Money-Growing: Simple Truths

Back to Basics

Nizhny Novgorod has over 1,280,000 square meters of office space, according to the Nizhny Novgorod Center for Scientific Examination. However, there are still no class A office centers operating in the city. The first and only such project is currently under construction by the Stolitsa Nizhny group whose track record includes a number of top class shopping malls. The office center is expected to be commissioned in December 2005.

Class B offices are rare, too. The only project worthy of mentioning is, perhaps, the Two Towers development – a business center comprising two buildings commissioned in July of 2004 and in January 2005 respectively. The management company in charge – Serebryany Vek – has positioned the center as class B+.

Redeveloped facilities worth mentioning are the class B+ Avantazh on Rozhdestvenskaya Street, or the class B Novaya Fabrika (New Factory) at 23 Rodionov Street, as well as Teledom, currently under construction on Belinsky Street next to the Nizhny Novgorod Project television center.

For the most part, local businesses run their offices within business centers which at best can be rated as class C. They are former Soviet-era research and design institutes, or redeveloped industrial facilities. For example, the business center at 6 Nartov Street occupies the premises of the Orbita factory.

Fusion of Genres

Tens of thousands of square meters of office space are being commissioned in Nizhny Novgorod every year. Most of it, however, occupies first-floor properties in residential blocks or non-residential properties in multifunctional estates. For example, the residential development at the intersection of Gorky and Proviantskaya streets has retail properties on the first floor, and offices on the 2nd and 3rd floors.

The house at 63 Belinsky Street, completed in early 2005, comprises two residential blocks linked by an arch with offices above. The first floor houses a shop. Another building, at the intersection of Ulyanov and Nesterov Streets, too, houses both residential and office properties.

That list is endless. The same picture is typical of newly launched projects where offices co-exist with residential and retail properties, or even with sports and leisure facilities, for example the stadium with offices on Gruzinskaya Street, and the office and retail centers on Gorky Street in the Black Pond district.

Virtually every development in the city center is a mixture of commercial and residential properties as if developers deliberately shunned purely residential estates or office centers.

Perhaps investors are not really sure whether business projects built solely for office use will pay off. The Shokolad shopping center was initially conceived as a class A office property, but while the project was on the drawing board the developers decided instead to raise a shopping center with a movie theater and an office section, now occupied by a local branch of UralSib Bank.

To justify their desire to combine residential units with office space within one building, developers often say that living in first-floor apartments or those with windows facing noisy streets would not be very pleasant and they are unlikely to sell well anyway. Incidentally, the first floor of properties in new residential estates in Moscow are non-residential, too.

However, a residential block with offices on its premises automatically loses the status of a top class property which virtually all the developments in central locations enjoy. Offices combined with residential units do not benefit from the neighborhood either, because such areas are short of parking facilities, and, most importantly, professional management, let alone the standard services commonly provided to office tenants by business centers even of a lower grade.

Tatiana Romancheva, head of the Nizhny Novgorod Center for Scientific Examination, believes that by combining office properties with residential units, developers either seek to alleviate risks – where an office property was planned originally – or boost returns on investments in residential development, given that office properties sell on average for 20% more than residential units.

Then, there is another practice: developers tend to sell office centers either in full or in parts, as was the case with the building on Semashko Street developed by the firm RUZG, a property near the Moscow train station by Nizhegorodstroi and on Gorky Street by Elteks.

The Vybor development company, too, has put its office development on Solganskaya Street up for sale although originally it planned to run the business center itself and did not even offer first-floor properties within the residential estates for sale, renting them out instead.

According to the company’s general director, Sergei Ivanov, the increase in prices for construction materials made the project too expensive. Had the company raised the loan to finance it, the project would have been even more expensive and taken longer to pay off. That is why the developer decided to sell the property instead of continuing to finance it at the expense of other projects.

Prestige Not a Priority

In 2004, some 40,000 square meters of office space were developed in Nizhny Novgorod. Approximately 83,000 square meters are slated for commissioning in 2005. Tatiana Romacheva believes that even the developments that are yet to be completed are already filling out the supply and affecting demand.

Small properties of up to 30 square meters are subject to the highest demand, according to the Commercial Real Estate Center. They are one-room units in business centers – such offers are very rare – or first-floor apartments reclassified as non-residential properties. In busy streets, all these kinds of properties have long been snapped up.

