The Russian commercial property market had a remarkable 2006. Nearly $3bn from foreign investors flowed in and, inevitably, the pressure from this wave of wealth resulted in tightening yields.
Darrell Stanaford, managing director for Russia at CB Richard Ellis, says: “In the second half of 2005, the pundits said they expected yields to drop to 9.5% before the 2008 elections, and then fall as low as 8% after the elections. But it now looks like we are going to get below 8.5% before the elections.”
To illustrate just how rapidly yields have been moving, Stanaford cites the example of a buyer who had an exclusive deal to buy the Dukat II office building in Moscow at a yield of 9.75%. The deal fell through but, within three months, London & Regional agreed to buy the building at a yield 50 basis points lower.
For many, the rapid yield movement in the Russian market mirrors the similar contraction seen in Eastern Europe as the Czech Republic and Poland converged with the EU.
Critical differences
Paul Kennedy, director of European research at Invesco, thinks that too many investors assume the two regions are the same, and are ignoring critical differences between Eastern Europe and Russia. “For a start, Russia is never going to join the EU,” he says. “There is strong economic growth in Russia, stronger than the EU, but also much higher inflation.”
Russian economic growth is also highly reliant on the continuing outperformance of the natural resources sectors. Kennedy is concerned about the Russian state regaining control of this sector. “State industries are not as efficient as the private sector,” he claims.
It is not all doom and gloom. “There is a strong growth of the middle class, and consumer spending is on the up,” says Kennedy.
This increase in consumer spending is spurring investors to look at cities other than Moscow and St Petersburg. Russia has around 14 cities with populations of a million or more, and these often lack office space and shopping centres.
Once again, investors must tread carefully. “A regional city can support only one or two quality office buildings, so if you miss out on those, there’s not much point investing,” says Stanaford. “It can probably support between four and five shopping centres, however, although investors need to ensure that the mall they buy has the best possible location.”
Location is not the only factor to consider when investing in Russia. Like other emerging markets, there are a host of issues to consider before spending money. “Investors need to pay close attention to yield definitions in Russia,” says Stanaford. “There can be more than 100 basis points separating gross and net yields.”
The whole deal process can be nerve-wracking, admits Robert Stolfo, fund manager at Invesco. “Your Russian counterparts can be very volatile during the whole decision-making process, and you can lose the deal at any time,” he says. “Once you have signed, however, you can be sure of the deal.”
Unlike Eastern Europe, foreign investors face stiff competition from Russians who have profited from oil and gas. “The Russians’ aggressive attitude to risk makes them tough bidders,” says Kennedy.
But foreign investment companies do have opportunities to form closer alliances with Russian developers. Stolfo explains: “During construction of a site, it may well be that we could offer the developer money at a cheaper rate than the banks.”
Russia’s decades of communist control have left a legacy of concrete air-hangar-style hotels, and the development of more comfortable establishments has become a hot sector.
According to the Emerging Trends in Real Estate Europe report from the Urban Land Institute and PricewaterhouseCoopers, Moscow suffers from a desperate lack of three-star hotels, and there is an undersupply of hotels throughout the country. “Hotels are undersupplied in all of the major regional cities, and developers tackling these markets are expecting high returns,” it states.
Kennedy has a final word of caution for investors: “Investing in Russia is not a no-brainer. Decisions to put money into the country should be weighed up as carefully as anywhere else.”
Hydromashservis project, Moscow: developer MirLand is converting the former factory into a 16,000m2 office scheme
Hydromashservis project, Moscow: the office conversion is one of several office, residential and retail schemes that developer MirLand is building across the country
Russian property stalwart Mirland focuses on regional cities
Developer MirLand has been involved in property in Russia since 2004 and is now building both residential and commercial schemes. The company was established by private Israeli investment group Fishman.
MirLand believes there is significant retail potential in Russia’s regional cities. It is building a one-storey shopping centre in Yarsoslavl, a regional town 280km north-east of Moscow and 750km south of St Petersburg. The scheme, which will have a 32,000m2 floorplate, is scheduled for completion this month.
Roman Rozenthal, chief financial officer at MirLand, says: “Russia’s regional cities have big populations that both the international and local retail chains are keen to tap into. But there are few competent developers in these cities, and our decades of experience at developing shopping centres with the right design that are attractive to the right tenants gives us the edge.”
The company is considering rolling out similar shopping centre projects to Yaroslavl in another 31 cities that have more than 500,000 inhabitants, including Novosibirsk, the Tomsk region and Rostov.
MirLand is also starting the construction of a mall centre in Saratov.
Rozenthal shrugs off suggestions that Russia is a tougher market to operate in than others. “It has the same risk for developers as any market in the world,” he says. “A developer needs enough experience to know how to get the right planning permission.”
Growth is not restricted to regional cities. In St Petersburg, MirLand is constructing a mixed-use development comprising 9,000 flats, with 30,000m2 of commercial space and 60,000m2 of office space.
To compensate for its development risks, MirLand aims to gain yields of 17% or above on the projects in which it invests.
