Better and better: A year in review and a look ahead
Ten years ago, few would have imagined that Russia would become the focus of international real estate investment. Today there is little doubt that Russia has made a qualitative leap forward, securing a place among the world’s leading markets.
Over the last five years Russia has made a steady climb upwards. Prime yields in the office market segment have compressed by nearly 1000 bps rendering a Q4 prime office yield of around 9-9.5%. Retail and logistics sectors also experienced impressive compression with prime yields softening 700bps and 900bps respectively. Capital inflows and an improved access to local debt instruments suggest that by the end of 2007 the market will demonstrate further compression.
A year end summary of 2006 finds the weight of demand now supported by international investors from around the globe, with many new entrants from across Western Europe. In 2007 we expect the investor base broadening to include new entrants from such markets as the USA, Australia and South Korea.
Total investment volume for the Russian real estate market in 2006 rounded out at USD4.5 billion, placing it in a similar league to China (USD5 billion). In 2007 conservative estimates see this volume growing to well over USD5 billion. A notable change for 2007 will be the increased weight of foreign capital, expected to top over USD3 billion.
While Russia’s investment market gained important depth in 2006, with increased transaction numbers and scale, it is still capable of attracting a range of investor types. Private investors or corporations favouring more opportunistic ventures are still present, but the trend toward institutional investment is expected to continue through 2007, with the possible entry of pension funds after the presidential election. An ongoing IPO boom in the country is diversifying investment opportunities for local and international investors.
On the back of growing investment volumes and secure economic fundamentals, Russia saw notable increases in consumer spending, placing even greater demand on the retail market. With more than 1.6 million sq m of shopping centre space in Moscow late 2006, we expect retail stock to expand to 2.24 mln sq m by year end 2007 fuelled mainly by an expansion of consumer spending through improved access to personal debt. Despite this growth in supply, market equilibrium is not expected to be met anytime soon.
The 2006 focus for the retail sector was regional development and investment activity. This trend will continue in 2007 with greater attention paid to investment as high quality assets hit the market in select cities. The regional retail investment volume for 2007 is expected to exceed USD1 billion.
On the financial side, Russian banks have prudently managed the challenge of development and investment, though lending rates have not been competitive with foreign banks. Western banks have been more aggressive with better adequacy ratios and capital, allowing them to provide more sophisticated and competitive debt to investors.
Russia’s impending banking sector consolidation, the advent of asset backed securities, and WTO accession all indicate good news for the Russian debt market.
The 2006 demand-supply imbalance on the Russian logistics market should begin to be resolved in 2007, with a number of large-scale schemes hitting the market. Though total market size is expected to grow by more than 30% to 4 million sq m, demand will continue to outpace supply, leaving rental levels stable over the short term.
Prime rents for the Moscow office market reached a new level in 2006 with a designation of a zone around the Kremlin in the city centre. Prime office rents in Moscow are now challenging those of London with rates of USD1200 per sq m per annum positioning the market in second place across Europe. In 2007 we expect these levels to strengthen indicating a clear preference for Moscow as a business location in Europe. This position will be strengthened further with the realization of large scale, high quality schemes in Moscow City, the new financial district.
Russia changed significantly in 2006 and all the evidence is pointing to a strengthening market in 2007. For many international investors Russia’s long term market potential is now comparable to most of the Western European and Asian markets, with opportunities evolving in all sectors and a growing force of international institutions playing an integral role in the future. A growing flexibility of capital and increasingly sophisticated financing and debt instruments (refinancing, mezzanine and joint venturing, to name a few) are becoming more prevalent, allowing investors and developers to pave the way for a more mature and developed investment market.