Offices in new developments are usually larger. That contradiction creates the impression that demand remains unsatisfied; though this is only true for a rather narrow segment of the market. Tenants today show more preference for business centers. While the rental rates in business centers are comparable to those charged elsewhere, business centers offer more convenient conditions, a variety of services and a neighborhood favorable for business growth.

Offices at the Two Tower business center are rented out at $24 per square meter per month including utility charges (electricity supply and telephone bills excluded). The properties are almost virtually ready to use. For comparison: offices at the residential estate on Varvarka Street, bought up by private investors, are rented without any fittings and furnishings at $18-25 per square meter per month. Besides, the tenant has to find and pay for all the security and cleaning services, which are not provided by the landlord.

“A poll among businessmen has revealed that they attach most importance to the size of the rental rate while prestige is at the bottom of their priority list,” Tatiana Romancheva said. For example, most small companies do not care whether their offices belong to class A or C while the difference of $8-10 per square meter may play a decisive role.

The occupancy rate at local business centers is nearing 100%, according to the Nizhny Novgorod Center for Scientific Examination. The office center at 23 Rodinov has practically no vacant properties. Vacant offices are still available in Avantazh on Rozhdestvenskaya and the Two Towers on Belinsky Street, but they are scarce.

“Demand has differentiated. The tenants know exactly what they need, at what price and where. And this means the market is saturated,” Romancheva says. Market saturation is mostly felt in administrative buildings and built-in offices. For example, the offices at the residential estates on Gorky Street and at 63 Belinsky Street remained vacant for a long time.

“Having to wait for tenants for over six months would be critical for an entrepreneur; only those who make their money elsewhere can afford to wait that long without bringing down prices,” maintains Yelena Solovyova, sales director at the Address real estate agency.

“We have an office that was put up for rent more than a year ago. No one is interested in a 100-square-meter office property – albeit, in the city center – at $35 per square meter,” says Natalia Ionova, manager at Commercial Real Estate Center.

Sooner or later every landlord finds his tenant, realtors say philosophically. Yet, where not one but many landlords have to wait too long it becomes clear that the market is oversaturated, especially in the city center where the bulk of new developments is being commissioned.

Today the Nizhegorodsky District of the city accounts for 38% of the local offices; moreover, approximately 60,000 of the 83,000 square meters of office space slated for commissioning in 2005 is being developed in the area. In other districts, the situation is less critical.

Parallel Curves

The main reason that supply has radically exceeded the extremely selective demand is that the supply grew considerably just as the regional industry plunged into recession, explains Alexei Troshenkov, head of the strategic analysis and valuation department at the Nizhny Novgorod Center for Scientific Examination.

“Niznny Novgorod’s commercial real estate market is following the same laws as elsewhere around the globe: the first to grow is the market for retail properties that bring the highest returns and pay back faster, then entrepreneurs start pouring money into the office market, and then comes the turn of the leisure industry,” says Tatiana Romancheva.

The retail boom in Nizhny Novogorod has already passed; while investors began to show increased interest in the office market local industry fell into recession, as a result the demand for offices has failed to catch up with supply; at best, it is not falling.

Tatiana Romancheva believes that part of the newly built offices never reach the tenancy market, as they are developed or purchased by businesses for their own use. Yelena Solovyova notes the growing demand for freeholds. Most buyers seek properties for their own use, while the number of private investors on the office market has dropped considerably, which also proves the market is in recession, Solovyova says.

Look Before You Leap

Although the current situation is hardly favorable for new projects, no one has as yet given up their development plans. “The emergence of target-oriented projects proves that the market has entered a new stage. The change of priorities is inevitable. But market saturation does not mean that new projects will not pay, it is necessary to calculate them more thoroughly and set the timing for their arrival on the market with more precision,” says Romancheva. Within the next two years the city is expected to see the development of another 65,000 square meters of office space.

Perhaps the unexpectedly abundance of office properties is forcing developers to address combinations of multifunctional projects – if not residential space with office properties, then retail space with offices, as the demand for retail properties remains high.

The payback period is likely to grow as well. “Today, smaller properties pay off in 3-5 years; larger properties – such as the business center on Reshetnikovskaya – may take 5-7 years to pay off. If the payback period is 8 years, there is nothing tragic about it and it shouldn’t be a reason for giving up on a project,” Romancheva believes.

Who knows, perhaps the region will overcome the industry recession and, with business activity growing in other fields, the demand for offices will grow. Why else was Valery Shantsev appointed governor of Nizhny Novgorod?