A seasoned observer of Russia’s retail real estate market knows that the country has been experiencing economic growth across the board over the past several years and this factor has influenced positively the country’s citizens. Even though overall prosperity may not seem apparent in mid- and small-sized cities, the buying power of Moscow’s population is tangibly improving, as reflected in the growing number of shopping centers and constant flow of customers. Consequently, developers are taking advantage of the consumer boom by building increasingly larger shopping centers. Naturally, there could never be too many stores for consumers. But how about market players?

Overview
According to official data, the population today spends more than 70% of its income on consumer goods and services, while salaries are growing by 18%-20% annually. Accordingly, even if salaries should not continue to rise in the future, the current consumer activity is expected to at least maintain its current level. Therefore, investing in retail real estate will very likely be very prospective for domestic and Western investors. Since the beginning of this year, the following notable deals have been concluded on the retail real estate market:

Podium Group announced acquisition of the main part of the Kvadro SC in February. Previously, the 16,200-sqm building located on Kutuzovsky Prospect belonged to Partia. Analysts estimated the deal at $35-$40 million.
Denmark-based Baltic Property Trust acquired the first phase of the 16,200-sqm Global City SC early this year. According to market experts, the deal was around $60 million.
In summer Baltic Property Trust also announced acquisition of the 8,000-sqm Kuhnistroi SC, located on the MKAD between Leningradsky Prospect and Volokolamskoe Shosse. The deal was around $20 million.
U.S.-based Apollo Real Estate Advisors acquired its first Russian project in June from Metro Group in Kotelniki, Moscow suburb. The deal is estimated at around $100 million. Prior to Metro Group, the building belonged to Germany-based Edeka, with the Marktkauf hypermarket located in the center.
Sedmoi Kontinent acquired Obyedinennaya Torgovaya Nedvizhimost, which owns 29 non-chain stores in Moscow, totaling around 68,000 sqm. Sedmoi Kontinent plans, within the next two years, to transfer the stores to its own brand name. Dekra development group sold the stores for a total of $150 million.

A significant number of international investors who are entering the Moscow market is both the cause and the result of the lowered risks on the national commercial property market, in general, and in the capital, in particular. As a result of the declining investment risks, yields and profit margins are also decreasing. Experts today valuate the yields generated from purchase and sale deals for retail real estate at 8%-10%, while a year ago this figure was 10%-12%. Nevertheless, profit margins still exceed similar indicators in most European cities.

Supply
Over the past three years, the amount of premises in quality retail buildings has increased by more than 2.5-fold; however, obviously this is not enough to meet the current demand. Indeed, as of mid-2007, according to data provided by Jones Lang LaSalle and Knight Frank, there were from 1,645,800 sqm to 2,486,000 sqm, respectively, of gross leased area in Moscow’s shopping centers. According to Jones Lang LaSalle, there were 56 quality shopping centers in Moscow as of mid-2007.
The difference in figures among the market experts, in terms of retail real estate on offer, is a result of each respective company employing various criteria when evaluating the quality of the premises in shopping centers. Retail market analysts may exclude small premises and those not meeting certain criteria, which differ from one company to another.
Analysts’ opinions also differed in the following manner, when estimating the rise in supply in the first half of 2007:

Jones Lang LaSalle calculated 90,400 sqm of quality space delivered to the market;
Cushman & Wakefield Stiles & Riabokobylko calculated the amount of new quality retail space delivered at 129,600 sqm;
Magazin Magazinov calculated that 153,000 sqm of quality gross leased area was delivered to the market.

As DTZ reports, the total space announced for delivery to the market in the second half of this year is expected to exceed 1.5 million sqm in total in large shopping centers (see Table 2), or around 800,000 sqm of GLA; however, taking into consideration the typical delay in delivering completed properties in Russia, some of the afore-stated space will be postponed until 2008. Typically, there are delays caused by both unforeseen complications associated with construction and by attracting extra finances. Following the valuation of the amount of retail space, several alterations could later arise during the construction of multi-phase projects, given that several phases not discussed could be added or their format and timeframe for delivery to the market could be changed altogether.
“Even the most experienced developer is not a guarantee that a particular facility will be completed on schedule,” states DTZ. “The number of planned retail centers increases each year, but approximately a third of these facilities do not reach the construction stage.”
According to Torgovy Kvartal’s estimates, the north and west of Moscow is better saturated with retail properties than other districts, while the east still has the least amount of space. Experts at Magazin Magazinov believe that the city’s east is so poorly developed because of numerous industrial facilities, making this district the least attractive area. However, many enterprises today intend to transfer there production beyond the city’s limits, having realized the value of occupying plots on which residential buildings and shopping centers are planned for construction. Therefore, the eastern area of the city is anticipated to catch up with the city’s other regions in terms of retail premises in the upcoming years.

