. These kombinats are prime candidates for restructuring as they have no long term future. At what rate they should be restructured depends on the demand for new housing and other buildings, on the development of the supply of alternative resources, and on the technical state of the plants themselves. No new major capital investment should be made in the existing plants. It may be that some of the plants 2/ At this time in Russia the privatization of construction contracting organizations, construction industry and building materials enterprises is practically completed. Chapter 8 169 BOX 8.2 THE HOUSING DEVELOPMENTPROCESS IN MOSCOW (1992) A schematic outline of the process for housing development under the Moscow City Council is shown in the diagram below. The initial stages of a project are handled by Moscapstroi including approvals. Then various territorial Moscapstroi organisations - Territorialnoye Upravleniye Kapitelnogo Stroitelstva tTUKS) operate as zakazchik or client representative, for specific projects. - "C-LIENT I MATERIALS SUPPLY S_LCER I I Su - CONTRACTORS When overall approval has been obtained and costs approved, the funds for the project are paid into a bank and the zakazchik chooses a design organisation and a builder, the latter generally from those operating in the area. Materials costs and labor works are based on published lists. The builder buys any necessary equipment. Builders and specialists request the zakazchik to arrange for materials, transport and security for the site. Access to materials is very important because materials have to come almost entirely from Mosstroikomitet organisations. Many miaterials are in short supply. Materials are supplied and paid for by the builder. The zakazchik supervises the work on site: the designer may also undertake some inspections. Builders receive advance payments of up to 40 percent. Thereafter payment is according to progress achieved. For contracts completed on time, a bonus of 1 % of contract value is paid. If building is behind schedule, a penalty of 5 percent is payable so that only 95 percent of the value is paid when the work is completed. Once a building falls behind schedule and work has stopped, there is no special incentive to complete it. The incentive to start work on another project is greater than finishing work on the first one. At one time, the builder received 10 percent of all housing units constructed before they were allocated to the client. This percentage has now declined. T'he fee charged to Moscow City Council by the zakazchik for a standard building is one percent of cost; for individual projects or awkward sites he will charge 3% or more. However, if the client is other than th Moscow City Council, the fee can be 5-7 percent. Clearly, the Moscow City Council receives very favourable treatment. 170 Chapter 8 could be converted to other material production. This should be assessed by commercial, financial, economic and production engineering studies. 8.13 Over the last few years, building and civil engineering cooperatives have grown and they may now be producing 8 percent to 10 percent of total construction output, though less in Moscow. The average employment of the cooperatives which are members of the Union of Civil Engineering Cooperatives and Entrepreneurs is about 80 persons but some employ more than 2,000. There is a tendency in some cities, such as Moscow, to dismiss building cooperatives as insignificant and/or incompetent and, therefore, they receive very little work. 8.14 The development of private sector organizations is a key link in the move towards a market economy, especially as many will be small organizations more suitable for single family dwellings, and rehabilitation, repair and maintenance work priorities in the housing sector. The opportunities for cooperative organizations to obtain work and access resources should be equal, in practice as well as in law, to those for former state building organizations. C. Building Technologies 8.15 It is beyond the scope of this strategic review to discuss at length the shortcomings of the closed industrial-housing systems organized around a technology of large panels of reinforced concrete. There is a well-documented record in countries like France and the U.K. that such a technology is entirely dependent on "reserved markets," i.e. large-scale monopolies created by the state.3 The urban regulatory system of Russia has been organized to favor this form of industrial housing, almost to the exclusion of all others. Chapter 7 on land use in Russian cities has stressed the interaction between land use, urban planning, type of financing available and the technological choices implemented by the building industry. This urban regulatory environment must be reformed and liberalized to meet new types of demand and therefore new types of housing products. The entire European experience, East and West, is that the development of the industrial production of reinforced-concrete components could only be insured with support from the government in the form of large-building contracts, for long periods of time, with explicit or implicit financial guarantees of various forms and often in the face of a hostile reception by those living in the apartment blocks. Such industrialized methods have taken the wrong direction and have become an obstacle to the further development of the industry. 8.16 A wide variety of technologies can be used to improve productivity of the sector. But none is universally applicable. A fundamental shift in perspective from a pure engineering and physical view of the construction process is essential in Russia. The new dominant perspective should be that the main feature of a good building technology should be that it facilitates organization and control, and is financially sound from the viewpoint of the life-costing of buildings. Industrial housing has been a failure in the East and in the West every time government planners have forgotten that economies and cost reductions are achieved mainly through efficiency, flexibility and speed, and 3/ In the 1950s and 1960s (Khrushchev period) this system was justified by the necessity to greatly increase the number of houses being built. At that time, Russia and the USSR ranked first in the number of apartments constructed per thousand persons of the population, but the houses built were of poor quality. Chapter 8 171 not through some golden low-cost material or industrial process. In particular, many of the early industrial systems concentrated on the core building structure. It is now well recognized that structure is an important part, but that it does not form the overwhelming part of total costs. Control of the internal environment of buildings for residential, commercial or office use is a major factor where the costs are high. In Russia, interior construction and finishing are a weak part of the construction process. 8.17 In industrial countries today, the central emphasis is on performance specification and design standards that regulate compatibility. The balance between on-site and off-site assembly remains flexible. In countries where the construction season is short due to climatic conditions, such as Scandinavian countries, market-worthy manufacturing methods continue to evolve. Much emphasis is given to rationalization and the application of modular coordination. Assembly-line techniques are reserved for building components that are not site-specific (windows, floors, etc.). D. Building Materials 8.18 The organization of the building materials industry reflects the types of housing products in Russia. Until 1990-91, the share of large-panel reinforced concrete units was over 50 percent of all units, while about 27 percent of housing was built of bricks. The type of housing is linked to the size of urban settlements. Buildings of 12-16 stories or more are built in large cities along main highways where large sites are available. Buildings of 9-to-10 stories are built in most cities. Buildings of 4 stories are built mainly in small towns and settlements. Single-story houses made of bricks, timber and other local materials are a significant type of construction only in rural areas. Individual housing construction, which used to represent 50 percent of all construction in 1960, was suppressed until it reached a low level of 5.9 percent of output in 1986. This is an activity that is once again considered politically acceptable. It fact, it is actively promoted by the body of new housing reform laws and the 1993 Government Housing Program. 8.19 As a branch of Russia's construction industry, the building materials industry's activity and size are directly related to the type of investment selected by policies. The building materials industry is organized into 20 sub-branches with over 14,000 enterprises employing more than 1.3 million people. Russia has 46 cement plants; about 2,000 plants making wall materials; 2,700 precast concrete factories and kombinats; 59 porous aggregate plants; 42 building ceramics plants; 215 plumbing fixtures plants; 2,600 gravel and crushed stone plants; and 90 thermal insulation factories. The building materials industry has produced enough to satisfy the needs of state building organizations for traditional materials, but the technology and quality standards, as well as the reliability and environmental safety of the equipment are lagging much behind world standards. 8.20 The age structure of basic equipment is a major cause for concern. Almost all the equipment is 10 or more years old. Nearly 80 percent of the annular kilns and half of the rotary kilns and shaftlime kilns are at least 20 years old. The general level is below world standards. Only 0.8 percent of all cement rotary kilns are considered to meet world standards. The majority of them (60 percent) fall below the average for the cement industry. Problems are similar in building ceramics and the manufacture of asbestos cement products. Because of the heavy work and low wages there is an acute shortage of manpower in some sub-branches of the building materials industry. Yet the share of manual operations is very high (above 30 percent), especially in finishing products. 172 Chapter 8 8.21 Throughout the federation, building materials production and supply are almost without exception under the control of state organizations.4 There are shortages of materials in Russia, but because of the fall in construction output these shortages should be shrinking, at least for materials domestically produced. One of the reasons why shortages persist is that some key materials come from outside Russia and, because of the break-up of the USSR, this trade is disrupted. (For nore details, see ANNEX 7: The Building Materials Industry in Russia). 8.22 The process of privatization and establishment of new firms has been significant in the building-materials industry. This process has first involved cooperatives and leased enterprises. Intensive organizational changes can be observed in the major industrial concern ROSSTROM which comprised 1,000 building-materials enterprises. In that concern the first cooperatives and leased enterprises were established in 1987. Since then, the process of decentralization has proceeded very rapidly. Joint ventures as a form of business organization have also spread in the branches. The first joint ventures were established for the production of reinforced concrete modules and products; ceramics, porcelain ware, and plastics; natural stone products; sand, gravel, and crushed stone; and plumbing fixtures. Yet the share of these joint ventures in the branch in terms of output remains insignificant. A survey of the ownership structure of enterprises in mid-1992 indicates that 94.5 percent of the enterprises remain under state and municipal ownership, and 6.5 percent are privately owned. 8.23 In January 1992, the prices of construction materials were liberalized, but these material prices are not representative market prices. They rose by a factor of 10-to-15 even though demand for construction was weakening. Such pricing behavior reflected monopolistic pricing by construction materials organizations as well as the increasing use of building materials as stores of value and assets of refuge due to the exceedingly high inflation of 1992. In many cities, the allocation system is still informally in place. Discriminatory pricing in favor of state organizations and against new builders is a frequent occurrence. 