Market Know-How: In the Labyrinth of Shopping Malls

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Russian people no longer subscribe to the Soviet-era mantra: “Let us suffer, but our children will live better”. Instead, people want to live and enjoy life here and now, says Aleksandr Borisov, board member of the Russian Chamber of Commerce and Industry, and the general director of the Moscow International Business Association and an aide to the mayor of Moscow. Borisov has drafted a report on the state of the domestic consumer market and posted it on the official site of the Chamber of Commerce and Industry.

In Borisov’s opinion, consumer psychology and its transitions are the driving force in predetermining the development of the retail sector, and, in particular, of commercial real estate. The consumers’ way of thinking and their incomes are the foundation bricks upon which wise developers base their projects when constructing retail centers.

Russians’ incomes grew 10 per cent in the first six months of 2004 as compared to the same period of 2003, according to ABN-Realty. This means their purchasing capacity has increased, which is the direct consequence of favorable macroeconomic conditions, in particular, of high world oil prices. For two years running Russia’s GDP growth rate has been 7 per cent, according to Colliers International.

The current situation has given rise to the rapid development of retail space in Russia’s capital and its economically successful regions.

“The volumes of retail center construction are growing,” says Maksim Gasiyev, director of the retail real estate department at Colliers International. “By the end of 2004 their total space in Moscow will reach 2.5 million square meters.” (Ganeyev is speaking here not of all the retail centers of the city but only those with a thought-out concept, meeting international standards – both newly built detached facilities and reconstructed properties. – Vedomosti.)

According to the real estate consulting company Magazin Magazinov, there are 50 high-quality shopping malls in Moscow. Their total space – excluding retail-office centers and showrooms – amounts to 1.7 million square meters, while retail areas proper occupy 750,000sqm, or 72 square meters for every 1,000 Muscovites residents. In Europe that parameter equals 365sqm per 1,000 residents on average, according to Knight Frank realty. The total volume of investment in the construction of new retail centers will reach some $650,000 in 2004, says Knight Frank.

The Market Just as It Is

Although the supply of retail areas in Moscow grows each year, the demand for high-quality properties, especially those conveniently located, remains as high as ever and considerably exceeds the supply, according to experts from Magazin Magazinov, Colliers International, Knight Frank, Noble Gibbons / CB Richard Ellis.

Roman Cheptsov, the head of the owners department at ABN-Realty, says that on the list of major European cities Moscow ranks among the lowest in terms of retail space per capita. The share of vacant properties in Moscow retail centers is 2 to 5 per cent, while, as international experience shows, the market is saturated when that figure reaches 10 per cent.

The reasons why the sector remains unsaturated and demand unsatisfied are clear. The main reason is that our market is still relatively young. Another factor that impedes growth is the lack of professional skills among the developers of retail centers, says Anna Shiryayeva of Magazin Magazinov. Moreover, this shows on all the levels –from preparing town-planning concepts to managing facilities.

Another negative factor is that many facilities are commissioned much later than initially planned. Real estate consultants report that the supply of retail areas increases by 300,000 to 500,000sqm each year. However, in the first six months of 2004 only 120,000sqm of properties in retail, retail-entertainment and office-retail centers were leased out, according to ABN-Realty.

Knight Frank has reported that some 100,000 square meters of retail space were commissioned over the same period, with development of another 110,000 square meters being completed in the third quarter of this year. But it remains unclear whether all the new facilities under construction and which developers said would be completed before 2005, will be commissioned by the end of the year. Judging by the number of facilities already commissioned and those that are supposed to be commissioned in December, by the end of the year the total volume of properties built this year could reach 300,000sqm, but not 500,000sqm, according to Knight Frank experts.

A landmark event on the retail real estate market of Moscow in the second half of 2004 was the commissioning of the Waymart-2 retail center at the 71st kilometer of the Moscow Ring Road (MKAD). With the completion of that development the city market grew by another 55,000sqm.

Waymart-2’s tenants are M.Video, Starik Khotabych, Sportmaster, Cinema City and others. By the end of this year the retail centers Gimenei, Tobtim, Mega-2, Yekaterinovka, L-153 and Sun Paradise are to be commissioned. Mega-2, developed by IKEA, will be the largest at 120,000sqm of retail space, according to Magazin Magazinov and Stiles & Riabokobylko.

Swiss Realty Group has named the supermarket chain operator Sedmoi Kontinent the company of the year. In 2004 Sedmoi Kontinent took over the Petrovsky chain of supermarkets and sold its premises in the Atrium mall for $22 million at a price of $5,000 per square meter.

