BRICKS & MORTAR: Back to the future in Russia

By bne IntelliNews July 27, 2010

Tim Gosling in Moscow -

During the boom years up to 2008, investors hunting for Russian real estate deals were forced into taking on development risk. It's all about to happen again, but there's a short window of opportunity for those who act fast.

Moscow's first institutional real estate deals since 2008 went through in June - the first sparks of what's likely to prove a brief flurry of activity on the market. Akron Group sold the small Bahrushin office building to UFG, whilst VTB Capital, rumoured to be powered by Omani cash, bought Capital Plaza at a 15% yield. Although the latter office project is a class-B project, such a yield is unlikely to be available in the future; the number of funds aiming to get into real estate has been building over the first half of 2010 and product remains scarce.

Before the crisis, international investors were clamouring - and failing for the most part - to get exposure to the Russian market, as the economic boom and a lack of supply saw leasing rates spiral. However, poor legal protection, an immature debt market, a lack of investment-grade projects and, most of all, the extremely high pricing expectations of owners limited activity. Some simply walked away, but for most the potential prize was too great, which pushed many institutional investors into hunting down a local partner and taking on development risk.

Whilst the recent deals may whet the appetite of some who have been waiting to get their feet under the table, they'll need to act sharpish. Agents in Moscow suggest there's a window open to find an opportunity - but its about to slam shut. As Tim Millard, head of Cushman & Wakefield's Moscow office, puts it: "We're going to see real momentum in capital growth in the next three to four months, so investors should get in now."

Summer fare

Although its still tricky to quote a benchmark yield for true class-A office in Moscow due to the lack of projects, let alone transactions, Millard forecasts that potential sellers will tighten expectations by 200 basis points (bps) or so to around 8% by year's end. He says the first two deals are but the first of a series set through the summer, claiming that C&W has three waiting to close, with yields hovering at 9-11%.

Tom Devonshire-Griffiths, head of capital markets in Russia for Jones Lang Lasalle, which brokered the UFG deal, says "there's a stand-off right now between equity and the need for it." That's been the case for many years in Russian real estate, and whilst some developers feeling the squeeze a little more than they have previously - due to their lust to take advantage of economic recovery coupled with an inability to access debt for the most part - asset owners have proved many times in the past how determined they can be in sticking to expectations.

They'll only be encouraged by the capital building up on the sidelines. Devonshire-Griffiths describes "a truckload of equity in the market, 60% of it Russian." Some funds - especially those featuring cash from other emerging markets such as TFI, a tie-up between the Qatari investment authority with Gazprombank - have been raising money since the start of this year. Cash from the West meanwhile - such as the $500bn that Morgan Stanley needs to invest in the next 12 months or so - has been around since before the crisis.

All of this cash will be chasing the same prize that it was pre-crisis, with lease rates looking set to rise rapidly once again. Large tenants are now moving to secure space, as they sense the market is only headed one way, with more than a few 40,000-square-metre (sqm) requirements out there. As such deals go through, Millard predicts, it will push other occupiers into action in the coming months.

The prospect stalking the whole market is a severe supply gap, probably in the second half of 2011, say both agents. Whilst projects which were stalled during the crisis should be delivered in the meantime, a total lack of new projects even going onto the drawing board in the last two years will, assuming the economic recovery continues, hit hard. This will provide the tipping point for some investment cash, with developers desperately keen to crank up their pipeline to take advantage. However, they're all up to their eyes in restructured debt and the IPO market offers little value right now. Therefore, the sale of income-producing projects is a temptation. It's just such a scenario that's fueling speculation that Moscow could soon see its first-ever truly class-A office deal, with rumours rife that Hines will cash in on Ducat III to top up its new $200m opportunity fund.

However, Devonshire-Griffiths suggests that some will dig their heels in, as the gap between expectations of the two sides is as wide as it ever was. "Buyers are looking for 20% yields, and so are baulking at the 10% demanded," he says. "Sellers meanwhile, laugh at 20% when development offers 30%." In his opinion, this leaves only one option, with the trend for development joint ventures set to revive in the coming months.

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