Crisis – One Year Later

“Just like most companies we weren’t prepared to face the crisis and most importantly we didn’t understand its impact and duration. And this is why the measures were temperate and there was hope that it would pass quickly,” says Vera Setskaya, President, GVA Sawyer.

Even companies that were rather pessimistic about the impact of the crisis and that understood that it would hit Russia in the near future, were actually surprised by the scale of the damages. “We were expecting some negative repercussions from the market slumps in the United States and Europe. We were getting ready for the crisis as early as the summer of 2008 and streamlining our expenditures,” says Christopher Van Riet, Managing Director, Giffels Management Russia. We were also certain that our investors and potential tenants were fully informed about these measures and were fully supportive. On the other hand, we were astonished by the magnitude of the economical decline in Russia and its impact on the demand for commercial real estate.”

According to Mark Jagger, Chairman of the Board of Directors for Russia and CIS, Jones Lang LaSalle, notwithstanding the Russian market was still growing in the first half of 2008, it was already obvious that banks were shutting down on funding, and that this had a direct impact on the financing of development projects and investment transactions. “We knew that the market had changed and began taking action at cutting investments in business expansion,” recounts Mark Jagger. “Nevertheless, we were just like everybody else surprised by the events that took place on September 2008 and by their impact on the Russian real estate market. We very quickly reacted to the changes and already by mid October implemented a business curtailment plan and other measures to safeguard our company from the crisis.”

The major issues that most developers came to face were as follows:

Overblown project portfolios simultaneously being realized at various stages of completion;

Major short and midterm indebtedness;

Sharp increase in currency rates which impacted on ruble loan repayments.

The worse hit were companies with overly high debts. In order to restructure their debt loads developers had to clear part of their assets or equity stocks. Those companies without short-term loan obligations and overblown portfolios were doing somewhat better, but had their own difficulties as well.

“Just like most companies working on the commercial real estate market, we weren’t prepared for the economic changes,” confesses Amiran Mutsoev, Vice President, Member of the Board, Regions Group. “However, thanks to the company’s well-balanced investment policies, the company wasn’t under any heavy debt loads when the crisis first hit us.”

According to Oleg Sorokin, Director General, Stolitsa Nizhny, the company always operated reasonably with well thoughtout decisions and had no real difficulties due to overblown portfolios. “Generally, we never work on more than two obkects at a time,” says Oleg Sorokin. “With regard to currency risks we did experience some serious difficulties but this had no impact on our relationship with the banks. They have always been reliable and confident and remain such even now.”

What’s the Plan?

The crisis forced developers to review their former strategies and swiftly develop new tactics. Christopher Van Riet recounted that the company in the framework of its antirecessionary program had to reduce the number of its employees by 15% and cut the expenditures of its head office by lowering leasing rates and reducing rented surfaces. “Furthermore, since all attempts at taking advantage of the new opportunities were relayed to a back burner until at least 2010, our efforts regarding business development were practically reduced to none,” says Mr. Van Riet. “But we didn’t lower salaries as we consider it most important that the backbone of our company was compensated according to its accomplishments in good or bad times. Also, our shareholders, among which are some of our management, allocated additional funds towards the business so that the construction of our industrial park Giffels SouthGate continued on schedule.” According to the crisis strategy of GVA Sawyer, part of the employees went through some training and were transferred to sub-divisions that remained operational. “For instance part of the consultants became temporary brokers and marketing specialists in the brokerage division,” says Vera Setskaya. “We developed a set of new services required on the market, including the project technical assessment, express consulting, express market monitoring and short-term market surveys. The valuation sector was expanded. On the whole, salaries weren’t reduced by more than 15-20%. During the crisis cycle the number of our employees was reduced by some 25%.”

The major antirecessionary measures undertaken by Stolitza Nizhny regarded a slowdown for certain projects, especially those at the design stages. Developers working on but a few projects funded at various levels succeeded in continuing their operations without any requirement for antirecessionary concepts. “The construction of the Mercury City within Moscow City received a long-term credit line from one of Russia’s major banks before the crisis,” accounts Irina Strizhova, Director, Marketing & Sales, Liedel Investments Limited. “Part of the funding comes from the actual shareholders. It is expected that additional funds will be raised through the sale of apartments and rental income from the offices. Such a position provided the company with a stable environment and was relatively spared by the vicissitudes of the crisis. But the crisis has obviously affected us to a certain degree and we have gone through some changes, but we didn’t need any specially elaborated crisis strategies.”

