Market Know-How: Non-residential Land in the Country

Development of office properties outside the city is more of an exception than a rule, say Knight Frank experts. “For a property to find a market among potential tenants there must be a site that -- in terms of its overall characteristics -- will suit a certain composition of tenants. An 18,000-sqm top class business center in the town of Khimki on Leningradskoye Motorway has long been offering space for sale and rent. Although the center has managed to attract prominent tenants like Volvo, the vacancy rate is still high,” Novikov says.

Large deals are still rare in that sector but the market is growing, spurred on by unsatisfied demand for warehouse facilities. Lawyers believe that recent changes to the legislation governing the sale of land in the Russian Federation are likely to contribute to that process, though it is not likely to happen before the government introduces effective mechanisms for implementing new rules.

According to Knight Frank’s assessment, demand for commercial land accounts for some 50% of the overall demand for land in the Moscow Region (while the remaining 50% is the demand for land plots for private housing construction). Demand for plots for developing industrial and warehouse facilities amounts to some 80% of the overall demand for commercial construction sites. At the same time, the market is experiencing a dire shortage of industrial land.

Defect of Status

Aleksei Novikov, leading industrial and warehouse properties expert at Knight Frank, notes that finding an appropriate plot of land in Moscow and the Moscow Region is especially difficult, as quite often the plots offered for sale are registered as arable land.

Plots considered most attractive by developers of industrial facilities, with convenient approach roads and utility lines in place, are often situated either within the city limits, for example, in central Moscow, or outside the city, but then those are, for the most part, arable lands.

The secondary market of large plots offers mostly land of former collective and state-owned farms.

Development of commercial real estate properties is possible on sites that enjoy the status of industrial and urban land. The demand for such plots is particularly high, while the supply is extremely low, says Yelena Novomlinskaya, head of the Land for Business department at Miel-Nedvizhimost realty.

“Still, the demand for arable lands, despite numerous encumbrances, is quite high but it is generated not on the open market, therefore, it is practically impossible to evaluate it,” notes Aleksei Novikov. “That demand is generated by major ‘resources-oriented’ companies interested in the acquisition of large plots of land to diversify their investments.”

Plots of arable land may have convenient locations, with all the necessary utility lines available, and yet commercial real estate developers are warded off by difficulties such as the high costs and time-consuming procedure of changing the legal status of such plots.

At times, investors fail to overcome these problems. For example, the U.S. concern Cargill was forced to give up its project for the development of a plant in Voronezh Region simply because it failed to have the federally-owned arable land reregistered as industrial land. Cargill had planned to invest up to $90 million in the project.

But then, dealing with industrial land is not easy, either. Industrial land owners have pushed up the prices so high that many developers lose interest in acquiring such plots, says Aleksei Novikov. Furthermore, industrial land is often full of ‘surprises’ for the buyer. In particular, owners of most of the industrial estates available for sale fail to duly re-register their right of unlimited use of the land.

The alienation of such sites forces companies to resort to gray schemes which also have a negative impact on the development of the land market. Additionally, developers may have to deal with the ‘fruit’ of their predecessors’ activities, such as polluted territory, and different kinds of burdens and social institutions dependent on the acquired enterprise.

Land Reclassification Procedure

On January 5, 2005, the federal law on changing land category (No.172-FZ, December 21, 2004) came into effect. The importance of that act cannot be overestimated even though the law only sets a legal framework while more detailed regulations have yet to be established, says Aleksandr Orlov, a lawyer with the company Legas.

“In essence, before that law came into force there were no rules governing the change of the land category except for one article of the Land Code. Self-government bodies used the situation to their advantage, rendering reclassification virtually impossible. That forced entrepreneurs to make use of large administrative resources in order to somehow tackle the problem,” he says.

The new law establishes a clear-cut procedure of reclassification of land and lays out grounds for refusals. In particular, it explains where an application must be submitted, what documents have to be enclosed with the application, within what period of time the application has to be reviewed, etc.

In other words, says Vitaly Mozharovsky, partner with Pepeliaev, Goltsblat & Partners, even though it has not brought about a revolution in land relations it has played a significant role in introducing order therein. At least now it is clear that reclassification of land lies within the jurisdiction of the regional authorities.

