Money-Growing: Unexpected Arrivals

Some market players complain that in Moscow securing building plots without connections in the city government is impossible. However, in some regions the situation is not much better. The cities considered to be the most attractive for investors tend to be the most unfriendly.

Over the past few years the retail sector has been booming in cities with populations of over 1 million and in some cities with over 500,000 inhabitants where the average monthly per capita income amounts to 4,000 to 8,000 rubles.

The best prospects for retail development and construction of shopping malls can be found in the cities of Kazan, Nizhny Novgorod, Yekaterinburg, Volgograd, Rostov-on-Don, St. Petersburg, Ufa, and Samara, according to assessments by the Moscow-based Noble Gibbons/CB Richard Ellis and the Nizhny Novgorod Center for Scientific Examination. The most favorable regions are the Moscow Region, Tyumen Region, Samara, Sverdlovsk, Chelyabinsk, Perm, and the republics of Tatarstan, Bashkortostan and Komi.

Development of the regional commercial real estate and retail market began several years after Moscow saw the arrival of its first modern retail centers. The capital reached its revenue peak in the early 2000s; today it is being registered in the provinces where the development of shopping malls can bring profits of up to 50%. Many Moscow-based investors, developers and retail chain operators are heading for the regions.

“Growth opportunities will soon be exhausted in Moscow,” says Oleg Voitsekhovsky, managing director of the Russian Council of Shopping Centers. “To expand their operations and also to safeguard themselves against attempts by foreign rivals to oust them from the capital city market, companies are breaking into the regional markets.” However, the potential of the regions is grossly overrated, he says.

The Price of Profit

By combining their efforts developers and retail operators could build a variety of modern shopping centers across Russia with an interesting concept, offering a range of essential goods and services. However, quite often economically developed regions already have construction companies, investors and product companies of their own and are reluctant to allow Moscow-based players – be it Mosmart or the international retail chain Metro – enter their markets.

Magazin Magazinov, the Moscow-based realty consulting firm, has released a rating of the least friendly Russian cities where newcomers are also facing considerable pressure from the local administrations. The list includes Nizhny Novgorod, Yekaterinburg, Kazan, Krasnodar, Samara and Vladivostok. Those risks are the price companies arriving in the provinces have to pay for the high returns on their projects.

Authorities in the regions are not rushing to roll out the red carpet for the out-of-town guests even though in public they express a great deal of interest in their projects. The official position of regional bureaucrats, announced at the recent Mall-2005 show held at the Moscow Exhibition Center in Krasnaya Presnya, is that they seek to attract investors and expertise from the outside and create equal conditions for all players – on a competitive basis.

Natural selection will determine who will stay in the regions and who will leave. But in private conversations, Nizhny Novgorod officials admit that the city has run out of vacant building plots with the exception of those with problems.

Yekaterinburg-based market players believe their city’s chains of fast food restaurants and retail centers and the entire real estate sector to be quite developed and competitive. Sergei Nikolaichenkov, head of real estate management at the Yekaterinburg company Obshchestvo Malysheva–73 – the city’s largest commercial real estate developer – says that local players do not want to have to deal with rivals. The situation is similar in many other cities with populations over 1 million.

Nizhny Novgorod’s Prospects

“If a company arriving from the outside agrees to contribute to the development of the municipal infrastructure, it will most likely reach an understanding with the government bodies,” said an official in Nizhny Novgorod. Commercial real estate developers here have to comply with a compulsory condition called “investment contribution”.

That contribution varies depending on the site and the type of project and may range from developing a public garden to resettling residents and pulling down dilapidated housing, from 300,000 to 1 million rubles or more.

For the time being only two external retail operators have launched outlets in Nizhny Novgorod – Ramstor and EuroSPAR. The Paterson chain also had plans to take root in Nizhny but retreated at the 11th hour, unhappy with the rental rates set by a local landlord. Monthly rentals in Nizhny can range from $30 to $70 per square meter. Unlike their Moscow counterparts local players do not usually come to agreements on rates.