However, market players still learn about many deals and planned projects only afterwards, says Anna Shiryayeva. Experts describe the capital city retail sector ‘obscure’, which is one of the reasons why foreigners are reluctant to invest in it. By ‘obscurity’ analysts mean certain flaws in the work both of city officials and companies involved in the business.

Retail is an industry that is controlled much less by the government, says Aleksandr Borisov. On the one hand, this is good for certain retail operators; on the other hand there are considerable disadvantages. “As the retail sector has been developing chaotically, virtually uncontrolled by anyone, what we see as a result is that western formats do not suit us, while domestic formats only very loosely meet international standards,” says Oleg Voitsekhovsky, managing director of the Russian Board of Retail Centers.

Big ‘Children’ – Big Problems

Investors and developers of ‘professional’ retail centers face a variety of problems, such as the shortage of land plots, highly-skilled staff, a lack of an established system of retail property management, and the time-consuming processes of coordinating development projects with city authorities, etc.

The biggest obstacle, judging by reports from developers, is perhaps the legal and administrative barriers both on the municipal and on the federal levels.

For instance, an investor never knows how much it will cost him to buy a rented land plot before the Moscow government issues a decree on the subject. Moreover, quite often the city officials actively interfere in the preparation of development plans, while their proposals – included in numerous government decrees – are not always commercially viable, holds Yulia Nikulicheva, deputy director at Jones Lang LaSalle.

In the opinion of Oleg Voitsekhovsky, the federal authorities also have very little control over the situation, and lack a clear understanding of the market. Addressing a conference on investments in retail real estate held on 28-29 October in Moscow, Aleksei Panfilov, president of Garant-Invest Financial and Industrial Corporation, urged developers, investors and consultants “to work closer with the authorities” and “to earn a good reputation in the eyes of any government agencies”, because, in his opinion, getting government bodies on side is one of the more favorable factors of the retail sector development.

The companies should work towards improving those ties not only for the sake of their own interests but also for the authorities to develop a better understanding of “what is going on in the retail real estate market” and what the difference between “a medley of kiosks and a shopping mall” is. “One of the factors impeding the development of retail real estate is us,” said Panfilov. “Given the lack of transparency in our projects and lack of instruments… we should work out such a model of relations with the authorities where they will hear us and we will not let them down.”

Foreign Investors Bide Their Time

Difficult relations between the market and the authorities, vague decrees issued by the Moscow government and the nerve-racking process of securing approval from the authorities, which may include up to 200 stages – these are the so-called “government-related risks”, which ward off foreign investors, says Maksim Gasiyev

Philip Bertere, deputy head of retail real estate at Jones Lang LaSalle, says that although on the whole the economic situation is favorable the number of international operators involved in the sector is very low when compared with other European countries.

Most foreign companies active on the Moscow retail market are either tenants (Lacoste, Zara, CAN and others) or retail chain operators, such as IKEA, OBI, Auchan, Marktkauf, Metro Cash & Carry. Chain operators, for the most part, develop and finance their Moscow projects themselves.

Incidentally, they belong to that minority that develops high-quality retail centers, says Anna Shiryayeva. In other words, foreign developers in Moscow can be counted on the fingers of one hand. Major overseas operators are not afraid to enter the Russian market, because even if their Russian divisions are hit by some crisis it will barely affect their budget, adds Shiryayeva. Other foreigners are still waiting.

Foreign companies have taken a wait-and-see approach, according to Philip Bertere, like in the case of world-famous retail chain Wal-Mart. Such operators begin by opening their representative offices in the capital to examine the local climate for several years. Whether they will ever develop their projects in the city, and when, nobody knows.

Andrei Petrov, a partner with Knight Frank, says that judging by his experience of communication with foreign investment funds, they have serious misgivings about Russia. Russia has no transparent investment climate; in particular, there is no clear-cut cadastral system of dealing in real estate. That is why even if foreign investors ever do venture to finance development projects in Russia they will look for reliable local partners, which will give rise to new forms of cooperation between foreign and domestic investors.

In 2004 Russia’s rating among the world’s most favored destinations for foreign direct investments, dropped from 8th to 11th position, says Knight Frank citing a yearly report on the Foreign Direct Investment Confidence Index. In Borisov’s opinion, an inflow of foreign investors is crucial because it could improve the situation in the sector, boost competition and speed up mergers.