However, the new law renders invalid the procedures developed earlier and complicates the transfer of arable lands into the category for industrial use, at the same time facilitating reclassification of arable lands as urban land and land for private housing construction. Such changes hardly seem logical, holds Mozharovsky. After all, it is possible to expand an existing settlement (urban area) or to build a new one – there are mechanisms to do that – and then to use a part of the urban land for development of industrial facilities.

“An indisputable advantage of the new law is that you now know what to do, and if you are right,” says Orlov. “But the disadvantage is that you still do not know who to ask for ‘assistance’ if changing the category is vital.” Experts are undecided on how long it might take before new mechanisms of land reclassification are introduced. For the time being, all transfer operations in the Moscow Region have been suspended.

In line with the new law the procedure for transferring land from one category to another is as follows: an interested person – not necessarily a land owner though the owner’s approval is necessary – files an application to a government body, indicating the cadastral number of the plot of land, the category it belongs to, the category to which the plot is to be transferred, substantiation of the transfer and the title documents.

The applicant has to enclose an extract from the land cadastre; copies of the applicant’s ID papers; an extract from the state register of titles (EGRP); an opinion from the state commission of environmental experts if expert examination is required by federal law; consent from the title holder; calculation of the losses for an agricultural enterprise and/or a forestry agency. An application has to be reviewed within eight weeks whereupon the authorities either issue an act of transfer or reject the application.

An application for transfer can be rejected if the transfer is subject to restrictions or banned by the Land Code, the draft law on the transfer of land, or by other legal acts adopted by authorized agencies; if the state expert commission does not endorse the transfer; or if the transfer to another category is at odds with territorial planning and zoning requirements.

The application cannot be rejected on the grounds of an improper substantiation of transfer, Legas’ lawyers emphasize. In other words, an entrepreneur can substantiate his wish to change the category of the plot citing solely the expediency of such a reclassification.

But if plans prove to be at odds with zoning requirements the applicant is likely to face serious problems, as such documents indicate the uses for the land in question. Thus, land in the area may be zoned for residential construction, agriculture, or other purposes and the authorities’ plans do not always coincide with investors’ wishes.

Environmental examination is compulsory, according to Legas’ lawyers, as it is aimed at determining the possible consequences of reclassifying a plot, such as a negative impact on the environment. However, no examination is required if the decision on the transfer of the plot into another category is taken on the basis of the above-mentioned regulations on territorial planning and land survey, which have already undergone state environmental examinations.

Most problems arise namely during the examination. For example, if a plot is tillable its reclassification usually brings about a negative impact on the environment. Transferring arable land into another category is only allowed in seven cases and the list of those conditions is exhaustive.

“The main thing is to prove that the plot is not fit for agricultural production,” experts at Pepeliaev, Goltsblat & Partners say.

The key argument in favor of – or against – the transfer is the cadastre value of the plot. It must not exceed the average cadastre value in the area by more than 30%. Especially valuable arable land is not subject to transfers either. In the Moscow Regions that is land with a cadastre value exceeding the average cadastre value in a certain district by 10%.

Non-residential Zones

The most popular areas for development of logistics parks outside the capital are in the north-west – along Leningradskoye Shosse [motorway] – and in the west (the Novorizhskoye and Minskoye motorways) of the Moscow Region, according to Knight Frank analysts. Those motorways account for most cargoes imported into Russian from EU-states. Demand is also high for land in the south and south-east of the region, along the Kashirskoye, Simferopolskoye and Ryazanskoye motorways, used for transporting freight to other Russian regions.

“Given their residents’ high purchasing power, Moscow and St. Petersburg remain the key markets for manufacturers in the Central Region of Russia,” says Aleksei Novikov. “The most convenient location for developing industrial properties in the Moscow Region is the sector between Novorizhskoye and Dmitrovskoye motorways, 50 kilometers from the Moscow Ring Road, where construction of warehouse facilities is also possible. However, the northern part of the region -- considering the concentration of logistics parks in the area, the proximity to Sheremetievo airport and the direct link to St. Petersburg – is the costliest option. Namely the abundance of positive factors in the southern part of the Moscow Region prompted major FMCG firms to launch their production facilities there.”

The southern part of the Moscow Region, holds Novikov, has a very good investment climate for major producers, due to the support of local officials for entrepreneurs – an important factor, Knight Frank experts say. Many Western firms, including Mars, Danone, Campina and Knauf, have already launched their production facilities in the area.

