Money-Growing: Window to the Regions

Following the investors’ example are domestic and foreign chains – fast food restaurants, popular clothes and perfume brands, supermarkets and hypermarkets – who have also headed for the provinces. In 2005 the regional expansion of investors and famous brands is set to continue and grow in momentum.

Expanding Giants

Living standards are improving in Russia’s regional capitals and the demands of the local populations have become a lucrative source of income. Real estate properties are among the most expensive merchandise.

Top class retail and office buildings for sale or lease along with modern residential estates and European standard hotels are considered the most profitable investment projects. Moscow-based financial and industrial groups account for a considerable share of the investment in the regions. Earlier, those same companies invested funds in industrial enterprises, plants and other ‘strategic’ facilities just as enthusiastically.

Major businesses have not missed the opportunity of diversifying their investment portfolios by launching commercial real estate development projects across Russia for further sale or lease.

For example, in summer 2004 the Bazovy Element (Basic Element) management company announced investment plans to develop regional hotel chains. “We focus on the cities with a population of over 500,000,” Bazovy Element’s managing director David Geovanis said at the conference Mergers and Acquisitions in Russia.

Geovanis explained to Vedomsti that Bazovy Element is “interested in the hotel business and commercial real estate. We are considering the development of office buildings and shopping malls, and not only in Moscow.”

Bazovy Element controls Ruspromavto (carmakers GAZ, UralAZ and others), Kuban Airlines, and holds shares in the Krasnoyarsk hydroelectric power station and the Irkutskenergo energy company. The company also owns Russian Aluminium (Rusal), the leading Russian aluminium producer that has stakes in the Kranoyarsk, Bratsk, Novokuznetsk and Sayanogorsk smelters, and the Achinsky and Nikolayevsky aluminous plants.

Russian Aluminium joined a pool of Moscow investors taking part in the development of a ski resort in Sochi and a tourist/sport center at Krasnaya Polyana. The grandiose project worth $1.68 billion will not be completed before 2015. Then there will be the wait for the complex to be commissioned and start making a return on the investment.

Russian Aluminium will share the burden of investment and the joys of making profits with Interros, AFK Sistema, Vneshtorgbank, Gazprom, RAO UES of Russia and 40 other companies. 57 ski runs will be built, along with hotels, sports centers and gyms, restaurants, night clubs, shops, parking areas, a filling station, a supermarket and a helipad.

All in One

Moscow-based development companies, too, are taking root in the regions. Usually a Moscow developer arrives in the province in the company of its subsidiaries or partners. For example, developers often invite consulting companies to develop the concept of a project, and management companies to run properties after construction is completed.

Such practices are widespread in Moscow where the most successful projects are, as a rule, the result of joint efforts by several companies specializing in different areas, not of a single ‘omnivorous’ giant.

But then regional projects are remarkably universal as most of them combine top class retail and office space under the same roof. However, says Yulia Nikulicheva, head of market research at Jones Lang LaSalle, of all the types of commercial real estate it is retail properties that are in the highest demand throughout the provinces.

For example, Moscow-based Avgur Estate is currently building the Slavyansky retail and office center in Belgorod. The 8,000-sqm center, bearing the name of a top class residential estate situated nearby, will meet all the class A standards.

Avgur Estate points to the high quality of construction, convenient location and the system of managing the center. The latter will include an entire spectrum of services ranging from relations with tenants to maintenance of engineering systems in Slavyansky. The first two floors of the building will be occupied by retailers. The third floor will house a food-court and several shops. The fourth and fifth floors will offer class A offices for rent. The center is due to be commissioned in summer 2005. Avgur Estate has already invested $9 million in the project. To complete construction it has to spend another $9 million on the project.

Why Belgorod? Over the past few years that region has been one of the most attractive in Russia in terms of investment, says Sergei Kuzminov, head of commercial real estate at Avgur Estate. “The retail segment of Belgorod’s commercial real estate market has serious growth potential,” he says. “The existing demand for retail properties considerably exceeds supply both quantitatively and qualitatively. As a result, the potential profitability of Slavyansky is comparable to the profitability of analogous projects in the capital.”

Like Belgorod, many other cities in Russia are experiencing dire shortages of high quality retail, office and residential space as well as hotels. It is important that the incomes of local residents are sufficient to ensure the profitability of an investment project. Apparently, Novorossiysk and Nizhny Novgorod already meet that requirement, as investors from the capital are set to spend tens of millions of dollars there.

