Money on Interest
When investing in commercial properties in St. Petersburg and the Northwest, Western and Russian companies expect a yield of around 8-10% per annum. In the opinion of financial consultants, the office space market is most dynamic, followed by the industrial and retail segments.
Prospective Markets
Vasily Belov, general director of Fosbourne Home, believes that, on the whole, the volume of the Russian commercial real estate market has been booming in recent years. He points to the fact that in Moscow the cumulative value of supply has increased by 10% since the turn of the year and by 58% as compared to July of the previous year. The number of projects has also grown by 2% against the beginning of 2007 and by 38% YoY. In view of its lesser saturation, the Petersburg market is ahead of the Moscow market in terms of growth rates. The city’s commercial realty market grows by 15% year after year, luring large investors and expediting the launching of various projects calling for long-term investment. The upshot: in 2005-06 investment in St. Petersburg grew by more than 200%.
“The average recoupment period is 7-9 years, although the payback time tends to extend due to the increase in the total number of properties,” says Aleksei Ponkratyev, managing director of the Petersburg Branch of Nomos Bank. Just two or three years ago an experienced investor could have returned his investment after 4-5 years despite the then average of 5-7 years.
As regards the entire Northwest, projects pay for themselves within roughly the same time as they do in St. Petersburg, despite the lesser market absorption in the regions, higher administrative barriers, and a less transparent land market. However, the influence of these risk factors on yields is brought to naught by feeble market saturation in the commercial real estate segment. Perhaps the saturation signs can be found only in Kaliningrad retail, where numerous projects of retail-entertainment centers have been declared of late. Moreover, as RBI experts point out, contrary to St. Petersburg, the regions are noted for slack demand in the premium-class segment — for class A business centers and boutique retail centers — so investors cannot count on any return from such projects there. Kaliningrad has certain prerequisites for sturdy development in this direction, but at the present moment it is beyond any comparison with the potential of the Northern capital. On the other hand, there is an acute shortage of class B and C office and warehouse facilities in almost all of the cities of the Northwest. RBI experts predict that during the next three years warehouse prices will be rising at the rate of 10-15% annually while office space prices will rise by 9-10% a year during the next couple of years.
Office Boom
Currntly, the office real estate accounts for 61% of the total volume of the Petersburg commercial real estate market. Warehouse properties rank second in terms of the aggregate area, followed by retail. A return on investment in different commercial properties varies from 10-15% to 100%. The total office space supply in St. Petersburg business centers came to 1.07–1.09 million sqm in 2006 and to 1.2–1.215 million sqm in the year 2007. The number of business centers grows by 10-15% per annum in Petersburg; nevertheless demand outbalances supply in business centers of all classes.
“Office real estate is a leader of growth,” says Mr. Belov. Vladimir Sergunin, analyst with the investment department at Colliers International. “The city market sees an apparent dearth of quality office space, especially in classes A and B; moreover their development potential is very high given the withdrawal of production facilities from the city center and the clearing of prime-location territories.”
In addition, he reminds of high rental rates which continue to grow by 8-10% per annum. The average capitalization rates for the office real estate come to 8.5–9%.
According to Leonid Zakharov, adviser with the strategic consulting department at Knight Frank Saint Petersburg, the office realty segment promises an investment boom. A significant amount of projects, ranging from 200 to 500,000 sqm of office space have been announced which may swell the Petersburg business space market by more than 2.5 times by the end of 2009 in the class A and B segments. The risks of investing in the construction of office facilities generally have to do with layout solutions, reasons Vasily Belov. “However even a poorly planned office premise can still be leased out while retail real estate development mistakes are sometimes irreparable,” he explains.
The interest of non-core investors in the office market is more evidence of its high potential. Thus many housing developers, such as M-Industria and RBI, announced the delivery of business real estate construction projects this year. As reported by CRE, Dorinda Holding, the owner of the Okay hypermarket chain, is brooding over the plan to construct a large office center near Elekrtosila subway station. The largest fruit importer JFC intends to erect a business center at the site of Frunzensky department store at the intersection of Obvodnoi (By-pass) canal and Moskovsky prospekt. Petmol is relocating its facilities from the same area in the hope to develop its old campus as an office district.
Warehouse of Opportunities
Vitaly Karavaev, director of the account management department at Absolut Bank, opines that office and retail segments have been developing in equal proportions during the recent five years. The warehouse market has even shot ahead of the office segment of late in terms of growth rates. This tendency can be explained by the fact that robust construction of retail complexes spurs traffic flows and hence the need for logistics and logistic services, he explains, which is impossible without up-to-date warehouses. In particular, the sector of special-purpose warehouses and multimodal logistics complexes is actually underdeveloped, reasons Maria Ivanova, head manager of the projects developed by Praktis CB.
