Problems in construction projects: why contractors refuse contracts

Developers are freezing projects for the time being - until the time when their financial models are no longer an unsolvable equation.

Victoria Pavlova

Almost 169.5 thousand state contracts in the construction sector for a total amount of 4.4 trillion rubles were canceled in 2019-2020 or their contractors were fined (for various reasons). More than 26% of contracts were torn during this period, that is, every fourth state building was in limbo, - said Nikolay Alekseyenko, deputy chairman of the State Duma committee on construction and housing and communal services.

Thus, the construction market is approaching a new crisis with a lump of unresolved old problems.

Today, the volume of existing state contracts is estimated at 19 trillion rubles. The number of outstanding contracts may increase by another 20% by the end of 2022, experts predict. Fearing further inflation, contractors stop participating in auctions.

The head of the Accounts Chamber of Russia, Alexey Kudrin, talks about a third of the thwarted state contracts at the moment:

“We are now experiencing up to a third of disruptions in trading, it may turn out that at the end of the year we simply will not seriously fulfill what is planned”, - Kudrin said at a meeting of the budget committee of the Federation Council.

According to him, last year the disruption of bidding was due to poor preparation of contract procedures, this year there are new reasons - an increase in prices for building materials. When contractors see that prices have soared, they understand that they will not be able to fulfill the contract on the old terms, the head of the Accounts Chamber explains. He also recalled that last year, when there was a similar situation with prices in construction, the authorities introduced a new flexible procedure for clarifying contracts. This year, there are much more contracts that need to be reviewed.

Inflation, a jump in prices for building materials, a break in supply chains and the refusal of foreign companies to cooperate with Russia can lead to an increase in the number of long-term construction projects. In state auctions, we recall, the participant who offers the lowest price for his services wins. Often this is dumping - the winner hopes to increase the price after the conclusion of the contract through additional agreements. In the current environment, it becomes even more difficult.

In fact, non-fulfillment of state contracts means freezing the construction of schools, kindergartens, hospitals, cultural and transport facilities, housing for orphans, migrants from emergency housing, the military, and so on.

The problems have already affected construction sites due to open in 2022. In jeopardy is a school overhaul program launched this year. According to Nikolai Alekseenko, up to half of the planned purchases in several regions of the country did not take place due to the lack of applications from contractors.

- The construction business is faced with a choice: to execute contracts at a loss or to try to somehow change the conditions laid down in them. In the case of government customers and major customers, it is impossible to change the terms of the contract. It is currently difficult to predict the behavior of small and medium-sized developers. The impact of the ruble exchange rate on the economy will be fully understood in a few months. It is likely that some of the small developers working in local markets will leave the industry. The most likely scenario is the completion of current projects and the abandonment of new ones, - says the founder of the urban planning bureau "Master's plan" Yulia Zubarik.

The state has a mechanism for increasing the cost of existing government contracts (Decree of the Government of the Russian Federation No. 1315, which allows raising payments), but so far it is working with a slip. Firstly, the customers themselves are reluctant to do this, and secondly, even after going through all the bureaucratic procedures, many contractors stumble upon a refusal.

Applications for recalculation were rejected for 60% of construction contracts, Anton Glushkov, president of the National Association of Builders (NOSTROY), said on Monday at an expanded meeting of the commission on pricing in construction and technological and price audit of the Public Council under the Ministry of Construction of Russia.

The government has previously stated that contractors should be allowed to increase the final prices of state contracts for construction, reconstruction and overhaul by up to 30% to compensate for the increased cost of building materials and resources. In the Ministry of Construction itself, 40% of approved applications, that is, 1339 revised contracts out of 3035, however, are considered a good indicator compared to last year.

Many state-owned construction projects and construction projects in general, in the absence of proper support, will soon find it difficult in principle to find a developer, experts comment.

Specifically, the difficulties are associated with the lack of a clear algorithm for supporting the industry by the state during this crisis period. In the coronavirus years of 2020-2021, when the construction business also faced rising prices, many contractors were pressured to fulfill contracts under the old terms, which meant absolute unprofitability. The experience of going through the coronavirus crisis is remembered by many as painful.

A number of developers told NI that they had shifted from ordinary state tenders to rather specific ones: "We are actively waiting for debt and bankrupt state facilities to be put up for auction, plots under which it will be possible to develop"...

In addition, banks have switched to saving mode - they are reluctant to lend to small and medium-sized construction businesses. “They may give out, but with two “buts”: only to borrowers that are understandable to them and at a percentage that is incomprehensible to such borrowers. Those who looked in this direction are changing their minds,” market participants comment.

In the new realities, another state support measure tied to the Central Bank rate is also becoming unprofitable - project financing using escrow accounts. Previously, it was popular with developers, but now it has become unprofitable to implement projects using this tool, objects are frozen for an indefinite period, because for many construction companies the question of whether or not to purchase materials and consumables is no longer worth it, market participants say.

"Banks are very willing to give loans - at 25-27% per annum, please. Project finance programs are likely to be adjusted to the new rate - up to 22-24%. At such rates, only 1 project out of 1000 will be able to get a profit according to the financial model. And even the subsidizing of rates up to 15% promised by the Government of the Russian Federation does not help much yet. Formally, banks are happy with any client, but when talking about the size of the interest rate, we forget that there are still hidden commissions. Sometimes very substantial. These include requirements for the amount of own participation (it was 15%, now it is 25-40% of the project budget), requirements for the speed of implementation of areas under construction, requirements for the experience of the developer and the presence of a certain set of employees in the state, requirements for "special" construction control from accredited companies and so on. Playing with these parameters, the bank, even for that one thousandth, can create a situation in which the client himself refuses a loan", - says Arkady Astrakhan, General Director of Specialized Developer LLC Regional Construction Management.

It appears that only high availability facilities will soon remain operational. High-rise buildings, which have the last upper floors left, and private houses with ready-made boxes are now being completed on the "old yeast". They prefer not to enter new projects - it is unprofitable and there are too many unknowns.

- The residential complex, which is in the final stage, we plan to put into operation this summer, and during the year we will complete the finishing work in the apartments themselves. The final stage, so that you understand, is facade work and landscaping. New objects are still in the design phase, and there are many more questions with them ... Why? It is almost impossible to predict the cost of their construction. Even the specification of materials and equipment now looks more like an astrological forecast than an estimate. The profitability of Moscow and St. Petersburg developers makes it possible not to shift the consequences of economic turbulence onto buyers, at least until the end of the year, but then everything will depend entirely on macroeconomics. The "paper" and "excavated" projects will have a significant share of conservation - my forecast: up to 70% for the first and up to 40% for the second, - says Oleg Dedkov, Managing Partner, LES Living Complex.

According to the expert, in order to restart the construction industry, it is urgent to rebuild logistics chains, to launch "Industrialization 2.0" - a real, and not a "show off" import substitution. And for a breakthrough in the domestic industry of building materials and equipment, subsidies are needed, just as mortgage programs need them to maintain consumer demand.

Moscow architect Alexey Krotov believes that it is necessary to revise previously launched programs immediately, otherwise the departure from reality will bring big problems to the entire construction complex. In particular, the expert criticizes the continuation of full-scale financing of mass construction projects in the capital, for example, renovation and resettlement of dilapidated housing:

"The technical equipment of the capital's construction complex depends on 90% of imported components, the money will be allocated and hung up in international transactions, and the mass construction itself can turn into giant "cemeteries" of unfinished construction". Krotov notes that the authorities should not rush to finance mass development projects, since they are only of interest to developers.