For Investors With an Appetite for Risk

Andrey Makhonin / Vedomosti

Total investment in real estate in Russia in 2016 will amount to $3.5-4.5 billion, consultants estimate, while less than $3 billion was invested last year.

Macroeconomic stabilization can have a positive impact on investment in Russia. It will allow the commercial real estate market not only to find its bottom, but to push up from it by adopting new rules.

Inflation is stable, the economy is weak, demand for credit is low, the budget is lean. But the market is very active, and there are big deals going on, Sergei Kamlyuk, CEO of KEY Capital, said. There are two major problems with real estate investment now: the lack of high-quality assets and customers' expectations of price, and the problem of liquidity, said Evgeniy Semenov, regional director and head of capital markets at JLL Russia & CIS. Many players think that there is money, and attractive objects but, in times of economic turbulence, it is really difficult to negotiate. A recent example is the termination of the agreement between Yandex and the owner of the Krasnaya Roza business center to buy space in exchange for shares in the Internet company. Since the signing of the agreement, the shares had risen and the buyer wanted to get more for them.

"Despite the correction in asset prices following the devaluation of the ruble in 2014-2015, the differences between the expectations of buyers and sellers in the price reach an average of 20-30 percent," said Alan Baloev, director of capital markets at Knight Frank. Natalia Tischendorf, CEO of Avica Property Investors (which manages the assets of the Romanov Property Holdings Fund), thinks that the price a seller wants and the amount the buyer is willing to pay always differs by an average of 15 percent, about the same difference as persists in the crisis, but the price level is different now. But not all vendors understand this.

Whose Money

According to Nikolai Kazansky, a partner at Colliers International, in H1 2016, the total volume of transactions amounted to $2.4 billion. Only $547 million of that was in Q2. "Investors are cautious," he observed. Natalia Kruglova, director of business fields at the Strategy Capital Advisor company, cites the sum of $2.5 billion, "while for the entirety of 2015, transactions of $2.8 billion were carried out." That is, activity is increasing. According to CBRE estimates, in July-August, $450 million (28 billion rubles) was invested in real estate, "which is 12.5 percent more than in Q2 of 2016, when $400 million (26 billion rubles) was invested," said Olesya Dzyuba, director of CBRE market research. For January to August, it was 20 percent more than in the corresponding period of 2015, she said.

JLL had different figures ($1.6 billion in H1), but the dynamics is also positive, up 46 percent over the same period last year, "which set a record for low investment activity for the decade," Semenov said. "Investors are focused on the Moscow market (82 percent of transactions closed in the six months) and on existing assets (84 percent)," said Semenov. End users made 84 percent of investments in real estate, added Kazansky.

Where Investors Come From

Semenov estimated the share of foreign investors in the total volume of transactions at 11 percent. "But they continue to be actively involved in negotiations," he said. "There are almost no foreigners on the market," Kamlyuk insisted. "There is a myth about a Chinese presence but, in reality, few people have seen them and even fewer have done business with them." "In fact, only the Arab fund Mubadala is a presence, investing in warehouses in the Moscow region," added Kruglova. But there are institutional players like MorganStanley on the market that continue to look at the office and retail assets. "In the second half of the year, we will see big deals in the retail segment, possibly with the participation of foreign capital," Kruglova said.

"Interest in the real estate market was transformed significantly after the imposition of sanctions and the deterioration of economic indicators," Baloev said. "Foreign companies and funds are frightened by the unpredictability of the Russian market, its political and economic risks." Some players have already expressed the desire to sell their assets and escape from Russia, others have seriously discussed this decision. But, on the other hand, a number of foreign investors, like Hines and IKEA, plan to continue to develop. Today's market is interesting to them because most prices have been adjusted up to 50 percent in dollars, and in some cases even more.

In Q2 2016, the strengthening ruble led to another revision of the contract value of the objects in rubles (mostly the original capital of the investors — in foreign currency), said Dzyuba.

Kazansky said that the money in H1 was 96 percent Russian. "The professional Moscow standbys are on the market, there is almost no hope that investors will come from Yakutia and buy everything," said Kamlyuk. Professional players have clear requirements: "Private facilities, quiet deals, reasonable prices." "Buyers work with their own money and money borrowed from their own financial institutions," said the expert. "Demand for stressed assets or profitable projects, capable of withstanding the credit load or provide 150-percent growth if properly managed, will always be there," said Kamlyuk. "The leasing business in the form 'sale-lease-back' interests private investors with a budgets from 150 million rubles to 10 billion rubles." Interest has shifted from large to small objects and liquid objects costing up to $50-100 million," said Baloev. "Companies and individuals are entering the investment market who have not previously invested in real estate." Finding buyers for large objects is easy. "In each segment there are just two or three objects that are put up for sale and studied by a limited range of companies," said Semenov.

