A growing economy and international investor interest point to a strong future.
commercial real estate market is in an exciting phase of development,
reflecting the Russian economy’s dynamic growth. One of the highlights is
Moscow’s office sector, which has surpassed London in total annual lease-up for
the first time this year and now is second in Europe only to Paris, reflecting
massive pre-construction leasing. Local and international retail chains
continue to expand deeper into untapped regional markets. The warehouse market
slowly is evolving although quality space continues to be scarce. Investment
markets across the board are growing quickly helped by the emergence of an
investment-grade property sector.
However, some hazards are associated with this market.
Political risks remain high in Russia
and there is a shortage of investment-grade buildings. The quality of asset and
property management needs to meet international standards, title issues often
are not watertight during the development phase, and the lease quality needs to
In a vast and heterogeneous country such as Russia where a
property is located is significant. Huge income disparities exist between the
Russian regions depending on whether the region is rapidly expanding or
stagnant. In Moscow, for example, average net
domestic product per person is 150 percent above the national average, while Kazan in northeast Russia is home to 5 million people,
but has an NDP of 41 percent of the Russian mean, according to Jones Lang
LaSalle. Major regional differences also
exist in terms of economic momentum. The following outlines the status of each
property sector in Russia’s
expanding economy and real estate market.
Russian companies’ preference to own and developers’
reluctance to sell are defining factors of the Russian office market, according
to Cushman & Wakefield’s Stiles Riabokobylko. The demand for office space
is driven mainly by growth in the following industries: banking, science and research,
telecommunications, commodity markets, and entertainment.
capitalization rates of fully tenanted class A standard office space in Moscow and St.
Petersburg is 11 percent to 13 percent (before taxes
and depreciation), although this is subject to variables such as location,
quality, and tenancy. Capitalization rates on prime office space are expected
to compress over the next three to four years, due principally to an expected supply
In most cases, quality office buildings in cities are built
by large private companies (particularly banks and oil companies) for their own
use, and only rarely do they come on the open market. Most speculative business
centers are erected in the cities by local construction companies at the
expense of future owners. Moscow
developers only now are starting to enter the regional markets with their
Class A office centers are present in some cities with
populations of more than 1 million including: Chelyabinsk,
Ekaterinburg, and Novosibirsk.
The first business centers of class A standard began development in Samara and
Rostov-on-Don in 2006.
At the end
of 1Q06, St. Petersburg
was leading regional cities with a population of more than 1 million by quality
office stock per 1,000 inhabitants, according to Jones Lang LaSalle. This
indicator was about 82 square meters per 1,000 inhabitants (5.5 times less than
Despite continued unfulfilled demand, the modern-quality
warehouse market remains hugely underdeveloped due to a combination of factors,
the chief one being the complicated and bureaucratized land acquisition and
rezoning process. Existing stock is insufficient and vacancies are virtually
nonexistent. The market continues to be characterized by high rents when
compared to developed European markets.
space is mostly made up of old industrial premises, class B properties, trading
depots, and hangars. Large logistics operators are almost completely absent
from regional markets. The range of quality logistics and speculative
warehouses in cities with a population of about 1 million is actively
developing, for instance in Novosibirsk.
New warehouses are being constructed or planned on new land plots at city exits,
which are close to federal highways.
supply of warehouse stocks cannot satisfy current and near-future demand. Class
B warehouses will dominate the supply structure for years to come. Average
rental rates for class A warehouses range between $140 and $120 per square meter
and $130 to $100 per square meter for class B, according to JLL. With the
emergence of large scale projects in the market in 2005 and 2006, landlords
aiming to secure big tenants have started proposing new pricing structures in
relation to the space rented and lease terms.
The retail sector is the most developed of Russia’s commercial
real estate. Steadily growing personal incomes in Moscow and the regions contribute to retail
being the most dynamic and quickly evolving sector of the country’s economy.
The modern, international-standard shopping centers appearing in Moscow are evidence of
this trend, as is increasing development in other large regional cities. Most
retail development continues to be done by local companies, but Sweden-based IKEA
is one of the few examples of an international company developing retail in Russia. The majority of international retail brands
are represented through franchisees.
foreign investors still are investigating the market and looking for properties
with minimum risks and maximum yields. Yields here for prime shopping centers
are 10 percent to 12 percent, and for high-street retail sites are 12.5 percent
to 15 percent, reports Cushman & Wakefield.
Russian and international retailers continue to look toward the regions as
attractive expansion opportunities. Two years ago developers’ ambitions lay in
cities with populations of more than 1 million; they now are actively building
across the country. Retail development is stimulated by increased purchasing
power in Russia’s
regions and a still tiny –- or nonexistent –- modern shopping center stock even
in some of the country’s largest cities. Regional centers such as Kazan, Yekaterinburg, Samara, Nizhny Novgorod, Perm, Voronezh, Chelyabinsk, and Novosibirsk
are seeing very active development. Important regional projects include IKEA’s
90,000 square-meter Mega Mall in Kazan,
which opened in late 2005. It was the company’s first Russian project outside Moscow and St.
