Will Moscow's Real Estate Bubble Burst?

By James Brooke



To Our Readers

The Moscow Times welcomes letters to the editor. Letters for publication should be signed and bear the signatory's address and telephone number.
Letters to the editor should be sent by fax to (7-495) 232-6529, by e-mail to oped@imedia.ru, or by post. The Moscow Times reserves the right to edit letters.

Email the Opinion Page Editor



This spring, prime office rents in Moscow are going above $2,000 a square meter, 50 percent higher than rents paid for offices in the "trophy" skyscrapers of midtown Manhattan.

On the supply side, the Moskva-City development marches ahead, hewing to a schedule to bring on line one major building a year until 2015. By then, Moscow, sometimes called the "Manhattan of the East," is to have the 10 tallest office buildings in Europe.

Is Moscow's office market a bubble waiting to pop? The answer is No.

Moscow currently has 7.4 million square meters of modern office space, about the same as Amsterdam. But Moscow has 10.6 million people, compared with Amsterdam's 750,000.

Rents will continue their upward trend, basically because of a lack of supply and continuing very strong demand. We should see a flattening-off of rates only after 2011.

This year, office rents could go up by 20 percent, following last year's almost 40 percent rise. Fueling demand are strong energy prices and Europe's biggest growth story. With a lot of money in the bank and the political stability apparently in place, Russia now is playing catch-up with the West.

By the end of 2009, Troika Dialog predicts, Russia will displace Germany as Europe's largest consumer market. By 2012, Moscow is to become Europe's largest metropolitan consumer market.

As the U.S. economy continues to turn down and as the European economy goes sideways, more and more investors will want to get in on Russia's growth spurt.

In one indication of red-hot demand, companies are preleasing office space two years in advance. They are signing leases on virtual buildings -- future constructions that consist only of foundations and cranes when the lease agreements are concluded.

Large and small, companies are seeing rents that cross the $2,000 per-square-meter mark. Overall, total office space rented in Moscow last year was about 50 percent more than in 2006.

To meet this demand, about 4.9 million square meters of office space are under construction. The city's total office stock should double over the next three years to 14.6 million square meters.

But the supply pipeline rarely delivers on time. Moskva-City, the poster child of city construction, is the epitome of the city's construction delays. It has been on the drawing boards since the 1980s. Real construction only started years after the shocks of the 1998 financial crisis.

Overall, Moscow's market continues to be constrained as longstanding difficulties in obtaining construction permits are now coupled with the first signs in Russia of the worldwide slowdown in construction financing. Taking the long look, Moscow's office rental prices will one day settle to levels within the range of other world capitals. But by the time they normalize, the country's 8 percent growth in gross domestic product may also normalize to levels of 2 percent to 3 percent.

For now, Moscow's market is marked by high demand, lack of supply and contraction of construction financing.

James Brooke is national director of external relations and special projects, Russia and CIS, for Jones Lang LaSalle.

By Alexei Bayer



The Far Eastern Economic Review once came up with the Erection Index, an economic indicator that suggests that when a country starts building the world's tallest building, it is well on its way to economic collapse.

Although this is a joke, there are plenty of sound economic reasons why it should be so. Russia has long wanted to build the largest building in Europe. I once heard a Russian businessman ridicule the idea by describing how, on an overnight flight from Vladivostok, he failed to spot a single light on the ground.

"Is it a country that needs to build to the skies?" he asked. Yet, work is starting in Moscow on Crystal Island, the world's largest building in terms of floor space.

Everybody knows the old cliche about the three most important things in real estate -- location, location and location. The global real estate market is divided not only into national markets, but also into various smaller regional and local markets. There is also a mind-boggling complexity of property types, from hotels and resorts to factories, offices and parking lots.

Real estate investment trusts, which are funds that own various types of property, offer highly differentiated niche products. Some types of real estate can be a safe haven from a crisis in others. For example, prices of single family homes and rents in apartment buildings are inversely correlated because if people are reluctant to buy homes they tend to rent apartments.

Nevertheless, seemingly isolated property markets around the world tend to respond similarly to global economic trends. Property prices have risen over this decade from Budapest to Bangkok. Now, a crisis in U.S. real estate, which began at the subprime low end of the residential sector, is a bell tolling for developers everywhere.

Real estate development is highly leveraged. Developers bolster their profits because they borrow liberally using the property as collateral. Easy credit triggered an international building boom, but lending standards have tightened everywhere. Moreover, building activity has a long time lag, which means that new properties keep coming to market even when the market is already sinking.

Moscow developers are no different, and commercial real estate prices in Moscow are unlikely to hold up in a global property-market downturn. True, the city had a dearth of quality office space at the start of this decade, and construction activity gained traction slowly. Just 100,000 square meters of office space was built in 2001, but this figure increased 10-fold by 2007. This year, 1.5 million square meters will be added.

Moreover, Russia's big business has come into its own in a period of plentiful money. Analysts covering Gazprom and Rosneft, as well as private companies such as LUKoil, know that many Russian companies are cash-rich, profligate and unmindful of costs. They have bigger, fancier corporate digs than they need. As their management becomes modernized, they may require less square footage in the future -- even assuming that commodity prices stay high and the economy keeps floating on the sea of liquidity.

Alexei Bayer, a native Muscovite, is a New York-based economist.