No Time to Argue

At the current stage, this segment of the market is intensively developing not in only in Moscow and St. Petersburg but also in other major cities across Russia, especially those with over a million in population. In the upcoming years, these cities are expecting a large number of new major retail centers to enter the market.
The analysts at Cushman & Wakefield Stiles & Riabokobylko have cited several factors that have made modern shopping so popular in Moscow, which, to some extent, are also applicable to the country as a whole. Overall, the increase in income, the growth of the labor market and the low rate of unemployment have instilled confidence in the future generations of working Russians, thereby stimulating consumerism.
In comparison with Western European countries, maintenance and utilities fees in Russia are considerably lower, which means more disposable income for shopping. In addition, the high prices of residential real estate, particularly in the capital, deter many Russians from saving their money to buy a home or apartment. Rather, many consumers prefer to rent in the private sector, and thus the rent money remains in the consumer market. Furthermore, a significant part of the cash turnover on the consumer market is attributed to the flourishing shadow economy, which includes salaries “in envelopes” and incomes derived from corruption. The consumer market is further spurred by bad memories of the bank and financial crisis that occurred in Russia in the previous decade. As a result, Russians have become wary of savings accounts, and many do not save their incomes but rather spend it immediately on goods and services.
In addition, after all the social and economic changes in the country, city-dwellers more or less lack strong traditional pastimes, and shopping centers have now become a major pastime and place of leisure for many Russians. Families have become accustomed to weekly visits to shopping centers, complete with cinemas and food-courts. As such, the changing psychology of the consumer and the general growth of the national economy further stimulate the retail boom.
The strongest stimulant for the market has proved to be consumer lending, the total of which is doubling every year and reached $43 billion in 2006.

Satiation but not saturation
In light of the growth in the number of retail centers across the whole country, the concern over market saturation has risen. However, despite active construction, the majority of specialists are certain that the retail real estate market is far from the point of saturation. “It is still too early to discuss market saturation in the regions or even in Moscow,” states Zhanna Bullock, president of RIGroup. “There are still relatively few professional retail properties that correspond to international standards. Global retail operators, both Russian and foreign, are just beginning to enter the Russian market, which still possesses a lot of unrealized potential. Acknowledging this fact, many Western investors have come to Russia and are ready to invest money.” Experts at ECE add that incomes continue to rise, which thus will fuel more growth. “Although Moscow has seen much more rapid development than any other major European city, there is still room for expanded development with regard to international retailers, the balance in the tenant mix and design. Increasing competition will set new benchmarks.”
The rate of construction and introduction of modern retail center in Moscow accelerated in 2006. According to the data of the company DTZ, in the past year, the total area of new offers exceeded 700 thousand sqm (including 360 thousand sqm available for rent). According to Colliers International, 11 new complexes opened in 2006, with a total area of 866,000 sqm, 378,000 sqm of which is retail area. As such, according to estimates by the company’s analysts, the increase in the volume of retail area in 2006 represents 30% of the total amount of quality retail premises. Colliers International further notes, “In the past several years, new premises have not been evenly introduced throughout the duration of the year but rather at the end of the year. This is because developers want to introduce new retail centers during the New Year’s holidays, when sales are at a peak.”
Jones Lang LaSalle estimates that for every 1,000 Muscovites there are currently 149 sqm of retail space in the Moscow area, which is significantly lower than for European capitals.
The opposite situation occurred this past year in St. Petersburg. According to the data of IB Group, based on the GLA, per every 1,000 inhabitants of St. Petersburg there is now around 220 sqm of retail space, which is an absolute record in Russia. According to Yuri Borisov, managing partner at IB Group, “The task of filling these complexes with tenants by opening day has been more difficult here, as is the case with the June complex, which had less than 50% occupancy. For this reason, it is necessary to ascertain the level of absorption of retail space.”
Considering that the level of vacant space in retail centers in St. Petersburg will top 5% for the first time, the city has been eagerly awaiting the arrival of two more giant complexes: Piter-Raduga (with a total area of around 100,000 sqm) in south of the city and Severnovo Mola (with a total area of more than 70 thousand sqm) in the north. According to Mr. Borisov, “The solution to the problem is the globalization and diversification of the market, which includes economic growth, the specialization of retail centers, multi-functional shopping centers, and the promotion of retail centers to consumers.”

