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. Last Updated: 07/27/2016

Warehousing's Stubborn Woes

Warehousing has always been considered the ill-favored runt of the local real estate market litter.

Even before the market was plunged into deep depression by the 1998 crash, developers preferred the glamour and high returns of glass-fronted office high-rises to the anonymity and low margins associated with developing storage space.

Now, with the devalued ruble holding down demand for imported consumer goods, the lifeblood of the warehousing market as it is now structured, the sector is nearly dead.

"The dynamic driving warehouse development is the perceived state of growth for consumer goods sales in Russia," says Darrell Stanaford, managing partner at The Western Group ONCOR International in Moscow, which manages several industrial real estate projects.

"Before the crisis, companies believed sales would grow," he adds. "Now that is flipped around. The main consideration is minimum cost and flexibility."

"A business plan based on importers does not work anymore for the long term," says Jukka-Pekka Uusoski, marketing manager of the YIT Corp., which is developing an industrial park near Moscow's Sheremetyevo Airport.

Most foreign firms are therefore still too wary of the market to invest in their own warehouse space. In most cases, foreign companies either out source by hiring logistics firms to take care of their warehousing headaches, or else rely on facilities located outside the country.

The few warehousing projects completed before the 1998 crash stand half-empty, real estate analysts say. Those that had not been completed are frozen in the planning or early construction phases.

The supply crunch means that prices for international standard warehousing space are among the highest in the world, despite the prevalence of half-built and half-used storage space in Moscow.

Current rates for leased warehouse space hover between $90 to $110 per square meter per year, according to Gerald Gaige, head of real estate consulting for Arthur Andersen in Moscow.

By contrast, the average rate in Paris is $60 per square meter.

The rates are less a reflection of supply and demand than they are a reflection of the market's general underdevelopment, Gaige said.

However, he believes this chronic underdevelopment is a sign of hope as well for industrial real estate developers who have cast their lots with Russia.

"The market is so small anyway that, even in depressions, there were not huge excesses of space," he said. "Any uptick in the economy will trigger a shortage."

However, the national economy's recent recovery has yet to change anyone's mind about the warehousing sector, industrial real estate agents and developers say.

"There is no longer a red light telling investors to stop," says YIT Corp.'s Uusoski. "What we now have is a flashing red light saying, 'Wait before proceeding.'"

YIT Corp. originally intended to sell off its project to one of the many strategic investors that had been eagerly expressing an interest in exploiting the pre-1998 shortage of industrial real estate.

As is still the case, most storage space was substandard, or otherwise did not meet the requirements of foreign companies.

"A lot of the stuff was not purpose-built," says Amanda Spring, managing director at DTZ Moscow. "You had churches and whatnot being used as warehouses."

Even such simple things like space with the even floors necessary for the operation of forklifts and stacking of pallets are still hard to find, she says.

Strategic investors have largely abandoned the industrial real estate sector, Uusoski says.

"Some companies are warehousing in the Baltics and Finland instead of using local warehouses," he says. "It is more expensive, but if they are not willing to invest here, then they have to use alternative solutions."

YIT Corp. is now exploring the possibility of developing its project as a mixed industrial/warehousing park and is no longer insisting on a single buyer.

"We are ready to customize to whomever," says Uusoski.

Many companies do desperately need modest amounts of international-standard warehouse space, but those companies' combined sales volumes do not justify a large investment in warehousing.

The main exceptions are importers and distributors of tobacco, electronics and alcoholic beverages sectors, says Stanaford from The Western Group ONCOR International.

Ironically, the crash of the real estate market may ultimately benefit the warehousing sector by encouraging developers to concentrate less on building new office space, says Stanaford.

"Before the [1998] crisis, demand for both categories [office and industrial] exceeded supply," he says.

"Now the vacancy rate for [commercial real estate] is higher, and the rents are lower, so there is no longer the guarantee that developers will get their high rate of return."

Even so, a sustained economic recovery and a higher level of investor confidence must materialize before foreign companies will begin considering major investments in warehousing facilities and services.

"Nothing big has to change for the better," says Stanaford. "It just can't change for the worse."