Development of the multifunctional Novocity complex is likely to become one of the most expensive projects in Novorossiysk, worth $100 million. Moscow-based GVA Sawyer is the developer, co-investor and designer of the 110,000-sqm complex that will occupy 5.5 hectares in the city center. The project was endorsed after an in-depth analysis of the economic activities of the city and its development prospects.

Novorossiysk won over the investors with its abundance of foreign and Russian firms that ensure the normal operation of one of Russia’s largest seaports and thus form the core of region’s business. Meanwhile, Novorossiysk’s infrastructure has grown obsolete with city hotels and offices failing to match modern standards. Novocity’s design is similar to that of Moskva-City International Business Center in the capital – a self-sufficient complex housing modern offices, entertainment facilities and residential space.

The Novocity project was created by GVA Sawyer’s specialists in 2004. In early 2005 construction began. All three phases are to be completed by late 2007. Novocity will include a shopping mall, class A offices, a top class residential area, an underground parking lot, a 4-star Novotel hotel, and a 3-star Ibis hotel. The complex will also house conference halls, a concert hall, and restaurants. The hotels within Novocity will be operated by the French hotel management company Accor. The plan also envisages the development of a nearby embankment and the construction of a yacht club.

Novocity is the first but by no means the only regional project by GVA Sawyer and its partners – Accor and the Kesko investment and industrial company. Their plans include the construction of 3- and 4-star hotels meeting European standards in eight cities across Russia. If they succeed in establishing good relations with the local authorities, new hotels will emerge in Rostov-on-Don, Chelyabinsk, Ufa, Yekaterinburg, St. Petersburg, Novosibirsk, Krasnodar and Kaliningrad over the next five years.

Mosmart plans to spend $35 million on the construction of a 14,000-sqm hypermarket in Nizhny Novgorod. Although the development company has not yet been named and no technical data has been released, Mosmart plans to commission the hypermarket by the end of this year. The company’s choice of Nizhny Novgorod as a venue for its new project is no coincidence, as it is Russia’s fourth largest city in terms of population.

The Nizhny Novgorod Region is one of Russia’s leading economic hubs, ranking 11th in terms of the share of regional production in Russian GDP, while the number of potential hypermarket customers in the area is higher than in any other region, as 25 percent of local residents are involved in small businesses.

“Compared to the average rate in the country, salaries in Nizhny Novgorod are quite high and they tend to grow each year,” says Natalya Orazova, a spokesperson for Mosmart. Civilized retail centers are highly popular with Nizhny Novgorod’s residents. Local and nationwide retail chains, such as Ramstor, Perekryostok, M.Video, and Eldorado, have outlets in the city while local companies are building new retail centers.

“The rapid development of retail in the regions is an obvious trend,” believes Natalya Orazova. “Russian and transnational chains are increasingly interested in the regions. The authorities should be open to dialogue and guarantee that investors are free from bureaucratic pressure and corruption.” Nizhny Novgorod is not the only city where Mosmart plans to open a hypermarket – it has already drawn up a list of cities it considers potentially interesting.

To begin with, those are cities with populations of over 1 million and large cities in central Russia. The second stage of the chain’s regional expansion includes large cities beyond the Urals. In addition to its outlets in Moscow and St. Petersburg, Mosmart plans to open hypermarkets in Volgograd, Kazan, Samara, Yaroslavl, Saratov, Rostov-on-Don, Voronezh, Tolyatti, Krasnodar, Izhevsk, Ufa, Perm, Tyumen, Chelyabinsk, and Yekaterinburg.

Hotels

Some of the companies developing commercial real estate across the country specialize in hotels. A hotel development project in the regions is valued at $10-20 million on average, says Marina Smirnova, deputy public relations director at the Hotel Consulting & Development Group. Among the regions with the best prospects for hotel development investors point to Sochi, Central Russian cities such as Voronezh and Lipetsk, the Urals (Yekaterinburg), and the Volga region (Nizhny Novgorod, Astrakhan, Samara, Kazan). Siberia, in particular Novosibirsk, is of less interest.

Developers usually opt to build chains of 10 to 100 hotels. An average hotel has 6,000 to 10,000 square meters of space and 100 to 150 rooms. The average room rate is from $80 to $175 per night. Payback on the $10-20 million investment in the construction of a hotel takes 8-12 years. Basic Element, Sputnik (Renaissance Capital), Menatep, Delta-Kapital, Alfa, Russkoye Zoloto, AFK Sistema (Intourist) and other companies have announced plans to invest in the construction of hotel chains.