8.24 The shortage of materials and their continued allocation by government has implications for the whole construction industry. It is the reason -- or an excuse -- for cities like Moscow not making the building trests independent units. Their inability to gain access to materials is a major reason why building and engineering cooperatives are unable to develop decentralized producers. Restricted access also prevents the development of maintenance by householders because it is so difficult to obtain materials. Other ramifications are the diversion of materials from building sites and manipulation of the centralized administrative system by those seeking private gain. 8.25 What remains of the system of allocation of materials in various oblasts and cities should be discontinued immediately. Each builder should be able to go directly to the plants and developing distribution centers. It is understandable that there will be substantial problems in dismantling the system. Now, however, is the right time to take this action because: the volume of work is decreasing in Russia as a whole so that the shortages of some materials will be less acute; 4/ See footnote for paragraph 8.12. Chapter 8 173 to do it over a long period of time would lead to hoarding and stock-building to take advantage of later price rises, which would then become the rationale for further controls; there is great disruption to the construction business because of the last price rises. Given the nature of the construction process, it is better to have all the disruption now rather than extending it over a long period. 8.26 At the same time, material-producing plants should be made independent units and should be required to make a profit. However, in order to establish competing independent units there needs to be sufficient numbers of organizations in the same type of business to provide competition or at least a basis for comparison of performance, e.g. return on capital employed. This is not difficult in major population centers where there are a number of different plants. However, the large scale of production of certain existing plants, together with the great distances involved, means that many plants are effectively regional, if not national monopolies. Breaking up monopolies would require careful examination, as the replacement of a public monopoly by a private one would be undesirable. 8.27 In the short-term there will continue to be shortages of certain building materials. Whatever the output and technology mixes, there will be a need for increased capacity for bricks and other walling materials, wood products, insulation and a number of finishing materials. Further work will be necessary to define what types of these products should be produced, the appropriate technology and scale of production, the locations of the plants etc. For Moscow -- a large urban area -- the production of most building materials should take place outside the city boundaries. Half the plant for materials factories comes from outside Russia. In the short-term, machinery for extra capacity will have to be imported. Joint ventures will be one way of financing investment. 8.28 The construction-materials industry in Russia should be the subject of a comprehensive review beyond the scope of this report. This should include the appropriate units for privatization, a series of pre-investment studies of bricks and blocks, insulation materials, timber and timber products, and ceramic tiles for all uses; and an overview of materials for finishing trades. These studies should be carried out immnediately. However, the creation of independent units should not be delayed even though details of privatization should await the results of the study. E. Procedures, Documentation, and Information 8.29 In Western market economies there are three main ways in which designers and other advisers are chosen: an informal assessment of expertise and reputation, a formal selection process, and design competitions. Clients should make their own decisions on designers and advisers according to their needs and the relative imnportance of time, cost and quality. 8.30 The appointment of builders is more straightforward. The choice is usually determined purely on the basis of price, by inviting tenders to undertake the work. In open tendering any contractor can submit a bid even if the project is far beyond his capabilities and he may do a bad job or go bankrupt half way through. Public-sector and most other major contracts should be let on a 174 Chapter 8 selective-tender basis, perhaps by using a contractor's registration scheme or prequalification for technical and financial adequacy. 8.31 The proposed method of tendering, including the documentation required, should be set out in a code-of-practice for selection of contractors. It would be mandatory for public-sector work. The selection of subcontractors by the main contractor should be similarly covered by a code-of- practice following procedures similar to those for main contractors. 8.32 The various parties to the construction process in Russia already have their obligations to each other embodied in contracts. These documents are very short -- about two pages each -- and need some elaboration. It will be necessary, for example, to set up a dispute-resolution mechanism. The reorganization of the public procurement process as well as private contracting will require a major redrafting of existing contracts and other documents. m. CURRENT CONSTRUCTION ISSUES 8.33 There are three other major issues competing for the attention of policy-makers and the increasingly scarce resources in the economy: (1) In addition to ordinary repairs and maintenance, the ageing of much of the housing stock is increasing the needs for major rehabilitation. (2) The unusually high degree of energy requirements of the housing stock during production and operation. (3) A large volume of unfinished buildings and works in progress. A. Repair, Maintenance, and Rehabilitation 8.34 Ninety percent of the housing stock in Russia has been built since 1945. Some of this was inappropriately designed and poorly constructed in the first place and most has received very little attention since it was completed and handed over to its occupants. Whatever repair, maintenance and rehabilitation has taken place has tended to be minor and superficial. Major works are almost certainly required to ensure the stock's continued viability and to bring it up to acceptable structural, weatherproof, thermal insulation, and services standards. More specifically the age distribution of the national stock is as follows: 1918-1941 10.04 % 1941-1950 6.14 % 1951-1960 21.99 % 1961-1970 21.12 % 1971-1980 22.45 % 1981-1990 24.40 % Chapter 8 ' 175 8.35 In past years, the perceived and actual housing need in Russian cities was for new units. Increasingly, however, there is a need to repair, maintain, rehabilitate and improve the existing stock. If this is not done, the general condition will deteriorate to the extent that building failures will occur and/or demolition will be necessary. This should, if at all possible, be pre-vented. All efforts should be made to keep the existing stock in operation. What is threatening right now is that with the abrupt reduction in the financing of maintenance from central and local budgets, the actual supply of housing services from the stock is shrinking at an accelerating pace. 8.36 Discussions in Western Europe indicate that after 25 to 40 years the need for major rehabilitation becomes increasingly pressing even when a building has not suffered from deferred maintenance. In Russia, before the budgetary disruptions of 1991 and 1992, it was already the case that resources allocated for maintenance were half or less of what was really needed. There is a large body of experience in Western Europe in both surveying and rehabilitating industrial and other types of housing. Such experience should prove helpful in carrying out surveys of Russia's housing stock. 8.37 Major housing-rehabilitation work in cities like Moscow is currently concentrated on the central zone of the city and on old residential buildings of traditional construction. These buildings were previously in multiple occupation and, in many cases, the rehabilitation is comprehensive, leaving only the external walls. The cost of this work is estimated to be not much less than some new building work. In 1990, a significantly smaller area was being refurbished than in 1980, but at a much higher unit cost. 8.38 The financial and real resources devoted to maintenance and rehabilitation should be increased. But, if financial constraints make this impossible, it is preferable to concentrate on maintenance and rehabilitation rather than building new units. 8.39 Whatever the approach adopted to housing privatization, it will tend to increase the pressures for building rehabilitation. Policy on, and approaches to, housing rehabilitation and demolition should be drastically reappraised. The cost-benefit ratio of money spent on maintenance will be typically higher than that for an equivalent amount of money spent on new construction in terms of the increased supply of housing services. Any additional maintenance and rehabilitation work is more labor-intensive which is currently an advantage in an economy with few near term employment possibilities. 8.40 In some of the more developed western European countries "do-it-yourself' (DIY) home maintenance and improvement makes a significant contribution to the maintenance and upgrading of the existing stock. Two factors severely constrain DIY activity in Russia: a lack of access to the necessary materials and components; and the type of high-rise buildings making up the housing stock. There are a few retail outlets for construction materials, and the range of goods is limited and the waiting periods are long. New retail outlets for materials should be established and the existing ones improved. These should stock not only materials but also a range of hand and small power- tools. Retail outlets could also act as local information centers where leaflets and advice on home improvements could be dispensed free (or at very low cost) to homeowners. 176 Chapter 8 B. The Energy Problem 8.41 The efficiency and effectiveness of residential heating systems in all Russian cities must be reviewed. It is quite likely that technical and economic studies would reveal inefficient use of heating plants, large transmission losses, lack of incentives or mechanisms for the control of heat to dwellings and very low thermal performance of buildings. The absence of metering is by itself a major cause of energy waste. The inability to regulate heating effectively is another. Poor insulation is a third one. A comprehensive study of energy supply, energy use, and energy conservation in the housing sector should be undertaken. 8.42 Alternative approaches are available which can both reduce waste and increase user comfort. The rehabilitation of buildings is an ideal opportunity to replace or modify heating systems and to upgrade the thermal performance of buildings. As energy prices increase, savings from such measures will be dramatic. C. Unfinished Buildings 8.43 There is a relatively large number of unfinished construction projects on which no work has been undertaken for a significant period of time. This trend is increasing. Many of these projects are residential. At least a portion of these buildings should be completed for sale or sold in their current state, with the condition that they are completed within a specified period of time.5 D. Resource Requirements Materials 8.44 The requirements for materials and the action necessary to make them available have been discussed earlier with the review of the building materials industry. One point which deserves emphasis is that the housing reforms recommended in this report will lead to a significant change in the types of building materials needed. Diversified low-rise buildings will have different requirements than the present assembly-line, large-panel housing units. Equipment 8.45 Equipment for use on-site is ageing, much of it is in poor condition and a high proportion is imported. The types required will probably change when the emphasis of the program shifts to rehabilitation and repair. Although some of the existing equipment will exceed requirements, new equipment may be needed. Similarly, power-tools will be required and will be especially useful in supplementing the capacity of skilled manpower. Credits should probably be extended for the supply of hand tools and, if an improvement and repair program is adopted, for special inspection and access equipment. 