Building Up and Over Again

Despite all the challenges, construction continues at a number of properties. “In the majority of cases, this takes place through a redistribution of financial resources,” explains Olga Yasko, Director of Research at Colliers International. “Developers are freezing projects an early phases and building the most promising properties to completion.” Furthermore, according to Olga Yasko, the most favorably positioned developers are those who managed to secure loans from the state banks at comparatively low rates.

For example, Horus Capital is building to completion the Lootch Office Center. InterRosDevelopment (OPIN) continues building the Domnikov Business Center, while Capital Partners is seeing through the Metropolis mixed-use center. Central Properties is working on the Dvintsev Business Center. This year should see the completion of work on business centers belonging to Capital Group (Capital City), Romanov Development (Romanov Dvor-3), Valartis Group (Zhenevsky Dom), Coalco, AIG/Lincoln (White Square), MCD Group (Mokhovaya), Centurion Hypermarkets (Western Gate). All these properties are located in Moscow. As for shopping centers, Patero Development this year plans to finish construction at Zolotoi Vavilon Rostokino. AFI Development continues work on the Mall of Russia in Moscow City, which should be up and running by the end of the year. Several properties should be finished in 2010, for example – River Mall, belonging to Kuznetsky Most Development, as well as the underground REC at Paveletsky Station Square, belonging to IPG Evrazia (both properties in Moscow). True, it should be noted that any of the above-listed properties could be halted at any minute, as the situation with financing and demand remains highly questionable. Mirax Group has frozen new projects as well new developments “on paper only” alike, so as to finish work on the Federation Tower, which was touted for quite some time as the centerpiece of the “Moscow City” International Business Center. “Even (the developments on paper only) require significant investments, while we need to finish building the properties that we have already started,” Mirax explained. True, they also pointed out that the company has over 40 of these “new ideas.”

“In addition, developers who decide to finish construction might be motivated by previously signed lease agreements with major companies, such as, for example, Deloitte, PricewaterhouseCoopers, etc,” Olga Yasko says.

Growth points

The most popular advertisement banner in the city right now reads “For Rent.” These days, supply is far ahead of growth. However, it is entirely possible that the proprietor’s market will come back soon: the majority of projects are frozen, and a few years from now, when the crisis is over, tenants may face a serious shortage of quality space. The developers understand this as well, so they try to stay as active as possible. According to Vera Setskaya, President of GVA Sawyer, starting a project today doe makes sense. The reason is that the pre-project phase – acquiring a land plot, creating a property concept, preparing documents – takes a year on average. After that, the drafting phase takes another 6-8 months. “These phases do not require significant material expenses, so it is possible to keep working, wait for the market to recover and finance to become available at reasonable rates. All of this will be necessary for the real construction,” Ms. Setskaya says. However, construction-related problems are not that simple, even for those developers with money. “The major problem today concerns a property concept, since market forecasts in the 2-3 year range are unclear,” Vera Setskaya also adds that “It’s really difficult to plan out demand for space and how quickly the space will be occupied. Rental rates are also hard to forecast.”

You no longer hear about ideas to create new districts, cities, and even islands, which developers had been dreaming about until recently, when every reasonably sized city wanted to have its own “City” from a top architect. Such projects were all the rage during MIPIM 2008. All that remains of this today is memories. “Nobody today is suffering from giant-mania,” agrees Evgeny Semenov, Head of the Investments Division at Knight Frank. “These days, nobody wants to put up 500 thousand sq m in a single go, or even 100 thousand. Nobody knows what will happen with demand and financing, and whether it will be possible to refinance loans.” According to Mr. Semenov, the greatest demand will be for smaller properties: 10-20 thousand sq m. “All of these will be in demand, especially those located in quality areas.”

Vera Setskaya fully agrees with Evgeny Semenov. She, in turn, suggests breaking projects into phases, and also supports the idea of mixed-use property complexes: “This lowers risks: when one type of property happens to be in market demand one reason or another, it compensates for the temporary lack of demand on another type of property.” According to Evgeny Semenov, quality property objects in smaller formats will be in demand no matter what. “The time has come to put up buildings that correspond to international standards. As a matter of fact, developers might even want to adjust current building projects.

According to Vera Setskaya, demand may rise for business-park formats, as well as for properties in low-story buildings with a corresponding parking: “Under the condition that a land plot is available in the right direction and at a good price,” adds the expert. According to Olga Yasko, investments in retail real estate are less risky: “If the project has already received financing, it makes sense to continue with construction. The situation in this sector looks more predictable than in the office and hotel sectors. The market will experience a real deficit of quality spaces two or three years from now, and the developers will be able to scoop off all the cream, particularly in cities with low competition.”

