Money-Growing: Small but Smart

The Bottom Line

The minimum sale price of a square meter of non-residential space in less prestigious commuter areas of the capital is $1,200 per square meter, according to reports by real estate agencies. In central Moscow and top-class residential estates the price may be as high as $10,000.

Average annual rental rates for non-residential properties on the first floors of residential buildings range from $300 to $600 per square meter for office use and from $450 to $1,500 per square meter for retail use. Moscow’s most attractive sites in the city center are leased out at $2,500 per square meter per year.

Thus, purchasing an 80-sqm property for $2,500 per square meter will cost $200,000. Renovation will require extra expenditure of some $500 per square meter, i.e. another $40,000. Letting the property at the rate of $600 per square meter will bring the landlord $48,000 annually and will pay back in five years. This is provided, of course, that rental rates do not drop and that a crisis doesn’t hit the sector. On the other hand, there is always the chance that rates will grow faster with time and the property will pay back sooner.

According to approximate calculations, non-residential first floor properties within residential estates account for 30-35% of the entire commercial real estate market, says Miel-Nedvizhimost realty.

Moreover, non-residential space in the city is expanding annually by 150,000 to 200,000 square meters as a result of programs carried out by the city government. By the year 2008 Moscow will have up to 3,000 food stores and household shops within residential areas – the so-called one-step-away shops.

Partially, the authorities are set to fulfill this plan by reclassifying first floor apartments as non-residential properties. “Earlier we saw titles to non-residential properties handed over to shared home ownerships (condominiums) who leased them out,” notes Olga Bogoroditskaya, real estate consultant at Kirsanova Realty. “These days, however, developers retain the title to those kinds of properties attracting tenants themselves.”

Location Is Everything

Purchasing highly profitable property requires profound knowledge of the criteria businesses are guided by in their search for tenants. First floor properties are of special interest to travel agencies, food stores, furniture stores, cafes, restaurants, wine boutiques, video rental outlets, beauty parlors, and sole proprietorships who cannot afford expensive office space in business centers.

Businesses located on the first floors of residential buildings fall into two categories. When choosing a location some companies look for a place that will help enhance their image while others attach most importance to the intensity of customer flow. The former group includes companies that focus on the status of the property, its location, the social composition of the residents, how developed the surroundings are, a parking area and the other amenities available in expensive residential estates.

“An example of such a tenant is the beauty studio Babor Cosmetics that rents a property on the first floor of the elite residential complex Vremena Goda in Staromonetny Pereulok [lane],” says Vladimir Kryuchkov, head of the commercial real estate department at Novoye Kachestvo.

The latter are, for the most part, companies running retail outlets interested in attracting large flows of potential customers passing by their offices or shops every day. Those firms attach great importance to transport accessibility, proximity to the metro, and the target environment.

“Our company assisted in arranging a tenancy agreement for a jewelry shop selling products from the Moscow Jewelry Plant in Stary Arbat. InvestSberbank and Globex banks have also taken up residence in busy areas,” Kryuchkov says. “Renaissance Insurance Company rented a property in Nikitsky Boulevard for its sales office.”

Boris Ignatov, general director of the Kutuzovsky Prospekt realty, says, “Our clients often seek our assistance in buying or renting first floor properties in various districts of Moscow. Demand for the city center, southwestern and western districts is especially high.”

Indeed, the best option for almost every company are non-residential properties on the first floors of buildings with direct access from the street – the so-called first line houses – in the city center. “All of them [such properties] are situated where customer flows meet and are noteworthy for high consumer demand on the part of various strata of the population, which makes such projects more profitable,” notes Yekaterina Tein, head of residential real estate at Knight Frank.

Commercial properties situated on the first floors in bustling areas are highly liquid. “Upon entering the market such properties are usually snapped up in no time, and in most cases without any preliminary advertising,” says Kryuchkov. “Many tenants and buyers – especially retail operators or banks, hunting for just this kind of property – decide on leases, or to purchase very quickly.” Non-residential properties of 50-160sqm leave the market almost immediately after going on sale or being put up for rent because the demand is so high.