5/ In June 1994 a Presidential Decree was adopted in the Russian Federation, which provides for the sale on a competive basis of uncompleted housing to investors (including private investors). Chapter 8 177 Manpower 8.46 There are already some skill shortages, particularly in finishing trade. These are likely to increase with changes in technology and the mix of work. There is, however, a comprehensive three-tier training and education system throughout Russia, with schools for operatives under the various contracting organizations, secondary professional schools and technical schools, and higher education. All those with whom training was discussed were confident that the necessary operative training could be provided. Training should continue to be a function of the public sector and should receive the support and supervision of the construction ministries as well as the private sector. Management Training 8.47 Most Russian firms lack basic free-market management skills. These include corporate planning, marketing, buying, cost and price determination, employment and personnel and financial control. All the managers met at the individual-firm level were anxious to have training covering all these topics. A management training program should be set up in conjunction with the Russian Committee for Construction, Architecture, and Housing. IV. THE TASK AHEAD A. Restructuring and Privatzation of the Construction Industry 8.48 A recent regional seminar on the building industry in transition economies concluded that the preservation of large-scale, vertically-integrated, multipurpose, state-owned construction enterprises would be counterproductive.6 In particular, housing construction kombinats are unable to function in a market environment for a number of reasons: type and quality of their product, speed of production, ability to innovate and profitability. The seminar discussed interesting cases of organizations which had 10,000 workers as late as 1989. Since then, restructuring has proceeded decisively. In about two year's time, new firms have emerged from the original vertically integrated organization. Activities irrelevant to the construction business such as training schools, health facilities, and others have been transferred to ministries or other more appropriate organizations. At the same time, the new units have formed around homogenous core activities with the potential to operate in non-bureaucratic ways and to be profitable. Their staff size varies between 20 and 800, with a new average-enterprise size of some 300 employees. Not all problems have been solved and units remain to be privatized. Yet, considerably greater flexibility has already been achieved. 8.49 There is a clear correlation between the choice of the national privatization strategy made in each country and the development of the construction industry, particularly Kombinats. Differences among countries are significant. These differences are linked to a combination of factors. Some are 6/ See 'The Building Industry In Transition Economies," Proceedings of a Joint World Bank-WIFO seminar, Vienna, Austria, Nov. 1992. The two sections which follow are based on materials from this seminar which included professionals, managers and experts from eight transitional socialist economies and five West European countries. 178 Chapter 8 directly linked to the privatization process itself: the national objectives of privatization, the political economy of privatization, the problem of control in labor-managed firms, and the methods used for privatization. Other major factors are the performance of the economy and the level and composition of demand. In a project-dominated industry like housing construction, enterprise restructuring is made possible only through the demand for new work. The Problem of Overcapacity 8.50 Common problems exists across the construction industries of the transition socialist economies. In particular, public enterprises remaining under the control of their national privatization agencies (or state property agencies) face a legacy of serious overcapacity. Persistent state ownership makes decision-making slow and inefficient. It also makes it more difficult to change attitudes within the organization. As long as these enterprises are not fully independent financially and converted into joint-stock companies, they will remain dominated by pressures to maintain employment rather than to improve the adaptability of the firm and its long-term viability. At present, these firms are surviving by transforming and selling some of their assets. Yet, continuing losses and incompressible overhead costs are bankrupting the organizations. Managers are making an increasingly risky bet that a large, state contract will eventually match their current capacity and carry their enterprises over their break-even point. These firms are not adjusting quickly enough with a rapid downward adjustment in operations. As a result, managers and their state overseers may soon be confronted with the liquidation of the enterprise and an haphazard distribution of their assets and skilled labor. 8.51 Labor redundancy creates a major problem for restructuring plans. The fall in real wages and rising open unemployment are evident in all transition economies. Easy solutions are rare. However, representatives from Central European countries (Hungary, Poland and Czechoslovakia) point to the rapid growth of small firms in the industry. Those firms have created new employment opportunities. (See BOX 8.3 on Contracting) The three elements needed to address labor redundancy in the sector are not yet present in too many countries of the region. These elements are: the implementation of pro-growth national economic policies and the use of macroeconomic demand management to revive demand in the sector; safety-net and labor redundancy programs for the short- term; and, perhaps even more difficult given the weak state of the banking system, the provision of financing for small and medium firms that are the backbone of employment-generation. Support to Emerging Developers and New Firms 8.52 Restructuring the building industry in transition economies usually has three distinct parts: support to the emerging new firms; the completion of the large volume of unfinished works; and the restructuring of the large state organizations for their privatization. At a time of reduced state budgets, support to the emerging developers that are market-driven is an area where governments can leverage resources at minimal costs. As can be seen in Poland and Hungary, a very large number of new small firms has emerged quickly. As in Western market economies, some of these small finms will not survive beyond five years. This will be true in the once socialist economies because the regulatory system was not meant for these new producers, but for massive, large-scale, industrial state projects. Chapter 8 179 8.53 The attitudes of chief architect offices and of other regulators often presents another obstacle which should be changed to allow and encourage private sector development. To increase the rate of success among small firms, regulation should be interpreted more liberally. Access to land should be faster and more flexible. Urban planning codes and building codes that are geared to huge projects should be adjusted locally until better codes can be passed. The leveraging effects of flexible urban regulations on small-scale activities are needed everywhere. These effects are likely to be the greatest where economic conditions have deteriorated the most, and old rules create steep barriers to small entrants into the sector. State regulators and other officials must change their thinking and keep in mind that this small new private sector can play a significant role as a surrogate social safety net during the worst years of the transition. Bureaucratic delays and potential corruption should also be reduced. Completion of Works in Progress 8.54 The large volume of unfinished construction projects is one of the conspicuous ills of central planning. The resources at stake represent several years of normal output, but a reliable accounting is not easy. Some projects had been launched as devices to get additional resources from the state to finish other works and were not intended to be completed from the outset. At a time of falling savings and sharpening shortages, the economic rate of return to completing unfinished housing units is expected to be high. In some countries, it has been proposed that unfinished projects be sold at auctions to private entrepreneurs who would finish and sell them. Such an approach should be encouraged, although it may not succeed easily because the design characteristics of these projects make them suitable mostly to the old, large state organizations and their technologies. An inventory of on-going projects should determine what can be completed quickly at low incremental costs. The state enterprises may use these projects for their internal restructuring. For that purpose, the size of the contracts should be lowered as much as possible. In quite a few countries, the "works in progress' include projects that have been approved, programmed in the plan, and designed but are not yet started on the ground. Such projects should be abandoned or redesigned, scaled down, and restructured to support the privatization of state enterprises. Ongoing projects at low levels of completion should similarly be used for state enterprise restructuring. Use of New Projects to Restucture and vatize State Organiatons 8.55 The construction industry makes a product which is unique because it is tied to a very specific location and is essentially sold before it actually exists. Project management stands at the core of the performance of construction firms which have a capital base that is usually a small fraction of the total value of their projects. This construction process is what differentiates construction from all other industries. The project cycle is particularly complex and decentralized in the building sector. 8.56 The approach to building, which was shaped by central planning, is rapidly passing away. Rather than attempting to slow down or stop the evolution of the industry, it will be more effective to work on the necessary changes. To restructure building organizations, it is particularly critical to change the dominant emphasis from technology to management. Decentralized systems are also less management-intensive. Policies as well as emerging market forces should encourage the change from large enterprises to many specialist contractors and small enterprises. Since building is a 180 Chapter 8 BOX 8.3 CONTRACTING,RISK ALLOCATIONAND CONSTRUCTION INDUSTRY RESTRUCTURING 1. The characteristics of the construction project cycle make the industry one of the most suitable to rapid privatization. Privatization will bring the management of project risks to center stage. Presently, due to central planning, Russian construction monopolies have limited abilities to evaluate the economic, financial, commercial, and even the technical risks of a project. Calls for Bids and Contractor Tendering 2. The risks involved in estimating demand correctly, acquiring land for the project, and getting the financing are assumed by the developer. Then comes the procurement process, including calling for bids. In the environment of TSE's, prices are shifting rapidly. In market economies, five types of contracts are common: - Lump sum (the contractor agrees to complete the task for a specified price). -Cost plus (reimbursement of direct and indirect costs as specified in the contract, plus a fee either fixed and agreed in advance or proportional to costs). -Cost plus not to exceed (same as cost plus but both parties agree on a maximum amount, and savings below it may be shared in varying proportions) . -Time and materials (this type of contract is often used for rehabilitation and maintenance when the scope of the contract cannot be determined entirely. A total cost is not agreed on, rather various rates are agreed on such as hourly rates for labor, markups for different types of materials, and reimbursement of other costs). -Unit prices (used for heavy civil works, especially those of a repetitive uniform nature where, for instance, the exact volume of earth moving cannot be known in advance. The exact volume is then measured after completion of the tasks). 3. The contractor's tendering problem is to cover all the elements of risk in his work: estimating errors, cost omissions, time and cost overruns, unforeseen conditions, project scheduling and, management failures resulting in time losses. One of the most critical skills in the industry is the preparation of cost estimates and bids. Subcontracting as Efficient Risk-Allocation 4. Subcontracting has evolved as the most efficient way to allocate risks and minimize transaction costs. A building enterprise chooses what to do in-house and what it wants to subcontract. Different markets, enterprises, institutional structures, as well as cultures, often require different strategies, leading to different contracting structures. During the transition to markets we can expect a very rapid rate of enterprise deconcentration and the establishment of many new small ftrms due to the advantages of subcontracting in the sector: - more efficient pricing through competitive bidding allows the general contractor to determine the reasonable price of a lot, or of an activity over various phases of a project; - reduced cost of information because specialist subcontractors are better informed of the cost, location, and availability of the manpower, materials and services necessary to carry out a specific contract; - better cost of materials because the subcontractor may be carrying several jobs of the same kind and buying in bulk; - better control over job delays since the subcontractor is managing his own inventories in his specialty and has his own network of suppliers; - better access to specialized labor and material inputs which may not be easily available to general contractors, Chapter 8 181 localized activity, the product should match the local market. Competition among specialist firms, usually of small or medium size, will accelerate the flow of resources into a project, thereby benefitting construction firms. 