Samara-based Vremya Group, which is developing the Park
House shopping center brand in the regions, actively is developing their own
chains of shopping centers across the country. IKEA opened its shopping center
in Kazan, and
it continues planning expansion to all other 1 million plus Russian cities in
the next few years, making it the most significant player in the regional
Another indication of
increased attraction to Russian regions is the planned opening of the first
Russian location of the British DIY chain Castorama in Samara.
Sources of Capital
The publicly traded vehicles still are at nascent stages. They
represent less than 0.5 percent of the Russian real estate capital universe, according
to the Russian Federal State Statistics Service. Similarly, the institutional
property investment market in Russia
also is in an early phase: Less than 5 percent of eligible stock is invested.
What is more, the implied owner-occupation ratio, or the share of the invested
stock in the total stock, is less than 2 percent, suggesting that more than 98
percent of all Russian commercial property still is owner-occupied. In
comparison, in South Korea
the implicit owner-occupation ratio stands at 80 percent, according to EIU. A
lower owner-occupation ratio frequently is used to justify a real estate
engagement in a specific market. In China
the respective ratio is 80 percent and in Japan it is 60 percent.
debt is the most important source of financing real estate in Russia. It
accounts for more than 60 percent of all institutional real estate investments.
Strong demand for commercial real estate lending in the last year was boosted
by falling interest rates, and a vibrant real estate investment market. In the
past four years, bank loans for commercial real estate have increased by more
than 500 percent to U.S. $1 billion, according to the Russian Federal State
Statistics Service. This number is poised to grow further in the next few
years, despite the government’s desire to slow credit growth. Also because real
estate loans still play only a minor role on the banks’ balance sheets,
commercial real estate financing via bank loans is very likely to continue its
investors also play an important role in the Russian investment market. At the
end of 2005, the total Russian private equity volume was roughly U.S. $1.6 billion,
accounting for 40 percent of the Russian real estate capital market, according
to IMS Group. In 2005, private property companies and individuals’ holdings of
real estate grew by 40 percent year over year.
The Russian pension fund system is poorly developed. Its
investment strategy can be characterized by a high degree of risk-aversion. Regulation
mandates that at least 90 percent of asset allocation is in government
securities or other approved securities. Its exposure to real estate sector is zero.
Changes in the pension funds’ asset allocation strategy largely will be driven
by congruent changes in regulation. In its absence, pension funds likely will keep
their large positions in government bonds and other approved securities.
true for insurance companies as well, given that Russian insurance authorities
still regard real estate investment as risky. Regulation for insurance
companies’ investment strategies remains restrictive. This will hardly change
in the near future unless the regulatory bodies ease regulations.
estate investment trusts nor real estate mutual funds exist in Russia,
implying that the real estate public markets are limited. The only way to invest
in real estate in the public market is through listed property companies, but currently
there are only a handful of these.
Although the Russian real estate capital market is small,
its momentum is remarkable, especially in the private equity and debt markets. In
2005 nearly $500 million of additional capital was invested into Russian real
estate, according to IMS Group. Strong growth in private equity was driven by
unlisted property funds and companies, which added around $100 million to the market,
as well as by private individuals. However, even more significant growth came from
private debt with commercial banks lending $400 million in 2005. Owing to a
lack of alternatives, commercial bank lending seems to be the most efficient way
of raising capital in Russia.
But both the private equity and private debt markets also are set to grow
significantly over the coming years, profiting from further project
developments and more foreign direct investment. In contrast, the public
markets are set to remain relatively small over the next few years. These
segments likely will remain relatively small until the private markets increase
in scale and, more importantly, the broader capital markets undergo significant
deepening and development.
has enormous potential in each property sector. Strong population growth, a
large pool of qualified workers, greater integration with the world economy,
and increasing domestic and foreign investment are fueling demand for office,
retail, and residential property. Although not discussed in depth in this
paper, this demand also can be applied to the hospitality sector.
forward, it will be a matter of exploiting this potential. For the real estate
industry, three aspects are most important. First, further opening to foreign
investment is desirable. Not only do international investors have the means to
finance new construction projects, they also possess the expertise in market
analysis, facility management, and building construction. In the short term,
these will act as catalysts to bringing greater transparency to the market. Secondly,
needs a stronger capital market base for property financing. The debate on the
potential introduction of REITs and real estate funds points in the right direction.
The introduction of REITs will give international investors in particular a
familiar investment vehicle. Private investors also could enter into indirect
investment in real estate. Although interest in new products is most likely to
come primarily from institutional investors, the rising middle class is likely
to seek new instruments aside from direct property investments in the short term.