Discount Season on the Real Estate Market

Season of wishes

At the end of September 2008 the X5 Retail Group announced its intention to purchase competitors’ retail chains as they became cheaper and cheaper. The company froze its longterm projects which were planned for completion next year. The X5 Retail Group intends to spend the proceeds received this way on the purchase of assets from retailers experiencing financial pressure in the context of the world economic crisis.

Nowadays a distressed assets strategy is considered as winning not only by X5 Retail Group. The most advantageous position is typical of those companies having financial resources. The companies undergoing difficulties with financing their current activities are ready to sell their projects with a significant discount. “This is a logical consequence of the liquidity crisis”, Dmitry Zolin, Managing Partner of London Consulting & Management Company | LCMC points out. – It’s already possible to find exclusive offers of commercial properties on the market which are listed for sale at a price one-half to two times lower than existed before the crisis. So it’s profitable to purchase such objects with a discount, as they will generate cash quickly, and in case of projects under construction one will need to wait for money back in 2–3 years”. Ilya Volodko, Director General of MACON Realty Group considers that speaking about finished projects the discount can be up to 25%, for projects under construction – up to 40%. “Purchase of assets that have become cheaper is a challenging strategy, – Ilya Volodko says. – For example it’s high time to expand your retail network on advantageous terms at competitors’ cost. At the same time one shouldn’t forget that any crisis, however long it might be, just cannot last forever. And after it ends and with the beginning of active growth the most leading positions would be occupied by those who used this time to grow their assets”. However there’s still no definite price for the said assets, and there are no deals that could be used as a starting point. Market participants interviewed by us consider a distressed assets strategy to be advantageous; however at the moment the companies announce only their wish to sell or purchase assets. Thus the Austrian Strabag has announced its commitment to purchase Russian construction companies. It was reported to the RIA News agency by the General Director of the Austrian Strabag Group Company’s Russian division – Strabag – Alexander Ortenberg. “We can make a purchase if the price is attractive for us and if the company has a stable order portfolio and a professional team”, – Mr. Ortenberg pointed out. Krasnoyarskbased network Alpi announced that it has signed a contract on selling 22 buildings of its hypermarkets to X5 Retail Group for $240 million and the deal would be closed in the nearest future. The O’Key retailer announced that under financial crisis conditions it was ready to buy regional chains provided the properties would meet the requirements concerning their format and location. The co-owner of the Vester Group Oleg Bolychev spoke about the sale of land plots. According to his statement seven land parcels with construction permits were listed for sale: one in each city in Omsk, Naberezhnye Chelny, Nevinnomyssk and two in each city in Stavropol and Kaliningrad. The total parcel area is 27.5 hectares and the company evaluates their cost at $50 million. The land was bought by the company for construction of shopping centers. It was planned to build a shopping center in Nevinnomyssk with the area of 30,000 sq m, and in Naberezhnye Chelny – a retail center of 45,000 sq m. The proceeds received from land sales, according to Oleg Bolychev will be used for the retail network’s working capital, as well as to repay some bank loans. “Only last month we repaid a total of $20 million of bank credits, and about $20 million we are bound to pay by the end of the year. Now the problem is that it’s difficult to obtain credits even for already opened credit lines”, – Oleg Bolychev says. That’s why Vester had to take out current assets to repay credits. “These projects are long-term and expensive, that’s why we decided to put their realization on hold”, – Oleg Bolychev explains. According to the latest information of the Vester company all of the deals are at the stage of consideration.

Experts say that the deals will start only in a half-year. “In the nearest time we don’t expect any serious (over $100 million) deals related to property purchases since during the crisis the cost of money increases and one has much less to spend. Big deals will be postponed until the beginning of next year”, – Anthony Selman, Investment Department Director of Blackwood makes his forecast. “The vast majority of investment funds are reconsidering their plans concerning Russia for the next year. When the deals start it will be hardly possible that sellers and buyers would disclose their details and make public any figures, unless the buyer is a public company liable to disclose this kind of information”, – according to Maxim Gasiev, Chief Operating Officer at Colliers International. No doubt that the closed nature implied in such processes suggests that some buyers and sellers have already brought their wishes to life. “I think there are some “first swallows” but they are hidden from our sight”, - Vadim Ulchenko, Country Manager of Eurohypo AG in Russia believes. – For certain such deals are now taking place. But they are not public. Even the information on a transaction price that has been made public can’t be a starting point to determine price-lists. No one will orient himself or try to correspond to it. After all the market should be capitalized and stabilized for this purpose. To talk about a common trend, a series of acquisitions should take place. Then we will be able to come to any conclusions”.

Sale as a means to survive

Asset sale is one of the first means for survival in a liquidity crisis and for the recovery of business processes. “The majority of development companies are facing the liquidity crisis and it’s natural that they need to have sources to cover the expenditure side in the course of their business activities, – Alexander Olkhovsky, VicePresident of Vneshtorgbank points out, – “If they have revenues from commissioned objects which generate cash-flow, there will be sources for this. It’s a question whether they are sufficient and whether they cover investments and the company’s costs that can’t be reduced. Companies that don’t have such properties have only one way out – to sell assets including land plots. Alternative forms of attracting capital are almost unavailable for the majority of developers. Credit finance is too short-term and is rather expensive, the bond loans market has almost collapsed, and attracting partners as shareholders is rather problematic. That’s why it’s natural that many developers consider realization of their assets as the only possibility to restore their liquidity on the current market”.