Where the Deals Are

"Deals, either very large or very small," Kruglova characterized the times. Large mostly for banks, small for end users. The vast number of major transactions in 2016 can be attributed to one of three types: "Transactions as a mechanism for polishing liabilities (debt to banks), as part of a transaction agreement scheme on other assets (a deal with the city, for example). Or the conclusion of transactions agreed on in previous periods." Almost all the deals in 2016, according to her estimates, were in the office segment. Kazansky agrees that, in H1, offices accounted for 88 percent of total investment ($2.1 billion). Eurasia and Evolution Towers in Moscow City and President Plaza business center changed ownership. In Q2, the sale of Marr Plaza business center was closed (about 4.8 billion rubles). The Moscow city government bought 55,000 sq.m. in Oko† Tower in Moscow City, Dzyuba added. "Office tenants continue to optimize costs and reduce area, which certainly reflects on investment attractiveness," Semenov said. According to JLL, offices accounted for 58 percent of the investments from the total volume of transactions closed in H1, "taking into account purchases for own needs." Andrei Bezverkhy, senior director of the capital markets department of Cushman & Wakefield, generally characterized the situation on the office market as "extremely difficult" because of the abundance of vacant space.

At Colliers, they say the retail segment is the least active (1 percent of transactions), although there is interest in the market. "The current situation has a significant upside (the possibility of increasing the capitalization of an object after acquisition) and a small risk of downside (further reduction of the value of the property after the acquisition), while at the same time they are quite capital-intensive, requiring further investment in the development of the object," Semenov of JLL assessed. Consultants questioned by REQ expect growth in demand for retail space on the part of investors. "There are a number of major retail assets under negotiation: the Immofinanz portfolio of five shopping centers in Moscow at a cost of about $1 billion, Leto in St.†Petersburg for 10 billion rubles, etc.," said Kazansky. He mentioned the sale by the Finnish company Sponda of the Solnechny I shopping center to the Russian company IT Development among the transactions that took place. Among the transactions of July and August, Dzyuba from CBRE also pointed out the sale of the premises (commercial and warehouse) of the Stolichnye Apteki chain, the purchase of a third of TsUM on Petrovka Street by the Mercury company and the purchase by the DG-19 company of a 55-percent share of Zelenopark shopping center. At Avica, they consider investment in shopping centers justified. For example, the expansion of Dream House shopping center on Rublevka and the construction of a second stage with an area of over 20,000 sq.m. is planned. "A 0.45-hectare lot has already been acquired for construction. The volume of investment in the project will be more than $20 million," said Lilit Adibekyan, managing director of Dream House.

At Cushman & Wakefield, they also believe in trade and logistics facilities with a stable cash flow. "They can bring a yield of more than 12 percent on invested capital," said Bezverkhy. According to Colliers, the volume of investments in the warehouse segment in H1 was $146 million. The largest transaction was the purchase by the Russian Direct Investment Fund and the Arab fund Mubadala Development of PNK Group facilities Ч PNK-Chekhov 3 (100,000 sq.m. and a plot of land) and PNK-Severnoe Sheremetyevo (106,000 sq.m.) for a total of about $100 million.

"The real estate market has its own blue chips that will be in demand at all times, these objects are the last lose tenants in a crisis and the first to recover," Baloev said. "Their advantage is their location." A business center in the so-called Kremlin zone now has almost half the vacancy of the average on the Class A office market Ч12 percent versus 20.5 percent. Shopping centers by Metro stations with large passenger flow are also in high demand from potential tenants. Atrium at Kursky, where the total volume of passenger traffic of three stations is about 150,000 people per day, has a long-list of potential tenants that has not decreased in the crisis," said Baloev.

The most attractive segment for investment now is land for the construction of mass housing, but only large investors with relevant experience can carry out such projects. And they prefer to bring to the project not "live" money, but, for example, shares in future sales.

What the Rates Are

Capitalization rates for Moscow premium real estate remained unchanged at the level of 10 percent for the commercial and office segments, and 12.5 percent for warehouses, said Kazansky. According to JLL, in St. Petersburg, it is 11.5 percent and 11.25 percent for office and shopping centers, respectively, and 13.5 percent for warehouses. "There are higher capitalization rates in Europe and other developed countries," said C&W's Bezverkhy. "The real estate market in the Russian Federation in 2016 remains attractive for investors with some appetite for risk."

"The appetite for commercial real estate remains high," CBRE's Dzyuba said. "According to our calculations, active investors, that is, those who are willing to invest in real estate, now have about $3 billion of equity available to them." But deals are few, and that explains the difference between the expectations of buyers and sellers. Semenov suggests investors "have faith in the market potential on a horizon of five years or more, and not depend on current rental rates and income at the moment."