Developers build hotels in the cities where the demand for such facilities is generated by corporate clients, as well as tourists. Restaurants, conference halls, and sports centers operating on hotel premises also attract local residents, thus ensuring additional revenues.

“The main problems arise from the shortage of spare cash (investors prefer to cover 50-70 percent of the costs by borrowing), a lack of experience in hotel management, and the specifics of hotel projects given the longer payback period as compared to office buildings and residential estates,” says Smirnova.

Companies specializing in hotel development are introducing formats that are new for the Russian market. For example, the UMACO group builds hotels with suites for sale. Such hotels are usually built in popular resort areas.

Russia borrowed the idea of selling country houses and apartments in resort areas from the West where such sales have been practiced over the past four decades. Such properties attract well-off patrons of resorts seeking to spend several weeks or months each year in the same place.

“People interested in a permanent place to stay on vacation and high quality hotel services are the type of people who are buyers and become members of the club,” says Roman Nakashidze, spokesman for UMACO. “An opportunity to lease a property to leading hotel operators and thus to receive guaranteed income is an important incentive when deciding in favor of acquisition.”

UMACO is building hotels with apartments for sale at the Krasnaya Polyana resort, in Sochi and Krasnodar. The company is involved in the development of the apartment-hotel complexes Katerina-Alpik and Katerina Residence in Sochi, planning to invest a total of 45 million euros in those projects. The 2-hectare Katerina-Alpik will include 11 buildings with 99 apartments of 50-265sqm.

Apartments will be equipped with individual floor heating and air conditioning systems, kitchen appliances from leading European manufacturers, telephone connections, satellite television and high-speed internet connection.

Apartment owners will be offered a gym, a SPA-salon, outdoor and indoor swimming pools for adults and children, bathhouses, a restaurant and a bar. Construction at Katerina-Alpik will be completed in summer 2005, whereupon UMACO will launch work on Katerina-Residence at Krasnaya Polyana. Unfinished apartments are being offered at 2,750 to 2,800 euros per square meter, but after the project is commissioned the price will rise to at least 3,000 euros per square meter.

In Sochi UMACO is also involved in the reconstruction of the Chaika hotel which is to be replaced by the state-of-the-art retail and office center Chaika Plaza. The construction work will begin this year, to be completed in 2006. In addition to offices and retail space Chaika Plaza will feature a block of apartments for long-term accommodation. Investment in the project will amount to 35 million euros with a payback period of not more than five years, according to UMACO’s evaluations. Chaika Plaza enjoys the status of a priority investment project by Krasnodar Region, which entitles the developer to state support on the regional level.

Problems

When entering the provinces Moscow investors can encounter a variety of problems the most serious of which is the same as in the capital – securing good construction sites. “The main principles of selecting a site are the same as in Moscow. Preference is given to sites situated within the city center, at intersections of pedestrian and transport flows, on the right-hand side of major motorways busy in the evening hours, and also sites with large residential complexes in the vicinity,” says Dmitry Vorobyov, deputy head of retail real estate at Colliers International.

But quite often it transpires that the territories considered most attractive in terms of investment are occupied with dilapidated housing. Demolition of such buildings and the re-housing of tenants significantly increase the prime cost of every square meter built on the cleared site.

The most obvious way of solving the problem is to seek the assistance of local authorities who are equally interested in the renovation and reconstruction. “Unfortunately, for a variety of reasons authorities are often unable to solve the problem of resettlement and investors have to shoulder that burden,” Sergei Kuzminov complains. “If tenants of dilapidated houses were at least partially provided with municipally-owned apartments, investors and developers would be more active in many regions.”

Some of the problems developers face arise from discrepancies in local legislation. Each region has its own mechanism for carrying out design work, and securing permission and approval from the authorities. Moreover, each area has its own specifics for establishing contact with local administration and licensing authorities. There is no universal recipe for handling such matters – ideas that may be welcome in one region may be given a hostile reception in another.

Nowadays authorities in many regions are trying to adjust the tender procedures that still lack one main aspect – clear-cut legislation. That is why ahead of each tender the authorities come up with new rules for bidding, more reminiscent of chaotic spontaneous acts than an effective market mechanism. Even the new Town-planning Code that came into effect on January 1, 2005, is not likely to alter the situation in the foreseeable future – at least, not before the necessary amendments are made to subordinate laws governing the same matters as the Town-planning Code.