MONEY-GROWING: Soaring Demand for Mini Offices
Low-cost class C offices account for the lion’s share of the Moscow office market. Experts estimate the total space of offices in the city at 11 million square meters, with class A and B properties accounting for less than 4 million square meters. Moscow also has 24 class B business centers – redeveloped facilities with a total space of 510,000 square meters (source: IRN.ru).
All three sectors are experiencing a dire shortage of properties, which is normal for an emerging market. But while the class A and B sectors are more or less transparent, subject to statistics, classification and research by leading realty consultants, and target major businesses with properties built by influential development firms, the low-cost office segment is completely different.
The class C and B- office sectors that account for approximately 8 million square meters of Moscow’s total office space are the least organized and least transparent. Most deals are made using shady payments schemes and are never officially registered. Therefore, establishing the true volumes in this sector of the market is difficult.
Tenancies are usually signed for a period of 11 months and hence are not subject to official registration, says Aleksandr Limarenko, the general director at ABN Realty. But it is namely the class C offices that are most in demand and soaring occupancy rates prove that, he adds.
Real estate analysts set the annual demand for inexpensive offices at approximately 200,000 square meters. In their opinion, many companies are attracted by the low rental rates. For the most part, class C and B offices are popular with small and medium-size businesses who account for the majority of companies active in Moscow.
For the ‘small ones’ the task of finding a home for their firm is much harder than for the market majors seeking prime office space. In Moscow it is virtually impossible to find a property redeveloped or built to suit the needs of small businesses and meeting their requirements in terms of size, comfort, period of tenancy, etc.
No Choice
Small companies in Russia, in line with the provisions of federal law No.88 on government support for small businesses in the Russian Federation, are production companies with fewer than 100 employees regardless of their turnover, or companies with 30 to 60 employees depending on their line of business. The Tax Code defines a small enterprise as a business with an annual turnover of below 15 million rubles.
Small businesses need inexpensive and, for the most part, small properties of 50-100 square meters, according to Aleksandr Limarenko. Average annual rental rates in the sector are $200-500 per square meter across the city, including VAT and operating costs, according to ABN.
Other businesses seeking low-cost properties are rapidly growing companies or firms – such as publishing houses, retailers, pharmaceutical companies – interested in class C offices within industrial estates, which can be used as production facilities or warehouses, according to commercial real estate analysts at MIAN.
The properties available on the market today are buildings that were formerly research institutes, administrative buildings, factories, schools and kindergartens, as well as basement floors redesigned hastily as offices.
Factory buildings and research institutes are concentrated mostly in the northeastern, eastern and southern parts of Moscow beyond the Third Ring Road and the Moscow outer ring road (MKAD), says Maksim Zhulikov, a leading commercial property expert at Penny Lane Realty.
Large companies who opt for a class C office usually seek a freehold to the property or enter into long-term tenancy agreements, whereas small businesses rent premises for shorter periods and are always in search of a new home.
“Our organization receives numerous complaints from small firms who literally sinking under the burden of office space problems,” says Dina Krylova, head of the center for the study of entrepreneurial problems at OPORA Rossia, the public organization for promoting small and medium-size businesses.
“They are facing difficult times. To begin with, it is impossible to rent a property directly from City Hall because leaseholds are being sold and bought while subleases on inexpensive municipally-owned properties are only available at prices that are nearly as high as market prices. Secondly, for a small enterprise it is impossible to secure a freehold to a municipally-owned property. Finally, class C offices are offered for short-term leases and tenants are often evicted after the buildings are taken over by new landlords.”
Authorities Tighten the Screws
Most class C offices in Moscow belong to the city authorities and are managed through agencies and firms established for the purpose, such as the city-owned GAO Moskva. A spokesperson for GAO Moskva has confirmed that the company leases municipally-owned offices to privately owned firms, but refused to elaborate.
Over the past twelve months City Hall twice attempted – in its own way – to bring order to the sector, first, by announcing its plans to increase annual rental rates from 700 rubles to the market rate of $400 per square meter, and then by prohibiting hotels from leasing out rooms for office or retail use.
A decree signed by Mayor Yuri Luzhkov banned municipally-owned hotels from leasing hotel rooms for office or retail use and came into effect on February 1, 2005. According to realty consultants, a third of all the hotel rooms in Moscow were used as offices rented at rates as high as $400 to $700 per sq.m.
Market players said that the move to increase rates was aimed solely at boosting the city’s budget revenues. Head of the Moscow department for economic policy development, Yuri Roslyak, told a news conference dedicated to the results of 2004 that the city budget earns about 10 billion rubles from leasing non-residential properties.
Even earlier, Vladimir Silkin, head of the city’s property department, claimed that certain tenants taking advantage of low rental rates sublease municipally-owned properties, thus earning an annual income of some $100 million.
“Prices in the class C sector will grow in 2005 as most properties are city owned and City Hall plans to nearly double the rates,” says Aleksandr Limarenko.
“The rise in prices for municipally-owned properties will only further aggravate the problems of small businesses,” says Dina Krylova. Higher rates will not make class C offices better. But the position of the Moscow authorities is understandable – they want to boost budget revenues and take measures against tenants who sublease properties secured on preferential terms, at market rates.
Considering, however, that detecting such companies is not a difficult task, it appears that the main goal of City Hall is to replenish its reserves. Meanwhile, low rentals help many entrepreneurs gain a firm foothold in business.
What the Market Has to Offer
Some of the properties available on the market are better than the dilapidated facilities of Soviet-era research institutes or basements floors. But such offers are few and far between.