Market Revolution

Since last October the commercial real estate market has suffered a global transformation. “One of the reasons why the market was so heavily affected was the fact that investments, funding and the demand on the part of tenants all crumbled simultaneously,” accounts Mark Jagger. “Usually market cycles affect one or several factors but not all at once and not at such a magnitude. Another sign that the market had changed was the withdrawal of foreign investment capital which won’t return on any considerable scale at least for the next year. Another trend that we have observed during the past 12 months was a large number of tenants who have approached their landlords in order to review their leases. On today’s market cash calls the shots and most players are trying to defend their capital and cut their costs.”

Many trends that we are seeing today, according to Mark Jagger, are conditional on this factor. Bill payments are being delayed, landlords are having to deal with their tenants constantly requesting lower rates, and everyone is trying to maintain their own cash-flows. Growth and expansion have been replaced by short-term tactical measures to release the least capital possible and keep expenditures under control.

In the last months of 2008 and early 2009 the number of commercial real estate surfaces on the market had been growing rapidly. Customers were either becoming insolvent or were assuming a wait and see attitude hoping for prices to fall even lower. “Foreign buyers left the market just like all other investors except for a few Russian corporations with strong balance sheets,” says James Corrigan, Global Head of Real Estate, Investment Banking, VTB Capital. The market was forced to institute dumping practices. “The desperate need for money and the superior bargaining skills could produce savings of up to 50% from the initial proposed price,” says Irina Strizhova. “And then the average price on the overall began falling up and until June 2009. And it’s only in JulyAugust that a relative stagnation overcame the market.”

Developers specializing in the area of shopping centers and malls were heavily affected by the difficulties of their partners, retail operators. “Due to a drop in the consumer demand, our partners-tenants began experiencing difficulties with regard to their revenues,” says Amiran Mutsoev. “We had to take this into consideration in our work. Many national retail brands decided to temporarily defer their regional expansionary plans. However, notwithstanding the complex situation, two of our projects in Ufa and Cherepovets are in a relatively good situation. The currently under construction mall in Cherepovets will be the first of its kind in the city. This is one of the reasons why the surfaces are being leased without any major difficulties.”

A Slow Start?

Brokers and developers have recently seen signs that the market is off to a slow start. “Since midsummer we are seeing a resurgence of activities in the brokerage department, there is a renewal in transactions for leasing as well as sales. A demand is appearing for consulting services which had totally disappeared early in the year. We signed letters of intent for three projects in August,” says Vera Setskaya. The number of players on the market has substantially decreased. On the other hand, according to Vera Setskaya, they have become more friendly and ready to cooperate and join forces.

The developers that remain alive began looking at sources of funding and the integrity of their long term projects more objectively. “The attitude of the developers has changed considerably as they have accepted the fact that certain projects have no future in Russia,” says James Corrigan. “Bad projects that weren’t adequate even before the crisis have totally disappeared.

Oleg Sorokin believes that the crisis graphically demonstrated the necessity of securing the stability of companies regardless of the market fluctuations and their magnitude. The economy is cyclic and any economic growth is followed at one point or another by a drop. The real estate market was indeed overheated. The increase in prices that took place in the last few years was not pegged to real market mechanisms and was fully speculative. The major lesson that developers learned from the crisis, according to Amiran Mutsoev, was that projects must be well designed from a funding risk perspective. Furthermore, companies must carefully review the expansionary plans of their partners-tenants and major market players and secure their support when undertaking new projects. “The changes that we have witnessed this year are obvious: the mood among developers, creditors and investors has changed. Now everybody understands what has to be done, a restructuring process has been initiated, assets are being sold, the interests of the players are beginning to overlap, which will translate into the availability of cash that has so far been restricted by the possibilities of the Russian capital,” says Maxim Sterlyagov, Managing Partner, Asset Management Group. “How will commercial real estate projects be restructured is not yet fully understandable, and what the solution will be for Russian real estate lending banks isn’t either. Even if all paper projects were to be halted and the debts for the next few years were restructured, refinancing problems will continue growing like a snow ball, and without major Western investments any talk of stabilization is premature.”

Mark Jagger, on the contrary, believes that in the next 12 to 18 months his business won’t necessarily be growing but will however remain stable. “We will continue to slowly expand some of our business areas in any way possible,” says Mr. Jagger. “We will keep on working in conformity with the market, instill motivational incentives for our employees and we must also be prepared for the market to pick up again. The crisis has made us aware that this market has no room for sentimentality. And this is why we have to be steadfast and develop our ability to quickly respond to market fluctuations.”