The Russian market has stabilised after its brief but steep downturn and now is the time for opportunistic investors looking for high yields and bargain prices, according to overseas real estate broker Tranio. Property values are at their lowest in ten years and 40% lower than their peak in US dollar terms. Furthermore, lease rates are earning 10% yields and, now that oil prices are stable, the economy is on the road to recovery.
Investments on the rise
Investments into Russian commercial property have already started growing and, according to forecasts, they are going to exceed the levels seen in 2014−2015. In January-March 2016, this market attracted $1.9bn, which is 4.5 times more than during the same period last year. In fact, the total annual investment volume is expected to reach $4.5bn, compared to $4.4bn in 2015 and just $3bn in 2014.
At the same time, the share of foreign capital on the Russian commercial real estate market hit a seven-year high of 42%, even though in 2014 it was as little as 16%, reports Russia's RBC. This growth is widely attributed to investors holding off on purchases during the two previous years due to economic and political uncertainty, but returning to the market now that recovery is in sight.
Even last year, there were some major transactions involving commercial property in the Russian Federation. For instance, the American Hines Investment Management group bought two office towers in the mixed-use Metropolis complex for $325mn in association with Czech Republic's PPF Real Estate, the biggest office property sale in Moscow. Adidas Group bought the "PNK-Chekhov" warehousing complex.
This year already has seen the acquisition of more distribution and logistics facilities: The Russian Direct Investment Fund (RDIF) and Mubadala Development acquired the "PNK-Chekhov 3" and "PNK Northern Sheremetyevo" warehouses for $100mn, the biggest transactions so far in 2016.
Attractive ruble rates
The weak ruble has made the Russian market more attractive for foreign investors than ever before. Between early 2014 and May 2016, the US dollar rose against the Russian ruble by over 80%: from RUB 35.2 to RUB 64.9. In other words, foreign investors have doubled their budgets without lifting a finger and can now afford much better assets now than in 2014.
However, this situation also has a flipside because owners can't predict the future of the exchange rate and the ruble's dollar equivalent, especially if the purchase was made using a foreign currency loan. Furthermore, a small portion (30%) of commercial lettings work on contracts in US dollars, but the majority switched to RUB after the 2014 currency devaluation. Many analysts believe that contracts in rubles will remain dominant.
The Russian property cycle is now entering the best stage for property price growth: the market is at its lowest point and is not expected to fall further. This means that investors are now able to make the most profitable transactions.
Russian real estate values depend largely on oil, and both have been suffering since 2014. Luckily, this year the price of oil has improved, meaning that foreign investors now have a chance to buy underpriced assets before the next surge.
According to RRG, a consultancy, in January-March 2016 the average US dollar price of commercial property in Moscow decreased by 10% year-on-year (now $3,148/sq m) but gained 5% in ruble terms (now RUB 221,304/sq m). Prices for warehouses have fallen the most (−20% in USD) as have those for office property within the central "Garden Ring" (−15%).
Lease rates for all commercial property have declined: by 24% on average for RUB contracts (now RUB 18,600/sq m per annum) and by 35% for dollar contracts ($265 per sq m per month). In 2016, lease rates will most probably remain at the current level owing to the steady dollar exchange rate.
As prices went down so did the supply volume in Moscow (–33%) as owners became either desperate or unwilling to sell.
High yields on Russian commercial property are another incentive for foreign investors, especially since they are so low in Europe. For instance, the office segment in Western countries has annual yields of 4–5 % on average, compared with 10% in the Russian Federation.
Between 2014 and 2016, average office yields in Russia increased from 8.5% to 10%, while retail yields grew from 9% to 10% and those of logistics/distribution rose from 11% to 13%. Nevertheless, these rates are lower than in 2010 when office, retail and warehouses had average annual yields of 12%, 13% and 14% respectively. This is a positive sign signaling that Russia's market is more reliable than before.
High yields do imply high risk and in Russia, this is because a lot of commercial properties are vacant. As of the first quarter 2016, the vacancy rate for Class A office property in Moscow ran at 29% and 16% for Class B properties. For reference, offices in London have annual yields of 3-4% and only 2-4% of the facilities are vacant. For this reason, it is advisable to invest in quality property in central locations when considering the Russian market.
According to experts, Russia's GDP should start growing again in 2017, which is a sign that the property market should enter the recovery stage this year. At the same time, the unemployment rate is expected to remain low and inflation to fall. The ruble is also expected to grow slightly in 2016 before getting cheaper again next year.
On the backdrop of positive economic dynamics in 2016, prices for Russian commercial property have stabilised, a factor that usually precedes the recovery stage. Recovery is expected in 2017, reinforced by industrial, GDP and oil price growth. This stage may last a little longer than usual due to the prolonged crisis that precedes it.