Money-Growing: Retail Games

Most Profitable Sector

Some market participants called the commissioning of the Mega-2 shopping mall in Khimki the event of the 2004. Admittedly, it was only after IKEA’s – third – attempt to end the conflict with the Moscow Region government proved successful that the mall was opened. However, the project worth $300 million gave the capital 230,000 square meters of retail and entertainment facilities on its doorstep.

Altogether, 413,000 square meters of retail properties were commissioned in Moscow last year, according to a Knight Frank report. A total of $650 million was invested in its development.

In 2004 retail became the most profitable sector of the commercial real estate market in Moscow, says Vladimir Kryuchkov, head of the commercial real estate department at Novoye Kachestvo. Over the year the sale price of one square meter in retail properties grew 10-15% as compared to 2003, while rental rates grew by 5-10%. According to the A.T. Kearney Global Retail Development Index, for two years now Russia has topped the list of countries most attractive in terms of retail development.

In 2004 the commercial real estate market drew increasing attention from major investment companies, which is also a good sign for the retail sector. Troika Dialog, a major Russian asset management company that invests its clients’ funds in profitable and promising projects, expressed interest in retail real estate. Last year Troika Dialog bought a 40% stake in the Arbat Prestizh retail chain. “We have bought into Arbat Prestizh, considering their potential profitability to be high, and their management professional.”

2004 also saw retailers entering the securities market. Sedmoi Kontinent sold 15% of its share capital in the form of shares in an IPO conducted in November 2004. The offering was a success, with the chain raising over 80 million rubles. 77 companies, including 15 Russian firms, bought stakes in the chain. Sedmoi Kontinent was glad to see international institutional investors taking an interest in their IPO. Other retailers, too, welcomed the chain’s decision to enter the securities market.

“A public offering by a domestic retail chain shows that the market is mature, and the fact that the entire stake offered has been bought speaks for the growing interest in the retail market on the part of investors,” says Natalia Orazova, a spokesperson for Mosmart.

To undertake an IPO a company must show positive financial results, in other words to prove that it can do fine without borrowing. The issue and sale of shares is aimed at sustaining the rate of development necessary to withstand competition. Sedmoi Kontinent also used other means of raising funds to enhance its operations. Last year the chain sold its property in one of Moscow’s largest shopping malls – Atrium on Zemlyanoi Val Street. The deal was valued at $22 million for a 4,200-sqm property.

Sedmoi Kontinent’s example shows how raised funds can work towards the development of a retail chain. In 2004 Sedmoi Kontinent secured the titles for the Semyon Semyonych and Petrovsky chains – a total of 26 stores. The Petrovsky chain is moving out of the retail sector.

Foreigners in Retail

Western retail chains no longer consider it effective to start a business in Russia from scratch, opting for the acquisition of local chains instead.

One of the more obvious examples was the German concern Rewe Group’s recent purchase of 19 supermarkets from the Marta holding. Earlier those supermarkets operated under the U.S. brand Spar in a sub-franchising agreement. Now the 19 properties have been transformed into Billa supermarkets. Within the next five years Rewe Group plans to expand the chain to 80 stores, investing $500 million in the project.

Large international anchors continued their expansion in Russia in 2004. Of special interest is the arrival of Leroy Merlin, a large European do-it-yourself chain. The Dubrule family – owner of the Auchan retail chain – holds a controlling stake in Leroy Merlin.

Two Leroy Merlin stores were opened in 2004 near Auchan hypermarkets on Ostashkovskoye Shosse and in Strogino. “With Leroy Merlin opening its second store and Germany’s OBI rapidly developing its projects, we see that the DIY format has a future [in Russia]. This will provide wider opportunities for attracting anchors involved in different sectors to shopping and leisure centers,” Philip Bertere, deputy head of retail real estate at Jones Lang LaSalle, says.

Before Leroy Merlin’s arrival the OBI chain was the only international anchor tenant present in Moscow’s home-improvement retail sector.