Half empty, half full?
On the Russian retail real estate market, there exist two opposing points of view concerning the market’s attractiveness for potential investors. On the one hand, the majority of specialists are certain that the segment of retail centers is currently the most attractive for investment. “On the current real estate market in Russia, the retail sector is the most attract for investors,” confirms Ms. Bullock. This opinion is upheld by the company Torgovy Kvartal: “If you analyze the situation on the market today, it is possible to observe that the interest of investors in Russia’s retail real estate is growing every month. For example, a year ago, investors were still reluctant to invest in retail premises in the regions, as they had a rate of capitalization lower than 14%. However, today, with the conclusion of several transactions, the current yield is 11-12%. The investors are beginning to understand the dynamics of the market and are working together to advance it,” comments Dmitry Zotov, general director of Torgovy Kvartal.
On the other hand, the company Magazine Magazinov offers an opposing viewpoint: “As a whole, retail real estate premises are less attractive for investment in comparison with other segments of the commercial real estate, such as offices and warehouses. This is on account of the numerous risks associated with the retail market, including insufficient disposable income of the population in Russia’s regions; rates of construction of retail centers exceeding the expansion of retail operators; as well as problems with bureaucracy and corruption,” notes Ilya Kuznetsov, senior analyst at Magazine Magazinov. He continues, “But at the same time, the high yield of successful retail centers is very attractive for investors. For this reason, despite high risks, investors are ready to offer large investments in the sphere of retail real estate.”
Ross Group also contends that the high yield of retail premises is one of the most attractive factors for foreign investors. “At present, the average yield of a retail center is so high that foreign investors, particularly those with access to considerable financial resources, will be hunting for quality retail center in Russia for many years to come,” states Mark Afraimovich, the managing partner at the holding Ross Group. “Today in Russia, the selling cost of a retail center, as a rule, is determined by subtracting operational costs from the annual rent income of the retail center. The result is usually multiplied by 8 years – and voila! We arrive at the selling price of the object. At current rent rates, the profit turns out to be high enough for investors to feel confident about investing in the purchase of a retail center.”

Searching for quality
Specialists unanimously agree that there are already enough foreign-investment funds that are looking for suitable properties to invest in on the Russian retail real estate market. However, most foreign investors suffer from the same problem – a lack of quality offers. This can be attributed to a variety of factors. In the first place, it was only recently that that a professional market for quality retail real estate corresponding to European standards began to form. Therefore, there are still very few projects that can truly be considered high quality. “In general, there is little to attest to the professional level of developers in Russia at the moment. Even those that can considered to be chains make mistakes that are uncharacteristic of a mature real estate market,” notes Yuri Borisov. “Furthermore, many projects are realized by developers who are not part of chains. Here is where the root of the market’s problem lies, especially when it comes to a lack of quality customer service and technical supervision. Unfortunately, not all mistakes in such projects can be corrected, even by turning to outside help. If there are too many fundamental weaknesses in the initial design of a new project, then it is very difficult to eliminate or correct problems later on.”
Secondly, with the realization of a sales transaction in Russia, the buyer may face a number of problems that were revealed during the due diligence process. If the problems are not major, then the buyer and seller can comprise and solve them. However, if this is not possible, then the transaction can be called-off. The due diligence is also a major problem for the buyer on account of the great amount of time and money needed to complete the process. “However, the situation is taking a turn for the better everyday. The market has become more attractive, transparent and civilized, and more importantly, a greater number of professional developers are entering the game,” states Zhanna Bullock.
The experts we spoke with listed the following two projects as the most significant transactions by foreign investment funds in Moscow: Austrian financial group Meinl European Land commissioned two Mall Gallery retail centers from ST Development; and Austrian fund ImmoEast bought two Golden Babylon retail centers from Wakelin Promotion.
Moreover, investors wishing to get involved in in shopping centers no longer limited themselves to the markets in the two capitals but rather are investigating projects in the major regional cities. “I would say that one of the main trends of the commercial real estate market in Russia today is the revolution in Western companies and funds’ perception of Russia. For them, Russia had expanded her borders; now, investors can look not just to Moscow and St. Petersburg but also to other major cities in the regions of our country,” states Dmitry Zotov of Torgovy Kvartal. He continues, “The total foreign capital invested in regional projects in the last year increased many times over. As such, one must note that due to the decreased rate of capitalization used for estimation, the price of sold objects grew by 20-30% this year. We can attest to these changes based on our own experiences.”
At ESE experts also see great potential for regional development: “The demand for in the regions is particularly high. Cities that are now creating transparent structure and are open for international developers will continue to develop in the future.”
Specialists are confident that these trends will continue to develop and that in the upcoming year, we will witness an intense competition between Western investment funds over quality regional projects.