According to Knight Frank’s evaluation, up to 95% of the overall demand for industrial properties in the Moscow Region is demand for plots situated within 45 kilometers of the Moscow Region. However, for production companies the remoteness of a property from the capital is not a hindrance. They tend to attach more importance to access for transport, manpower costs, proximity to a satellite town and the price of the plot.

Industrial estates are growing rapidly in the districts of Stupino, Ramenskoye, and Kashira, more than 100 kilometers from the Moscow Ring Road. For example, a Mars plant is situated in Stupino, 105 kilometers from Moscow. Yegorievsky District is also actively attracting investment for industrial facilities.

New construction is on the rise in the south-east and north-east of the region, according to Knight Frank. Yelena Borisova, leading country-house development expert at Komstrin, says that the eastward-bound motorways – Shchelkovskoye and Gorkovskoye – linking the capital with traditional industrial districts of the region are extremely inconvenient, as they are narrow and regularly jammed with traffic.

Nonetheless, there are many land plots available for commercial use both along the Gorkovksoye motorway, not far from the Moscow Ring Road, and on Shchelkovskoye, but closer to the town of Shchelkovo, she says. Yelena Borisova complains that despite the apparent abundance of offers, the choice of plots fit for commercial development in the area is restricted in terms of location, size, price and category. Many market analysts point to a discrepancy between supply and demand on the market for commercial land.

A square meter of a warehouse property would cost an investor approximately $500, land price included, according to Vesco Realty’s assessment. A square meter of a warehouse property in Kryokshino, 24km west of Moscow between the Kievskoye and Minskoye motorways, is evaluated by the experts at $500-$700. There the National Logistics Company is set to develop what will be the largest warehousing complex in the region, with a total space of 300,000sqm, by the year 2007.

When selecting a plot buyers proceed from the properties of a future construction, say Swiss Realty Group experts. The buyer has to examine the geological characteristics of the site, establish its real market value, find out whether construction is technically possible on the site, whether deforestation and the laying of communication lines and building driveways is possible, or if there are any encumbrances on the plot. The legality of earlier transactions involving the plot, the reputation and ability of the seller to pay and other factors also have to be checked.

According to Swiss Realty’s evaluation, development of a heated warehouse of 10,000sqm requires a 2-hectare site with communication lines in place, or where it is possible to lay communications so as to ensure access to power lines (9 to 12 megawatt on average), a water supply, sewage and gas. Sometimes, a rail link is also necessary. Buyers are also interested in sites situated close to Moscow and with a link to a motorway that is not excessively busy.

If Not Warehouses, Then What…?

Office properties outside the capital also attract large companies interested in minimizing costs by moving part of the personnel from the city where office space is far more expensive. “Businesses will gradually move to the Moscow Region where rental rates and public utility payments are much lower. Within 3-5 years we expect the rapid development of office centers, as well as production facilities and warehouses in the Moscow Region not further than 5km from the Moscow Ring Road,” says Andrei Ufimtsev, deputy general director of the real estate agency Novoye Kachestvo.

The best locations for companies’ back offices, in Novikov’s opinion, are in the west and north-west of the Moscow Region, but it is still too early to speak of a withdrawal of office properties from the city as a noticeable trend. So far, the only example cited by Knight Frank is the gigantic office complex of Gazprom on Kaluzhskoye Motorway. Hotels and motels are also rare, says Yelena Borisova.

The Price of Land

The price is the key issue that determines the choice of a plot. The price of a hectare of land in Moscow is $1-1.5 million, excl. VAT, according to Knight Frank. Plots situated in the immediate proximity to the Moscow Ring Road (MKAD) are offered at $0.5-1 million, or $10,000 and over for a hundredth of a hectare, according to Vesco Realty’s evaluation. Plots situated 5-10 kilometers from MKAD cost $300,000 to $500,000; 10-30 km from MKAD cost $200,000 to $300,000. In Novikov’s opinion, the price of properties for industrial use should not exceed $500,000 per hectare.

Prices vary greatly across the region depending on the distance of a plot from Moscow and its business potential. Thus, in 2004 prices for arable lands bordering federal highways and situated within 15 kilometers of the Moscow Ring Road, which can be used for constructing warehouse facilities, retail properties or facilities catering for tourists, ran up to $2,500-3,000 per hundredth of a hectare, Miel reported.

