Escrow accounts - saving co-investors or increasing the cost of housing?

Less than thirty years after the first scandal with the defrauded co-investors, Mr. Putin gave instructions to protect them. Moreover, since our President is already used to the fact that the government does not care about the consequences of reforms, so he strongly recommended that all changes be made without prejudice to housing construction. But as the first 7 months of practice showed, the favorite quote from Chernomyrdin worked again: "There's never been anything like this before, and now here we go again".

The "most significant reform of the construction industry in Russia since 2004" has a collective creator: Ministry of Construction Industry, Housing and Utilities Sector; Ministry of Economic Development; Ministry of Justice and; of course, the foreign consulting companies, which are struggling to work for the $2 billion allocated to them by the Russian Government every year.

Any major decisions that change the life of the industry should be implemented carefully and gradually. But some decisions in the government of the Russian Federation, decisions that are usually beneficial to some lobbyists, are implemented almost at lightning speed. On December 11, 2018, an order was issued, in March 2019, changes were agreed to in Federal Law No. 214-FZ, and from July 1, developers switched to project financing.

The principle of protection of co-investors is simple: their money is transferred not to the developer, but to an authorized bank with a BBB or higher credit rating into a special escrow account. In Russia, there are only 95 such banks out of 484.

Escrow account — a special bank account where the buyer's (customer's) funds are put and they will not be available to the seller (contractor) until he fulfills all obligations to the client. To create an escrow account, a three-way agreement is concluded between the seller, the buyer, and the bank. The bank is the guarantor of the security of the transaction and receives remuneration in the form of a percentage of the transaction or a fixed amount for mediation. Only after the bank confirms that all the conditions are met - the funds will be transferred to the seller's account.

Thus, in the construction sector, banks become intermediaries between co-investors and developers. Funds in escrow accounts are frozen until the ownership of the apartment is transferred to the co-investor. The bank will transfer them only after verifying the authenticity of the commissioning certificate of the residential complex and an extract on the registration of the buyer's right of the apartment ownership from the Unified State Real Estate Registry (RUS ЕГРН).

Savings in escrow accounts are insured for up to 10 million rubles. In most cases, this provides a guarantee of a refund, even if the bank where they are kept goes bankrupt.

Under the old rules, several groups of developers are allowed to work if:

• projects are in high readiness;
• construction of problematic facilities is being completed;
• projects with a volume of 4 million square meters of housing in at least 4 regions or the developer develops the region's territories in a complex way. The so-called "major property developers".

As usual, the reform started before a thorough study of the situation. And government officials ignore the predictable problems of working under the new scheme even after 7 months:

• Who will make the decision to terminate the contract and return the funds if there are complaints about the quality of construction? The bank's employees are not authorized to do this, so they are obliged to bring experts and pay for their work, which will eventually lead to an increase in the cost of the bank's services. The examination procedure is not worked out, the risks and additional costs of the developer are unclear;
• 10 million rubles will not cover losses in case of an unsuccessful choice of the contractor for elite housing;
• Using escrow accounts does not allow the use of maternal capital, targeted housing subsidies, or other benefits.
• Some players can return to opaque schemes - selling shares to legal entities to reach the threshold of purchased apartments required by law, so as not to work with escrow accounts, and then resell the apartments to final buyers at an inflated price.
• Money in an escrow account can be kept for up to 5 years. Funds are not indexed. The bank uses them without remuneration of the co-investor. Therefore, due to inflation, the funds in the account partially lose their purchasing power.

By the way, what are the consulting companies paid for if they are unable to identify obvious problems before the reforms were launched?

As usual, those responsible for introducing the solution were full of unjustified optimism. The head of the Ministry of Construction Industry, Housing and Utilities Sector Vladimir Yakushev said that nothing like this will happen – "the market is quickly adapting to the new rules and there will be no excesses in the form of rising housing costs". Most importantly, co-investors will receive guarantees, and no more fraud with their money will occur, and developers are now interested in building faster and transferring the housing into ownership

Mr. Yakushev was being frankly disingenuous: when did banks do charity work and provide services for free? This contradicts the very essence of their existence.

At first glance, it was already clear that the decision will have a lesser impact on the growth of the cost of apartments in the "economy" format. This term in construction was forbidden to use by law, and now the segment has a grand title- "standard". It is the blocks in the "standard" format that are being built en masse by major developers on the outskirts of cities. But developers in the "standard+" and higher segments now have to either use their own funds, or take a loan from the same banks that charge them for keeping escrow accounts.