Primary versus Secondary

First floor non-residential properties are available for sale both on the primary and secondary real estate markets. Each of those options has its advantages and disadvantages. The positive aspects of the secondary market include a developed infrastructure and environment. “Quite often a newly built house and neighboring houses can take quite a long time to fill up, which means that a firm based there will not work at full capacity as long as the situation does not change,” believes Maria Kryukova, chief spokesperson for Swiss Realty Group. “Another undeniable disadvantage is the continuous renovation work, which means noise, dirt etc., which often accompany the occupation of newly built blocks.”

Properties offered on the secondary market may only require minor repairs. However, notes Olga Ksovreli, head of the company Paritet, regardless of whether a property is bought on the secondary or on the primary market the costs of repair work is approximately the same.

Properties in old or renovated houses account for the bulk of the supply in the sector of first floor properties within residential buildings, according to Knight Frank. “Earlier a large share of such facilities were privately owned, used as a place of abode by certain individuals who had secured the title to those apartments way back in the Soviet era,” says Yekaterina Tein. “However, over the past several years practically all first floor areas in first-line apartment blocks in the city center have been sold or leased out.”

But then again the primary market, too, has its advantages. Sergei Makin, head of the commercial real estate department at the Domostroi realty outlines the reasons that make primary market offers quite attractive: “New buildings, as a rule, are occupied by well-off customers; the primary sale is always a legally clean deal; purchasing a property before construction is completed is far more profitable than buying it after the house is built.”

Besides, it is not easy to buy a property in a recently built house as most developments are sold before the end of construction. Knight Frank insists that retail chains quickly snap up the majority of offers on the primary market.

Developers of modern top class residential estates intentionally build no apartments on the first floors because buyers do not favor first floors, and, secondly, selling first floor properties for commercial use can be very profitable. One can find a large number of non-residential first floor properties for rent on Ostozhenka Street.

Although that district is densely inhabited with the well-off, it clearly lacks the sufficient commercial infrastructure. A palace style complex to be built within the so-called Golden Mile residential area is expected to at least partially remedy the shortage of such properties. Tein believes that in addition to offering a variety of services to local residents the complex will also have a positive impact on the general development of the area.

The potential buyers and the tenants of properties in Moscow’s most expensive residential estates are clothes boutiques, famous restaurateurs, beauty parlors, and design studios. Kirsanova Realty’s experts note that such properties are in great demand in the areas of Ostozhenka, Patriarshiye Ponds and Plyushchikha.

Yet, it should be noted that a truly club-type house where you can count the apartments on the fingers of one hand will not be considered a prime property if its first floor is occupied by a night club, a store or some other establishment open for wider public access.

Although properties in new residential estates are expensive – $2,000 per square meter, on average – it is possible to buy non-residential space at an affordable price, making an investment before construction is completed. Thus, the price of one square meter in the Grand-Park residential complex stood at $1,000 when the foundations were laid; upon completion the costs were as high as $2,800 and even $3,750. In comparison, non-residential properties – with a minimum space of 300-500sqm – in administrative buildings, with a centralized security system and a fenced-in territory cost $4,000 to $4,500 per square meter even at the stage when the foundation pit is being dug.

“Purchasing a property at the construction stage increases the risks,” says Aidar Galleyev, head of research and information in the commercial real estate and development department at Miel-Nedvizhimost realty. “On the other hand, they are completely new premises with open floor plans, and as such provide opportunities for organizing business operations.”

Commenting on the importance of the concept developed for the building, Yekaterina Tein says: “The concept of a residential estate provides for commercial properties from the beginning, and the composition of the future tenants is predetermined. At the next stage that property is offered to specific companies involved in the appropriate segment of the market.”

