Russia: The revolution`s here, and so is the red tape
Russian revolutions have historically taken many forms, whether they be political, economic or social, but the latest
sweeping Russia is the upturn in the capital's commercial property sector. It is driven by easily available cash,
lack of supply and the promise of double-digit returns.
The Russian economy over the last few years has seen more companies gravitate to Moscow - the only real site of the
commercial office market - creating a shortage of premium office buildings.
Demand is now so strong that vacancy rates of Class A buildings in the capital are running at about 3 per cent,
compared with 11 per cent in London and 14 per cent in Frankfurt.
This, says Natasha Reteyum, development director at Knight Frank Moscow, is caused by class A and B office space in
the capital totalling about only 800,000 sq metres.
This squeeze on supply has created a market where typical yields on premium space are 13 to 14 per cent - against
yields of 5 to 8 per cent in the rest of Europe.
Chris Bell, managing director Europe at Knight Frank, says the situation has put developers in an enviable situation:
"You can pay for the cost of a building in five years, less than half the time taken in the UK, not to mention
getting perhaps a 20 per cent return on your money," he says.
Unsurprisingly, alongside a growing band of dedicated local developers, Russian oil and gas companies, have been
drawn to commercial buildings, with their security of investment and impressive returns.
This use of local capital is something that Stephen Wilson, managing director of DTZ Moscow, believes still typifies
Russia as an emerging market.
He estimates this form of financing will continue for the next 12 to 18 months, with foreign investment emerging over
the next two years, eventually leading to a fully-fledged investment market within five years.
Other indicators of the immaturity of the Russian market, according to Jones Lang LaSalle, include the relative
scarcity of reputable tenants; the absence of long-term leases with no break clauses; an opaque legal structure and lack
of high quality construction using flexible floorplates.
However, the biggest hurdle that many see to the development of a full-fledged investment market is Russian red tape
surrounding planning permission, lease and freeholds and tax structures.
This says Ms Reteyum makes it hard for western developers to compete efficiently with local developers.
"Something that could take a local developer a couple of days to sort out using contacts in the local planning
office could take a western developer months."
Additionally, the attractive yields are themselves throwing the brakes on an investment market, as Russian developers
hang on to buildings and enjoy the rents rather than selling buildings on. This resulted in only five or six proper
investment sales last year.
History is also weighing on the minds of many investors, who are holding back from what should be tempting
propositions.
"Investment funds are sceptical," explains Ms Reteyum. "They still see the market as too risky. In
Moscow there are no 10-year leases, we tend to have a maximum of five-year leases and break clauses. Everyone observed
what happened in 1998, when the economy crashed and tenants turned round and demanded rent reductions of up to 40 per
cent."
However, many believe the past is unlikely to repeat itself given Russia's growth levels. Even president
Vladimir Putin's decision to sack most of the government last month failed to cause serious anxiety. "It was
widely tipped to happen, but most expected it after the elections," says Mr Wilson.
Despite his precipitous behaviour, some observers believe that Mr Putin's all but certain re-election on March
14, will provide further political stability, if only because the government will be more firmly under his control.
One group that is already involved in Russia is Fleming Family & Partners, which last year closed a $60m Russian
property fund aimed at buying high quality office buildings in Moscow.
Gavin Rochussen, group chief executive of Fleming Family & Partners, says the move is in keeping with the
family's understanding of risk and appetite for investing in emerging markets.
So far, Fleming has bought one building at a cost of $32m, and says its expectations of yields of 12-15 per cent are
being met.
Maksim Kunin, head of real estate at Fleming, believes the benefits of getting first mover advantage outweigh the
risk. He thinks it is a matter of time before the group, the first western investment fund in the Russian property
market, faces foreign competition.
One of the drivers of competition will be the development of a debt market, replacing funding from Russian banks who
discourage most developers and investors with interest rates of between 14 to 18 per cent and insist on short payback
periods. Additionally, the development of long-term take-out finance will mean that properties can be leveraged to
produced the risk-adjusted returns expected by many foreign investors.
But for those looking to make quick money in today's revolutionary market, Mr Wilson of DTZ advises that
"these stellar returns come with a serious health warning and reflect the risk in the market".
A view echoed by Mr Bell. "You can get carried away by the returns and not understand the principles. In Russia
knowledge is king, and it will not be the last market where investors lose a lot of money because they don't have
the knowledge."
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RUSSIA IN FACTS