Remarkably, the world-famous retailer IKEA gave up a site within the city limits, where it initially planned to build a large store, and moved to the country – the Nizhny Novgorod Region – alleging that the plot in the city had been swampy. At the same time, IKEA’s principle, which it never tires of reiterating, is the choice of low-cost plots and low construction costs because its outlets, too, are designed to cater for medium-income buyers.

Nizhny Novgorod’s economic results are quite good. In 2004 the city retail sector reported sales of 11.3 billion rubles, which is 29.6% higher compared to 2003. The food industry accounts for 27% of the total production volume. Nizhny has five food store chains of its own, including Sladkaya Zhizn headed by Vadim Agafonov, who held the posts of the city’s deputy mayor and director of the Economy Department for several years.

Large non-foods manufacturers include the Karina furniture maker headed by Dmitry Birman who is at the same time a deputy of the city Duma [legislature] and chairman of the regional union of entrepreneurs.

Nevertheless, the regions do need external investments, says Tatiana Romancheva, consultant at the Nizhny Novgorod Center for Scientific Examination. Nizhny has 2,690 shops of various retail formats, of which only 15 are large shopping centers. Only two of those – the recently built Shokolad and Etazhi – match Moscow’s standards.

Both present positive examples of the expansion by Moscow firms. The Shokolad project was run by a unit of the Moscow-based group Torgovy Kvartal, jointly with the Nizhny Novgorod construction firm Rekonstruktsia.

Last year that mall was named one of the country’s best shopping centers. Incidentally, Ramstor rented properties in Shokolad. The Etazhi shopping center, developed by local company Stolitsa Nizhny, was partially financed by Moscow investors. The Gipermarket construction company – a partner of Mosmart – plans to begin its expansion into the regions with Nizhny where it has already secured a building plot.

Cold in the Urals

Yekaterinburg is a prospering industrial region. The nationwide enterprises Kalina, SladKO, and Uralmash are based here. The Yekaterinburg authorities have rejected the terms laid down by McDonald’s and the famous fast food chain has still not opened a single outlet here. Moscow-based retail operators also experience difficulties in the city.

According to Sergei Nikolaichenkov of Obshchestvo Malysheva–73, Yekaterinburg has two large companies owning food store chains – Kirovskaya and Kupets. The quality of service they offer is quite high and the range of goods is broad. “Our Mac Pik’s hamburgers are not worse than those at McDonald’s,” Nikolaichenkov says. Deputy head of the Yekaterinburg administration Viktor Konteyev agrees: “Over the past four or five years we have sought to develop local chains. Our leaders are Kupets, and also some 25 other chains. Today we can assess their development with confidence.”

Yekaterinburg’s shopping centers, according to local media reports, “are fruitful and plentiful”. Rental rates in the central shopping malls of the city run up to $960 per square meter per year. Sales turnover reached 82.2 billion rubles in 2003.

A briefing on the development of modern retail centers organized in the city – such events are held regularly in Yekaterinburg these days – announced that the city has 29 shopping centers. Viktor Konteyev then set out the tasks for the future. In 2005 the city administration plans to commission 120 retail and public catering outlets and the number of shopping centers in Yekaterinburg is to reach 60.

Plots for the construction of large shopping centers are available on the outskirts of the city. In line with the designs of top city officials, the projects will offer a variety of services to attract more customers. In particular, the shopping malls must be surrounded by parks.

Nonetheless, Yekaterinburg’s market players insist that the city suffers from a shortage of high-quality retail properties built in compliance with international standards. Sergei Nikolaichenkov shares that view.

According to Obshchestvo Malysheva– 73, Yekaterinburg has 400 square meters of retail space per 1,000 people (of those only 250 square meters are within shopping malls). By comparison, Moscow, with a population of 10 million, has 2,000sqm of retail properties per 1,000 residents, of which only 72sqm are properties within shopping malls.