8.57 Bigger projects should be broken into smaller components to gain efficiency in the local marketplace. This is financially more efficient in terms of diversifying risks. Specialized subcontractors will also increase their own efficiency by working on several projects simultaneously, thereby gaining a much sharper sense of cost management. The overall result will be a major shift from giving priority to building technology to process efficiency. In spite of this shift, the rate of innovation is likely to be considerably higher than under central planning. Today is not the time to search for a dramatic technological 'breakthrough". Such efforts have typically led to financial and social failures in the West as well as in the East, particularly in the building sector which uses unique localized products; 8.58 Large state organizations must privatize and adapt to market conditions without incurring severe losses of human and capital assets. They can do so by breaking down projects into a series of phases. The more these phases can be collapsed into fewer new projects the better. The initial step would be to break up the present monolithic organization into independent firms matching the major parts and functions of the present organization: client, designers, general contractor, each major building trade group operating as a basic subcontractor (siteworks, structural, mechanical, plumbing, electrical, finishes), and materials suppliers. 8.59 The process of differentiation and business independence can proceed at different speeds for the various units involved in the building project cycle. For instance, a global design unit can divide into specialized service firms covering structural, electrical, plumbing, and mechanical work in different projects. Similarly, the general contractor and its newly formed subcontractors will find benefit in differentiating themselves further for each new project. This restructuring process will be accelerated by the rapid reduction in the average size and higher frequency of new projects, whether they originate from enterprises for commercial and industrial buildings, from local governments for public buildings, or from private demand for residential or commercial use. This strategy is particularly applicable to economies where the end of the central plan is very recent. In such economies, almost all demand for building has originated from the state until now, and the recently emerged new private producers are much too small to make up a significant part of the total output in the immediate future. 8.60 In many countries, including Russia, the competitive restructuring of some of the building- materials organizations has been proceeding faster than that of construction organizations themselves. This is partly due to the traditional manufacturing nature of their products, which can be stored and even hoarded for some time. This difference is also due in part to the important role that barter trade of materials has played recently in the Russian economy under high inflation. B. New Demand for Building Materials and Equipment 8.61 The building-materials and building-equipment branches of the construction industry adhere to the traditional manufacturing rules: the production process can be internally controlled within the enterprise, the goods are produced in advance, and they are shipped around wide geographical areas. 182 Chapter 8 Therefore, the problems faced by these industries today are problems of degree of market competition and ease of entry, quality control and standardization, technological innovation, and ability to finance badly needed investment. Central planning has had two effects on the construction industry. First, due to the risk-averse and bureaucratic management of the building industry, a peculiar gap can be found between advanced building-materials research in government laboratories and run-down, obsolete building-materials production facilities. Second, housing has been a relatively low priority due to the system's bias for "priority sectors" i.e. heavy industry and defense. Conditions for the production of residential construction materials linked to "closed" industrial housing systems are particularly poor; the facilities are often very old and the technology is obsolete. With the new types of housing demand there is a mismatch between the building materials and equipment available and what is needed. This is true both in terms of quality (uniformity in dimensions, technical quality, and energy efficiency) and volume. 8.62 In the short-term, the output of the building-materials industry tends to fall less rapidly than construction output itself because building materials have become an effective store of value under high inflation. Whenever they can, firms purchase materials as early as possible and store them. Firms unable to warehouse materials are forced to buy whatever they need at a diminishing purchasing power. Often the quality of the materials is lower than what could have been afforded at the beginning of the project. Building materials have also become an instrument of barter. This situation is particularly pronounced in the countries of the former Soviet Union where the governments have not yet been willing or able to stabilize their economy. 8.63 The type of privatization, and the role that foreign joint ventures will play in the modernization and restructuring of the building materials industry, are functions of the ease of entry and the geographical scale of the market. Foreign joint ventures are likely to concentrate on materials with an oligopolistic market structure and a relatively high degree of capital specificity. Here returns on investment appear to be particularly promising once economic growth resumes. Three groups of building materials producers can be expected to privatize differently: (1) Products with a high cost of entry due to high capital and technological requirements including: - cement is an oligopolistic sector with typically four or five firms controlling about 70 percent or more of the market in small economies. But in Russia competition can be greater. Foreign joint ventures are prevalent. - some plaster derivatives such as plaster boards - some ceramic products such as sanitary fittings (2) At the other extreme are products marked by ease of entry and low levels of processing. But they are impaired by their bulk, high transportation costs, and dependency on localized sources. These highly dispersed activities are marked by rapid and local privatization: - stone quarries - sand and aggregates Chapter 8 - 183 (3) In between are activities with high capital requirements but less market concentration than the first group. There, domestic privatization could also progress rapidly, but with enterprises on a much larger financial scale: - brick, tiles and clay products - other ceramic products - concrete products and elements. 8.64 The market for building and construction equipment is now international in scope for the four basic types of equipment used by the industry: leveling and earth moving, road equipment, processing of materials, and lifting equipment particularly needed in the building sector. As a result modernization of the sector will be affected by the availability of foreign exchange and joint- ventures, particularly in the smaller transition economies. Equipment rental, leasing and maintenance are new types of services that have yet to develop in most transition economies. 8.65 In market economies, seven important industrial sectors are major, indirect suppliers of the construction industry: wood and wood products; glass; steel and other metals; foundry and metal works; the mechanical industry; electrical products; and the chemical industry. Their rapid modernization and privatization is crucial to the construction industry. However, these usual industrial products are not location-bound and can be imported. Temporary shortages are as much a result of poor domestic pricing policies that maintain price controls as they are of overvalued exchange rates, which reflect poor trade and foreign exchange conditions affecting all sectors of the economy. C. The Changing Role of Government 8.66 The changes proposed in this report will remove from government units at the national, regional, and local levels many of their former functions. These functions include design of buildings, detailed management of projects, construction of new buildings, rehabilitation and repair of buildings, and the production and allocation of building materials. Thus most of the bureaucratic layers of organizations should be disbanded. Still, important functions remain Government will still act as client for all construction work on housing and other building which remains in the public sector. It will also regulate land use in Moscow and stimulate appropriate development of the Russian cities. 8.67 There is another government function which is only partially fulfilled, namely, watching over the development of the construction industry and taking steps to promote its efficiency. When the various parties to the process are established as independent units and privatization is under way, there must be an organization to monitor the efficiency and performance of the industry; to observe in good time when things are not going well and to consult and advise on how to put them right; to step in to help to establish new organizations as necessary; to assist in obtaining funds for investrnent in plant and in training; to set up or develop organizations which provide services for the industry as a whole - training, research, documentation, statistics, legal framework and standards; and to forecast demand for construction and the consequent need for resources and take steps to ensure that these are made available by the private sector. The Russian Federation has such an organization in the State Committee for Construction, Architecture, and Housing. BOX 8.4 indicates the profound 184 Chapter 8 change of orientation which is needed to achieve the for Ation of ministerial organizations able to guide the industry safely through its transition to a market-based system. 8.68 The recent division of the Ministry of Architecture and Planning, Construction, Housing and the Communal Economy into two committees is regrettable. This decision seems to have been based more on short-term administrative convenience than on a search for greater efficiency in the sector. It is clear that new construction and maintenance and rehabilitation are distinct operations. This renewed division suggests that, conceptually and operationally, there is still insufficient appreciation in Russia of critical concepts such as life-costing of building and construction projects, and the fundanental links between good design, good construction, and low operating costs. Part of the problem is also that the concept of the "communal economy" is managerially inefficient: the supply of housing should be clearly separate from the financing, operation and maintenance of urban services and various utility networks. 