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In 2023, the construction sector and real estate transactions accounted for around 16% of GDP, and related industries accounted for around another 11%.
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The transition of the analyzed sector to a new financing system, which involves the use of an escrow mechanism, made it possible to increase the share of housing construction using funds in escrow accounts from 25% at the beginning of 2020 to 97% by the end of May 2024.
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After the introduction of the escrow mechanism, the credit quality of developers who issue bonds improved, which was reflected in a consistent upgrading of their credit ratings by an average of two to three notches over the past few years.
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Half of developers currently have A category ratings; around 40% of companies have a BBB category ratings1.
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The number of issuers from the residential construction sector has grown considerably over the past few years, yet the segment has remained highly concentrated — the five largest issuers account for around 70% of bonds in circulation.
- Private investors and project finance partner banks are key investors in developers’ bonds.
In this joint research, analysts from ACRA and DOM.RF have analyzed developers who are present in the Russian debt market. A selected analysis of the credit quality of industry representatives before and after the escrow reform was conducted, and the impact of the reform on the levels of credit ratings of developers and the subsequent change in the perception of the industry by bond market participants were assessed.
1 Data was used on issuers with national scale credit ratings from ACRA and/or Expert RA. If an issuer had ratings from both agencies, the credit rating assigned by ACRA was used.
PROVIDING A BOOST
The construction sector plays an important role in the Russian economy and has a high multiplier effect, which positively influences the dynamics of many other sectors. The development of construction is currently one of the main drivers of the growth of consumption of metals, construction services and materials, as well as transportation services. The construction sector’s direct contribution to the country’s GDP was 5% in 2023, and taking into account real estate transactions, it was around 16%. The contribution to GDP of construction-related industries as of the end of 2023 was estimated at around a further 11% (Fig. 1). In general, the contribution of construction and real estate transactions to GDP in 2023 was comparable to the pre-pandemic indicators of 2018 (about 15%).
Figure 1. Contribution of construction and related industries to Russia’s GDP in 2023
* Taking into account adjustments for areas involved in the construction industry
Source: Rosstat
Since 2020, there has been a positive trend in the construction of residential buildings, although the volume of housing under construction has not yet returned to the levels recorded in the pre-pandemic period. The volume of current construction amounted to 112 mln sq. m at the end of 2023, having increased by 3–5% annually since 2020.
The area of commissioned residential buildings grew from 82 mln sq. m in 2020 to 110 mln sq. m by the end of 2023. According to DOM.RF, the five leading regions in terms of housing commissioning in 2023 included the Moscow Region (12.5 mln sq. m), Krasnodar Krai (7.6 mln sq. m), Moscow (7.3 mln sq. m), and the Leningrad and Tyumen Regions (4.2 mln and 3.7 mln sq. m, respectively).
Figure 2. Residential construction dynamics in RussiaSources: Rosstat, UDR
The transition from the old scheme of financing projects using developers’ own funds and the funds of shared construction participants to the new project financing system happened rather quickly. The share of apartment buildings built using escrow accounts in the total volume of residential construction from the start of 2020 to the end of May this year grew from 25% to 97% (Fig. 3).
Figure 3. Share of construction involving escrow accounts
Source: nash.dom.rf
Although construction activity is growing, Russians continue to experience low housing supply and there is still considerable unsatisfied demand for high-quality housing. Around 30% of the country’s housing stock was built more than 50 years ago and is now worn out and obsolete. As Fig. 4 shows, over 17 years (from 2006 to 2023), the share of housing built prior to 1970 declined by 13%, while from 1971 to 1995 this indicator declined by 10%. The share of buildings erected after 1995 has increased by more than 2.5 times. At the same time, a quarter of the housing stock needs to be renewed, which is one of the incentives for building new housing. Under Decree of the President of the Russian Federation No. 309 dated May 7, 2024 “On the national development goals of the Russian Federation until 2030 and for the future until 2036”, the housing stock must be updated by no less than 20% by 2030 compared to the indicator for 2019.
Figure 4. Breakdown of housing stock by construction yearIn addition to resolving the issue of defrauded homebuyers, the shared construction reform also improved the credit quality of developers. The project financing mechanism works according to the principle of isolation of the financed project from other projects. The bank provides a targeted loan to finance the project and then exercises complete control over the expenditures of the developer’s SPV — a legal entity created to carry out the project as part of the construction supervision procedure in accordance with Federal Law No. 214-FZ “On participation in shared construction of apartment buildings and other real estate objects”. However, the funds from selling apartments accumulate in the escrow accounts held at the bank. After a property is commissioned (i.e. when its tenants receive the keys to their homes), the escrow accounts are disclosed and the bank transfers these funds to the developer’s SPV.