Rental rates depend directly on the technical characteristics of the property, as well as the location. “We once had a case where the difference between rental rates for the first floor property in a newly built shopping mall and a property on the first floor of quite an old house amounted to $100 per square meter. Both buildings were in the same street,” says Mikhail Gets, head of commercial real estate at Blackwood. “The property in the residential house was cheaper, but tenancy in the retail center offered more conveniences including parking space and professional management.”

Lost in Reclassification

Today, banks do not give loans for the purchase of non-residential premises. But sometimes their clients obtain mortgages to purchase an apartment, whereupon they reclassify the residential space as non-residential.

“In 2003 we bought a residential property on the first floor in the Central [Administrative] District of Moscow and five months later had it reclassified as non-residential,” Ksovreli recounts. “It would have been just like any other deal if it hadn’t been for the long-term mortgage loan we had raised. It was the first such deal ever to be effected in Moscow. The payments on the loan are considerably lower than rental rates, especially in the Central District.”

Reclassification of residential properties as non-residential is governed by federal and local laws. The entire procedure can take from three to twelve months. At first, the title holder has to gather the necessary paperwork and obtain permission, in particular, from the sanitary and epidemiological inspectorate and architectural authorities.

Then, documents have to be submitted to an inter-departmental commission of the district council (uprava). The district council then submits the dossier to the city commission with an application for the reclassification and a change to the property value conversion factor. If the city commission agrees, the landlord receives the title deeds to a non-residential property.

By law only first floor properties can be reclassified as non-residential; reclassification of dilapidated buildings subject to demolition or in need of capital repairs is prohibited. Moreover, the apartment must be vacant and accessible from the street, or the building of such an entrance must be technically possible.

Reclassification is a complicated procedure, and companies offering their services evaluate it at $150-600 per square meter depending on the technical characteristics and location of the building.

Reclassification of residential space as non-residential in prime residential estates does not pay, says Olga Bogoroditskaya. Another rule of thumb is that reclassification of properties in recently built houses works out to be more expensive. Reclassification of residential apartments as non-residential is possible through the mediation of a number of real estate agencies.

When purchasing a first floor non-residential property it is not always possible to buy or rent parking spaces for customers. Moreover, developers never used to include non-residential properties on the first floors in building projects, and few potential commercial tenants were happy with the standard layout of residential apartments.

These days, however, in order to be commissioned all newly built blocks in Moscow must feature first floor properties for commercial use. “The principle of comprehensive development, the basis on which modern residential estates are being erected, envisages a developed infrastructure in the area,” Galleyev notes. “That is why from the start new residential projects provide a wide choice of commercial properties.”

In line with the Russian Civil Code the title to non-residential properties as well as tenancy agreements are subject to state registration with the single state register of titles. The titles to real estate property are registered by the Moscow main directorate of the Federal Registrar Service. The procedure takes four weeks from the day an application is submitted. If the application is rejected the applicant has the right to take the matter to court.

Today it remains unclear whether leases of non-residential properties are subject to state registration. Leases for non-residential properties are governed by the law on state registration and Article 34 of the Civil Code. In line with the provision of Article 651 of the Civil Code, a tenancy agreement for non-residential properties signed for a term of not less than 12 months is subject to state registration.

“However, in practice, for a tenancy agreement to be considered valid the tax authorities and other government bodies insist on state registration even if the agreement is signed for less than a year,” notes Boris Ignatov. “Analysis of such cases shows that these demands on the part of the government bodies are not legally substantiated.”

Obtaining a mortgage for the purchase of a non-residential property is far more complicated than for the purchase of a residential apartment. In theory, mortgages for commercial properties are available to legal entities and individuals.

The latter can get a loan from a bank for a period of up to 10 years; legal entities up to three years. Interest rates are about 13-14% for individuals, and 16-19% for companies. But when compared to residential mortgages, a mortgage for non-residential properties is more expensive.