8.69 It is expected that there will be some resistance to change from many of the control organizations in Russia. The Russian State Committee for Construction, Architecture and Planning is able to take a more detached strategic view and must ensure in its policies that the changes taking place will create real choices and that the institutions being set up will ensure competition among independent units. This ministry should take the lead in introducing such change because only it has the power to do so. However, it will be supported in these tasks by the operating units themselves in the public sector, which are anxious for real independence and control over their own operations, and from the newly developing private sector. The present public-sector operating units will become a more powerful force for change as they become truly independent. Such private organizations will develop when the legal and practical environment in which they operate gives them equal opportunities to obtain work and resources. Reforms: a Provisional Checklist 8.70 The key requirements for a well-functioning construction industry are: - separation of control of client, designer, builder and material supplier. It is acceptable for, say, two of these to be under single control on a particular project, e.g. designer and builder. But, in general, there should be clear separation of these functions; * choice by client of advisers, designers, and builders; * choice by builders of their subcontractors, material and equipment suppliers to enable them to select from an array of independent professional and design firms, general builders, specialist firms, and material manufacturers and distributors; * incentives to all participants in the process, including management and labor, to perform efficiently; * a pricing system which helps to balance the demand for, and supply of inputs for construction; * procedures and documentation to ensure that competition is fair and not wasteful of resources, and that the links between the parties to the process are well organized and face an equitable distribution of risks. Chapter 8 185 BOX 8.4 THE INSTITUrONS AND PROFESSIONS OF THE MARKET The development of the institutions and professions to operate a market is critical to successful new enterprises and new projects. Markets are not self-defining; they must be developed. The two highest priorities of construction ministries in transition economies should be first to support the development of 'midwife' services to facilitate the evolution of the industry toward the marketplace. Second, in cooperation with ministries of finance and banking authorities, they must develop financial services for the industry. These heavily bureaucratic ministries need to move away as rapidly as possible from direct decision-making in the sector such as price controls, and direct resource allocation, as well as involvement in the internal operations of construction enterprises. They must shift their attention to incentive-based interventions linked to market development. Such a major reorientation typically implies a drastic reorganization of these ministries. The development of markets in the construction industry includes the following functioning elements: - - A market-oriented legalframework which typically includes clear property-rights, a commercial code, a new urban planning system, and new construction and building codes - A market-oriented procurement system is a critical requirement, particularly for large public projects. - A market-intelligence system is essendal to the operations of the industry. A major complaint of foreign firms attempting to operate in transition economies is the low quality and paucity of timely economic information. This void is a major obstacle to feasibility studies and to project pricing. Project risks are greatly increased. When uncertainty is too great, projects are simply abandoned. Consulting firms are now emerging to meet industry needs in transition economies such as Hungary. The production of market-intelligence data also requires a total reorganization of statistical reporting on the industry by public agencies. - Financial services for contractors and the development of commercial mortgage finance for both residential and commercial construction are also central elements of a market-based industry. - A major need of all transition economies is management and business training of the professionals in the sector. Professional associations are very different from the old industry associations under central planning. They must be formed to disseminate new practices and to produce guides and other training instruments to help people operate in a market. Priority needs include market feasibility studies, contracting, project management, cost control and construction enterprise management. - Under central planning, the state eventually assumed all risks. Insurance services and new bond instruments to provide guarantees of good completion usually are a prerequisite to bidding in a sound market environment. - Under central planning, taxation was usually implicit and typically negotiable between individual enterprises and the state. A sound, clear, uniform and predictable taxation system for the construction industry is another pillar of a fully developed market system. Source: Findings of the World Bank-WIFO Seminar on the Building Industry in Transition Economies, Vienna, Austria, November 1992. 186 Chapter 8 8.71 To meet these conditions, changes are required in every sector of the industry, and in the nature of housing provided. In particular there must be greater choice for consumers and clients of product suppliers, and greater incentives to producers. In the construction industry, the task of privatization is less overwhelming than it might appear at first sight because of the project focus of the industry, and the operating skills already present in the sector. The strategic starting point will be the emergence of the new developers, which combines proper financing with competitive bidding. 8.72 In developing the role of government in relation to housing and the construction industry: Eliminate the surplus hierarchies of control over the production process -- one year. Develop the market-oriented role of the Russian ministries. Modify and improve the role of government in physical planning and land use. Assist in the provision of documentation and procedures for the federation. Ensure that the privatization program creates independent competing units rather than private or de facto public monopolies: Create sufficient independent operating units in zakazchik organizations, in design offices, in builders and in material producers. When privatization follows, units should not be under the control of large holding companies. Encourage the development of private-sector enterprises: Ensure equal treatment in all respects as soon as possible. Remove legal or practical restrictions on competition among units: Establish and operate a selective tendering system for all public-sector and most other projects. Develop codes of practice for selective tendering, contracts and other documentation, possibly with external technical assistance. Introduce a registration scheme for all builders so that selection for tendering can be made on an impartial basis, giving equal opportunity to former public-sector and private or cooperative organizations. Ensure an adequate supply of a diverse range of building materials: Cease allocation system of building materials everywhere immediately, use prices to allocate resources. At the same time, allow prices to become true market prices. Create independent operating units in building material plants. Undertake a thorough study of the building materials industry as soon as possible. Privatize the building materials industry - after the building material study is completed. Develop method for assessing material requirements and use it for continual monitoring of the demand for, and supply of, materials on a continuing basis. Chapter 8 187 Separate functions of client, designer, builder and material supplier: This should happen automatically after above action on establishment of independent competing units and privatization. Nevertheless, monitor that it has in fact happened. Encourage all clients to take a more positive role in ensuring they get the building they want at optimum combination of quality, cost and time: Encourage clients to experiment in choice of parties and relationships between them. Give designers a greater participation in cost assessment and site supervision. Split zakazchik function into advisors to clients on a consultant basis and part of client team. Develop a range of housing provision: Encourage the development of private sector and cooperative housing. Develop a range of alternatives to precast concrete panel technology, e.g. timber, bricks and blocks. Undertake an economic and production engineering study of the kombinats. Meanwhile make no new major capital investment in them. Finish uncompleted buildings or sell them for completion in a specified period. Preserve and improve the existing stock: Develop new forms of housing maintenance organizations, (See chapter 5). * Increase the financial and real resources for maintenance and rehabilitation. Carry out housing condition surveys. Establish new, and improve existing, retail outlets for materials and give advice on home improvements. Undertake a comprehensive study of energy supply, use and conservation in the housing sector. Reconsider current policies on rehabilitation. Improve the supply of resources for construction. Improve management capabilities by establishing with external assistance a management training program under the Russian Ministry of Construction, Architecture and Housing. Retain the training of operatives under government control and use a similar method for building materials to determine training needs. Similarly assess future equipment needs; consider obtaining credits for supply of power-tools. Establish a documentation center and facilities for exhibition of materials technologies and design. Encourage foreign study tour for housing and construction professionals. n:pw_ nd.v9 17O9AWm 2, 1995 STATISTICAL APPENDIX Table of Contents 1. MACROECONOMIC STATISTICS Table 1-1: GNP Growth Rates Table 1-2: Trends in Inflation and Wages, 1989-1992 Table 1-3: Trends in Prices of Housing and Municipal Servies, 1990-1991 Table 1-4: Changes in Prices of New Housing, 1985-1993 Table 1-5: Incomes and Expenditures, Per Person and Per Household, 1992 Table 1-6: Housing Expenditures in Budgets of Urban and Rural Working Households, 1980-1992 Table 1-7: Russian Income Distribution, June 1992 2. POPULATION Table2-1: Population, 1970-1991 Table 2-2: Population by Regions, Autonomous Republics and Territories, and Oblasts 3. HOUSING STOCK Table 3-1: Housing Stock and Housing Shortages Table 3-2: Waiting Lists in Urban Areas, 1986-1991 Table 3-3: Housing Stock by Ownership, 1980-1990 Table 3-4: Quality of Urban and Rural Housing by Ownership, 1990 Table 3-5: Unoccupied Housing by Ownership, 1990 Table 3-6: Hostels and Dormitories, 1990 Table 3-7: Housing Stock by Period of Construction Table 3-8: Structure of Regional Housing Stock by Ownership Table 3-9: Estimated Regional Urban Housing Shortages, 1990 4. PRIVATIZATION OF HOUSING STOCK Table 4-1: Progress of Housing Privatization by Region, 1991-June 1992 5. NEW HOUSING CONSTRUCTION Table 5-1: New Housing Construction, 1980-1992 Table 5-2: New Housing Construction: Alternative Projections for 1993-1995 Table 5-3: Housing Investment, by Source of Funds, 1980-1993 Table 5-4: Net Changes in Housing Stock, 1990 6. FISCAL AND FINANCIAL STATISTICS Table 6-1: Operating Subsidies for the Housing Stock and Average Cost Recovery for Maintenance and Utility Services Table 6-2: Operating Subsidies for the Housing Stock and Trends in Cost Recovery for Municipal and Enterprise Housing. 1987-1991 Table 6-3: Operating Subsidies for the Housing Stock: Moscow City Housing Maintenance Budget Table 6-4: Savings Bank of Russia: Interest Rates and Deposits and Loans Table 6-5: Housing Construction Loans Issued to Households, 1980-1990 RUSSIAN FEDERATION Table 1-1: Growth Rates of Net Material Product, in Constant Prices, 1986-1991 1986 1987 1988 1989 1990 1991 1/ Net Material Product (NMP) 2.4 0.7 4.5 1.9 -3.6 -11.0 Agriculture 10.3 -3.0 4.0 2.8 -6.2 Industry 0.1 1.7 6.2 2.0 -2.2 Construction 17.1 7.1 7.5 0.8 -4.3 Transport and communication 5.7 0.8 4.9 -9.1 -5.4 Domestic trade and public catering 0.6 -4.3 7.6 8.2 3.2 Receipts from foreign trade -8.9 -4.7 -6.8 3.9 -0.7 Other 1/ 2.5 6.2 2.3 10.2 -25.7 NMP used domestically 1.7 0.5 6.8 2.3 -4.2 Total consumption 1.0 2.7 4.0 5.4 2.0 Personal consumption 0.2 1.5 3.4 5.4 1.4 Other consumption . 