Igor Vodopianov, managing partner of MC Teorema, actively investing in office and logistics projects, believes that the returns on investments in office and warehouse properties have been comparable of late while the average recoupment period for such projects is 5-6 years. As estimated by RBI experts, offices will remain most attractive for investments in the sphere of commercial real estate. “But in the long run warehouses are more attractive,” we were told at the company. Logistic properties pay for themselves during five years or more while their yield starts from 20%.
In the words of Leonid Zakharov, the warehouse real estate has been booming in terms of investor activity in recent years. As of the present moment, industrial projects with the aggregate space of around 2.5 million sqm are at different stages of delivery and another 1 million sqm or so are being actively constructed. “The investment in class A warehouse construction averages $800-900/sqm for the development of storage facilities proper, and if land acquisition and engineering preparation costs were factored in, the cost would reach $1,100-1,200/sqm and higher,” he says. The average market capitalization in logistic properties amounts to 10%.
Retail Backs Down
According to Leonid Zakharov, the investment boom in the retail segment has already passed. The peak of investment activity in this segment fell on the years 2005-06. The year 2006 broke all records in terms of retail space delivery — about 1 million sqm. Now the amount of investment in retail-entertainment complexes has stabilized. The forecast delivery for 2007-09 keeps within the range of 750–900,000 sqm.
“In recent years the retail complexes had been filled up with tenants before they were actually commissioned,” reasons Vasily Belov. “We witness the tendency towards burgeoning demand for retail premises in the shopping centers. Currently, the occupancy of most functioning retail complexes is at the level of 95%,” he says.
They fall little short of the 100% occupancy level only because of tenants’ rotation. Therefore a careful calculation is needed every time new projects are delivered to the market. Location, design, a pool of tenants and logistics are vital factors for a shopping center. Therefore we have to admit that a combination of good location, design and pooling of tenants may not work so it is most important today to choose a working concept for the future retail center. The rate of capitalization is lower in retail than in the rest of segments – 9.0-9.5%.
Attractive Mixed-Use
“The mixed-use territorial development comprising both residential and commercial functions possesses great potential,” says Ms. Ivanova. More than 30 such projects have been announced in St. Petersburg. Four or five-star hospitality properties remain a very attractive segment for investors. Analysts point out that investments in commercial properties are now more promising than those in residential real estate.
“This has to do with the fact that demand for commercial properties is now higher than for residential properties,” explains Mr. Belov, “although just a year ago, under the turbulent growth of housing prices, investments in residential real estate were more attractive for potential investors.”
As of today the yield of the housing sector is still higher than that of commercial properties and the return may exceed 100% on invested capital, assumes Sergunin. “But as the housing market is being saturated at a fast pace, the future belongs to the commercial real estate market — at least in the nearest 3-5 years. Even the primary housing market can hardly be described as transparent and so it is much less attractive to western investors than the commercial real estate market,” he says.
Maria Ivanova agrees that international funds are more trustful of the Russian commercial real estate market, and this also applies to St. Petersburg. Not only is the entry of European and Asian funds expected; American investors show much greater interest in the market. The British fund Aberdeen Property plans to invest in Saint Petersburg real estate; three Israeli companies — namely, Ashtrom Properties, Pangaea Real Estate и Electra Ltd — have also announced their entry to the Russian market. They intend to buy both land lots and finished properties. In addition, Marbleton Property Fund (American JER Partners in a joint venture with Russia-based Alfa Capital Partners) plans to invest more than $800 million in Russian commercial real estate during the next three years. Aleksei Ponkratiev is confident that the yield on the Petersburg commercial real estate market will gradually edge closer to the norm for European capitals while the emergence of the greater number of investment-class finished properties will enable institutional investments to switch from entering the projects to acquisition of operating businesses in the middle term. The terms of attracting financing to development projects are also expected to improve in the foreseeable future: interest rates on credit lines will be sinking while credit periods will be extending. “During the nearest three years the market saturation with office, retail and warehouse facilities will go on,” predicts Igor Zhigunov, member of the managing board at the City Mortgage Bank, “also due to the development of new programs of bank financing and mortgage loans aimed to leverage the acquisition of commercial properties.”
As for the regions where the commercial real estate market is expected to develop most dynamically and where crediting lines will be required, the financiers mention Leningrad, Vologda and Archangelsk.