Opportunity Knocks: The Benefits and

Dangers of Turn-Key Solutions for CEE

Markets

Leonid Peisakhin, Exclusive Analysis Ltd.

Leaf Contractors Summit, Prague

March 24, 2006

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RISK SELECTION

RISK ALLOCATION

RISK REDUCTION

RISK DEFENCE

RISK IMPACT MITIGATION

POST-EVENT RISK

RESPONSE

RISK AVOIDANCE RISK MANAGEMENT

STAGE IN RISK CYCLE

FIN

AN

CIA

L O

PP

OR

TU

NIT

Y

CORPORATE

SECURITYAUDIT

FRONTLINESECURITYCOMPANY

POST-LOSSAGGREGATION

BAILING OUTDURING

FLOODING

Early-Stage Risk Identification is Most Valuable

CEE Construction Market: General Trends

Growth is expected over the next 1-2 years As costs increase in Hungary and the Czech

Republic, firms will start targeting further East e.g. Romania and Bulgaria

Russia’s construction market will dominate in CEE

Non-residential real estate returns will decrease while residential and civil engineering segments will grow

EU structural and cohesion funds injectioninto infrastructure in Czech Republic, Hungary & Poland will spur market growth

Poland’s recent construction malaise will reverse

Major change likely on the Moscow market

CEE Construction Market: potential pitfalls

• Burdensome administrative practices are likely to persist throughout 2006.

• Corruption will remain rampant across CEE, improving only gradually.

• The involvement of organised crime in the construction sector in Russia and Bulgaria will continue.

• The hope of rapid spending of EU regional funds in the Czech Republic and Poland is misplaced: bureaucratic inefficiency will get in the way of this.

Political risks of investing in Russia: general observations

• GDP growth (2005): 5.9%

• Construction market growth (2005): 10%

• Residential housing market is expanding rapidly (esp. cities with more than 1 million inhabitants and Black Sea resort areas)

• Expansion of residential housing is one of President Putin’s national projects

• Mortgage provisions are being rapidly developed

• Sixty percent of all housing stock is dilapidated and in need of renovation/replacement

Political risks of investing in Russia: general observations

BUT• Burdensome regulations

• Widespread corruption and administrative incompetence

• Large construction firms are linked with municipal governments

• Supply of building materials is virtually monopolized

• Expropriation pressures and murders

• Regime change risks

• Terrorism risks

• Cargo/supply chain disruption risks

• How long will the boom continue?

Political risks of investing in Russia: the Moscow market

• Highly lucrative: property prices growing at 30-40%pa in recent past

• Industrial areas are being earmarked for commercial and residential development and some residential areas are being re-planned

• Administrative procedures are due to be simplified in 2006-7

BUT• Mayor Luzhkov controls the allocation of building

permits and indirectly controls a construction empire

• Supply of building materials is tightly controlled• The problem of illegal workers• MAJOR CHANGE LIKELY: Luzhkov is likely to leave

the mayoral post in 2006-7

Political risks of investing in Poland

• GDP growth (2005): 3.3%

• Construction market growth (2005): 7.4%

• Negative growth trends of the last several years are finally expected to be reversed this year

• Poland ranks last in Europe in terms of the number of apartments per 1,000 residents

• Demand for residential housing will also be driven by the fear of VAT increase on apartment purchases to 22% in 2008

• Poland needs to undertake major civil engineering projects to conform with EU legislation

Political risks of investing in Poland

BUT• The country will be slow in making use of EU

cohesion and development funds• Large scale corruption along with administrative

inefficiencies will likely persist• Investment in engineering and infrastructure

projects will be hampered due to lack of local development plans

• Political risks associated with early parliamentary elections

• ON THE POSITIVE SIDE: the Government has talked about comprehensive regional planning law, changes to PPPs, a new construction act and maintenance of preferential VAT rates beyond 2008

Political risks of investing in the Czech Republic:

• GDP growth (2005): 4.6%

• Construction market growth (2005): 4.2%

• Most developed construction market in the CEE, particularly in non-residential property

• Large investment in infrastructure is expected (EU funds)

• Growth potential still present but limited

Political risks of investing in the Czech Republic:

BUT

• Large-scale corruption connected to awards of public contracts and building permits

• Slow and inefficient administrative processes

• Malicious disruption of construction projects

• November 2006 elections

• ON THE POSITIVE SIDE: sound economic indicators

Political risks of investing in Hungary

• GDP growth (2005): 3.7%

• Hungary leads in terms of new housing in the CEE, yet investment in construction expressed as percentage of GDP is the lowest in CEE

• Civil engineering projects represent the next growth area

• Healthy development potential within the Golden Triangle and in eastern Hungary

Political risks of investing in Hungary

BUT

• Administrative inefficiencies and corruption

• Cumbersome and slow legal system

• Likely tightening of development and rezoning regulations overtime

• Economic indicators

• April 2006 elections

Political risks of investing in Romania

• GDP growth (2005): 5.2%

• Construction market growth (2005): app. 7.5%

• The boon of EU accession

• Demand for commercial space is growing rapidly as is that for residential housing in the cities and for industrial space along major motorways and in western Romania

• Romania has seen some mildly successful economic reforms in 2004 and 2005

Political risks of investing in Romania

BUT

• Corruption and red tape persist

• Construction market is dominated by state-controlled companies

• Negative economic indicators

• The outlook for regime stability

Political risks of investing in Bulgaria

• GDP growth (2005): 5.4%

• The boon of EU accession

• Expansion of the residential construction market due to promotion of mortgage schemes

• Sizeable investment in infrastructure

• Sofia, the capital, and Black Sea resort areas are the construction hot spots

Political risks of investing in Bulgaria

BUT

• Widespread corruption is a major problem

• Administrative processes extremely inefficient

• Organised crime involved in the construction industry

• Bureaucracy outside of the capital is extremely difficult to deal with

• Economic indicators

• Political stability

Conclusions

• CEE states, and particularly Russia and Romania, present a major opportunity

• We’ll likely be seeing a movement eastwards as the EU expands and the cost of doing business in Central Europe rises

• BUT CEE markets must be navigated with care• Municipal and central governments usually work

in tandem with local firms• Corruption levels are high across the CEE• Red tape can be mind-boggling and permits take

a long time to secure• Regional governments are usually more difficult to

deal with than authorities in the capital• Foreign firms are best off operating through

subsidiaries registered in states where construction is undertaken and/or in tandem with major local construction companies

Opportunity Knocks: The Benefits and

Dangers of Turn-Key Solutions for CEE

Markets

Leonid Peisakhin, Exclusive Analysis Ltd.

Leaf Contractors Summit, Prague

March 24, 2006