A booming real estate market is not something that immediately comes to mind when an outsider thinks of Moscow, but to city residents the omnipresent building cranes are vivid reminders of the transformation that Russia’s capital is going through.
A city with virtually no modern, international-standard office, retail, warehouse, hotel or residential buildings just a decade ago, Moscow is quickly emerging as one of Europe’s biggest and most important real estate markets. And for the local and foreign developers that are changing the city’s face forever, the sky is the limit – both literally and figuratively.
Moscow is now home to Europe’s tallest residential building – the recently completed, 264-metre Triumph-Palace; eastern Europe’s biggest shopping mall – the 230,000-square metre Mega Khimki, which opened its doors in late 2004; and the 340-metre Federation Towers office complex, currently being built as part of the ambitious Moscow-City development, is expected to become Europe’s highest skyscraper when it opens its doors in two years’ time.
High profits, high rises
Driven by a combination of rising personal incomes, new-found political stability, and high profits from oil and gas exports flowing into construction and property acquisition, Moscow’s real estate is undergoing a period of spectacular growth, not unlike that experienced by Russia’s eastern neighbour, China. According to international real estate consultant Jones Lang LaSalle, in 2000 Moscow had only eight modern shopping centres, with a total area of 116,540sqm; today, it boasts more than 1,053,950sqm of retail space in 41 malls.
Correspondingly, the total stock of modern office space has nearly doubled since 2000, reaching 3,544,000sqm by mid-2005. And the combined area of Moscow’s international-quality warehouse space grew 2.4 times in the same period, reaching 1,604,300sqm. Jones Lang LaSalle estimates that in the next three years about 2-2.5 million sqm of new office space, 1 million sqm of up to as much as 1.5 million sqm of new warehouse space will hit the market.
More to come
Still, even with this new stock, Moscow, a city of more than 10 million people, will have only a fraction of London’s offices, Paris’s retail outlets or Berlin’s warehouses, possibly suggesting many more years of active real estate development across all sectors.
With this in mind, it is hardly surprising that Russian oligarchs are looking at construction and real estate development in Moscow. For example, in August billionaire Oleg Deripaska’s Basic Element group acquired controlling stakes in Moscow’s Glavmosstroi and Razvitiye building giants, gaining control of roughly a third of the city’s lucrative construction market.
Norilsky Nickel and Guta Group holdings have recently acquired blocking stakes in OAO City, a management company, for the $12bn Moscow-City project, which envisages the construction of 2.5 million sqm of office, retail, hotel and residential space on a 60-hectare site in western Moscow by 2008.
Local stranglehold
The strong role of local groups and local capital also sets Moscow apart from other former communist bloc capitals in eastern and central Europe. While Western investment funds and banks have been actively present in Prague or Warsaw, in Russia their involvement in the real estate market remains limited.
“Currently, inflow of Western investment [into real estate] is well behind the capabilities of Russian market players, which tend to swifter, more aggressive and more flexible,” says Natalya Pirogova, head of real estate at Britain’s Fleming Family & Partners (FF&P), which invests Western pension money into Moscow’s prime real estate. “Not to mention that Russian companies are anything but short on funds these days.”
Since October 2003, when Moscow clinched its first institutional real estate investment deal – the acquisition of the 10,900-sqm Gogolesky 11 office building for an estimated $30m by FF&P, the city has had only two other institutional investment deals by foreign funds: one by FF&P (a 7500-sqm Class A office and retail centre at Lesnaya 3 in March 2005 for about $25m to $30m) and one by Switzerland’s Eastern Property Holdings REIT, which bought Berlin House office and retail complex in central Moscow for more than $40m in May 2004.
By comparison, oil giant Lukoil’s subsidiary, Perm Financial & Industrial Group, alone has bought three Class A office buildings in Moscow since late 2003 for roughly $110m.
Western reluctance
While Russian groups’ better familiarity with local market conditions and overall quicker decision-making process plays a role, it is ultimately a lack of high-quality, investment-grade properties that explains why Western investors have not been very active in Moscow, says Maxim Kunin, real estate adviser to Morgan Stanley, who advises several international companies on their real estate plans for Russia.
“In Moscow today, you can either find a prime office building with bad title, or a substandard building with all documentation perfectly in order. It is rare that you see an investment-grade building with a world-standard title,” Mr Kunin explains. The situation is gradually changing, however, as a number of high-quality new buildings are scheduled to hit the market in the next few years, he adds.
Lack of international-standard properties in Moscow means that today potential investors are “basically forced to stand in lines to sign deals”, agrees Olga Arkhangelskaya, head of real estate advisory services at Ernst & Young. “But the market is evolving very quickly and becoming more sophisticated and professional.”
FF&P’s Ms Pirogova reckons the market is still too small even for two or three large Western investment funds. “Many Western players are looking at this market but don’t see any real opportunities here. The minimum requirements for their entry are stability, presence of investment-grade product and adequate risk to profitability correlation,” she says. “With this in mind, I do not anticipate a massive entry of Western funds into the market.”
As a sign of the lack of absolute confidence in the Russian real estate market, Germany’s Invesco Real Estate fund will devote no more than 20% of its €750m Central European Real Property Fund II to acquiring office, retail, industrial or mixed-used properties in Russia, concentrating instead on Czech Republic, Poland and Hungary.
“The only way we were able to sell Russia [to our investors] is by creating a blended product, where Russia wouldn’t play the key role,” said Guy Barker, head of fund management at Invesco Real Estate, during a real estate conference in Moscow last autumn. The fund is expected to make its first Russian acquisitions between early 2006 and late 2008.
In July this year, The UK’s Raven Russia Limited announced its plans to invest up to £500m into Russia’s real estate, chiefly in the industrial sector.
European deals
On the development and financing side, European real estate lending institutions are also becoming increasingly active in Russia, offering much more competitive lending terms than their local competitors. For example, in March 2005, Hypo Real Estate International completed its first Russian deal: the $23m refinancing of the Gogolevsky 11 office building for FF&P.
“Investment opportunities are just tremendous across all four commercial real estate sectors – offices, retail, industrial and hotels,” says Michael Lange, managing director at Jones Lang LaSalle in Moscow.
Mr Lange predicts than in the next 12 months institutional debt financing will grow “many-fold” and surpass $1bn for the first time in a given year. Much of this sum will come from Western mortgage banks, which are about to enter the market, he says.
