Tim Gosling in Moscow -
Just as the enthusiastic entrance of foreign specialist lenders started challenging the high costs and terms of debt financing for the Russian real estate industry, the international liquidity crisis appears to have undone the advances.
Following the arrival of the likes of Eurohypo and Hypo Real Estate in late 2005, costs and terms available to developers and investors began to soften, as the major Russian banks began to respond to the competition for a share of this lucrative market. By late the following year, institutional investors buying into prime developments were reporting offers of financing, in euros, from Sberbank at single-digit interest rates.
Now, rates in the dominant Russian institution are being discussed back up at the level of 14-15%, according to analysts, as foreign banks in particular hang back while the global liquidity squeeze persists.
The director of Central & Eastern European operations at one of the German specialist banks claims that both his main competitors are now closed for business to the end of the year, while his own bank can do new business only "in exceptional circumstances."
He says that the latest deals on the market from foreign banks, negotiated in the summer before the crunch, went through at margins of 300-500 basis points (suggesting interest rates of 8-10%), and with full amortization falling between 10 and 20 years. However, such deals have apparently vanished for the near term.
"Just a few months ago the foreign banks were still saying 'Oh my god, Russian real estate, we've got to get a piece of it!', and so they had to be aggressive to do that," says Kim Istyan of Uralsib. "Then when risk aversion rose, it became 'Whoa! Russian real estate - what were we thinking?!'"
Some terms have perhaps survived - namely the extension of amortization to between 10 and 20 years; previously anything more than 7 years was unlikely - but the withdrawal of foreign competition, along with the higher cost of funds for the banks themselves, is seeing developers and investors having a far tougher time in finding funding for projects.
At least one major project is known to have lost a financing deal in the autumn, although the common view, as expressed by Roman Herzog of Raiffeisen, is that in general most deals in the summer went through with some minor renegotiation.
While the property yields to be had in Russia suggest that the industry should be able to stomach the rising costs, the concurrent drop to 60% on the maximum loan-to-value available is one of the most crucial factors seeing a real impact on the sector. At the same time, alternative funding options such as joint ventures and IPOs are also feeling the strain.
Of course, this is only feeding the appetite of the major Russian players, who are insulated from the global problems, know the market better and have a different risk profile for Russia. In addition, it is of course their only market. "Apart from the few stories we've heard on the mortgage markets," says Iskyan, "the Russian banks have remained far more active in continuing to make money available for the market."
As a recent note from Alfa points out, Sberbank and VTB are continuing to take advantage of the weakness of private and foreign banks during the prolonged liquidity squeeze to reinforce their role in the lending market. In September, the pair provided 70% of corporate loans in Russia. According to Central Bank of Russia (CBR) statistics, corporate loan growth in September remained surprisingly strong at RUR300bn (€8.4bn). Alfa added that the state-controlled banks are only likely to increase their dominance: "Sberbank's plan to attract an $800m syndicated loan in December, and VTB's intention to borrow from the CBR, will help both banks gain additional market share before the end of the year."
Borrowers, meanwhile, are hoping that the foreign banks regain their nerve in the near future. "All the developers are looking for financing - that hasn't changed," claims one property investor from a global investment bank. "It's on the bank side that deals have stopped. This is likely to last until the end of the year when the books will be closed and they can see where they stand more clearly."
"Anyone striking new debt financing deals over the last few months would be doing so for projects starting in 2009 at the earliest, so for the moment, most should be able to wait - but within the next year, many will need to source new capital," suggests Herzog. "One or two that have been slower in arranging debt are now saying that they will wait some months before buying projects because the costs are so high right now, but that they expect them to drop."
Turn of the tide
A drop is already being seen in project prices, according to many, as the cost of debt and lowering loan-to-value levels spark real effects on the ground. With investors no longer able to gear equity at previous levels, they either have to be less aggressive to maintain internal rate of returns, or even put a halt to acquisitions if they depend on high leverage.
Several in the market agree that the liquidity squeeze has seen the tide on the property investment market turn for the meantime. For half a decade, international money has been searching for finished product in Russia with little success. Now assets are cropping up on the market, but interest from international investors is increasingly harder to whip up.
These assets are coming to market from two sources: those that believe yield compression has reached its zenith for near term, and those that are highly-leveraged. For instance, British private equity investor London & Regional Properties has been perhaps the most active on the market for the last 12-18 months, taking full advantage of its penchant for speed and leverage to make a big dent in the $1bn it pledged to Russia. Now, the company is not only said to have pressed pause on new acquisitions, but is putting the central offices at Ducat Place II - which it bought around a year ago - up for grabs.
Still, the national director of another foreign private equity investor, busy snapping up assets, says that although many international players are pausing for breath, that doesn't necessarily mean he faces less competition. Increasingly, he says, he's finding himself bidding against some of the highest profile Russian entrepreneurs. With the huge volumes of equity currently sitting in selected hands in Russia, these new players can be extremely aggressive once they're convinced that plays on institutional-grade product are just as worthwhile as the cheaper brown-field plots they've concentrated on so far.
Still, the pull-back by investors suggests that the options for commercial developers to maintain their margins in the midst of the liquidity squeeze are dwindling - joint-ventures or forward sales having been the most popular alternative for to debt financing to fund projects; at least for those without their own capital resources.
A commentator from a global investment bank building a platform via the purchase of equity in Russian developers says his institution hopes the situation will prove a strong opportunity. However, he'll likely be eyeing the IPO of LSR Group, which will see its first day of trading in London on November 9, for a clue as to how much leverage it could give.
The issue is the first from a Russian developer since the summer, and may prove a test for investor sentiment towards the sector following not only the liquidity squeeze, but also the poor performance of some of those that listed in the first half of the year. Setting the price in the middle of the range on November 8, the subscription is said to be healthy - although it's also thought that it's the company's construction materials operation that is the most attractive. Still, it's an event that many Russian developers will no doubt be watching closely.
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