In 2006 the British home-improvement giant Kingfisher will add to the list of DIY retailers present in Moscow. Over the next decade Kingfisher is set to open 60 Castorama hypermarkets in Russian cities with populations over 1 million. The company intends to spend $600 million implementing its plans. Kingfisher’s first hypermarket is to be completed in the first quarter of 2005. In the future the company plans to buy up 25% of Russia’s construction materials and home goods market which is estimated to be worth $5-6 billion.

Next year the foreign-owned Auchan and Ramstor retail chains will be faced with another foreign rival – Real; home appliance retailers will have to compete with Germany’s Metro, which plans to open Media Market stores selling home appliances and electronic goods in the capital.

America’s Wal-Mart corporation, which runs the world’s largest retail chain, is also pondering an entrance into the Russian market. In 2004 Wal-Mart commissioned a survey of the Russian market. If its results prove favorable, Wal-Mart will not hesitate in launching operations in this country.

Concept is Key

As competition grows stronger the requirements for retail centers are changing. More emphasis is being placed on the concept of shopping malls. A modern retail center is not merely a box with properties for rent; it must “conform to all the canons of the genre,” says Mikhail Gets, head of commercial real estate at Blackwood. They include proximity to major transportation arteries, convenient approach roads, and the quality and quantity of services.

Visitors must have a choice of shops and entertainment facilities such as movie theaters, pool halls, cafes and restaurants. The range of services and the quantity and composition of tenants represent the concept of a retail center. More and more often retailers entrust the development of a concept to leading consulting companies who determine the optimal way to fill retail areas.

It was namely the concept of Mega-2 – the retail hit of the year – that drew criticism. Marty Wilan, director of Astera, described some of the drawbacks in the concept of the mall. Mega’s anchor tenants – IKEA and Auchan – are situated in the side buildings of the mall while smaller tenants occupy the central building.

To get to the central building from IKEA customers have to walk a long way – hardly an inspiring prospect for someone already tired after strolling around IKEA. No one drives to large shopping centers for the sake of visiting a small shop alone – most buyers are heading for the hypermarket.

It transpires that a considerable share of small shops at Mega-2 risk never seeing the customers who visit IKEA and Auchan. In Europe and the United States anchor tenants – the same sort of hypermarkets – are situated deep inside the building of the mall. Thus, before the buyer enters the hypermarket he or she will pass dozens of smaller shops and boutiques. Of course, those smaller shops have a better chance of selling their merchandise.

The correct layout of a shopping mall also requires a large number of entrances. While the world’s largest shopping mall in Canada has as many as 59 entrances, Mega-2’s buildings have only one entrance each. The mall is also criticized for its inconvenient location, because there is only one approach route to Mega-2 – from Leningradskoye Shosse. One driveway is nowhere near enough for such a large compound. There is a real risk that many potential visitors will decide against shopping at Mega-2 simply because they are unwilling to spend a couple of hours in an infuriating traffic jam.

It should be noted, though, that IKEA’s internal layout matches western standards fully. Customer traffic is organized so that approximately the same number of visitors pass by the doors of each shop. The main principle is based on the retail outlets being situated along the perimeter.

The desire of customers to combine pleasure – shopping – with even more pleasure – entertainment – is making movie theaters within shopping malls increasingly popular. “As an entertainment option almost all developers seek to include a multi-screen theater in their project,” says Yulia Dalnova, head of the retail real estate department at Knight Frank. “Ironically, in some cases movie theaters are not the main attraction for potential customers.”

For example, a mall’s proximity to a metro station is enough to boost attendance, provided the tenants are selected correctly. In this case it is not necessary to build a movie theater on the premises: all that is needed is a small fast-food court. “However, domestic developers have been so absorbed with the ‘cinema fad’ that in 2004 this became a tendency,” concludes Dalnova.