4.9 8.5 6.9 5.1 5.0 Accumulation 3.6 -5.4 15.0 -6.1 -22.5 Net fixed investments 5.8 3.5 -2.8 -10.3 -17.8 Memorandum item: Gross domestic product -9.0 Sources: Goskomstat; Fund staff estimates 1/ Preliminary 2/ Material technical supply, forestry, data processing and other branches. RUSSIAN FEDERATION Table 1-2: Trends in Inflation and Wages, 1989-1992 Price Changes (monthly % change): Avrerage wage Real wage, (Rbs/month) Industry RPG CPA IWP Defla Industry All sectors March 1991 =100 1991 January 6.6 62.9 320.0 February 4.8 18.9 340.0 March 6.4 7.1 340.0 100.0 April 54.4 63.5 8.2 420.0 75.6 May 2.3 3.0 3.8 447.0 63.2 June 0.0 1.2 2.8 447.0 77.1 July -0.7 0.6 17.3 560.0 96.1 August -0.2 0.5 15.2 596.0 101.7 September 1.3 1.1 6.6 660.0 111.4 October 3.9 3.5 5.8 760.0 124.0 November 9.0 8.9 9.4 870.0 130.3 December 12.6 12.1 11.3 1200.0 1100.0 160.4 1992 January 221.0 245.0 382.0 253.2 1801.0 1470.0 69.8 February 24.0 38.3 75.0 34.2 2567.0 2040.0 71.9 March 20.8 29.8 28.0 22.2 3464.0 2732.0 74.7 April 14.0 21.7 16.5 14.5 3769.0 3024.0 66.8 May 11.0 12.0 23.0 13.4 4296.0 3675.0 68.0 June 13.0 18.6 36.0 17.6 5948.0 5067.0 79.4 July 7.4 10.0 17.0 9.3 6305.0 5452.0 76.5 August 9.0 9.0 13.0 9.8 6734.0 5876.0 75.0 September 11.0 11.5 14.0 11.6 8140.0 7379.0 81.3 October, preliminary 18.0 22.9 27.0 19.8 10371.0 8853.0 84.2 November, prel. & pr 25.0 32.0 43.2 28.6 December, projection 25.0 32.0 43.2 28.6 (average annual % change): (annual average): 1989 2.4 1.2 '275.0 259.0 1990 5.6 3.9 311.0 297.0 1991 90.4 115.0 138.9 585.0 534.0 1992, incl. projection 983.6 4291.4 1327.8 (Dec to Dec % change): 1991 152.1 160.4 236.9 140.4 1992, incI. projection 1547 8161 2249 Sources: Goskomatat, Update of Russian Economic Trends, Vol. 1. No. 2. (26 Nov 19921 tables 1 & 4, IMF, EC3 RPG - reteil prices for goods. The indicators for the last quarter of 1992 are preliminary estimates (October) and projections (November - Decemberl. CPA - consumer prices of all goods and services IWP - indural wholese prices. The indicators for November - December 1992 are projections. Defoa - GOP deflator, weights: 80% consumption (rpg), 20% Investments (iwpl. RUSSIAN FEDERATION Tabbe 1-3: Trends in Prices of Housing and Municipal Services, 1990-1991 Apr1 1991/ June 1991/ Doc 1991/ Avr. 1991/ 1992,1V qJ/ Dec 1990 Dec 1990 Dec 1990 avr. 1990 avr. 1991 (percentage change) All consumer services 64.5 79.7 99.7 70.6 Housing and communal srvices 4.5 5.6 26.7 20.0 Rents, state housing 0.0 0.0 Maintenance fees, coop housing 3.2 3.7 Central hoating 0.0 0.3 Waste disposal 5.3 5.8 Capital repairs of housing 76.5 92.9 Buildin marials industy 215.0 147.0 2515.0 ConstuctIon 2772.0 IV quarter 1992 projections Building materials Construction IV q. to I q. 348.0 376.0 IV q. to III q. 220.0 181.0 IV q. to Aug-Sept 125.0 129.0 Sources: the Statstkil Yerbook, 1990; CEM; quarterly data for building materials and construction: Ministry of Labor RUSSIAN FEDERATION Table 1-4: Changes in Prices of New Housing, 1985-1993 (Rbs per square meter) 1985 1990 1991 1992 1993 Type of Construction IV q. IV q. proj. Large panel, 9 story 260 321 900 11000 20000 Large panel, 1-2 story 410 506 1420 17300 311400 Clay brick, 9 story 285 351 980 12000 21800 Clay brick, 1-2 story 450 555 1550 19000 34530 Pre-cast elements, including cellular concrete blocks, 1-2 story 320 400 1000 11000 18000 Mixed technology: large panel & small pre-fab elements - - 24400 Brick, improved technology, 1-2 story - - - 18000 Non-autoclave cellular concrete, 1-2 story - - - 17700 Playwood and polyurethane foam, 1-2 story - - - 15300 Sources: Ministry of Construction, Special Government Program in Housing', Dec 1992 RUSSIAN FEDERATION Table 1-5: Incomes and Expenditures, Per Person and Per Household, 1992 Urban Population: 1/ All Population Workers, Blue & White Collar: Pensioners (Workers) 1991 1992,1st 1992 1992, Ist 1992 1992,1st 1992 quaner half year quarter half year quarter half year INCOME fIn Rbs, per person in household in period stated) 2/ All Money Incorne 4261.6 3355.1 9545.5 3664.1 10459.8 1928.1 5721.5 in which 1%): wages and salaries 70.9 72.0 78.4 81.3 1.5 1.5 revenues from collective farms 2.6 2.1 0.2 0.2 0.1 0.0 pensions, allowances, stipends 16.9 16.9 12.6 11.5 84.1 86.2 other cash revenues 9.6 9.0 8.8 7.0 14.3 12.3 EXPENDITURES (in Rbs. per person hI household hI period stated) All Expenditures 3988.7 3121.2 8604.9 3419.3 9421.7 1825.5 5254.2 in which 1%): food 31 32.8 41.1 41.5 40.1 40.3 66.9 68.4 acoholic bevrwage 3.6 4.2 3.7 3.8 3.4 7.1 5.7 durable/nohourable goods 41.2 33.4 32.6 34.3 33.1 12.7 12.5 rwvic s 7.7 7.7 8.0 7.9 8.7 7.0 7.0 taxes 7.0 7.8 8.1 8.5 8.0 0.2 0.4 other 7.7 5.8 6.1 5.4 6.5 6.1 6.0 HOUSING AND COMMUNAL SERVICES IRbs, p/wusehold, hi period stated) Total Expenditures 148.0 86.2 217.7 96.4 239.4 60.2 149.0 in which (RbaI: rent 46.4 17.2 38.7 19.5 45.5 9.0 18.8 heating 22.5 13.2 33.0 15.0 37.9 11.3 27.3 electrcity 39.8 24.2 58.0 27.0 64.9 17.0 40.0 gos 14.8 14.8 44.1 13.4 39.2 11.5 35.4 water, other services 24.5 16.8 43.9 19.7 52.0 11.4 27.5 Source: GOSKOMSTAT, Household Budget Survey 11 A proxy for urban households. Excluded are workers on collective farms, both active and retired. 2/ The average household size of 2.7 can be used to calculate the share of housing in total expenditures. 3/ The shwre of food in workes' budgets fell from 35% in 1980 to 28.2% in 1990 before raising again in 1991. RUSSIAN FEDERATION Table 1-6: Housing Expenditures in Budgets of Urban and Rural Working Households, 1980-1992 Expenditures for rent plus utilities as % of total household expenditures: 1980 1985 1986 1987 1988 1989 1990 1992 June 1/ Workers, non-agric.,blue/white collar 3.0 3.0 3.0 3.0 2.9 2.7 2.5 0.9 Workers on collective farms 2.0 2.0 2.0 2.0 2.2 2.2 1.7 1.7 Sourco: The Statistical Yearbook for 1990 1/ For the first half of 1992: estimate; for 1991, the estimated share for all households is 1.4%. RUSSIAN FEDERATION Table 1-7: Income Distribution, June 1992 Average Monthly Income All Population Persons in Households per Person, in Rbs: 1/ with 2 children less than 1000 4.0 6.9 1000 - 1500 15.5 20.9 1500 - 2000 21.8 24.2 2000 - 2500 19.9 18.9 2500 - 3000 15.0 12.6 3000 - 3500 10.2 7.7 3500 - 4000 6.6 4.5 4000 - 4500 4.1 2.6 more than 4500 2.9 1.7 Source: Goskomstat 1 / An estimate of the average household income of Rbs 6750 can be calculated by multiplying the average personal income by the average household size of 2.7. RUSSIAN FEDERATION Table 2-1: Population, 1970-1991 1970 1979 1985 1989 1990 1991 Population, in mln 130.1 139.0 143.1 147.4 148.6 148.8 Urban, in % 62.0 69.0 73.0 74.0 74.0 74.0 Rural, in % 38.0 31.0 27.0 26.0 26.0 26.0 Active Age 1 83.0 84.0 84.0 Over Active Age 24.0 27.4 28.8 Population growth rate, % 0.6 0.5 0.5 0.4 0.2 0.1 Crude birth rate 1.5% 1.6% 1.7% 1.5% 1.4% 1.2% Mortality rate 0.9% 1.1% 1.1% 1.1% 1.2% 1.1% Sources: CEM; estimates of numbers of households: Nadezhda Nozdrina Estimated household size, 1989: total - 2.5 urban - 2.5 rural - 2.5 1/ Includes women aged 16-55 and men aged 16-60 RUSSIAN FEDERATION Table 2-2: Population by Regions. Autonomous Republics and Territories, and Oblasts, 1st January 1991 Population Share of Total Urban Rura Urban Population RSFSR - total 148543 109799 38744 0.74 Severny r-n 6161 4746 1415 0.77 Arkhangel'skaya o. 1577 1164 413 0.74 Vologodskaya o. 1361 898 463 0.66 Murmanskaya o. 1159 1068 91 0.92 Kareliya r. 799 655 144 0.82 Komi r. 1265 961 304 0.76 Severo-Zapadny r-n 8305 7208 1097 0.87 S.Peterburg 5035 5035 0 1.00 Leningradskaya o. 1670 1103 567 0.68 Novgorodskaya o. 755 530 225 0.70 Pskovskaya o. 845 540 305 0.64 Zentralny r-n 30478 25249 5229 0.83 Bryanskaya o. 1464 1000 464 0.68 Vladimirskaya o. 1660 1322 338 0.80 Ivanovskaya o. 1317 1076 241 0.82 Tverskaya o. 1676 1203 473 0.72 Kaluzhskaya o. 1080 759 321 0.70 Kostromskaya o. 813 560 253 0.69 Moskva 9003 9002 1 1.00 Moskovskaya o. 6718 5339 1379 0.79 Orlovskaya o. 901 566 335 0.63 Ryazanskaya o. 1349 899 450 0.67 Smolenskaya o. 1166 802 364 0.69 Tulskaya o. 1855 1512 343 0.82 Yaroslavskaya o. 1476 1209 267 0.82 Volgo-Vyatskii r-n 8480 5902 2578 0.70 Nizhegorodskaya o. 3712 2874 838 0.77 Vyatskaya o. 1700 1202 498 0.71 Mariya-EI r. 758 470 288 0.62 Mordoviya r. 964 556 408 0.58 Chuvashiya r. 1346 800 546 0.59 Centralno-Chernozemny r-n 7761 4747 3014 0.61 Belgorodskaya o. 1401 897 504 0.64 Voronezhskaya o. 2475 1523 952 0.62 Kurskaya o. 1336 792 544 0.59 Lipetskaya o. 1234 784 450 0.64 Tambovskaya o. 1315 751 564 0.57 Povolzhskii r-n 16586 12225 4361 0.74 Astrakhanskaya o. 1007 685 322 0.68 Volgogradskaya o. 2632 1998 639 0.76 Samarskaya o. 3290 2869 621 0.81 Penzenskaya o. 1512 948 564 0.63 Saratovskaya o. 2708 2026 682 0.75 Ulyjanovskayja o. 1430 1032 398 0.72 Kalmykiya r. 328 151 177 0.46 RUSSIAN FEDERATION Table 2-2: Population by Regions, Autonomous Republics and Territories, and Oblasts. 1st January 1991 Population Share of Total Urban Rura Urban Population Tatarstan 3679 2716 963 0.74 Severo-Kavkazsky r-n 17030 9823 7207 0.58 Krasnodarsky k. 5175 2817 2358 0.54 Adygeya r. 437 230 207 0.53 Stavropolsky k. 2926 1573 1353 0.54 Karachaevo-Cherkesiya r. 427 211 216 0.49 Rostovskaya o. 4348 3098 1250 0.71 Dagestan r. 1854 816 1038 0.44 Kabardino-Balkariya r. 777 478 299 0.62 Sev.Osetiya r. 643 443 200 0.69 Checheno-Ingushetiya r. 1307 598 709 0.46 Uralsky r-n 20397 15310 5087 0.75 Kurganskaya o. 1110 612 498 0.55 Orenburgskaya o. 2194 1432 762 0.65 Permskaya o. 3110 2411 699 0.78 Sverdlovstaye o. 4730 4135 595 0.87 Chelyabinskaya o. 3641 3001 640 0.82 Bashkortostan r. 3984 2574 1410 0.65 Udmurtiya r. 1628 1145 483 0.70 Zapadno-Sibirsky r-n 15158 11090 4068 0.73 Altaysky k. 2851 1601 1250 0.56 Gorno-Altaiskaya r. 196 53 143 0.27 Kemerovskaya o. 3180 2780 400 0.87 Novosibirskaya o. 2796 2098 698 0.75 Omskaya o. 2163 1475 688 0.68 Tomskaya o. 1012 696 316 0.69 Tumenskaya o. 3156 2440 716 0.77 Vostochno-Sibirsky r-n 9243 6652 2591 0.72 Krasnoyarsky k. 3625 2641 984 0.73 Khakassiya r. 577 419 158 0.73 Irkutskaya o. 2863 2314 549 0.81 Chitinskaya o. 1392 916 476 0.66 Buriatija r. 1056 635 421 0.60 Tuva r. 307 146 161 0.48 Dalnevostochny r-n 8057 6146 1911 0.76 Primorsky k. 2299 1784 515 0.78 Khabarovskii k. 1851 1462 389 0.79 Amurskaya o. 1074 730 344 0.68 Kamchatskaya o. 473 384 89 0.81 Magadanskaya o. 534 436 98 0.82 Sakhalinskaya o. 717 612 105 0.85 Yakutskaya Sacha r. 1109 738 371 0.67 Kaliningradskaya o. 887 701 186 0.79 Source: Statistical Yearbook of RSFSR, 1990 RUSSIAN FEDERATION Table 3-1: Housing Stock and Housing Shortages Jan 1986 Jan 1991 Total Urban Rural Total Urban Rural Population (Mill) 143.9 104.8 39.1 148.1 109.4 38.7 Households (000) 1/ 50242 36046 14196 50173 37370 12873 Families (000) 1/ 58547 44197 14350 Housing Stock (Mill m2) 2138 1492 646 2431 1721 710 Apartment Units. (000) 44629 30193 14436 48394 33578 14816 in which Communal 2603 1820 783 1464 1411 53 Hostels/ Dormitories (000 1 7387 6512 875 8712 7712 1000 Avg Unit Size (m2) 46.3 47.3 44.3 50.0 51.0 47.0 Floor Space Per Person (m2) 14.9 14.2 16.5 16.4 15.7 18.4 Ratio of Households/Dwelling Units 1.13 1.19 0.98 1.04 1.11 0.87 Source: Ministry of Economy 1/ Households include single persons, residing separately. RUSSIAN FEDERATION Table 3-2: Waiting Lists in Urban Areas, 1986-1991 1986 1987 1988 1989 1990 1991 Households 1/ on waiting lists, in 1000s 8037 8766 8983 9156 9456 as % of all urban households 23 25 25 25 26 Waiting lists in selected cities 2/; Moscow 346 426 as % of all households 12 13 St. Petersburg as % of all households 20 Novosybirsk 112 as % of all households 25 Sverdlovsk 131 as % of all households 31 Omsk 109 as % of all households 31 Ufa 119 as % of all households 36 Source: National statistics: Statistical Yearbook "National Economy of the RSFSR in 1990": City statistics: J. E. Tedstrom I1 990) and the Ministry of Economy 1/ Including one-person households 2/ Waiting lists are relatively smaller in larger cities. The following is the 1989 population of listed cities, in thousand of persons: Moscow - 8,972 Sverdlowsk- 1.365 St. Petersburg - 5,024 Omsk- 1,148 Novosybirsk - 1,437 Ufa- 1,078 RUSSLAN FEDERATION Table 3-3: Total Housing Stock by Ownrsnip 1/, 1980-1990 'SodalIzed stock: Total Floor Space State-Owned 2/ and Privately % 'Socialized' % Private mhi m2 Coops, min m2 Owned Stock Stock 1980 1861 1241 620 66.7 33.3 1985 2138 1514 624 70.8 29.2 1986 2202 1574 628 71.5 28.5 1987 2261 1629 632 72.0 28.0 1988 2320 1685 635 72.6 27.4 1989 2379 1742 637 73.2 26.8 1990 2425 1784 641 73.6 26.4 Source: Natlon Stetidcel Yerbook. 1990. Mnsty of the Economy 1/ Data for end of yea., include hostels and dormitories. 2V State.owned stock hcudes munliW wnd nterprie housJng as weN as housing baklgin to other publc organizzaons. Tabl 3.3b - 1993 Totd Foro Spac unhcp Deptrental Autonomous Other Coops Privae nin m2 Housing Housing Enterprises Public Tota 2493.9 629.7 50.7 898.6 67.9 95.9 751.1 Urban 1780.8 611.2 39 698.9 12.7 95.5 323.4 Rura 713.3 18.5 11.7 199.7 55.2 0.4 427.7 Souace: _ .dm tM " od Ysmboek. 1990. Misry of te Econmy 11 Dat for end of yew, ncludes hostels mid donritories. 