As for the conditions for developers arriving from other regions, Viktor Konteyev said that “in terms of securing a plot there are no obstacles for any company – whether based in another city or foreign. The conditions are equal for all businessmen.” However, the only outside developer that has managed to break into the local market so far is the Samara-based Vremya.

The Yekaterinburg firms at the Mall-2005 conference arrived for the most part in search of tenants for their shopping centers. But the booklets they distributed contained information about plots of land awaiting external investors and developers.

To Let

The owners of newly built shopping centers from Kazakhstan, Volgograd, Cheboksary, Novosibirsk and Astrakhan arrived at Mall-2005 in search of tenants. Some of them welcomed any kind of tenant, while others expressed an interest in famous brands, and still others were after large retail chains or hypermarkets, such as Ramstor. But, it appears, there are many places where food store chains are unwilling to go.

Anatoly Platonov, manager of an Ulyanovsk shopping center developed by DARS, admits that “attracting tenants even to a relatively small shopping center of only 6,000 square meters is not an easy task”. Incomes are low in Ulyanovsk while retail chains focusing mainly on cities with over 1 million inhabitants.

On the other hand, Novosibirsk, with a population of 1.5 million, is still waiting for the advent of large retail operators. Sergei Smolkin, a manager at Novosibirsk-based development company Trud, believes that the situation will change soon. Although the city has a developed chain of discounters it still lacks high-quality middle class food stores.

In the near future new retail properties are set to appear in Novosibirsk. The city still does not have a single food court within its shopping malls. None of the local restaurant owners are willing to adopt such a format, says Smolkin. Moscow-based restaurant owners have shown an interest in opening new restaurants in the city but not food courts.

The Road Ahead

Moscow-based developers are the least frequent visitors to the provinces, though they do agree that the markets outside the capital are attractive. Managing projects without leaving Moscow is difficult. Besides, Muscovites have to reckon with the local developers whose positions are strong.

“If we look at the figures I am not sure that developers from the capital will prove conspicuous in their presence in the regions, against the general background,” says Oleg Voitsekhovsky, of the Russian Council of Shopping Centers. “The Samara-based Vremya group and Park Hauz from Volgograd have built giant entertainment centers in Samara and Volgograd; their next stops are Yekaterinburg and Tolyatti. Those developers move across the regions without visiting Moscow. The same is true for the Kit group from Yekaterinburg. It has enormous investment funds and is involved in construction in numerous cities.”

Regional markets are more likely to receive investments from the capital and from abroad rather than development resources. Nina Novikova, head of research at Noble Gibbons, notes that lately companies involved in other sectors of the economy, such as banks and industrial holdings, have begun to invest in regional retail.

The so-called full-cycle companies acting as investors, developers and retailers in one person, such as the foreign chain Metro or Russian firm Mosmart, have been more or less successful in their regional expansion. Oleg Voitsekhovsky believes that most successful of all are home appliances stores and clothes shops of popular brand names. For instance, the Moscow chains Eldorado, M.Video, Tekhnosila, Mir and Sportmaster were the first to launch their outlets in Yekaterinburg.

The supply of land plots in major cities is not unlimited. The second stage of regional expansion will most likely focus on the cities with populations of around 500,000, says Nina Novikova. They are, primarily, the cities of West Siberia. Voitsekhovsky believes the cities and towns of southern Russian such as Krasnodar and Rostov are ripe for development.

“Both local and Moscow-based developers have serious plans with regards to those cities,” he says, “and I think a lot of retail properties will be built there.” The Moscow-based company RAMO has built the 31,000-sqm Red Square shopping center in Krasnodar. Construction of the second, 70,000-sqm phase of the project has begun. Red Square is RAMO’s first construction project. Earlier the company actively sold various goods in Krasnodar and is familiar with the city.

Other companies likely to conquer smaller Russian towns are those who have failed to secure sites in Moscow and other cities with populations over 1 million. But satisfying regional demand is only in the power of those who possess flexibility in business. That quality has already been shown by management companies who have set up various inter-regional projects on mutually beneficial conditions.