That means that the developer will pay the bank twice: for keeping an escrow account and for an interest on the loan. Automatically, the cost of housing for the developer increases by at least 10%. The same 10% that he uses to attract consumers through discounts and promotions with gifts. In fact, banks "gobble up the good stuffs" intended for the consumer.

The developers "are catching on fast", so the increase in the cost of housing was predictable from the very beginning.

What changes can we talk about today, 7 months after the start of the reform?

Every fifth apartment is built through escrow accounts, and banks received 1 trillion rubles. It is obvious that in 1-2 years the majority of project financing will be covered. So far, the reform has led to a sharp decrease in the activity of developers. Only those projects which the developers can't postpone their commencement are entering the market. Many developers have taken a time-out, trying to understand how the situation in the industry will develop, some of them are trying to get the status of a major developer.

Preliminary results:

• Rising cost of housing. According to official data from the Ministry of Construction of the Russian Federation, by the end of 2019, the average cost of 1sq. m. of primary housing in Russia has increased by 8% on average. Mr. Yakovlev managed to forget his previous statement and made a new one: "at the beginning of 2019, there were forecasts that the cost of housing could grow by 30% or even 40%. In fact, the price of a square meter in the country as a whole increased by 8%. That is, we can say that everything is within the bounds of reason...I can say that square meter was undervalued." Another hypocrisy. In order that the price be increased by 8% in the country as a whole, the use of escrow accounts actually led to an increase in the cost of project construction by at least 20%.
• The use of schemes started. For example, in Moscow, a month after the start of the reform, the number of Cost-sharing Arrangement contracts increased from 7,589 to 11,677. But thanks to The Federal Service for State Registration, Cadastre and Cartography (Rosreestr) data, it is clear that more than half of the contracts are registered with legal entities. Developers buy apartments themselves, so that when the threshold of 30% of purchased apartments is reached, they can attract buyers' money directly. The actual number of cost-sharing arrangements dropped by 20-30%.

We have assessed the situation, and now let's try to understand why or for whom the fever in the construction industry is settling and the load on the end user is growing.

All in order that there were no deceived co-investors? In 2018, their number increased by 1.8%, and in 2019 – by 1.3%! In other words, the entire huge mass of victims today is the result of unfair supervision by regional authorities over the construction of yesterday's properties. The reform started to work when the fraud companies have virtually disappeared from the market.

It is not for nothing that we draw your attention to the fact that the bill was initiated when new defrauded co-investors in the market almost disappeared. Why did such a necessary bill appear after 20 years of Putin's rule, although foreign practice of such decisions has been in effect for a long time? Why is the reform implemented grossly, without eliminating serious errors?

Because the bill is not a result of Mr. President's "kindness" to mere mortals. This is another step towards influential lobbyists. The main beneficiaries will be three banks – Sberbank, VTB and Bank Dom. RF. They will get the lion's share of payments: from 30 to 60%.

We believe that over the next 3-4 years, the banks, using the escrow account scheme, will receive 3-4 trillion rubles of the money of citizens involved in the construction industry, and about the same amount will be the loans taken by developers. The share of the three banks is from 3 to 5 trillion rubles per year.

In other words, the largest banks in Russia will receive additional benefits, and the construction market is beginning to eliminate the weakest players. The remaining developers will be compensated for the additional funds spent by the consumers who are not satisfied with a "standard" apartment and life in the ghetto.

The saddest thing is that the decision was made to protect co-investors – the problem can not actually be solved. It brought back the gray schemes, so the number of defrauded co-investors will not decrease.

The reform is another decision of the government, which clearly harms the market and does not fulfill the tasks set. Again, under the guise of caring about consumers, they created a super-feeder for lobbyists, in this case, banks, and they artificially increased the cost of new buildings. All the new expenses have been passed on to the consumer, for whom the path to their own apartment will become even longer and more unpleasant. Stalin was thanked for a happy childhood. Putin will be thanked for an "eventful" adult life filled with daily fear of "falling to the bottom", years and decades when the family counts every penny. He will be thanked for an unforgettable mortgage experience, for the extra years it will take to pay for the appetites of brazen creditor banks that have once again found another way to cash in on the defenseless population.

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