Property Crash Undermining City Revenues

When The Moscow Times approached real estate professionals to help compile the accompanying table of property deals in which the Moscow city government was involved, one property market advisor joked that it would be easier to list the few projects where the city was not a key player.

Sometimes directly, sometimes through proxies, the city has stakes in almost all big office developments, all the city's hotels, major retail developments and a huge network of city-sponsored housing projects.

This was a gold mine when Moscow had one of the most lucrative property markets in the world, with annual rents per square meter of office space around $800.

But the financial crisis has sent rents tumbling, pushed up vacancy rates and endangered several big ticket projects in which the city is a big investor.

The effect on the city is hard to measure because of the lack of transparency of many projects. Loans to commercial projects are not clearly reflected in the books and many projects are carried out by off-budget entities.

But Moscow Mayor Yuri Luzhkov knows that the trend will certainly be down. This will hurt revenues and it could also provoke unrest among the 500,000 construction workers who depend on city contracts.

Under City Hall's official budget for 1998, planned revenues from city property for the first nine months of the year were 2.3 billion rubles, or 6 percent of total revenue.

But this may be an understatement when off-budget entities are included. Timothy Fenwick, senior partner at Jones Lang Wootton international property consultancy, said the city and related entities earn more than $2 billion annually from their property portfolio.

The official figures showed a fall in revenues even before the crisis. For the first nine months of 1998, real estate revenues were already 30 percent below target. They must have fallen much more in the past three months.

The city collects modest rents on the huge stock of low-grade municipal buildings. These rents will fall behind inflation since they can only be reviewed once a year - in April.

Revenues from selling long-term leases of land, which were a huge earner for Moscow under Luzhkov, are now drying up, said Fenwick. The standard 49-year lease has been earning $7 million a hectare in the city center, down to $1 million a hectare in the city outskirts.

Even at the start of this year, sales were diminishing as the supply of good property dried up, he said. Sales are now all but stopped. One sign of the city's push to boost revenues is that it recently pledged to start selling land outright, rather than just long-term leases.

Partly or fully city-owned developments will also be hit by the sharp fall in all property markets. The city has completed this year or will complete next year about $1 billion of real estate investments and has a passive share in many more.

Since August, commercial rents on A class office space have dropped by at least 30 percent across town - down from an average of $650 to $700 to around $500 per square meter - and very few deals are being signed.

For instance, the totally city-owned, $60 million Usadba Center, behind City Hall, rented out all 22,000 square meters at $700 a square meter per year before completion last fall. That would be an income stream of about $15 million a year.

But many tenants now cannot pay and want rent reductions. For instance, Renaissance Capital, which rented 9,000 square meters, has just negotiated rents down from $700 per square meter to under $500 per square meter, according to industry sources.

The soft market will make it hard to lease a lot of other city projects which are due for completion next year, including the 27-story, 20,000 square-meter City Gate Tower, the first stage of the enormous AO City development west of downtown on the Moscow River, and also the $371 million renovation of the Gostiny Dvor hotel and shopping center, adjacent to Red Square

The city's portfolio of "investment contracts" deals may also be suffering. Such deals involve the city granting a developer the right to develop one or more sites, getting in return a major stake in the building when it is completed.

Classic joint ventures set up this way include the Mosenka buildings, Mosalarko Plaza and the Vosstaniya Square complex being developed by Entes beside the U.S. Embassy. Although such projects do not involve expenses for the city, the slack market means expected revenues are just not there.

For example, Mosalarko, a 6,300 square meter office block near Taganka square, due for completion over the next few months, has yet to sign a single lease, said Michael Lange at Jones Lang Wootton.

Similarly, Entes' Vosstaniya Square project, a large complex planned to include 30,000 square meters of offices and 8,000 square meters of retail space, is being topped off and there are no plans to finish it for now, one analyst said, speaking on condition of anonymity. Entes declined to comment.

The city also has heavy exposure to a downturn in the retail market. The fully city-owned, $350 million shopping mall under Manezh Square, opened last fall, is also suffering from the crisis. Over the summer, two big tenants - BHS and Next - pulled out.

A spokeswoman for management company Torgovy Tsentr Okhotny Ryad, admitted rents had also fallen as a result of the crisis, but said the mall was fully leased.

Despite empty store fronts visible in the mall, this may be technically true. According to one source, the center is fully leased to the Plaza Group headed by Umar Zhabrailov, who is also the general manager of the Radisson-Slavyanskaja Hotel. Plaza Group managed the center when it opened, and then leased the entire mall to itself and has since been sub-leasing. If so, Plaza Group, could be taking most of the losses.

Plaza Group declined to comment, saying it has no connection to Manezh Square.

