Investors have begun construction on business centers in downtown Moscow. The project is expected to accelerate the stabilization of the capital real estate market

The Moscow government made a decision to create an international business center, Moscow-City, back in the early 1990s. A 100-hectare plot was assigned to the project and a management company, City, was established under the control of the city administration. The project drew the attention of both Russian and foreign investors. In 1993, an international consortium with US and Japanese corporations was even established to implement it. But construction had never started. In 1995, Canadian developer, Reichmann Asia Co Ltd., which had experience building similar business centers abroad, became interested in the Moscow-City project. However just one year later, the authorities dissolved the contract with Reichmann. After the 1998 crisis, large foreign investors lost any interest whatsoever in Moscow real estate, and domestic companies didn’t have enough funds to finance such a large-scale undertaking at the time. As a result, the Tower-2000 office complex and the Bagration pedestrian bridge, which were built on the occasion of the 850^th anniversary of Moscow, have been the only installations at the site for a long time. It seemed that the Moscow-City project had run out of steam.

The process begins

However, in the middle of the last year, the ball got rolling at one of the fifteen sites of Moscow-City: Turkish Enka Company began building an office complex, Bashnya na Naberezhnoi (The Tower on the Embankment). It consists of three A-Class buildings 16, 27 and 52 stories high and with a total area of 220 thousand m2. First the company plans to build the smallest building by area, scheduled to open this autumn. Enka’s total investments will amount to around $150 million. Soon afterwards, several Russian companies got involved in the project. Their mighty ambition distinguished them from their Turkish colleagues. For example, one developer, Capital Group, announced that its plans included a multi-purpose complex, Gorod Stolits (The City of Capitals) designed by Dutch architect Erik van Egeraat. The complex consists of two skyscrapers 53 and 64 stories high (symbolizing Moscow and St. Petersburg) as well as two dome-shaped buildings opposite the towers. The lower floors of the buildings will accommodate offices of 200+ m2. The upper floors of the towers will consist of residential apartments. The project envisages 15 types of apartment, ranging from 75 m2 studios to two-tier penthouses of 900 m2 each. The total amount of investment in the Gorod Stolits is estimated at $250 million.
Another company, Stroimontazh will take up construction of the Federatsiya (Federation) office complex: this structure consists of two towers with a different number of stories designed by German architects. The 92-story tower will hold offices and the 44-story tower will include apartments and a hotel. By preliminary estimates, investment in the construction of Federatsiya may amount to more than $0.5 billion. NIKoil Financial Group is participating in funding the project.
Quite recently, Tekhinvest Company announced plans to build a 75-story building in the City. It is ready to invest about $250 million in this project. The 300-meter skyscraper will have a total area of more than 200 thousand m2 and will hold offices, apartments, a fitness center, a casino and a hypermarket. Severstaltrans Company intends to construct an office building of more than 74 thousand m2. The total amount of investments in the Moscow-City project is estimated at $12 billion, including funds from the city budget. 

While It’s Hot 

In general, Moscow investors have rushed to develop Moscow-City. Most players on the commercial real estate market believe that the increasing shortage of land and the price euphoria reigning in the real estate market are contributing factors to this stir. Basic rental rates for high-class (A and B) offices remain high ($500-700 per m2 a year on average). The demand for offices is consistently high despite the increasing amount of new construction. Thus, for example, from 400 to 500 thousand m2 of international class offices were built last year (15-20% growth versus 2002). Some analysts predict that the increased demand for offices will continue and forecast a minimum of 5-8% growth in rates. In a word, strike while the iron is hot but do it with caution, taking into consideration the whole spectrum of opinions on the outlook for office space investments. For example, one should take into consideration that rental rates have changed slightly versus those in the last year. This trend is especially conspicuous among B-Class offices. A share of vacant A-Class offices increased slightly to 8% of the total office space area late last year. Prices of office purchases have remained virtually unchanged. That is to say, there is a tendency toward market stabilization. Incidentally, the situation on some real estate markets in Eastern Europe developed according to a similar scenario. 
Stabilization of rental rates will by no means lead to decreased risks and lower costs for investors making investments in commercial buildings. Hence, one should expect the rate of return to fall. It is some experts’ opinion that now the yield gained by investors doesn’t always meet their expectations. By some estimates, the current average market rate of return amounts to around 18%. In the long term, it may decrease by 4-5%. Not only market conditions but also subjective factors will contribute to this. Today, non-professional players often try to act as investors-developers, and, as a result, a large quantity of poor-quality space appears on the market. They are owned by domestic companies that invest surplus money in construction. These companies are ready to bear higher risks and hope to gain much higher return in exchange. 

Vague prospects

The pre-conditions for market stabilization already exist, and those who hope to a bundle on the current upturn may simply not have time to do it. Putting the Moscow-City business complex into operation will only accelerate market processes, since the total area of space in the City scheduled to be available on the market by 2007 will amount to around 1.4 million m2. That’s a lot. Furthermore, according to Maxim Zhulikov, the leading consultant in office property at Penny Lane Company, a multitude of other projects will be built by 2007 in Moscow, apart from the City. This office space explosion will be a tough test for the Moscow market.
In Shershnev’s opinion, it’s not a given that the drop in prices will affect Moscow-City. Zhulikov, however, sees City’s immunity to price fluctuations differently. “Many A-class projects faced difficulties during construction last year. Although on the whole there are enough companies in Moscow ready to pay $600-700 per m2 a year without VAT for an office, demand doesn’t keep up with the steadily growing supply. The area of the Moscow-City project alone is exponentially greater than the A-class areas that open in Moscow each year,” Penny Lane’s expert maintains. “In addition, future Moscow-City residents may face serious transportation and infrastructure problems. This would by no means make rental rates increase.”
Many experts have their doubts as to economic soundness of building skyscrapers in the City. “In Russia, when the cost of capital is high, all projects are sensitive to implementation terms,” Cameron Sawyer, the President of CVA Sawyer, stresses. “A building of 150 thousand m2 cannot be built in less than three years. And the extended terms of project implementation may affect the rate of return greatly. Except for the cases when buildings are constructed for particular tenants.”
The technical risks related to high-rise buildings cannot be ignored, either. Developers may incur heavy costs because of the lack of experience in construction and operation of such buildings. High-rise buildings should be equipped with more sophisticated operating equipment. “For example, (they should be equipped) with a system of control over the state of load-carrying structures,” Leonid Tishkin, Chief Engineer of M+W Zander Company, says. “There are also a host of other nuances that may affect building operation costs afterwards. It is important to arrange parking correctly or, for example, to find effective technical solutions to service fronts.”
Finally, the City has many aspects the general public is unaware of. For example, the cost of each investor’s joining the project and infrastructure costs. This doesn’t enable independent consultants to estimate the City’s investment appeal. Most projects being implemented at the City are risky due to their large scale.

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