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. Last Updated: 07/27/2016

BRICK by BRICK: Overseas Investors Are Intrigued, But Waiting




Many real estate companies have been reporting increased interest from overseas investors over the past 12 months. However, this has not led to the increase in capital transactions that one would expect.


The investment market remains immature, partly due to economic conditions, partly because of political instability, tax issues and clear title concerns.


At present, there is a reasonable level of demand from purchasers, many of them foreign vulture funds, seeking to acquire distressed property at yields of 25 percent and above. In most cases, they have not been able to identify suitable projects. This is because they require reliable and well-known tenants, leases of five years or longer and good quality property in an established location for its use.


This may appear to be an easy demand to satisfy, however there are very few investment class buildings in Moscow. Furthermore, since August 1998 most tenants have been unwilling to sign leases in excess of three years, and the presence of tenants' break options further increases the risk of future void periods.


Another reason the market has not satisfied this demand is that many property owners do not differentiate between cost and value. They therefore find it difficult to understand how the building they completed 12 months ago at a cost of $4,000 per square meter can now be worth only half of that. The Russian taste for opulence has exacerbated this problem as many properties were finished with expensive materials, sometimes excessively so. Unfortunately, in these harsh economic times neither purchasers nor tenants are willing to pay extra for luxurious surroundings.


A further factor is that debt financing has never been readily available in Moscow. Hence, many building owners are not under pressure to dispose of their properties. This has produced a wide gap between the price that purchasers are willing to pay and the price that vendors will accept.


Even when a property is to be the subject of a forced sale, lack of transparency can interfere with the achievement of a satisfactory result. An example would be the case of a prominent class A office building that was supposed to be sold via a sealed tender during 1999. There appear to have been a number of seriously interested investors, however the tender process was not administered clearly and the result seems to have been a sale at a lower price than might have been reasonably expected had the process been clearer.


Property development is another area that has seen some interest from foreign operators, many of whom have failed to identify suitable projects. Although site identification may appear to be a simple process, there are often difficulties in this first step. To give an example, the high cost of providing utilities will often rule out seemingly suitable options. Even where a suitable site is secured and a developer is convinced that he will achieve a satisfactory return on his investment, there are a myriad of problems to be overcome throughout the development process, not least because of the lack of transparency in dealings with the authorities.


Despite all of these problems, it is clear that there is a future for the real estate marketin Russia. Most large companies plan to remain in this market and this will ensure that there remains a demand for international quality accommodation. As and when the country achieves economic and political stability, the level of returns demanded by investors will fall, and this in turn should result in a more active market for capital transactions and an increase in development activity.


Amanda Spring is the managing director of DTZ Zadelhoff Tie Leung in Moscow.