As an option, it is possible to buy a mansion in the secondary market for reconstruction. Such properties are offered at $500-700 per square meter. The company Region Development suggests that after securing a freehold to the property the buyer may renovate it, take over part of the premises for their own use and rent out the rest.
The rate of return from a successfully renovated class B property is 15-20%. But the supply of such properties on the market is low. A cheaper alternative is a non-residential property on the first floor of a residential estate. These kinds of properties – already reequipped for office use – are available for rent, or they can be purchased before the end of construction and renovated to suit one’s own needs.
The price of a 300-square-meter property with a separate entrance stands at around $3,000 per square meter in the city center or $1,500 on the outskirts. Renovation will require $500 per square meter. Another option is to secure a stake in the development of a business center. Class B offices situated a good distance from the city center are sometimes available at rates comparable to those charged for class C properties in more prestigious locations, according to consultants at Noble Gibbons.
Kings of the Industrial Estates
The Vizavi investment firm is one of the leading participants in the class C office market who do not shun the limelight. It first distinguished itself by securing a freehold to 500,000 square meters of city industrial facilities two years ago. Having occupied the vacant niche, the company launched reconstruction of obsolete estates and established the Office Park Vizavi chain.
The company has already opened several business parks across the capital where properties are leased out at $200-350 per square meter. The Burda publishing house, for example, rents a 14,000-square-meter property at the Sheremetievsky office park.
Vizavi has spent $100 million on the purchase and redevelopment of the facilities and expects a rate of return of over 30% per year. Office rentals are low because the properties are leased out by the landlord without any intermediaries, Pyotr Koshkin, deputy director general at the investment company Vizavi, explains.
Class C and B offices account for some 400,000 square meters of the total office space within the Vizavi chain. Vizavi’s business parks are: the 6-hectare Mozhaisky business park in the West Administrative Okrug [district] of Moscow, Dmitrovsky in northeastern Moscow (4.5 hectares), Sheremetievsky in the district of Maryina Roshcha (6 hectare), Varshavsky, featuring a 2,690-square-meter office building and a 7,300-square-meter office and retail center, and the 1.3-hectare Krasnoselsky business park.
Currently, the company is working on the design of the 45,000-square-meter Kursky Park. In Moscow the business parks are sprouting up on the premises of former industrial enterprises occupying large plots of lands, says Koshkin. Such facilities must have a parking lot, a security system, all the necessary communication lines, warehouses and shopping areas. The management of all the business parks belonging to the chain is carried out by Vizavi itself.
Some analysts doubt that the Vizavi project will yield high returns. Penny Lane Realty’s experts believe that given the enormous size of the properties, attracting tenants into all the office parks will be impossible. JLL, on the contrary, believes that the underdeveloped class C sector is showing good rates of return these days.
For the time being, business parks and business incubators designed to help businesses to become established and profitable, are still rare in Russia, and in Moscow. Dina Krylova considers business incubators the most acceptable option for promoting small businesses. The model is widely used in Europe, while in Russia there is only a handful, and they fail to meet European standards.
For example, in Berlin alone, with a population of 5 million there are about 80 business incubators built in convenient locations where small enterprises enjoy access to all the necessary facilities and can receive business counseling.
Properties are offered for rent at preferential rates of $140-180 per square meter. Young companies enjoy the privileges in the first 3-5 years before they become established. The development of such parks is financed equally by the federal and regional governments and in some cases also by city authorities and private investors.
Business parks with a total space of less than 2,000 square meters are considered unprofitable. In Germany the supply of such facilities exceeds the demand.
Business parks – still a vague notion for Russia – are being built in Moscow on the sites of former industrial estates or factories that were moved out of the city. In line with the general plan for the city development till 2020, as many as 5,300 hectares of Moscow land currently occupied by industrial estates are to be vacated.
However, market analysts admit that the withdrawal of operating enterprises from the city is an extremely costly and complicated task that requires endless permission, developing the vacated territory, dismantling its facilities, restoring the factory in a different location, etc. That is why, in practice, new owners simply take over the buildings of ‘dying’ companies by purchasing them from the previous owners and redevelop them into business parks.
Companies involved in such projects include Solnechny Gorod, ALM Development, and Forum Properties – the only company in the city that actually arranged for the withdrawal of an industrial facility, and used the vacated site for the development of the Avrora Business Park.
“The majority of our facilities have opted for self-reforming and rehabilitation, in line with Moscow legislation. The withdrawal of industrial facilities takes place before we take an interest in the sites, as developers,” Pyotr Koshkin explains.
Office Cubes
Not long ago, Aleksei Dobashin, chief executive at Krost, announced his plans to develop office centers for small and medium-size businesses – multi-storied facilities consisting of smaller blocks for companies with 20 to 150 employees, targeting mostly young entrepreneurs of 25-30 years of age.
Every office center will have about 50,000 square meters of total space with offices to be let at $300-350 per square meter per year. Currently, the company is working on the development of the architectural concept for the project and looking for appropriate building sites.
Dobashin plans to build several buildings across the capital, with the first facility set to appear in northwestern Moscow. They will resemble business parks offering a wide range of amenities.
Krost hopes to attract foreign engineers and architects, psychologists and even feng shui experts to participate in the project. The company will use natural materials for the construction so that the buildings would not grow obsolete within fifty years. The prime cost of construction is estimated at $1,000 per sq.m., while the forecasted rate of return is 18%. The first projects are due to be completed in 2007.