2/V 8tiwd stock indmkidand enterps houas weE thusin b ing to othr pubk orgaadon. RUSSIAN FEDERATION Tabb 34: Quafity of Urban and Rural Housing by Ownership, 1990 Urban Stock Rural Stock Percentage of dwellings with: Percentage of dwellings with: Piped Sewage Centr. Bath Hot Piped Sewage Centr. Bath Hot Water Heat. Water Water Heat. Water Total housing stock 78.2 75.3 79.2 71.0 64.3 n/a n/a n/a n/a n/a State-Owned stock 91.9 89.8 89.9 85.2 76.8 48.0 37.6 40.3 33.8 20.8 Local Government 94.0 92.9 91.5 89.2 83.2 47.1 39.3 44.9 34.7 19.0 Enterprises & Organizatbons town-budget) 90.1 87.3 88.4 81.9 71.3 47.8 37.0 39.4 33.4 20.5 Enterprises 6 Organizations (budget financed) 85.2 80.0 81.3 73.1 63.6 57.5 49.8 55.5 42.1 34.8 Other Enterprises & Organizations 1/ 67.2 59.3 57.9 53.4 36.7 44.7 29.1 23.6 25.7 11.1 Housing Construction A Housing Cooperatives 2/ 99.9 99.9 99.9 99.9 96.4 99.4 99.4 97.8 99.3 90.1 Housing (Non-Buiding Coops) 99.7 99.7 99.0 99.7 92.2 Privately-Owned stock 17.9 11.1 31.2 6.5 6.4 n/a n/a n/a n/a n/a Soure: Minty of Economy 1/ Include collective farms, other cooperative-type organizations and public bodies 2/ Housing cooperatives are located predominantly in cities RUSSIAN FEDERATION Table 3-5: Unoccupied Housing by Ownership, 1990 % vancie in total ratio of unoccupied new units residential stock to all vacancies 1 /, % Total Urban Rural Total Urban Rural Total housing stock n/a n/a n/a n/a n/a n/a Stte-Owned gtock 0.3 0.3 0.6 61.5 71.6 30.6 Local Government 0.1 0.1 0.5 44.6 49.2 3.6 Enterprs & Oriations lown4xxuget) 0.5 0.4 0.6 65.9 77.9 33.8 Enterlse & Organlzstiens centraliyfianced) 0.3 0.2 0.7 32.1 51.3 11.7 Other Enterprises & Organizatioms 1/ 1.0 0.4 1.1 36.5 57.4 35.5 Houing Constuction & Housing Cooperatives 2/ n/a n/a n/a 100 .0 100.0 - Ho-fn INon-1uding Coops) Source: Miny of Economy 1/ Occupancy of newly completed buildings is often delayed by delays in infrastructure connections and WMer p. FWSSLkN FEDERATION Tabb 3-& Hostels and DormMoters 11, 1990 LMnog Spac LMno Spc Resdet Pnlesdnts O In Hostels as In Hostels In Hostes as % UVb. Hostels % of Total Cliles as % aU lFskdents as % of al LMng Space of Total Urban Residing In LMng Space Urban Stock Tlad houdng stock 2.7 3.4 n/a n/a State-Owned stock 4.0 4.3 5.0 5.5 Local Goenment 0.5 0.5 0.6 0.6 Enterlie & Organton (own-budge) 6.3 7.5 7.5 9.3 Entlrpre & Oroanzaon (centrally Onancd 6.9 6.7 7.4 7.4 Other Entprses & OrganzaUons 2/ 2.1 7.8 2.1 9.2 Houdng Contrucio & Housng Cooperatis 31 Houing (Nonudng Coops) Priasty-Owd stock Source: Mihy d Economy 1I Workes hosel and dormikores orly 21 Include colectv tums and ote cooperative-tpo organizalIons as wel as other public bodlis 31 Housing coopera wre Iocated predomhiantiy In citles. RUSSIAN FEDERATION Table 3-7: Housing Stock by Period of Construction tIn prcentage of al stock) Construction Period Total Urban Rural Total 100.0 100.0 100.0 Before 1918 2.7 2.8 2.6 1918 - 1940 4.2 3.8 5.8 1941 - 1950 3.3 3.0 4.9 1951 - 1960 13.0 12.1 16.8 1961 - 1970 22.9 22.5 25.0 1971 - 1980 26.8 28.2 22.5 1981 - 1991 27.1 27.6 22.4 Source: Ministry of Economy RUSSIAN FEDERATION Table 3-8: Structure of Regional Housing Stock by Ownership Total Floor Structure of Ownership, in Percentages: Share of Space private in State Ownership: Other Housing Private housing min m2 Muni- Enterpr Total org. Coops Stock in urban cipal stock RSFSR-total 2,425.1 25.2 41.7 66.9 2.9 3.8 26.4 15.1 Severny r-n 103.5 24.8 55.6 80.5 1.6 2.1 15.8 5.9 Arkhangel'skaya o. 26.7 17.2 57.1 74.3 1.5 2.8 21.3 8.7 Vologodskaya o. 25.7 13.3 55.9 69.2 4.1 2.2 24.5 8.9 Murmanskaya o. 17.1 49.5 47.1 96.6 0.4 2.1 0.9 0.7 Kareliya r. 13.8 33.4 53.8 87.2 0.3 2.0 10.5 6.9 Komi r. 20.2 22.9 61.9 84.8 0.4 1.1 13.8 4.2 Severo-Zapadnyr-n 150.6 50.4 26.7 77.1 1.2 8.8 12.8 6.0 S.Peterburg 79.7 69.4 14.6 84.0 0.1 15.3 0.6 1.3 Leningradskaya o. 31.1 27.0 49.7 76.7 0.3 1.2 21.8 14.5 Novgorodskaya o. 14.4 20.7 41.7 62.4 3.0 1.4 33.2 19.9 Pskovskaya o. 16.7 18.1 33.7 51.8 7.2 1.8 39.2 19.2 Centralny r-n 530.3 35.4 37.8 73.2 2.4 5.3 19.2 11.0 Biryanskaya o. 25.7 16.5 25.5 42.0 4.0 2.7 51.3 37.7 Vladimirskaya o. 28.7 18.3 47.8 66.1 2.7 5.1 26.1 17.8 Ivanovskaya o. 23.0 20.7 42.5 63.1 2.9 4.8 29.2 25.5 Tverskaya o. 31.5 18.7 39.7 58.4 6.2 2.7 32.7 20.5 Kaluzhskaya o. 17.2 18.2 45.0 63.2 4.6 1.8 30.4 16.4 Kostromskaya o. 14.6 22.4 41.1 63.6 7.2 2.5 26.8 20.4 Moskva 156.9 72.0 18.2 90.2 0.1 9.4 0.3 0.3 Moskovskayao. 107.6 19.7 55.9 75.5 1.2 4.0 19.3 13.3 Orlovskayao. 16.0 18.5 30.8 49.3 8.1 3.2 39.5 22.1 Ryazanskaya o. 24.1 19.2 36.1 55.3 4.5 3.8 36.5 16.7 Smolenskaya o. 21.0 17.3 48.8 66.1 4.1 1.7 28.1 17.0 Tulskaya o. 34.0 21.3 52.3 73.6 3.0 2.7 20.6 14.0 Yaroslavskaya o. 26.4 21.9 50.0 71.9 2.9 4.5 20.7 12.1 Volgo-Vyatskii r-n 140.1 16.7 43.3 60.0 4.4 3.7 31.9 15.5 Nizlhgorodskaya o. 64.0 14.7 47.6 62.3 3.7 4.7 29.4 16.7 Vyatskaya o. 26.8 12.9 55.8 68.8 8.8 2.4 20.1 14.2 Mariya-EI r. 11.6 22.6 41.8 64.4 4.0 2.2 29.4 11.8 Mordoviya r. 16.7 18.1 28.5 46.6 4.5 4.1 44.7 18.6 Chuvashiyar. 21.0 24.1 25.8 50.0 1.3 2.8 45.9 12.8 RUSSIAN FEDERATION Table 3-8: Structuro of Regional Housing Stock by Ownership Total Floor Structure of Ownership, in Percentages: Share of Space private in State Ownership: Other Housing Private housing min m2 Muni- Enterpr Total org. Coops Stock in urban cipal stock Centralno-Chernozemny r-n 141.9 13.3 28.9 42.2 4.7 3.0 50.1 27.9 Begorodskay o. 26.0 11.9 31.5 43.5 6.2 2.9 47.5 25.9 Voronezhskaya o. 45.7 14.5 24.5 38.9 4.0 3.0 54.1 31.6 Kurskaya o. 25.1 10.7 27.6 38.4 5.1 3.2 53.3 25.9 Lipetskaya o. 22.3 15.0 35.9 51.0 3.6 3.3 42.1 21.9 Tambovskaya o. 22.8 13.6 29.4 43.0 5.1 2.4 49.5 31.5 PovolzhskiUr-n 273.3 21.0 43.4 64.4 4.1 3.5 28.0 17.1 Astrskhnmskaya o. 14.9 24.4 33.1 57.5 4.5 2.6 35.4 25.5 VoalgoWdskaya o. 45.6 29.6 34.6 64.2 3.9 3.6 28.4 21.7 Samamkaya o. 54.6 19.3 55.0 74.3 3.8 3.5 18.4 10.7 Penzenskaya o. 25.7 15.8 35.5 51.3 4.0 3.7 41.0 26.2 Saratovskay o. 44.9 14.4 48.7 63.0 7.1 4.7 25.2 19.7 Ujanovskaja o. 23.7 21.8 39.1 60.9 4.7 3.4 31.0 18.1 Kalnykiya r. 5.0 24.3 43.9 68.2 3.5 0.8 27.5 28.8 Tatastan 58.9 21.8 43.0 64.8 2.0 3.0 30.1 11.7 Severo-Kavkazsky r-n 270.3 17.1 24.4 41.5 2.4 2.6 53.5 34.6 Krasnodarsky k. 83.5 19.0 19.0 38.0 3.0 2.4 56.6 37.6 ind.Adygeyar. 7.4 15.9 15.3 31.1 1.3 2.1 54.7 41.6 Stavropolsky k. 45.9 21.6 21.9 43.5 2.7 2.0 51.7 34.8 inc.Karachaevo-Cherkesiya r. 7.0 14.7 24.0 38.7 4.2 1.1 56.0 32.0 Rostovskaya o. 73.7 13.3 38.0 51.3 3.1 3.3 42.2 32.5 Dagesten r. 28.6 10.7 15.7 26.4 0.5 1.1 72.0 32.4 Kabardino-Balkariya r. 11.3 17.6 19.2 36.8 1.0 4.2 58.0 36.1 Sev.Osetiya r. 10.7 30.9 14.9 45.8 0.6 4.9 48.6 29.7 Checheno-lngushetiya r. 16.7 13.8 22.5 36.2 0.5 1.8 61.5 37.8 Uralsky r-n 317.6 17.9 51.7 69.7 3.1 3.7 23.5 14.9 Kurganskaya o. 17.6 12.8 44.0 56.8 8.9 4.0 30.2 21.0 Orenburgskaya o. 34.8 11.0 50.9 61.9 5.7 2.4 30.0 21.7 Pormskayao. 47.1 17.9 55.8 73.8 3.0 3.8 19.4 12.6 Ekatirenburgskaya o. 77.3 14.3 63.3 77.6 1.4 4.2 16.8 13.4 Chelyebinskaya o. 56.8 15.0 60.5 75.5 1.3 4.5 18.6 15.5 Bashkortostan r. 60.8 30.6 28.6 59.2 2.5 3.3 35.0 13.7 RUSSIAN FEDERATION Table 3-8: Structure of Regional Housing Stock by Ownership Total Floor Structure of Ownership, in Percentages: Share of Space private in State Ownership: Other Housing Private housing min m2 Muni- Enterpr Total org. Coops Stock in urban cipal stock Udmurtiya r. 23.1 18.3 51.4 69.7 6.4 2.5 21.4 14.8 Zapadno-Sibirsky r-n 232.5 20.1 51.8 71.9 3.3 2.9 21.9 16.8 Altaysky k. 45.7 20.8 38.6 59.4 5.4 3.0 32.3 21.6 inc. Gorny Altai r. 2.4 18.7 30.7 49.3 8.9 0.6 41.2 34.6 Kemerovskaya o. 51.6 11.8 61.8 73.6 1.1 2.1 23.3 21.1 Novosibirskaya o. 40.8 27.7 42.4 70.1 3.9 4.7 21.3 17.4 Omskaya o. 34.4 24.8 43.8 68.6 5.0 5.1 21.2 18.3 Tomskaya o. 15.0 23.6 54.4 78.1 1.9 2.6 17.4 14.0 Tumenskayao. 45.0 17.1 67.5 84.7 2.2 0.7 12.5 7.0 Vostochno-Sibirsky r-n 135.1 22.5 55.2 77.7 2.7 1.6 18.0 12.5 Krasnoyarskyk. 56.9 21.2 58.4 79.6 2.2 1.8 16.3 11.2 inc.Khakassiya r. 8.6 20.5 55.7 76.1 0.8 0.9 22.2 18.1 Irkutskaya o. 43.9 28.2 52.2 80.4 2.0 1.7 15.9 11.7 Chitinskaya o. 16.5 16.0 54.6 70.6 6.2 0.6 22.6 17.9 Burjatija r. 14.1 16.0 53.4 69.4 3.5 1.8 25.3 14.8 Tuva r. 3.8 27.9 50.9 78.9 1.5 0.3 19.3 16.1 Dalnevostochny r-n 115.6 30.1 53.7 83.8 1.8 1.2 13.3 9.9 Primorsky k. 33.1 31.5 52.8 84.2 0.7 1.5 13.5 10.3 Khabarovskii k. 27.4 39.1 47.9 87.1 1.2 2.4 9.3 9.1 Amurskaya o. 14.8 21.8 56.0 77.8 4.7 0.9 16.7 17.3 Kamchatskaya o. 6.3 37.8 51.3 89.1 4.6 0.9 5.3 5.6 Magadanskaya o. 8.0 30.9 61.5 92.5 0.2 0.0 7.3 7.7 Sakhalinskaya o. 10.9 28.9 60.6 89.5 3.0 0.3 7.2 7.0 inc.Yakutskaya Sacha r. 15.1 17.2 55.9 70.3 0.9 0.0 27.4 9.7 Kaliningradskaya o. 14.3 46.9 38.3 85.3 4.8 3.7 6.3 2.4 Source: Goskomstat: Derived from Consolidated Report on the Status of the Housing Stock and Number of Dwellers by the End of 1990. RUSSIAN FEDERATION Table 3-9: Estimated Regional Urban Housing Shortages, 1990 Estimated Number Number of Urban Estimated Urban of Households Units. 1990 Housing Shortage in thousands. 1989 IRatio of Households to Dwelling Units) Total Urban RUSSIA 58,844 43,159 33,500 1.29 NORTH (Region) 2,504 1,914 1,654 1.16 Archagelsk 615 448 390 1.15 Vologda 574 351 362 0.97 Murmansk 450 416 313 1.33 Karelia 314 259 243 1.07 Komi 515 385 344 1.12 NORTHWEST (Region) 3,476 3,025 2,207 1.33 c.S-Pater 2,155 2,155 1,288 1.67 Lening.obl. 669 434 462 0.94 Novgor 329 216 183 1.18 Pscov 368 221 190 1.16 CENTRAL (Region) 12,461 10,317 8,036 1.28 Bryansk 580 377 231 1.63 Vladimir 674 536 422 1.27 Ivanovo 569 466 322 1.45 Kalinin (Tver' 111 733 497 403 1.23 Kaluga 440 305 235 1.30 Kostroma 332 229 209 1.10 C.Moscow 3,684 3,683 2,812 1.31 Moscow obl. 2,740 2,150 1.665 1.29 Orel 348 220 179 1.23 Ryazan 552 351 299 1.17 Smolensk 481 314 279 1.12 Tula 748 680 518 1.17 Yaroslavl 601 492 407 1.21 VOLGA-VYATKA(Reg.) 3.349 2,302 1,847 1.25 Gor ky/Nizh.Novg.1i 1,489 1,158 887 1.31 Kirov 714 504 421 1.20 Mary-El 278 176 157 1.12 Mordovia 371 210 171 1.23 Chuvashia 481 301 211 1.42 CHERNOZEM (Region) 3,199 1,366 1.316 1.42 Belgorod 534 324 243 1.33 Voronezh 1,014 598 397 1.51 Kursk 525 298 214 1.40 Upetzk 511 308 243 1.27 Tambov 540 293 220 1.33 VOLGA (Region) 6,457 4,752 3.710 1.28 Astrakhan 390 277 189 1.47 Volgograd 990 759 614 1.24 Kuybyshev/Samwrall 1,241 1,002 850 1.18 Penza 578 366 278 1.31 Saratov 1,105 829 654 1.27 Ulyanovsk 549 401 291 1.38 Kalrnykia 107 51 60 0.85 Tatwstan 1.315 967 774 1.25 NORTH KAUKASUS/Reg. 5,934 3.584 2,374 1.51 Krasn.kray 2,063 1,149 697 1.65 Stvw.kray 1.056 614 402 1.53 Rostov 1.659 1,201 s8o 1.48 RUSSIAN FEDERATION Table 3-9: Estimated Regional Urban Housing Shortages. 1990 Estimated Number Number of Urban Estimated Urban of Households Units, 1990 Housing Shortage in thousands, 1989 (Ratio of Households to Dwelling Unitsl Total Urban Daguestan 506 238 16o 1.49 Kabard.Balkar. 242 169 84 2.00 North Osetia 210 157 100 1.57 Chechen-Ingush 357 171 121 1.42 URAL (Region) 7,565 6,052 4,689 1.29 Kurgan 433 240 244 0.98 Orenburg 799 560 456 1.23 Perm' 1,258 969 740 1.31 Sverdlov/Ek-burgil. 1,840 1,711 1,252 1.37 ChalVabinsk 1,414 1,169 889 1.31 Bashkiria 1,431 924 735 1.26 Udmurtia 586 432 373 1.16 WEST SIBERIA/Reg. 5,533 4,344 3,370 1.29 Altay krav 1,081 620 582 1.07 Kemerov 1,202 1,050 743 1.41 Novosib 1,084 816 616 1.32 Omsk 763 557 500 1.11 Tomsk 388 273 234 1.17 Tumen' 1,124 84e 696 1.22 EAST SIBERIA/Rag. 3,533 2,497 2,058 1.21 KrasnoVarsk.kr. 1,430 1,036 879 1.18 Ircutsk 1,087 se8 697 1.25 Chita 504 34e 238 1.45 Burvatia 375 n/a 191 Tuva 97 46 53 0.88 FAR EAST (Regionl 3,073 2,458 1,927 1.28 Primorski kr. 921 716 563 1.27 Khabarov.kr. 712 589 464 1.30 Amur 405 288 226 1.28 Kamchatka 181 149 116 1.28 Magadan 215 172 145 1.19 Sakhalin 285 236 204 1.16 Yakutia 364 260 220 1.18 KAUNIGR.OBL./Reog. 361 287 252 1.14 Source: Goskomstat RUSSIAN FEDERATION Ta 4-1: Progres of Housing Privatization in Urban Areas, 1991 - July 1992 Total number Total spa Number of Number of Units Units Averaga of publicly of publicly units units privatized privatized size of owned units owned units privatized privatized as % of all as % of all privatized in urban aea (urban and as of units, units, as of unit, in m2 rural areas) in 1991 July 1992 1992 July 1992 RSFSR - total 33,500,270 1,631,735,327 113,140 826,196 0.34 2.47 51.0 Sevemynr-n 1,653.565 78,807,140 1,750 19.294 0.11 1.17 46.8 Arhangelskays o. 390,488 19,169,026 450 3,606 0.12 0.92 45.4 Vokbgodskaya o. 362,208 17,389,754 243 6,765 0.07 1.87 46.0 Murmanskayao. 313,391 15.115,947 429 3,387 0.14 1.08 42.0 Kweliyar. 243,009 11,288,017 502 2,963 0.21 1.22 52.0 Komi r. 344,469 15,844,396 116 2,583 0.03 0.75 45.1 Savero-Zanaspvhr-n 2,266,791 119,860,278 1,204 23,586 0.05 1.04 49.8 S.Peterburg 1,287,523 72,058,659 41 10,531 0.00 0.82 54.4 LeninWradskayao. 462,203 22,706,178 447 8,451 0.10 1.83 49.2 Novgorodsk yao. 183,080 8,686,814 241 1,878 0.13 1.03 44.7 Pskovskaya o. 190,096 9,165,856 475 2,666 0.25 1.40 48.9 Zentrainy r-n 8,036,258 398,436,561 8,430 239,846 0.10 2.98 51.5 Bryanskaya o. 230,698 11,385,013 249 1,166 0.11 0.51 55.2 Vladimskay o. 422,237 19,759,872 501 4,460 0.12 1.06 43.8 lvanovskayao. 322,399 15,045,718 428 6,148 0.13 1.91 39.4 Tverskaya o. 402,711 19,377,986 976 9,184 0.24 2.28 48.4 Kalugskaya o. 234,516 10,965,666 457 6,177 0.19 2.63 48.9 Kostromskayao. 209,014 9,696,080 137 1,548 0.07 0.74 47.1 Moskva 2,812.226 147,586,308 945 166,375 0.03 5.92 52.0 Moskovskays o. 1,665,406 80,928,374 1,845 13,346 0.11 0.80 60.5 Orlovskayao. 178,599 8,819,431 217 2,560 0.12 1.43 46.2 Ryazanskays o. 298,860 14,017,319 852 2,641 0.29 0.88 46.6 Srobenskaya o. 279,403 13,505,788 187 13,020 0.07 4.66 49.2 Tulskaya o. 618,332 25,195,411 807 7,754 0.16 1.50 50.5 Yaroslavskaya o. 406,865 19,462,894 889 5,081 0.22 1.25 45.9 Volo-Vvatkv r-n 1,846,896 87,373,474 1,570 22,665 0.09 1.23 48.8 NizeWorodskayao. 