Stock is one of the options of possible sales. “Considering this sale in the context of the banking crisis, – Dmitry Zolin specifies, – everything is simple. Companies need money to invest in future construction, and banks have almost stopped financing new projects or issue credits at very high interest rates: if before the credit crunch a developer could attract funds at 8%, now banks charge 25%. Thus “not to sink” the companies have to look for new ways to solve this problem. One of them is sales of successful projects which have already been realized. The stock sales are both a way to “exit the business” and a means to attract investments. That’s why each situation should be considered individually. Each company should decide on its asset structure. “Now the cost of publicly traded companies’ stocks is falling down as a result of a general stock market collapse, – Vladimir Pinaev, Managing Director, Corporate Clients and Owners Services of Jones Lang LaSalle, Russia and CIS points out. – The cost of these stocks contains a significant percentage based on the assumption of future potential development and prosperity and not a crisis. Such assets are of no investment interest at all.”

Attractiveness criteria

“Nowadays we can see that everybody who still has money seeks to buy distressed assets, – Vadim Ulchenko says. – As a rule they are shopping centers and offices, constructed with short-term loans, and they have no means for refinancing; or almost ready projects that can’t be finished because the planned budget was exceeded or banks don’t want to continue financing for some reasons. The developers seek to sell such properties cheap or look for somebody to get a stake in the project”. The assets most in demand among development projects, according to Maxim Gasiev, are unfinished buildings. “Land plots are in less demand and finished buildings the least in demand since their owners want to sell them as real estate that is profitable with a definite capitalization rate, and the capitalization rate is а rather volatile multiple at the moment, – Mr. Gasiev explains. – Investment funds should act as buyers of finished properties, and they are waiting for changes in sales terms. Moreover they have no loans. And developers, if an unfinished project requires additional financing, have good chances to enter projects and get a significant share in it having added the missing amount, let’s say 30% of the projects cost”.

According to Vadim Ulchenko, regional developers who have available capital buy sites with a view to the future. And at much lower prices than before the crisis, - Mr. Ulchenko underlines. The same concerns Moscow and Saint Petersburg. The highest priority belongs to the projects that can be frozen with a perspective to commence construction in two-three years from now provided availability of long-term rent or ownership of land. For sure everybody is looking for quality projects and properties. In case of offices and elite residences – they must be in the city center. If retail property – the main preferences are given to a good concept and an ideal location. The cost of public companies’ stock decreased many times. It can be suggested that someone is buying them hoping for future growth. As for the stocks of non-public companies I should say that in general it doesn’t matter who will buy their stock or assets”. Mr. Olkhovsky considers that more time should pass for the current uncertainty to decrease so that it would be possible to discuss what assets are more or less liquid. “In my opinion everything will depend on overcoming the crisis scenario”. In case market participants “dig for fire” with an excess volume of financial resources , then land property with a good location can be deemed as an asset insuring its owner against inflation. The same arguments are logical for finished properties of high-class office and retail projects. Quality properties become obsolete more slowly, and it could be one of the most decisive factors in investment decision-making process”.

Distressed assets buyers

Distressed assets buyers are generally funds, private investors, individuals, and big retailers. Vadim Ulchenko hopes to see professional players of real estate market that haven’t lost their money due to proper business planning, long-term financing and correct management of their projects as the most likely buyers. “Most likely the crisis funds will act as buyers and the idea of their creation is very popular at the moment”, Mr. Ulchenko believes. They are specifically aimed at the purchase of distressed assets for the purpose of generating a high rate of return. But this idea is hardly conceivable for me. It’s unlikely that those who could save their money would trust such funds. Everyone seeks to control the process and to overcome the crisis fully on their own. Presently it is easier for Russian companies to make decisions in a timely manner under crisis conditions than for international funds”.

Dmitry Zolin considers that small private funds with enough money as well as big industrial and natural resources groups will act as investors. “And surely as the Russian state is a major investor as it has already provided government support to Russia’s largest banks – Mr. Zolin suggests. – The City Governments of Moscow and Saint Petersburg are also developing programs of financial support for residential developers as part of their budgets”. Vadim Ulchenko speaks about the fact that commercial property was not, is not and will never be a priority sector of the economy: “Presently all money is directed towards the energy utilities, Oil & Gas, metallurgy, transport, engineering. Not only Moscow but also all other cities in Russia will have to solve their problems with housing. With regard to any commercial projects it’s hardly possible that the state will participate in them”. Mr. Olkhovsky considers that residential projects are attractive to investors at their final development stages. In his opinion such state support of the construction market seems the most optimal. “If the state enters projects they won’t be purely commercial but social ones as well, as they will target improvement in cities’ infrastructure. Since it’s not the first concern of the state to make money out of developers’ problems but to do good for people”, – Maxim Gasiev suggests. Ivan Zavadsky, analyst of Kapital e-newspaper doesn’t agree with him. “At the moment the state makes use of the difficult situation the developers experience and organizes some kind of an auction to sell the real estate at lower prices. I think that first the state will select the best assets and then it will consider the distressed ones”, – Mr. Zavadsky concludes.