As a manifestation of that tendency, in 2004 Yekaterinburg Art group (EA) unveiled its plans to open what is to become the country’s largest multiplex movie theater within the Waymart-2 retail center at the 71st kilometer of the Moscow Ring Road (MKAD). The 16-screen cinema will have a total of 2,500 seats, with each hall estimated to be worth $700,000 to $800,000. The management of Sedmoi Kontinent has also decided to build several retail and entertainment centers.

Developers would probably not be mulling plans to open new multiplexes in retail centers if similar projects had not already proved so successful. In 2004 the 9-screen, 1,200-seat Cinema-Park opened at the Kaluzhsky shopping mall. Also, in 2004, the construction of Titanic Cinema City with 16 screens and a total of 2,500 seats was completed. An 11-screen movie theater with a record number of seats – 3,100 – was also opened at the Mega-2 mall.

Moscow exercises an increasingly prudent approach to the development of retail centers. The professionalism of retailers is growing as shopping malls face tougher concept and maintenance requirements. In other countries many retail centers enter into agreements with management companies specializing in retail properties. As yet there are no such firms in Russia. However, according to one market participant, two professional retail management companies plan to open their offices in Russia this year.

The Further, the Better

Moscow’s retail real estate market is a symbiosis of state-of-the-art retail areas and open-air markets with portable stalls and mobile kiosks that can hardly be viewed as real estate properties.

The former variant represents a model of what is commonly referred to as civilized trade; the latter is considered a hangover of the 1990s. Retailers agree that even though open-air consumer goods and home-improvement markets still account for a considerable share of retail trade, their share will shrink gradually in favor of indoor malls and hypermarkets.

As regards the prospects of retail development in Moscow, it would be fair to say: “The further, the better.” In the following years shopping malls will spring up like mushrooms across the capital.

“Provided existing projects are commissioned in time, Moscow may have some 250 square meters of retail areas per 1,000 people in 2005, and from 430 to 450 square meters per 1,000 in 2006,” says Igor Kachalov, general director of the Kachalov and Colleagues consulting agency, specializing in real estate market research. By comparison: Paris has some 400-420sqm of retail space in large shopping malls per 1,000 people.

The deluxe class home goods mall Drim Haus (Dream House) will open in May 2005 on Rublyovo-Uspenskoye Shosse, and the retail and office center Neglinnaya Plaza. The development of an underground shopping mall beneath the square near the Belorussky train station will also begin this year. New retail centers will emerge in commuter areas that have a shortage of high-quality retail space. The problem is especially acute in the South and East administrative okrugs (districts) of Moscow, says Yulia Dalnova.

Foreign players will continue to expand their operations on the Russian retail real estate market over the next few years. Unfortunately, few of those have moved as far eastwards as Russia. However, successful projects by foreign chains who have already cast their anchors and commercial representatives in Russia, as well as the growing investment appeal of this country, will promote its popularity with international retailers.

Today the Moscow retail market lacks financing. Sometimes a developer may have a good concept for a shopping mall and a prestigious location for construction, but lacks a couple of million dollars to implement the project. It is unlikely that such a developer can count on an unknown investor having enough enthusiasm to invest in the project.

For the most part, developers involved in the construction of retail properties still use their personal contacts to raise money. But that practice is not really adequate on a civilized market. Recently, consulting companies have been assisting developers by finding investors. “Jones Lang LaSalle helps developers find sources of finance; this is done through a traditional scheme, with the use of traditional instruments,” says Philip Bertere. Should the practice help boost investment in the retail sector, the market will be given another powerful impetus on its road to development.

As new retail centers open in the city, competition in that sector of real estate will grow stronger throughout 2005. Mergers and acquisitions will probably continue. As regards the dynamics of rental rates, the opinions of market analysts differ. Yulia Dalnova believes that “as competition increases in some of the city districts we can expect a slight decrease in rental rates, by some 3%.”

Vladimir Kryuchkov, on the other hand, believes that “given the shortage of properties for rent, rental charges will grow. Next year they will fluctuate between $1,200-3,000 per square meter per year. But in exceptional cases properties in the most prestigious shopping malls may be leased at $4,000 to $5,000 per square meter per year.”