886.682 42,122,762 607 16,777 0.07 1.89 48.0 Vyatskaya o. 421,179 19,506,275 102 2,761 0.02 0.66 53.5 Mriya-Elr. 166.601 7,336,078 287 1,697 0.18 1.08 53.6 Mordoviya r. 171,258 8,329,853 339 784 0.20 0.46 45.0 Chuvashiya r. 211,276 10,078,506 235 626 0.11 0.30 47.6 RUSSIAN FEDERATION Tble 4-1: Progrs of Housing Privatization in Urban Areas, 1991 - July 1992 Total mnber Total apce Nunbe of Number of Units Units Average of publicly of publicly units units privatized privatized size of owned units owned units privatized privatized as % ot all as % of aO privatized in urban area lurban and as of units, units, as of unit, in m2 rural areas) in 1991 July 1992 1992 July 1992 Centrakno-Chernozemnv r-n 1,316,473 64,032,866 5,368 27,497 0.41 2.09 55.7 Balgorodalcaym o. 243,006 12,231,144 2,098 12,366 0.86 5.09 62.0 Voronezakays o. 396,660 19,034,896 1,971 6,737 0.50 1.70 49.7 Kurskayao. 213,513 10,539,442 688 4,941 0.32 2.31 54.6 Lpezkaya o. 242,975 11,805,685 549 1,192 0.23 0.49 52.0 Tumbovakaya o. 220,319 10,421,699 662 3,059 0.30 1.39 49.0 Povolgskyr-n 3,710,073 180,250,356 16,584 62,141 0.45 1.67 51.1 Astrachanskaya o. 188,544 8,607,248 2,531 5,196 1.34 2.76 48.0 Vologradskaya o. 613,766 29,977,871 2,113 21,716 0.34 3.54 52.4 Samask yayo. 849,565 41.315.514 849 8,679 0.10 1.02 47.2 Penzenskayao. 278,471 13,761,348 913 7,927 0.33 2.85 53.5 Swratovskayao. 654,055 31,132,389 1,525 5,345 0.23 0.82 48.6 Ulyanovskaya o. 291.130 14,641,590 93 687 0.03 0.24 45.8 Kalmykiya r. 60,286 3,167,310 1,109 3,441 1.84 5.71 59.4 Tatantan 774,256 37,647,086 2,113 3.812 0.27 0.49 50.4 Severo-Kavkaz&kvr-n 2,374,229 113.271,255 43,242 142,496 1.82 6.00 50.5 Krandwauly k. 697,184 32,812,155 14,183 43,672 2.03 6.26 51.0 kc. Adygeya 49,644 2,414,481 2,095 6,738 4.22 13.57 45.1 Stawopolaky k. 401,649 19,848,808 11,365 43,080 2.83 10.73 53.5 kc. Kwarchevo-Chwrkesiya 56,205 2,807,910 1,245 5,081 2.22 9.04 45.6 Rostovkays o. 810,442 38,417,967 6,794 18,349 0.84 2.26 51.7 Dagstanr. 160,137 7,187,646 936 11,401 0.58 7.12 47.2 Kabwrdino-dalkaiyar. 84,317 4,117,033 2,600 5,949 3.08 7.06 45.1 Sev.Osetiya r. 99,742 4,994,953 635 1,626 0.64 1.63 42.8 Chechano-Ingushetiya r. 120,758 5,892,793 3,389 6,590 2.81 5.46 45.6 UraIsky r-n 4,688,520 223,435,461 9,297 84,825 0.20 1.81 49.9 Kvganskkyao. 243,676 11,193,503 977 7,578 0.40 3.11 44.9 OreNburgskayso. 455,860 22,313,761 1,514 8,786 0.33 1.93 90.3 Peray o. 739,669 34,698,372 1,161 3,370 0.16 0.46 49.5 Ekatirewixgskaya o. 1,252.406 59,782,304 625 20,256 0.05 1.62 45.9 Chdlyubkkaya o. 889,222 42,958,840 1,749 37,351 0.20 4.20 50.2 BEshkorstan r. 734,959 35,214,792 3,052 5,849 0.42 0.80 49.1 RUSSIAN FEDERATION Table 4-1: Progress of Housing Privatization in Urban Areas, 1991 - July 1992 Total number Total space Number of Number of Units Units Average of publicly of publicly units units privatized privatized size of owned units owned units privatized privatized as % of all as % of all privatized in urban area (urban and as of units, units, as of unit, in m2 rural areas) in 1991 July 1992 1992 July 1992 Udmurtiya r. 372,728 17.273,889 709 2,105 0.19 0.56 46.5 Za0dro-Sibirskyr-n 3,370,363 163,747,148 16,455 115,607 0.49 3.43 51.6 Altajsky k. 581,623 28,186,688 2,443 5,193 0.42 0.89 54.6 inc. Gornyi Altai r. 29,661 1,361,707 5,244 36,385 17.68 122.67 46.4 Kemerovskaya o. 743,189 36,400.622 1,937 10,268 0.26 1.38 43.8 Novosibirskaya o. 616,058 29,522.570 491 24,766 0.08 4.02 49.5 Omskaya o. 499,687 24,742,388 5,457 19,733 1.09 3.95 52.4 Tomskaya o. 233,907 10,855,587 328 1,399 0.14 0.60 41.9 Tjumenskayao. 695,899 34,039,293 755 18,063 0.11 2.60 52.2 Vostochno.Sihfrsk r-n 2,058,208 100,025,679 5,212 48,037 0.25 2.33 52.3 Krasnoywsky k. 878,910 43,188,216 529 13.731 0.06 1.56 46.7 inc. Chakassiya 129,625 6,299,673 289 7,832 0.22 6.04 47.5 Irkutskays o. 696,695 33,667,573 2,081 17,840 0.30 2.56 59.4 Chitinakaya o. 238,249 11,056,959 783 2,161 0.33 0.91 46.3 Buryatiya r. 190,926 9,409,414 1,320 3,864 0.69 2.02 51.4 Tuva r. 53,428 2,703,517 30 2,430 0.06 4.55 50.9 Dalnavostochnv r-n 1,926,820 90,078,886 1,805 35,227 0.09 1.83 50.2 Prlmonky k. 563,043 25,935,688 487 13,934 0.09 2.47 48.4 Chabarovsky k. 453,611 22,308,149 550 6,320 0.12 1.39 46.8 Amurskaya o. 225,606 10,894,940 32 9,070 0.01 4.02 58.1 Kamchatskayao. 116,095 5,336,147 217 2,139 0.19 1.84 42.6 Magadanskayso. 144,949 6,486,806 80 2,612 0.06 1.80 42.4 Sachalinskaya o. 203,628 9,240,446 56 128 0.03 0.06 44.1 Yakutskaya Sacha r. 219,888 9,876,710 384 1,025 0.17 0.47 42.2 Kainingradskayao. 252,074 12,416,223 1,762 4,553 0.70 1.81 47.7 Source: GoCkodmtat *Con_oled Report on the Stutus of the Housing Stock and Number of Dwellers'; 'Privatization of Flats in Muncipal and Departmentsl Housing Housing Stock.' Compilation by N. V. Kalinina. RUSSIAN FEDERATION Table 5-1: New Housing Constrution, 1980-1992 1980 1985 1986 1987 1988 1989 1990 1991 1992 1993 Totai New Corsbucton, mli m2 59.4 62.6 66.2 72.8 72.3 70.4. 61.7 48.3 41.5 41.8 Index, 1980-100 100.0 105.4 111.4 122.6 121.7 118.5 103.9 81.3 69.9 70.4 Index, Previous Year= 100 105.8 110.0 99.3 97.4 87.6 78.3 85.9 100.7 State-Financed (Local Governments and Enterprises) 2/, min m2 49.6 50.2 53.3 59.2 57.8 56.0 47.5 36.7 29.2 22.0 Index, 1980-100 100.0 101.2 107.5 119.4 116.5 112.9 95.8 - - - Index, Previous Year =100 106.2 111.1 97.6 96.9 84.8 - - - Local Govemments 2/, min m2 49.6 50.2 53.3 54.1 30.1 27.6 21.0 Index, 1980=100 100.0 101.2 107.5 109.1 60.7 55.6 42.3 Index, Previous Year= 100 106.2 101.5 55.6 91.7 76.1 Enterprises, mln m2 - - - 5.1 27.7 28.4 26.5 Index, 1987-100 100.0 543.1 556.9 519.6 Index, Previous Year= 100 543.1 102.5 93.3 - - - Financed by Housing Coops, min m2 2.5 3.4 3.6 4.1 4.1 3.7 2.9 2.4 2.1 1.9 Index, 1980 =100 100.0 136.0 144.0 164.0 164.0 148.0 116.0 - - Index, previous Year 105.9 113.9 100.0 90.2 78.4 Financed by Other Enterprises, min m2 and Organizations 31, min m2 3.3 5.3 5.4 5.3 5.2 4.8 5.3 - - Index, 1980 = 100 Index, Previous Year = 100 Private Construction, min m2 4.0 . 3.7 3.9 4.2 5.2 5.9 6.0 5.4 4.9 5.6 Index, 1980=100 100.0 92.5 97.6 105.0 130.0 147.5 150.0 135.0 - - Index, Previous Year =100 105.4 107.7 123.8 113.5 101.7 90.0 Source: Ministry of Economy 1/ As % of new construction of the first half of 1991 21 UntI 1987, centra budget resources were channeled through local governments and enterprises. Since 1987, enterprises' funds began to replace centralized financing. Local govemments continue to receive central budget transfers, but they will be increasingly expected to generate own resources for housing investment. In 1992, they built approximately 3.8 mln square meters of housing using locally raised funds. 3/ Include collective farms, other cooperative-type enterprises, as well as other public bodies. RUSSIAN FEDERATION Tabl 5-2: New Houing Construction: Ateamativ Projections for 1993-1995 Pro(ctions, Viant I PWcton, Varant II 1992 1993 1994 1995 1092 1993 1994 1995 Total New Constucton, min m2 38-40 55-60 70-80 90-100 20-22 20-25 25-33 35-41 State-Financed (Central Budget/ Local Budgets/Entrprisean,m nm2 26.5 38.0 44.0 48.0 13.7-14.1 13.7 16.3 21.4 Central Budget, min m2 5.1 9.0 10.0 12.0 2.6 2.5 2.7 3.4 Local Governments. own funds 3.8 6.0 9.0 11.0 2.3-2.5 2.5 2.9 3.8 Enterpries, min m2 17.6 23.0 25.0 22.0 8.8-9.0 8.9 10.9 14.2 Finaced by Houg Coops, min m2 1.5 3.0 6.0 8.0 0.5-0.9 0.9 1.1 1.4 Finced by Other Enteprises, min m2 snd argdzatoni 31, mhimn2 6.3 7.8 13.0 17.0 5.2-5.8 6.8 7.6 9.9 Privat Construction, min m2 3.7 6.5 13.0 22.0 0.6-1.3 1.8 3.0 5.3 Souoa: Mhsths of Cosauhloo and of Econrm 11992 projectons) RUSSIAN FEDERATION Table 5-3: Housing Investment, by Source of Funds, 1980-1993 (in min Rbs) 1980 1986 1987 1988 1989 1990 1991 1/ 1992 1993 proj. 1/ proj. 2/ Total Outlays 13,227 18,629 20,180 21,339 22,339 22,919 37,100 191,000 1,372,900 as % of total national investment 14.0 15.4 15.7 15.4 15.5 15.9 18.9 State Investments 11,497 15,587 17.076 18,036 18,853 18,880 30,800 154,000 Central Budget-Financed 15,587 15,709 9,045 8,521 8,347 11,500 55,000 114.500 Local Government Funds 84,000 Enterprise Funds - - 1,367 8,991 10.332 10,533 19,300 99,000 988,800 Housing Construction Cooperatives 404 689 773 772 682 654 1,100 6,000 Other State/Public Organizations 1,762 1,678 1,674 1,678 2,168 4,300 26,000 37,800 Population Funds 379 591 653 857 1,120 1,217 900 5,000 96,600 Sources: Ministry of Economy; Projections for 1993: *Special Government Program: Housing", Ministry of Construction, Dec 1992 1/ Outlays of 1980-1990, in constant prices of 1984. For 1991 and 1992, in prices of 01/01/1991. 2/ Projections for 1993 in prices of the IV quarter of 1992. RUSSIAN FEDERATION Table 54: Net Change in Housing Stock, 1990 Urban Urban Urban Rural State-Owned Private Total Stock Reduction, 1000 m2 4725 3363 1149 3719 Reduction as % of Total Stock 0.3 0.3 0.4 0.8 due to: (in %) conversion to non-residential use 12.7 16.7 3.0 6.1 demolitions: old, dilapidated stock 46.9 54.1 31.6 75.6 demolitions: natural disasters 4.0 4.0 4.6 7.9 demolitions: for new construction 21.8 11.5 55.5 7.8 other 14.6 13.7 5.3 2.6 Total Stock Increase, 1000 m2 63166 56901 2944 21314 Increase as % of Total Stock 3.8 4.4 1.1 3.2 ot which new construction, % 56.5 54.9 60.0 70.4 Source: Ministry of Economy RUSSIAN FEDERATION Table 6-1: Operating Subsidies for the Housing Stock and Average Cost Recovery for Maintenance and Utility Services January 1, 1991 January 1, 1993 September 1, 1993 January 1, 1994 April 1, 1994 Total cost of operation of housing stock, per 1 m2 of total floor space, in Rbs 2.1 146 620.0 1071.0 1740.0 in which: maintenance & current repairs 1.0 41 125 240.0 290.0 utility costs 1.1 105 395 831.0 1450.0 Costs covered by tenants, per 1 m2, In Rbs / in percent 0.38 / 18.1 5.32/3.64 26.62/4.9 32.82/3.1 54.62/3.14 in which: maintenance & current repairs 0.12/ 12.0 0.12 /0.3 0.12/0.10 0.12/0.05 0.12/0.04 utility costs 0.26 / 23.6 5.2/5.0 25.5/6.0 32.7/3.94 54.5/3.76 Source: Ministries of Construction and Economy, 'Special Government Program in Housing', Dec 1992 RUSSIAN FEDERATION Table 6-2: Operating Subsidies for the Housing Stock and Trends in Cost Recovery for Municipal and Enterprise Housing, 1987-1991 Ratio of revenues 1/ to recurrent & capital Local government housing Enterprise housing 2/ expenditures, per 1 m2 of living space, in %: 1987 48.1% 30.0% 1988 47.6% 31.3% 1990 52.2% 29.2% 1991 38.0% 22.7% Total expenditures per I m2 of living space, in Rbs: 1987 7 9 1988 7 10 1990 7 11 1991 15 26 Source: Ministry of Economy 1 / Revenues include rental revenues from lease of commercial space 2/ Exchlding budget-dependent units RUSSIAN FEDERATION Table 6-3: Operating Subsidies for the Housing Stock: Moscow City Housing Maintenance Budget 1/ 1990 1991 preL. 1992 projected Revenues per/l m2 of living space, in Rbs 4.5 6.8 30.0 of which, in %: Residential rents 41.0 27.0 6.2 Commercial rents 38.0 46.0 86.3 other 21.0 27.0 7.5 Current expenditure per/l m2 of living space, in Rbs 3.5 11.4 143.2 of which, in %: Current repairs 52 26 23 Maintenance/administration 28 21 28 Labor 14 35 35 other 6 17 14 Nominal total per 1 m2 cost index, 1990 = 100 100 326 4091 Ratio of total revenues to expenditures, in % 126.2 60.2 20.1 Ratio of residential rent revenues to expenditures, % 51.8 16.4 1.3 Sources: Department of Housing Maintenance of Moscow 1/ Only for operations and maintenance: excludes capital repairs and capital recovery. RUSSIAN FEDERATION Table 6-4: Savings Bank of Russia: Interest Rates on Deposits and Loans 1990 1991 1992 before after July 1 July 1 DEPOSITS Sight deposits 2.0 2.0 3.0 20.0 Term deposits wl compensation 3.0 3.0 - Term deposits 1 - 3 years 5.0 10.0 30.0 3-5 years 7.0 15.0 40.0 over 5 years 9.0 25.0 50.0 Special deposits 4.0 9.0 25.0 60.0 Special/premium deposits 3.0 5.0 7.0 30.0 1990 1991 1992 LOANS Housing 1/ Construction, purchase of single-family houses 3.0 15.0 20.0 Construction/repairs of garden houses 3.0 15.0 20.0 Purchase of apartments - by agreement Housing construction coops 3.0 15.0 20.0 Agriculture Purchase of cattle 3.0 15.0 20.0 Establishment of private farms - 15.0 20.0 Other Consumer emergency loans 6.0-8.0 14.0-16.0 30.0-60.0 Interbank 12.0 22.0 Business related Interbank + 2-3% Sources: Savings Bank of Russia ISbarbank) 1/ Borrowers pay 8%. The balance of 12 points is a (central) budget subsidy. RUSSIAN FEDERATION Table 6-5: Housing Construction Loans Issued to Households 1 /, 1980-1990 1980-1985 1986 1987 1988 1989 1990 No. of No. of No. of No. of U Units No. of # Units No. of # Units borrowers borrowers borrowers borrowers completed borrowers completed borrowers completed Total Federation 742,077 85.899 103,242 73,798 6,466 53,141 10.726 124,430 40.394 in which: Northwest Region 1,552 202 1,061 90 2,527 389 St Petersurg City 7 146 86 27 0 105 10 329 35 StPetersurgOblast 461 67 177 558 12 538 13 1,217 159 Novgorod Oblast 771 314 273 155 13 201 27 498 94 Central Region 4,370 392 5,428 582 10,759 1,998 Moscow City 72 17 3 1 0 1 0 1 1 Moscow Oblast 3,874 1,656 389 1,512 208 1,928 123 3,956 475 Ryazan Oblast 822 85 646 186 6 222 43 391 107 Volgovyatsky Region 3,192 382 2,071 623 5,820 1,854 Gorki Oblast 4,127 1,088 1,595 1,053 83 551 109 1,543 636 Western Siberia Region -- 7,817 1,185 6,651 1,169 12,450 5,115 Novosibirsk 5,678 1,412 1,479 962 495 461 176 2,226 1,710 Source: Savings Bank of Russia ISberbank) 1/ Excluding garden houses 4, l I, !I1'I p I 'f' "''