MONEY-GROWING: Foreigners Play It Safe

So far, there are just a handful of projects, most of which are in the early stages of implementation. Foreign investment firms are showing increasing interest in the acquisition of local companies active on the market, especially in the hotel sector.

“Foreigners exploring the commercial real estate market in St. Petersburg are scared off by the risks – too high, as they see it – and administrative hurdles that are even more significant than those in Moscow,” says Nikolai Vecher, president for real estate development at PSB-Invest Group.

“Such investors opt for retail projects where the payback period is quite short and it is easier to pull out. Besides, retail centers are usually built to suit concrete retail chain operators with anchor tenancies signed before the construction begins or at its early stages. Office and hotel projects are more complicated while returns are lower and foreign firms avoid joining them at the development stage. They are interested in seeing an understandable investment product or a strong and reliable local partner.”

“Domestic investors, of course, are more active in St. Petersburg than foreigners,” says Sebastian Fitzlion, chief executive at S. Zinoviev and Co. “Although, in terms of the rate of return the market is appealing for foreign firms they still have little knowledge of it. These days foreigners are more interested in Moscow and Eastern Europe, the more so as securing a building plot is extremely difficult in St. Petersburg.”

“I think that foreigners show little interest in investing in commercial real estate,” says Aleksei Chizhov, head of office real estate at Bekar Consulting. “They view it rather as an auxiliary function for running their core business. Office facilities are, for the most part, purchased for personal use, while retail centers, for the most part, are being developed by chains themselves.

“Moreover, foreign investors are afraid of working with local partners due to poorly developed legislation and local trade usages. They seek to cooperate with western developers and management companies. That is why we only see a handful of investment projects today.”

Pioneering Business

In the wake of the 1998 financial crisis foreigners shunned St. Petersburg’s office real estate market for a good few years. Some players even withdrew from completed projects. In the years 2002 and 2003 the Swedish firm JGB Consulting sold two small Class B offices in the city center with tenancies in place, on Serpukhovskaya and Divenskaya Streets.

In 2002, Skanska put Class B offices and residential properties on Kazanskaya Ulitsa [street] and on 8th Sovetskaya up for sale. New owners took over both properties in 2003.

Interestingly, three of those four buildings, originally developed as business centers, were redesigned by the new owners for their own use. The building on 8th Sovetskaya now houses the offices of a Gazprom subsidiary while the Zolotaya Kazanskaya facility now belongs to the industrial and construction group LSR, one of the largest in northwestern Russia.

The first and, so far, the only office center built after the 1998 crisis by a foreign investor is Renaissance House. It was commissioned in June 2004, at number 17 2nd Sovetskaya Street, only a block away from Nevsky Prospekt.

The project was implemented by the Turkish firm Renaissance Construction. Earlier the same company acted solely as a contractor for the development of residential, commercial and industrial facilities across the city. Curiously, it initially entered the Renaissance House project in that status as well. But at a certain stage the rights were ceded and the Turkish contractor became the investor.

The business center was built from scratch on a small site of 1,850 square meters in the densely built up historic area. The center features two 6-storied buildings with a total space of 8,150 square meters including 5,200 square meters of rentable space. The building facade facing the street is in the classic style while the second building to the rear is quite modern. The offices have open floor plans; the facility is equipped with engineering communication lines, an underground parking lot and is positioned as Class B+. Payback on the $5 million investment is expected in 3 to 4 years.

In the spring of 2005 the occupancy rate at Renaissance House stood at 95% with annual rental rates of $400 per square meter. Anchor tenants included Bank Societe Generale Vostok (1,100 sq.m.), Russian firm Terminal (1,000 sq.m.) and others.

Renaissance Construction is part of the Turkish investment group DESNA. In the spring of 2004 DESNA bought the real estate properties of the former perfumery Severnoye Siyanie at 69-71, Ulitsa Marata [street] from Unilever-CIS at a price that was never disclosed.

The property had been offered for $5 million plus VAT. The new owner took over a 14,000-square-meter office compound and a 8,000-square-meter plot of land beneath it. DESNA plans to build a commercial center worth $20 million on the site. Its parameters are yet to be determined. What is known is that the future complex will feature a Class B+ business center. The construction is to be completed in three years.

