Regional Retail is a Strong Story But Transactions Remain Low
- Mar. 11 2013 18:28
National Director, Head of Corporate Finance, Jones Lang LaSalle, Russia & CIS
Local investors show growing interest in developing and leasing but raising finance is a challenge, with little alternative to bank finance, and few oportunities for joint ventures.
As a company, Jones Lang LaSalle has been a strong believer in the Russian regional retail story over the last two to three years. The reality is that we have not seen the level of investments that we predicted. The rationale exists even more so today as we shall see, and the implementation of regional investment strategies is finally taking place.
Retail stock in Russia amounts to 14.3 million square meters, out of which Moscow, Moscow region and St. Petersburg account for 5.5 million square meters (38 percent of the total). Let's talk in more detail about the remaining 8.8 million square meters, of which 4.3 million is situated in Millionniki cities (11 cities with populations in excess of a million) and 4.5 in smaller cities with populations above100,000.
Before the crisis broke in 2007, regional retail investments amounted to 25 percent ($500 million) of the total investment market in Russia, yet in 2012 this number reached only 2 percent. Why are investors still so cautious about buying stabilized (built and let) regional assets today? The main concerns we see are: stable rental income and liquidity (understanding of exit at the time of sale).
Retailers have clearly defined their regional expansion strategies. They have prioritized regional cities and decided on the optimal number of stores in particular cities. As a result of such activity, high-quality regional shopping centers have a waiting list of tenants. SEC Aura in Novosibirsk and SEC Planeta in Krasnoyarsk can be named among such assets. In general the vacancy rate in the regions does not exceed 5 percent.
High-quality regional shopping centers have a strong tenant mix with almost all federal retailers comparable to the retail assets in Moscow and St. Petersburg. Therefore the covenant strength of 70 percent of the tenants would be identical. But current prime cap rates for Moscow retail are 9 percent; for regional shopping centers they vary from 10.5 to 11.5 percent, depending on quality, competition and location.
Liquidity of the assets is a fundamental question for investors with regional appetite. Total investments doubled in 2012 in comparison to 2011, and the total volume of trading in Russia was once again at record levels ($8.7 billion compared with $5.1 billion in 2008)
In 2012 RB Invest acquired SC Karnaval in Chekhov (16,700 square meters GLA). It was one of a few public deals in the regional retail market last year. In 2010 the same fund bought a portfolio of Metromarket assets in Moscow (14,781 square meters GLA). The transaction volume was in excess of $120 million. The main distinguishing feature of the shopping center in Chekhov was a much smaller deal volume — about $60 million. In this case the fund sees the small transaction volume as an important factor providing liquidity for the future re-trade.
Based of the lower rental rates and higher capitalization rates, one square meter in the best regional asset is valued three to five times cheaper than the asset in Moscow, which allows the investor to maximize the exit price by both capitalization rate compression and net operating income increase, in terms of increasing turnovers, rental rates and cost optimization.
So whilst the number of investment transactions remained low, we see a high level of interest in development and leasing in the regional markets. Three shopping centers are planned for delivery in 2014-2015 in Yekaterinburg — Gagarin Mall (135,000 square meters GLA), Phase 4 and 5 of SC Greenwich and SC Olymp (141,000 square meters GLA), while Tyumen with its great growth potential will accommodate two new shopping centers. One as-yet-unnamed shopping center with 75,000 square meters GLA will be opened in 2013 and multifunctional complex, Maxim, with 80,000 square meters GLA will be opened in 2014. Among the landmark regional investment projects that deserve special mention, we include the projects of Renaissance Development in Surgut (opening of the shopping center took place in autumn 2012) and Yaroslavl (opening of the shopping center is scheduled for the end of 2013) and SC Novo mall project in Novosibirsk, acquired by TPS Nedvizhimost.
Certainly, the total project costs are considerably affected by the land price which on average amounts to 20 percent of the total development budget. Whereas regional sites with good location may cost $1 to 1.5 million per hectare maximum, in Moscow it will reach at least $7 to 8 million per hectare. In addition in the regional cities the investor will receive the freehold title for the land, in Moscow in most cases, leasehold. Moreover, it is very challenging to find a permitted, centrally located land plot in Moscow.
Cost of finance is obviously a key factor in the project development success. Currently, it is very difficult for local developers to raise funds for the regional project other than bank financing. A local developer faces a limited opportunity for the establishment of joint ventures, caused by the fact that federal professional developers are the main investors in the regional market and they require control over the project. Such developers include companies like Renaissance Construction, Tashir, RosEvroDevelopment and TPS Nedvizhimost.
The main investment criteria would be location, as well as the economic and industrial development of the city, driving the level of income and spending power of the local population. The interest of market players is focused primarily on the large cities with underdeveloped commercial real estate market and shortage of quality retail space. These cities include, for example, Perm, Krasnoyarsk and Saratov. However, developers may also have an interest in the cities with a developed real estate market if these cities offer high-quality projects in large residential areas or central parts of the city. This refers both to Millionniki cities and those with a population of 500 to 700 thousand people.
The acquisition of the Arkada shopping center development project in Ufa by Soyuz Property Development is a recent example of this trend. The interest in such projects comes not only from the international investors but also from international and federal retailers; for example Auchan and M.Video will be the anchor tenants of Arkada shopping center.
Retail in Russia is the most rapidly developing sector. Consumer spending (75 percent of income is spent on goods and services vs. 30 to 40 percent in Europe) is strong right across the country, not just in Moscow. Regional retail schemes have generated more interest and we see that 2012 evidenced a positive investment trend in the regional investment market. Developers and investors strengthened their position in an expanding regional retail market by understanding the necessity of being the first in the market and acquiring the best available projects.
Russian investors maintained their leadership in regional cities in 2012. With new high-quality developments coming in the regions, we believe that the retail real estate sector will grow significantly during the coming years and that the sector will become a pioneer in attracting foreign investment to the regions of Russia.