Demand
The demand for quality retail space remained stably high in the first half of this year, as a result of expansion of currently operating and newly arrived Moscow retail operators. Magazin Magazinov reports that a significant number of European brand names are present in Moscow, and the capital, vis-a-vis other developing markets, is in the lead. Additionally, virtually all of the world’s best-known brand names not available on the Moscow market thus far have announced their intentions to enter the market. The examples include French Carrefour Corp. and U.S. Starbuck coffeehouse chain as well as Swiss H&M and a number of others.
“The extended entrance of many long-awaited brands is owing to each company seeking the optimum development route on the local market, such as acquiring domestic players, developing via franchising, etc,” we were told at Magazin Magazinov.
External political factors could also have an influence on a company’s decision to enter the Russian market. In fact, South Korea-based Lotte Group, having completed construction on the Lotte Plaza retail and office center in Moscow, has postponed introducing its own retail brand to the Russian market until the Russian Federation has acceded to the WTO. Market experts also note that Western players are also anticipating the upcoming Duma and presidential elections, which could keep Western companies from entering the Russian market.
GVA Sawyer reports that premises of less than 200 sqm (please see the diagram) enjoy the greatest demand.
The share of vacant space in shopping centers remains low, with the most premises, according to C & W S & R, being available in the central business district - possibly as a result of repletion of the retail space submarket. Also, vacant premises in the Third Ring Road district picked up a little, with GVA Sawyer reporting that the amount of vacant quality retail space is 0.5%-2%.
Newly built high-end projects are in the keenest demand as well as those projects with waiting lists for several months in advance. In turn, facilities with initially inconvenient or obsolete concepts and locations are starting to decrease in demand, given that as market saturation approaches, specifically these facilities will have to review not only their lease rates, but also to be reconstructed and redesigned, as demand for them flags.

Rent
Non-anchor tenants today pay an average lease rate of around $1,500/sqm per year, excluding VAT and operating expenses with the dearth of vacant premises causing rates to continue rising by 7%-20% per annum, according to various valuations.
In addition to fixed-rate leasing, a new lease-rate arrangement based on the percentage of a store’s turnover is starting to make headway; however, under the conditions of a lessor’s market, the owner is always in the driver’s seat. Consequently, an arrangement which would require a developer to split the risks with the tenants is rather difficult to require on today’s market.
According to data provided by Cushman & Wakefield Stiles & Riabokobylko, operating expenses are around $150/sqm per year on average. The cost of constructing retail real estate, excluding the price for the land plot, is approximately $1,500/sqm, according to Jones Lang LaSalle’s valuations.

Trends

New facilities will continue to be built beyond the MKAD because of the shortage of development land within the MKAD. Bedroom communities are recently being actively built up, particularly those in close proximity to the MKAD as well as the Third Ring Road and the planned Fourth Ring Road.
The overall size of Moscow’s shopping complexes today will swell with the expansion of the existing shopping centers whose owners have announced their intentions to construct additional phases for their respective facilities.
Neighborhood corner shops and community retail centers will continue to grow in popularity, affording shoppers the convenience of buying goods on the way home.
As more shopping centers selling all the necessary goods and services open up in bedroom communities, shoppers will feel less compelled to complete all of their weekly shopping at one fell swoop. However, regional and super-regional shopping centers will continue to operate regularly owing to the overall increase in buyer activity.
The dearth of requisite premises and the peak of competition among facilities in Moscow will draw developers’ interest to the regional markets which, similar to Moscow, are not quite replete with quality retail premises. The suburban cities near the capital have also recently drawn the interest of investors and developers.

Projection
The country’s increasing consumer buying power bodes very positively for the continued development of retail real estate. In the mid-term range, lease rates will very likely continue to increase and the low vacancy rates of premises will be maintained. Looking ahead to the beginning of the next decade, we see that experts differ in their forecasts of what shall happen, with one group predicting blues skies for the development of the retail real estate segment and another group foreseeing a global crisis.
However, most likely we shall witness a happy medium, where today’s planned large-scale projects will be delivered to the market, thus diverting consumers to the highest quality and most successful shopping centers. In turn, tenants will very likely depart from the least competitive complexes, thus they could most certainly anticipate a differentiation in the lease rates, depending on the quality of the retail facility.
In conclusion, a shopping center’s ability to attract additional visitors via entertainment, educational and sport facilities will take on added significance as competition toughens on the retail market.

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