While the office and retail property markets are soft, the city could also lose revenues from its hotels. With a few exceptions such as Kosmos, Aerostar, Novotel, Sofitel Iris and the newly opened Swiss Diamond, City Hall owns every hotel in Moscow.

The city gets "at least $100 million a year" from these stakes according to a hospitality industry source.

This is likely to decrease if occupancy rates stay down. Rates are down from over 72 percent pre-crisis to below 50 percent, according to a study comparing October-November 1997 with the same months this year by Arthur Andersen Hospitality Consulting. Revenues per room are also down, said Scott Antel, a hospitality expert at Arthur Andersen.

Tracking the revenues to the city is complicated. For example, the Marriott Grand belongs to Mospromstroi, a construction company majority-owned by the city, according to an industry source who spoke on condition of anonymity.

The city is also a major player in the high end of the residential property market. It invested at least $100 million into the Olympic Village in south-west Moscow constructed for the World Youth Games, and another $250 million into a huge development at Michurinsky Prospect in conjunction with Sberbank. Apartments in that building and other upscale city residential blocks are on sale for $1,100 to $1,300 a square meter.

The upscale apartments are still selling at a reasonably good pace, analysts said, but the city's biggest commitment in real estate has been the $3.5 billion or more it spent in the past three years on building residential housing. In 1996 and 1997, the city built a total of 6.5 million square meters of low quality housing, mostly on the city's outer fringes, at a cost of between $500 and $600 per square meter. Ruslan Rostovsky, deputy president of the Non-Budget Planning Administration, an off-budget organization which runs this huge program using funds borrowed from the city and commercial banks, said that profits from the program are used to provide free housing to the needy.

In 1998, a further one million square meters of housing will be completed. Rostovsky said that, despite the financial crisis, sales were unchanged at about 50,000 to 60,000 square meters a month. He said the stock of unsold apartments was minimal.

Despite Rostovsky's claim that sales have been unaffected by the crisis, some analysts said that a significant proportion of residential development in the outskirts is empty.

The pace of construction slowed this year. Svetlana Osina of Elit Estate, a real estate agency in charge of a city-backed mortgage scheme that aims to shift some of this property, said that 750,000 square meters were built this year.

Rostovsky said that prices of apartments in rubles had been raised only slightly, but this was not a major problem since the Non-Budget Planning Administration's debts were all in rubles.

The Administration is under pressure to continue building, but financing is short. Rostovsky said the administration was looking to borrow on foreign markets.


Building, address Size/sq.m. City involvement

Capital Plaza, Vorontsovskaya Ul. 2,500 Owned by Mosenka, of which city owns 50%

Golutvinsky Dvor, Yakimanskaya Nab. 14,000 City gave $18m loan to developer; has some stake

Japan House, Savvinskaya Nab. 15 9,500 City had stake in Moskva/Seiyo one of the investors

McDonalds 1905 Goda, 2,800 City originally owned 40% of developer Moscow-McDonald's Krasnaya Presnya 45 through Mosobshchopit, now owns 20%

McDonald's Klim., Klimentovsky 16/21 1,057 As above

Mosalarko I, Marksistskaya Ul., 16 6,500 JV, 50/50, between city and Mosalarko

Mosenka Park Towers, Taganskaya 20,000 Owned by Mosenka, of which city owns 50%

Mosenka Plaza, 2,400 Owned by Mosenka, of which city owns 50%

Ulyanovskaya Ul.

Mosenka Plaza III, 7,000 Owned by Mosenka, of which city owns 50%

Sadovaya-Somotechnaya Ul.

Parus, 1st Tver-Yamskaya 12,000 Owned by Mospromstroi, in which city owns majority stake

Perestroika buildings, 7,000 Perestroika half-owned by Mosinzhstroi,

(6 small downtown office blocks) of which city owns majority stake

Pushkin Plaza, 16 Tverskaya Ul. 10,000 City took building over after original investor Microdin defaulted

Riverside Towers, Phases I-III 37,000 Developed by Enka; city owns 20 percent stake in project

Kosmodamianskaya Nab.

Samsung, Bol. Yakimanka 9/10 5,000 Built by Samsung; some level of city involvement

Samsung Plaza, Bol. Gnezdnikovsky Per. 3,500 Samsung; some level of city involvement

Smolensky Passazh, 19,600 City/Moscow Sberbank took it over

Smolenskaya Ploshchad after original developer Tema ran out of money

Stoleshnikov BC, 5,000 Owned by Mospromstroi, of which city owns majority stake

Stoleshnikov Per.

Usadba, Vosnesensky Per. 22,000 100% city owned

Note: List is selective, includes only known city-owned property.

Source: The Moscow Times