The 10 largest developers account for around 20% of the current construction volume. They include PJSC Samolet Group, LSR Group PJSC, Setl Group, Ltd, and “Brusnika. Stroitelstvo i development” LLC, who are active participants of the bond market.
Table 1. Ten developers with the largest area of housing under construction as of June 30, 2024Source: nash.dom.rf
In order to compare the creditworthiness of developers before and after the transition of the housing construction industry to the escrow mechanism, indicators of leverage and debt service were assessed, and an analysis of the debt structure of 19 residential real estate developers who entered the bond market in 2016–2023 was carried out.
Fig. 5 shows a breakdown of the credit ratings of developers before the escrow account reform and at the present. The analytical sample took into account issuers with credit ratings from ACRA and/or Expert RA.
Figure 5. Bond issuing developers and their credit ratings
Sources: ACRA and Expert RA
Prior to the transition to the escrow mechanism, most of the issuers from the residential construction sector who had credit ratings were part of the BBB rating category, a few were rated BB+, and only one had an A rating. Besides this, there were a number of defaults on bond issues of residential construction sector issuers3 from 2007 until the transition to project financing in 2019.
3 Taking into account the adjustment of the sample for the actual activities of companies in the housing construction industry and the exclusion of repeat registration of issuers within the same group.
Table 2. Bond market defaults by issuers from the residential construction sector
After 2019, the number of issuing developers increased significantly, and the spectrum of credit ratings assigned to them broadened greatly. Currently, half of the representatives of the sample have a category A rating, and around 40% have a category BBB rating. It is important to note that all companies from the sample that had credit ratings of categories BB and BBB before the escrow reform moved to higher ones — BBB and A, respectively. The gradual upgrade of the credit ratings of these issuers (in most cases by two to three notches) was driven by the improvement of their credit quality over the past few years due to growth of business size and segment and regional diversification of projects, as well as higher financial stability amid positive leverage and coverage dynamics recorded by some developers.
ACRA’s methodology defines the industry risk of housing construction as very high, which has a certain restraining effect on the credit ratings of companies in the construction sector. However, the Agency positively assessed the transition of developers to the system of financing using escrow accounts and reduced the weight of the industry risk profile in the overall assessment from 35% to 20%. This has somewhat reduced the impact of industry risk on developers’ ratings, although the assessment of this risk is still significantly above average.
PROJECT FINANCING STARTS AND WINS
Today, almost 100% of the current construction-in-progress is carried out by developers using project financing from banks. Under this arrangement, the loan interest rate depends on the dynamics of sales and accumulation of funds in escrow accounts. If the sales rate meets expectations, developers receive bank financing at a below-market rate. If sales deviate from the model, the cost of financing increases to the market level.
Fairly long construction periods result in the predominance of long-term borrowed funds in developers’ loan portfolios. According to ACRA’s estimates4, in 2016–2023, the share of long-term debt (maturing in more than one year) was about 75% (median value), and in the last two years it was 66%.
As shown in Fig. 6, the main source of project finance in the total debt of the sample companies in 2017–2018 was corporate debt5, which accounted for 60%. In 2019, the housing construction industry began to gradually migrate to the project finance mechanism. By the end of 2023, the share of borrowed project finance funds reached an average of about 74%. Project debt substituted corporate loans whose share decreased from 60% to 9% of the developers’ debt portfolios. The share of bonds decreased less significantly, and therefore they became the second most important source of borrowed funds. Developers have increasingly resorted to financing through bond issues in recent years as the financial market has become more developed. The number of developers from the sample who issued bonds increased from 10 in 2018 to 19 (that is, all the companies analyzed in this study) by mid-2024, and the total volume of bonds issued by all companies in the sector grew by more than 1.5 times —from RUB 150 bln to almost RUB 250 bln.
4 Hereinafter, calculations are based on available corporate consolidated IFRS financial statements for 2016–2023.
5 Corporate debt includes bank loans; other liabilities are lease obligations and other borrowings, including DFAs.
Sources: corporate IFRS financial statements, Cbonds, ACRA
DEBT-DRIVEN GROWTH
The ratio of net debt6 to EBITDA7 was used to analyze the companies’ leverage. As seen in Fig. 7, the leverage of the sector companies in the sample has increased on average since 2018, as the share of project financing in the total debt has increased: the median ratio of net debt to EBITDA grew from an average of 1.3x in 2016–2018 to 2.1x in 2019–2023.
