It is a self-evident truth that the Russian economy is in the middle of a significant slump and it does not take a genius to understand that the only causes that really matter are the oil price and sanctions. We have been living with these effects for a couple of years now; MIPIM 2014 was when the sanctions started to have an effect. The economy has learnt to live with sanctions, but the oil price is an outside factor and it is therefore now the most important for any Russian economic recovery.
To an extent then, what the Russian recovery will look like and when it will take hold is dependent on outside factors. This is evidenced by the fact that the ruble is now tracking the oil price very closely and can be frustrating as, economically at least, Russia has surrendered much of its ability to control its own destiny.
As I write, oil has comparatively strengthened and the ruble has followed its master’s call and dutifully strengthened in light of this to near RUB75 against the US dollar. This may only be a short-term blip, but it neatly highlights the problems facing the Russian economy and therefore, by extension, its real estate markets: we are dependent on outside factors.
I remain, though, stubbornly optimistic for the Russian property market and I believe that now is the perfect time to be investing. That may seem counter-intuitive, at a time when all independent analysts are downgrading their forecasts for the Russian economy in 2015 and 2016, but I will explain my reasoning.
The Russian economy will remain in recession for most, if not all, of 2016. The green shoots of recovery may start to appear in the fourth quarter of this year – and it does seem that growth will remain elusive and sluggish through much of 2017. However, it is certain that growth will reappear and that the period of import substitution that has been artificially imposed will give a kick-start to certain sectors of the economy. Demand will start to return across the board.
At the same time, we are in a period of historically low completions in all property sectors, including residential. The devilish brew of current low demand, low rents and capital values, weak confidence, uncertainty surrounding the rublisation (or not) of the commercial property markets and lack of availability of project financing means that future supply is likely to be even more constrained.
Underneath the surface
Although, on the face of it, market fundamentals are weak, a little deeper analysis gives the lie to this view. Vacancy rates are high in all sectors compared with, for example, the historical levels in Moscow, but are not high when viewed in an international context and are certainly not high if you look at the actual number of square metres that are available. Demand patterns may be shifting, but I expect increased demand in all sectors from the end of this year and this will collide with severely constrained new supply and will result in the markets returning to balance far faster than most people expect. At that point, the opportunity to secure a long-term lease of office space on very favourable terms, or to lock in your retail expansion plans, or to buy an investment property at high initial yields, compared with other international markets, will have passed.
Macroeconomic factors will improve – oil price recovery, higher GDP growth, a stronger ruble (although not at the levels seen before November 2014) and lower inflation will, on their own, improve returns from property investments. These will be further enhanced by improving fundamentals, as higher demand across the board kicks in at precisely the time when new supply is low. The development cycle in Russia is comparatively long, so there is likely to be a sustained upswing in the Moscow property markets.
The market is very challenging at the moment and the negative news is, perhaps understandably, dominating and defining the Russian narrative. This has taken Russia off the radar for many investors and multinationals. However, the size of the economy, its underlying strength (balance of payments, foreign reserves), the resilience of its consumers, the retail potential and, yes, the amount of natural reserves with which it is blessed, means that it will be an important source of future growth particularly when more mature markets are struggling.
I do not pretend that there will not be challenges – but it is precisely for this reason that I believe the investment case for Russia is strong.
Tim Millard, Regional Director, Head of Advisory Group at Jones Lang LaSalle