According to the company’s report, arable lands situated farther from MKAD (30-50km) with inconvenient access roads and busy motorways can be offered for sale at $200-500 per hundredth of a hectare. Following its transfer to the category of urban or industrial land, the same piece of land can be sold at $3,500-5,000 per hundredth of a hectare.

Availability of utility lines increases the price of a plot by about 50%. The average cost of purchasing a hundredth of a hectare of industrial land for developing warehouse facilities, with engineering systems in place and a rail link ranges from $1,000-1,800 depending on the distance from Moscow, transport access, the quality of communication lines, and other characteristics, according to Swiss Realty Group. Yelena Borisova sets the cost of a hundredth of a hectare of land within 30 kilometers of the city at $2,500-9,000.

Ilya Shershnev, development director of Swiss Realty Group, says that it is difficult to speak about real sums for transactions because prices vary greatly – by several hundred percent – depending on the buyer’s ability (or inability) to provide all the necessary paperwork. But the total sum of such deals run into millions of dollars. The commercial land market simply does not know low prices.

How to Buy

Lawyers at Pepeliaev, Goltsblat & Partners believe that the Moscow Region differs from the capital because local authorities apply federal laws more accurately, the Land Code in particular, and the number of private landowners is higher there.

In Moscow where authorities lay stress on the city’s “special status” land relations are so peculiar that only a handful of federally owned plots have been privatized over the past years while most sites are leased out for 3-5 years, not for 49 years as is the case in the Moscow Region. On the whole, the verdict both of lawyers and investors is that working in the region is easier than in Moscow.

What is most important is that the Moscow Region offers land plots for sale. In mid-October 2003 the region even held its first – but so far the only – land auction. Three plots in the Klin District -- approximately 100km from the MKAD -- were put up for sale by the Moscow Region’s Property Fund. Two of them were sold.

Plots of 41.8 and 29.8 hectares of land for the development of production or retail and warehousing facilities near Leningradskoye Motorway were sold for 9.4 million rubles – too cheaply, other market participants said later commenting on the results of the auction.

A plot of 21.7 hectares of residential land near the Zavidovo reserve failed to find a buyer. The regional authorities promised to put up more plots of industrial land in Chekhov and Stupino districts as soon as all the related paperwork was ready.

Land auctions could become a more attractive and transparent means of acquiring plots and make things easier for investors, experts are convinced. The regional authorities regularly hold tenders, but they are won by those who have ties in the government, according to market participants. Today, buyers of land plots purchase them from large landowners or buy enterprises with a title to the land, reaching an agreement with the government. Those are some of the possible ways of buying a plot, according to Swiss Realty.

Andrei Ufimtsev believes that the best option for the buyer is to work directly with the district administration, especially if his plans envisage the development of production facilities which means more jobs and tax revenues for the local budget.

Land plots on the secondary market are offered for sale, for the most part, by investment companies and banks who used to buy into collective and state farms in the past. According to Yelena Novomlinskaya, in the Moscow Region there are at least 20 landlords who own hundreds and thousands of hectares, offering plots with or without the assistance of realtors.

Shershnev believes that in the future the de facto price of a plot of land will depend on the policy of about a dozen or so large holdings trading in liquid land resources purchased earlier, with each entity holding at least 50,000 hectares. Within the next decade 3-5% of those plots will be sold, enough to sustain a price balance on the market.

Often investors opt to buy into an enterprise occupying a plot they are interested in. This enables them to evade the ban on the ownership of land by foreigners. Moreover, they do not have to re-register their rights to the land, etc. But such a method has its drawbacks, says Vitaly Mozharovsky, as buying shares means buying not only assets but liabilities as well. In the long run debts can exceed the cost of the acquired land.

Swiss Realty’s experts recommend paying special attention to the legal history of the transactions in the plot, including privatization and further re-sale, and to examine the possibility of construction on the plots.

Professional realties offering consultation services to investors for all the stages of acquisition of land plots are few and far between on the secondary market. But there are numerous brokers who are very active in that sector seeking to make money on the resale of land. According to Yelena Borisova, the price of a plot can grow by $1,000-2,000, as a result of intermediaries’ efforts.