The Austria Business Center project at 4, Orenburgskaya Street, launched way back in 1992 was reanimated last year. In the early 1990s the company ABTs won the title to the former Karl Marx hospital through an investment tender held by the Property Fund. Afterwards, the new owner also secured a freehold to the 8,400-square-meter plot of land.

But for various reasons construction work was put on hold. Eventually, the Austrian firm completed the dismantling of a dilapidated hospital by August 1998, and then put the project on hold again having already spent some $1.5 million on it. Finally, in 2003 Austria’s industrial engineering producer, GAW Group, sold the project to an Austrian developer, Tilman Kraus Property Group. Austria’s AMR Baugesellschaft m.b.H. was awarded the general contract at a tender.

Construction work on the site situated near Vyborgskaya Naberezhnya [embankment] began last winter. The first phase of the facility – the 5-storied 6,500-square-meter building with a restored historical fa?ade – is to be commissioned in January 2006. The project is estimated to be worth 6 million euros. Offices in the future Class A business center will be offered at an annual rate of 400 euros per square meter. Investors plan to build two more office buildings on the site. The total space of the future complex will include 20,000-25,000 square meters of commercial properties.

And this is the end of the list of foreign development projects in the St. Petersburg office real estate sector. Nevertheless, foreigners do express an interest in local business centers.

“Today we are working with a major European company interested in purchasing an operating prime facility with leases in place. Such clients do not seek to economize by taking the risk of launching a project from scratch. They are interested in completed projects, preferably managed by western operators,” says Yulia Anikeyeva, managing director at DTZ St. Petersburg. “But there is no adequate supply.”

Measured Risks

The only hotel development financed mostly by foreign investors over the years since the market reform began in St. Petersburg was the five-star 164-room Radisson SAS Royal Hotel, at the intersection of Nevsky and Vladimirsky avenues, commissioned in 2001.

The $30 million project financed by the U.S.A.-Russia investment fund and the EBRD was implemented by Turkey’s UCGEN (general contractor) and Radisson SAS.

At the current time Estonian hotel chain Reval Hotels that runs several hotels in the Baltic countries has set about building a four-star hotel at 11-13, of the 8th line of Vassilyevsky Island. The 200-room hotel is due to be commissioned in mid-2006. The projected investment is $18 million. Another participant in the project is the Estonian construction firm Manutent.

Reval Hotels is set to develop and run 3-4 medium class hotels in St. Petersburg. The Estonian chain is a subsidiary of Norway’s Linstow International Ltd.

Other investment projects with foreign participation still only exist in the form of business ideas. For the most part, foreign hotel chains opt for the role of operators without investing their own funds in the development of new hotels.

“International operators, as a rule, sign agreements with Russian developers and investors, provide them with detailed specifications, quite often even take part in the design and then – provided all their requirements are fully complied with – take over the management of those hotels without investing their own capital,” Nikolai Vecher explains.

Thus, the five-star 102-room Renaissance St. Petersburg Baltic Hotel opened in May 2004 near Isaakievskaya Square at 4, Pochtamtskaya Street, and is run by the Marriott chain. The reconstruction of the hotel had been financed and overseen by Evrotrans, an affiliated company of the Baltic Construction Company.

A four-star hotel to be managed by Kempinski will open at 22 Naberezhnaya Moiki, not far from the Hermitage, in summer. The St. Petersburg real estate agency is an investor in the project.

Also in summer the city will see the opening of a four-star 230-room Novotel at the corner of Nevsky Prospekt and Ulitsa Mayakovskogo. The investor is the Moscow-based Galias-Terminal company. The hotel will be managed by the French operator Accor. This is Accor’s first project in St. Petersburg.

But in the near future the chain will open its second hotel, the three-star Ibis at 54, Ligovsky Prospekt (222 rooms), to be commissioned in the spring of 2006. The key investor is the Moscow-based firm Kesko. GVA Sawyer is the developer and coordinator of construction.

