Radius' South Gate warehouse complex a microcosm of turbulent Russian economy

Radius' South Gate warehouse complex a microcosm of turbulent Russian economy
By Ben Aris in Moscow January 11, 2016

The South Gate Industrial Park is Russia’s economy in microcosm. One of the biggest Class A warehouse complexes in Russia, South Gate and the toing and froing of its tenants reflects the complicated situation in Russia’s economy today.

Radius Group has been building up this 650,000-square-metre (sqm) facility since the beginning of this decade and invested hundreds of millions of dollars in it. The tenants include international brands like Leroy Merlin, General Motors, Pfizer, Next and John Deere, but each company is reacting to the recession differently. “It’s official: we are in crisis,” says Chris van Riet, who put Radius together and is the CEO.

Warehousing is an interesting proxy for not only how companies are doing, because they need be able to store their goods before they sell them, but also for how they think their business will develop, as companies buy or rent warehouse space based on what they predict their storage needs will be in the near future.

Three of South Gate’s biggest tenants have taken dramatically different views on the future of their Russian business. In 2012 General Motors commissioned a 50,000sqm warehouse from Radius that they took delivery of at the start of this year. But with car sales in free fall, the US car maker has decided to shut all its factories that were producing 200,000 cars a year and import some 2,000 cars a year instead. Overnight the company wanted to more than cut its warehousing floor space in half to 22,000sqm.

US agricultural machinery producer John Deere is in the middle. It has kept its 40,000sqm floor space, but asked Radius to help it make more efficient use of that and cut costs.

And finally Polish DIY company Leroy Merlin passed up offers on cheaper rents on Class A warehousing that abound in Moscow at the moment and commissioned Radius to build its largest warehouse in what was the biggest warehouse construction deal in the world last year – the 100,000sqm state-of-the-art facility, which will be delivered in the first half of 2016.

You don’t have to look too far to see the reasons for some of these decisions. The car market is collapsing after sales slumped 38.5% year on year (y/y in October to 129,958 and sales over the first ten months were down by a third y/y to 1.32mn units, according the Association of European Businesses. That is far off the 4mn units a year Russia was going to sell in 2008 before the global crisis broke that autumn.

Agriculture is doing better and Russia is on course for another strong harvest of over 100mn tonnes – the third strong harvest in a row. With the Russian state and leading companies investing heavily in the sector as Western sanctions bite, if anything John Deer’s approach looks a little cautious.

The interesting one is Leroy Merlin’s decision to invest in 100,000sqm of expensive warehouse space. Given warehouses have a 30-year lifespan, they have locked themselves in for the long run. This suggests the company sees great long-term potential in the Russian retail market and the country as a strategically important market.

Future of warehousing

The warehouse market is feeling the pain of Russia’s economic slowdown. Vacancy rates have risen to just under 10% from the traditional low of 1%, and rents have tumbled from an average of $135/sqm to around $70 now. In ruble terms – and the leases are increasingly now priced in rubles, not dollars – the typical cost of a square metre is RUB4,500 per month, but can go as low as RUB2,500 or high as RUB6,000 depending on how desperate the landlord is.

Warehousing in Russia has been hurt more by the ruble's sharp devaluation than the asscociated recession. “Real estate leases were typically denominated in dollars, as they have a 30-year life time and long-term dollar financing was cheaper to use than ruble… Currently we have the lowest ever warehouse lease rates in dollar terms but the highest in ruble terms,” says van Riet, who hails from Texas, but has spent 20 years in Russia, previously working as CFO of the Dixy supermarket chain. “The problem is that as half the inputs into a quality warehouse are imports, half the rent is directly affected by the volatility on the currency markets. You can’t build new warehouses in these conditions.”

Despite the downturn, Russia’s leading retailers are snapping up warehouse space or commissioning new ones, as even after a decade of economic growth there is not enough supply: major retailers are investing in the long term by renting warehouses now while rents are cheap, but construction costs are low too. “The oversupply of warehousing means that business with developers is down. The inflation that has hit the rest of the economy has not reached warehouse developers yet and so the construction prices are also low,” says van Riet.

There is also consolidation going on in the sector. “The strong are getting strong,” says van Riet. About 400,000-500,000sqm of new warehouse space will come on the market by the end of this year, roughly half the level of the year before when about $1bn was invested in warehouse construction. At some point demand will pick up and prices recover. However, in the meantime the more speculative projects have run into trouble. BIN Group has been snapping up troubled assets and in three years went from nothing to one of the biggest owners of warehouse assets in Russia.

And Russia is still lagging well behind the rest of the world. In the US there is about $8,000 worth of total retail turnover per sqm of total warehouse space, whereas in Russia that number is closer to $30,000/sqm. That is still a vast improvement from the $466,000/sqm it stood at only in 2005 at the start of the current boom, but it will take until 2025 to get to even $20,000/sqm, reckons van Riet.

Those numbers also testify to a changing trend amongst retailers. For most of the last decade companies were using their stores to keep their stock. It has only been since about 2009 the volume of retail business got large enough that they needed to rent dedicated warehouse space, says van Riet. “That means between now and 2025 there will be another $30bn invested into building new warehousing and we already control 20% of this market,” says van Riet. “Even if the sector grows a lot slower than we are expecting, you are still talking about sums on the order another $10bn invest in that period. Whichever way you cut it, a lot of money is going to go into building the necessary new space.”

Though times are tough, van Riet remains optimistic about the long term and is certain the market will continue to develop: the only issue is at what speed it will grow. “There is a population of 140mn highly educated people sitting on top of the greatest store of natural resources in the world,” he says. “As an American, I believe that we share the same values and people want the same things – a comfortable life, to be able go to lunch with your children, to go on holiday with your family and live a comfortable life – even if the culture and politics are different.”