On the Wave of Slack Demand

According to Knight Frank, the vacancy rate in the Moscow Region is 9% (a year ago it was 0.5%). Taking into account the current realities, it is not that serious a problem. However, in the regions the situation is quite different. There are cities where 35% of high-quality areas remain vacant. New projects have been frozen, but a number of objects are being completed. In the Moscow region 600,000 sqm of class A areas are expected to be commissioned by the end of this year (in 2008 around 2 million sqm were announced). In other regions, there are about 750,000 sqm (against the 3 million sqm announced). The gap between expectations and reality is significant. “The demand for quality areas has been greatly reduced – several-fold. All of us have slightly overestimated this market,” the participants of the debate agreed. According to the director for business development at FM Logistic, Jean-Louis Nault, too many areas came onto the market at the time of crisis. Although now, he said, demand is slowly starting to recover.

The sizes of requested areas have also decreased. In Moscow, the average size being sought by tenants has been reduced from 7,000 to 3,000 sqm. In the regions this demand today is only in the range of 1,000-1,500 sqm.

The structure of demand has also changed. Previously the major tenants were logistics operators, but now the major actors are distributors and retail chains, according to the report presented by Knight Frank. Only the largest players, such as the X5 Retail Group and Auchan can afford expansion into the regions.

Anecdotal Rates

In the struggle for tenants, owners are being forced to reduce leasing rates. For many projects such a downward correction can be a serious blow. The hardest time is being experienced by those developers, whose construction costs were higher than that of their competitors. Basically this concerns objects constructed in late 2008 and 2009.

Seeing how fast prices for building materials and land were going up, developers, let us recall, were predicting increases in average leases rates of up to $150. This should have happened in 2008-2009. Today in the Moscow Region, there are many warehouses which are being leased as low as $80.

In the race to reduce leasing rates, not only the developers, but also the end users can come off as losers – warns Alla Solovieva, the executive director of MLP. “There are many developers who are making deals at anecdotal rates, just to get at least some cash flow. It is easy to see why they are doing this – this is their survival strategy. But there is a possibility that soon they will find themselves in a situation where cash flow does not cover their commitments. End users that are currently leasing premises at low prices risk serious backlash within a year or so, when the market situation, according to our forecasts, changes. No developer will want to keep a bad contract in his portfolio, when he can easily conclude a new and better deal with someone else,” says Alla Solovieva.

Speculating on a drop in prices, the tenants should not push too far, a reasonable balance is more desirable, was the final advice of the discussion moderator, Roman Burtsev, Partner, Industrial and Land Property, Knight Frank.

Yuri Petrov, Managing Director, Santens Service Logistic spoke, about what tenants feel on this subject: “Neither party should feel uncomfortable. The crisis has taught both tenants and landlords to be flexible and find compromises. We revised the conditions with the developer and are now paying not in dollars, but in rubles. We have concluded an agreement for five years, but provisions are included for annual indexation. If we cannot agree on a fair annual indexation, then a consulting company will be brought in as an arbiter.”

“We don't negotiate with every tenant,” says Alla Solovieva. “There are companies that are in extremely difficult situations (mostly these are logistics operators), and they face a choice – to leave the market or to become insolvent. Then we try and work things out. However, if a client comes and simply asks for a discount because everyone is given a discount today – to these we have a different approach.”

Another participant of the discussion, Oleg Mamaev, executive director of PNK, explained the antirecessionary measures of his company. “We do not sign contracts that could lead us to bankruptcy. You cannot enter into a contract in rubles, if you have a loan in dollars. You cannot fix low rates for the long term, if such contracts do not allow you to meet your financial obligations. We see many of our competitors making this kind of risky decisions. For now I have not heard about any high-profile bankruptcies in our market: if there is no financing available, then the parties negotiate, loans are restructured. But one should not fill a portfolio with bad contracts, although it is clearly difficult to be in the market today with the same prime costs as a year or two ago.”

In addition to reducing the leasing rates, all developers are prepared to make other concessions as well. This flexibility is shown in terms of payments (reductions in the advanced period, the reduction of deposits), increase in lease vacations, granting extra options (such as free parking spaces), performing the installation of facilities in the premises, partial compensation for relocation expenses. “When speaking about concessions for tenants, it is important to bear in mind that most of the large complexes are investment projects, i.e. flexibility of the owner depends on the conditions set by the investors, providing financing for the project,” says General Director of Espro Development, Vitaly Antonov. Alla Solovieva notes in this regard, that today the market belongs not only to the tenant, but also to the banker – it is difficult to negotiate with Russian and with Western banks. “In future we will see consolidation taking place in the market; there will be, I believe, some Miraxes in our own industry,” says Alla Solovieva, referring to Russia's largest bankrupt developer.

Adjusted Warehouses

Despite the difficult times, participants of the conference were optimistic. They agreed that things were not as sad as they seemed, the situation was gradually getting better, and demand was coming back. “It is significant that all recent real estate transactions took place at good rates. This, of course, was not $150 and not $130, it was a little more than $100, but this is good too,” comments Oleg Mamaev. Vitaly Antonov also agrees with the participants of the discussion. “Today we are really seeing a strong recovery in demand; many companies want to improve their working conditions. One could say that the tenant’s market has moved from something on the mind to something in kind. In addition, the companies that used to lease the class B areas are becoming interested in high-quality warehouse spaces, because the difference in the rates has leveled out.”

At the same time, experts doubt that in the near future we will see any new areas of construction. Obstacles still exist because of financing, cash flow volatility (it is difficult to calculate exact cash flow) and the problems with demand – a large proportion of vacant areas remains in the market. “It does not make sense to create the new projects, no investor would be interested in them until the situation with demand and rent is resolved,” notes Alla Solovieva. “So soon we will see no new constructions. Another matter is those companies that possess land resources. As soon as they feel the revival of demand, then they can start new construction within the framework of their old projects.” PNK Group might well be such a company, but Oleg Mamaev asserts that he is not completing, but building new facilities and for this purpose, the company is even buying new land: “It is traditionally believed that the current supply will be absorbed by the demand and the situation will sort itself out. But we forget that the current supply is of low quality. If you now build and offer tenants better facilities, and there is such a possibility, then the old buildings will remain empty for a few more years.” With regard to financing issues today, in the opinion of a number of specialists, it is not an insoluble problem. Banks are interested in having well-balanced loan portfolios themselves, so they are looking at the warehouse sector too. “Banks will look for the most stable and promising partners. One needs only to become such a partner, and there will be financing. During the time that I spent at the conference, representatives of the three banks offered me their services, even if in dollars and at the rate of 14%. This is a highly exaggerated interest rate. But we know that the cost of financing is not the most important component of the prime cost. Reducing the term of construction, managing the prime costs, one can achieve good results,” says Mamaev.

Vitaly Antonov is confident that, despite the difficult times, the developers have opportunities to attract financing and on very profitable, pre-crisis, conditions. If the project is interesting and the banks are confident in its potential.

Experts agree that today the market needs adaptable warehouses – the platforms that can easily be adapted to the real needs of the client. As for the build-to-suit format, for now its future is uncertain. In a time of crisis it is difficult to plan one's activities for a long time ahead, since prospects are not clear. And build-to-suit facilities are long-term projects.

Regarding the level of rental rates, according to experts in the Moscow region, they will reach an average of $100 – 110/sqm/year. “Rental rates in general have reduced by 15% and now we are seeing some stabilization. This trend may indicate that the bottom has already been reached and is behind us,” believes Vitaly Antonov. So companies wishing to lease areas at crisis prices should hurry, consider the experts. Not far off is the time when the deficit of high-quality warehouse areas will return.