To estimate debt coverage, the ratio of EBITDA to interest and the ratio of EBITDA to net interest8 were used. The median ratio of EBITDA to net interest for all companies in the sample deteriorated from an average of 6.3x in 2016–2018 to 5.2x in 2019–2023 (and the median ratio for 2023 at about 6.0x was lower than the average median ratio for the period before the introduction of escrow accounts), and the median ratio of EBITDA to interest decreased from an average of 4.9x to 4.7x for the above periods, respectively.
6 Net debt is the total debt less cash and its equivalents and escrow account balances. Escrow account balances should not exceed project finance debt. Accordingly, the escrow account balance is used if it is less than project finance debt, or project finance debt is used if the escrow account balance exceeds this amount.
7 Hereinafter, we used EBITDA as calculated by companies and disclosed in IFRS financial statements, investor presentations, or issuers’ reports.
8 Net interest is the difference between interest earned and interest paid.
Sources: corporate IFRS financial statements, ACRA
At the same time, the increase in developers’ leverage after the introduction of escrow accounts is a natural consequence of both the changed structure of project financing and the growth in the volumes of housing construction and mortgage lending. These factors required developers to attract additional funds (mainly project financing) in order to scale up their business and expand project portfolios.
In the analyzed period, the effective interest burden was relatively stable due to the lower borrowing costs of project finance in comparison to ordinary lending. According to the Bank of Russia, in Q1 2024, the rate on the project finance portfolio was 6.9%, which is almost 1.8 times lower than the corporate lending rate of 12.5%.
TO SUIT ANY TASTE
According to Cbonds, at the time of preparation of this research, the volume of outstanding9 ruble-denominated market bond issues of corporate issuers was about RUB 10 tln (Fig. 8). The construction sector is part of the top ten by par value of outstanding issues and in the top five by the number of issues10.
9 Hereinafter, excluding securitization, DFAs, structured products, and mortgage, subordinated, commercial, and replacement bonds.
10 Hereinafter, taking into account the adjustment for actual activities in the housing construction industry and the exclusion of issuers who belong to the same group of companies.
Figure 8. Structure of market issues of outstanding corporate bonds
Sources: Cbonds, DOM.RF
Currently, the construction industry bond market remains highly concentrated. The top five issuers, who are also the country’s largest developers in terms of construction-in-progress, account for about 70% of the market (Fig. 9). These companies have been assigned category A credit ratings, which corresponds to a moderately high creditworthiness and opens access to a wider range of institutional investors, thus contributing to an increase in bond financing.
Figure 9. Structure of developers’ bonds market by outstanding volume
Sources: Cbonds, DOM.RF
MORE TO COME
The transition to escrow accounts has contributed to increasing the reliability and transparency of the construction industry, which, in turn, has improved investors’ perception of the credit quality of issuers who are developers. The number of active issuers, bond issues in circulation, and their volume have increased by almost 50% since the escrow reform. In addition, the number of new bond issuers, mainly regional developers, has increased significantly.
The construction industry is one of the most diversified and widely represented by issuers of various rating groups in the Russian debt market.
Figure 10. Model map of the developers’ bonds market
Sources: Cbonds, DOM.RF, Moscow Exchange
Another impetus for the expansion of bond issues offered by housing construction companies was the increased involvement of private investors in the financial market. In 2023, the number of retail investors grew to 29.7 mln compared to 3.9 mln in 2019. Developers’ bonds offer a significant premium to OFZ yields, which attracts certain categories of private investors. An additional factor of investment attractiveness is the widespread brand awareness of a number of developers who issue stocks as well as bonds.
Most developers do a lot of preparation to effectively enter the bond market. The Moscow Exchange’s listing rules require the consolidation of assets, preparation of IFRS financial statements, presentation of a balanced financial model matching the company’s development strategy, and the improvement of corporate governance practices. All these preparations are also necessary for a comprehensive assessment of the potential issuer by a rating agency and the assignment of a credit rating that serves a key factor in subsequent pricing.
The presence of developers in the bond market may further expand in view of the following: 1) the perception of the sector by market participants has changed for the better in recent years; 2) the credit quality of issuers continues to improve, which is reflected in the increasing number of issuers that have category A ratings and in the growing interest of institutional investors; 3) the activity of private investors in the bond market continues to grow, providing a significant amount of demand for developers’ bond issues. The state, in turn, provides consistent support to the housing construction industry, which will contribute to the further development of the market.