The French chain also plans to open hotels on Konyushennaya Square, at the corner of Moskovsky Prospekt and Naberezhnaya Fontanki, and in a few other locations across St. Petersburg.

Investors Court Completed Projects

While foreign investors exercise extreme caution with regards to development projects, they willingly invest in operating hotels. Early this year a complicated international deal involving St. Petersburg’s leading five-star hotel Grand Hotel Europe was sealed in the city. The details of the deal are shrouded in secrecy.

The controlling stake in the hotel was secured by Orient-Express Hotels Ltd. Earlier, a stake of over 70% in JSC Evropa Otel belonged to the Swiss firm GHE Holding AG. The new owner also bought the management contract from Kempinski and took over the day-to-day running of the hotel.

Orient-Express plans to invest in the expansion of Grand Hotel Europe by annexing a neighboring building, and to equip new deluxe suites and penthouses, thus increasing the number of rooms by 10% (today, the hotel has 301 rooms). Also, the new owner is set to secure a freehold title to a plot under the development and to take part in restructuring the hotel’s debts. Grand Hotel Europe is the first project of Orient-Express Hotels Ltd. in Russia. It plans to spend $250 million on the development of its chain in Russia over the next three years.

In May of 2005 Malta’s International Hotel Investments Pls (IHI) – the owner of the 288-room Corinthia Nevsky Palace – announced its plans to overhaul the hotel and expand it at the expense of neighboring buildings at 55 and 59 Nevsky Prospekt. The amount of spending on this large-scale and extremely complicated engineering project has not yet been outlined. According to preliminary estimates by the investors, it could require 60 million euros.

The Maltese firm hopes to complete the project by 2008. The renovated Nevsky Palace will get 28,000-30,000 square meters of extra hotel, retail and office space and become the city’s largest five-star hotel featuring a state-of-the-art conference hall.

IHI bought the hotel in 2002 for $130 million. The company transferred the amount to repay the hotel’s debt on a loan it had received from an Austrian bank in 1989 for redevelopment of what was then the Baltiiskaya Hotel. Under an investment agreement signed between IHI and the city government the Maltese firm secured the rights to the neighboring buildings. The firm arranged for the resettlement of several families and found a new property for the privately owned shop Yubilei.

IHI’s project envisages the redevelopment of the property at 55, Nevsky Prospekt into a 14,000-square-meter 8-storied retail and office center, Nevsky Plaza, where shops will occupy the first two floors. The property at 59, Nevsky will feature 105 additional deluxe rooms and a 2,000-square-meter conference center.

The project is being implemented by an international team including the UK architectural and engineering firm ARUP, acting as a general designer. Zemtsov, Kondiain and Partners are preparing the architectural design together with the British firm Aukett Fitzroy Robinson.

Foreign investors have also taken part in the major sell-off of hotels held by the St. Petersburg government over the past two years where the government’s stakes in 11 city hotels were sold.

For example, Mirkempi Hotels, co-founded by Kempinski, purchased a 74.9% stake in the 840-room Pulkovskaya Hotel for 510 million rubles, or $18.2 million, thus becoming the sole owner of one of the city’s largest four-star hotels. The buyer had taken out a loan to finance the deal. Earlier, the company had secured a 25% stake in the Pulkovskaya. The hotel, registered as a limited liability company, was not put up for auction. By law, its co-owner had a pre-emptive right of purchase for the government’s stake at a price set by an independent body and he exercised it.

The same scheme was used in the case of the Astoria Hotel taken over by the British firm Rocco Forte Hotels International.

Foreigners also took part in hotel auctions, but did not win. The Russian investors proved to be more generous. For example, Norway’s chain Olympic Park Hotel bid for the Oktyabrskaya Hotel virtually to the bitter end but the 60% stake in the property eventually ended up with a firm close to the Viking Bank. Market analysts believe the hotel sold for nearly $50 million and was severely overpriced.

“The commercial real property market is becoming less risky, while at the same time returns drop as saturation grows,” says Aleksei Chizhov. “Foreign activity will depend on which of those tendencies prevails in the future. If rates of return drop significantly as a result of the general economic situation, foreign participation in projects will remain rare.”