Dearth of Foreign Departments Stores

The Moscow retail sector clearly has a blank area in the niche for foreign department stores. In Bertere’s opinion, it will take a long time before U.S. department stores arrive in Russia, while European chains like Karstadt, which has been forced to curtail its operations, have problems at home. The Moscow market is not yet ready for the advent of the foreign department store, as there are no projects of the appropriate format here, says Aleksei Mogila, development director at Leeds Property Group. Operating a department store is a “labour-intensive and conservative” business, says Mogila. Bertere believes that foreign department stores could increase their presence in Russia through franchise deals, following the examples of Mango and Zara.

Searching for Financial Instruments

The retail sector is experiencing serious problems borrowing money, says Maksim Gasiyev. In recent years Sberbank, Russia’s leading savings bank, Vneshtorgbank and Garant Invest Bank have been playing the leading role on the Moscow market.

At the conference on investment in retail real estate Vneshtorgbank’s vice-president Dmitry Khodko sought to convince developers that investing in real estate is a risky business, and his bank does have funds for crediting projects for the development of retail centers, but first of all developers must convince the bank of the project’s viability.

Khodko suggested that developers “learn to find a common language with investors”. Deputy director of the department for financing construction projects at Sberbank Yelena Klisho says that the main principles her bank is guided by when examining the prospects of financing a construction project are its economic effectiveness and feasibility. Sberbank is ready to finance individual investment projects as well as large-scale investment programs including construction of several facilities.

“For instance, investors are more willing to put up money in the residential real estate market,” says Panfilov, “as it is better developed, advertised and more understandable. The residential sector operates a great variety of financial instruments, which the retail sector lacks.”

According to Gasiyev, most retail real estate development projects are financed with private investments and bank loans. So-called export crediting is also a possibility, adds Gasiyev. That form of lending is widely practiced on the equipment and industry markets. An export loan is extended by a foreign bank to a bank of a country-importer, or to the importing party itself for the importer to purchase certain goods or equipment from an exporter.

All economically developed countries have established governmental export credit insurance agencies (ECA) that insure creditors against political and commercial risks that arise in the importing countries. “I have not heard of any such projects in the Moscow retail real estate sector,” says Gasiyev. “But our clients in Ufa intend to have a project financed through an ECA in Hungary. Foreign construction companies will play a big role in securing such financing.”

In Panfilov’s opinion, in the future closed mutual investment funds will play a key role in the financing of commercial real estate development projects. One of their advantages is tax deferrals. “We will soon come to understand that existing retail centers and those under construction should be registered as closed mutual investment funds, not as open joint-stock companies or limited liability companies,” says Panfilov.

But not all the management companies agree with that view. “The cases of retail real estate being registered in the form of an investment fund are few,” says Natalia Prokopyeva, development director at Region Development. “So far only two management companies have done that, and, unfortunately, not those in Moscow. The VAT issue also remains unsettled. A real estate fund, being the owner of a property, cannot pay VAT, as it is neither a legal nor a natural entity. But the tenants want to offset VAT.

“Another restriction is that real estate funds need to enter into long-term lease agreements, that is, for the full term of the fund’s operations – by law funds can be set up for a period of one to 15 years. Most of the funds operating on the market today have been established for five years – for only then will the fund be able to guarantee its members stability and a return. But this is not practiced on our market today. Nevertheless, we believe that financing real estate projects through a closed real estate fund has good prospects.”

Forecasts

The further development of the domestic sector of retail real estate is not likely to be subject to any shocks or upheavals, says Oleg Voitsekhovsky. Analysts believe the initial division of the market will be completed by 2009 whereupon Russian and foreign market players will begin sharing their zones of influence. Part of the market will be controlled by western chains. New retail formats will be implemented. Perhaps, by the year 2008 Russian consumers will see more ‘high-quality’ shopping malls built by foreign developers.

As regards the Moscow market proper, real estate consultancy firms – Swiss Realty Group, Colliers Int., Knight Frank – forecast that new shopping malls will be built outside the city center, in commuter areas and outside Moscow. Major shopping complexes will continue to appear near MKAD. The Leroy Merlin and IKEA Abramtsevo projects are currently under construction at 1, Ostashkovskoye Shosse and at the 130th km of the MKAD respectively. Moscow’s old Soviet-built retail outlets will be reconstructed (Gimenei, Voyentorg). According to Knight Frank, most of Moscow’s retail properties are concentrated in the central, western and northern administrative okrugs (disricts), while there is a shortage in eastern and southern districts.