According to other experts, the hotel industry may develop in the crisis period. “This segment is so underdeveloped that no crisis can scare it,” says Vera Setskaya. “I would invest in those properties in case operators support me.” The same opinion is expressed by Dmitry Koltunov, Strategic Development Specialist at Partner Invest (the company intends to build a hotel): “Hotel real estate is not as vulnerable to crises as office real estate, because people never stop traveling. And there is a lack of quality hotels in the country.” According to Dmitry Zolin, Managing Partner at London Consulting & Management Company | LCMC, new growth points might include discounters and shops in the “corner store” format. This idea finds support among the experts at GVA Sawyer – the company plans to invest in the construction of outlet centers – conglomerates of various brands. However, this idea has its critics, who doubt that such stores can blend in Russia. Cameron Sawyer, Chairman of the Board of Directors at GVA Sawyer, happens to believe the opposite: “Outlet malls are immune to economic cycles. This is the point in crisis times when the brand conglomerates show the most profit, and when sales go up, as companymanufacturers sell off their previous seasons’ collections.” GVA Sawyer intends to invest in this program using its own funds. “Besides (GVA Sawyer), other investors include Fashion House (a famous European outlet mall operator), as well as a group of European investors,” Vera Setskaya says. In total, the company plans to build 10 outlet centers in Russia’s biggest cities. According to GVA Sawyer representatives, the first land plot has already been purchased. The crisis helped save money on the purchase, although the company declined to specify the terms of the sale, mentioning only that it was at a discount. Construction is scheduled to begin in 2010, and the entire program is calculated for 5-6 years.

According to Evgeny Semenov, demand may increase for so-called “urban development” construction. It is possible that new Western manufacturers will make an entrance, who in turn will build new industrial and warehouse facilities. “There have been several announcements by Western companies who would like to enter the Russian market exactly right now. It’s hard to imagine a better time, since construction costs are down, as well as wages. There are certain things that will always be in demand, for example – medicine.”

When it rains, it pours

Many experts suggest beginning work on new projects today. “If a company has the opportunity, this is the best way to go today,” agrees Evgeny Semenov. “When you consider the decreasing costs of construction, a property with an area of 20,000 sq m can certainly be financed with personal funds, or a consortium can be created to finance construction via private capital sources.”

Many companies support this position. The investor-developer Partner-Invest is planning construction of a hotel in Tomsk. According to an official press release, investment in construction will total $100 million, which includes both borrowed funds and the company’s own money. The company plans to seek borrowed financing somewhere in the future, when a “thaw” sets in on the market, a company expert told us. For now, the developer is searching for a land plot and holding negotiations with the Rezidor Hotel Group hotel operator.

Meanwhile, according to Olga Yasko, starting construction on company’s own funds is quite risky. Hopes to bring in an investor later on or find a source of borrowed financing is risky as well, even if the project has an approved concept and a fully prepared building site. “Another threat in this case is that a lender is likely to issue a margin call.”

It’s a separate matter if the developer is perfectly well off with money. While some are in panic, others are strengthening their positions on the market and even expanding their business. As a rule, these are companies that either had a low share of borrowed capital or none at all. Even in the regions, some businessmen are actually happy about the crisis. For example, Igor Kovpak, a retailer in Yekaterinburg (the Kirovsky chain), who invested profits in the development of his business, has bought out many of his competitors (developers included) at bargain prices. And Mr. Kovpak is not alone in this approach. Another business owner from a million-plus city (speaking under the condition of anonymity) built five business centers using his own money (small properties of about 3,000 sq m apiece). And although the analysts consider all regional markets in Russia dead, the above-mentioned businessman has not curtailed his business, believing the market is not yet penetrated. He has recently decided to raise the capitalization of his properties and hired professional managers. Small companies are not the only ones charging forward. IKEA, one of the first developers in Russia, is not only not curtailing activity, but expanding, moving forward with plans to open new stores in major Russian cities. The recipe is the same: financial independence and a cautious expansion plan – no loans, no collateral, no debt. Now IKEA as well as many others are well-positioned to gain from the crisis. First, prices on land are decreasing (a large selection of quality sites are available on the market), as well as prices on labor and construction materials. There is also one more advantage: the crisis is slowly but surely reducing competition on the market.

“Only a few developers have their own funds,” Olga Yasko says. They build smaller properties either for themselves or particular end users – either tenants or buyers.” New players on the real estate market might include non-state pension funds, insurance companies, and asset management companies. Following losses on the stock market, such companies might switch their focus to real estate. According to Evgeny Semenov, interest has been shown by Leader Asset Management, Blagosostoyanie non-state pension fund, and other players. Whereas before companies in this sector expected to go into projects receiving high yield on future capitalization, today they are looking into readybuilt properties, which produce stable yield.”

“Unexpectedly, new players are appearing on the market that no one has heard of, and who we didn’t pay attention to before,” Evgeny Semenov says. “These are mid-sized companies and companies with major private capital. They have resources, but it is too early to call this a trend.”

Equally noteworthy are the companies that have been promised state support, for example – Inteco, belonging to Elena Baturina, wife of Yuri Luzhkov, Moscow’s Mayor. The developer plans to build not only residences, but office and hotel properties as well. As a reminder, other companies in the systemcore list include Oleg Deripaska’s Glavstroy, the PIK Group, SU-155, the LSR Group and DSK-1. Almost all of the above developers have the real estate assets of their own. True, being included in the list of systemcore companies has not helped Oleg Deripaska’s Glavstroy; the VTB bank recently filed a suit against the developer in a Moscow Court with a demand to repay debts.

Every expert agrees on several points: construction hot spots will appear as soon as the market starts to budge and new rules of the game are formed. For example, Alexey Belousov, Commercial Director at the Capital Group Holding, says that one underlying factor is prices on construction-installation work. “I relate any kind of change on the market with the appearance of a fundamentally new pricing structure on building-installation work,” Mr. Belousov says. “An adjustment is happening even now. But the developers will not start to actively explore new land plots until this process has finished.”