MARKET KNOW-HOW: Class X Warehouses

Another reason why many projects take years to implement and turn into what is commonly described using the Russian term ‘dolgostroi’ – or never-ending construction – is that local developers are notorious for their incompetence and attempts to economize on key stages of construction. Even properties positioned as class A facilities can take years to be built. The failure of developers to meet deadlines and the use of cheap construction techniques affect their properties’ allegedly prime quality.

Ads Are Not to Be Trusted

Promotion is the first step most warehouse developers take when launching their new projects. Everything begins with pretty packaging in the form of advertising modules in glossy magazines, a series of features in newspapers and magazines where the projects are presented as warehouse terminals or class A industrial parks built in strict compliance with top international standards, available for sale upon completion.

As a result it may seem that some state-of-the-art property has at last entered the market. In truth, however, such projects often fail to live up to the images presented in the ads.

Sometimes, the developers themselves, as well as the marketing agents who place their ads in printed media, are to blame for that. A closer look at the dates of commissioning indicated in some ads reveals a curious tendency: quite often, while the project is still in its early stages developers promise to complete construction earlier than it is physically possible.

Moreover, monitoring the same ads posted regularly over a period of time one can see how the dates are changed, with commissioning being postponed for several months.

Therefore, the size of new developments as declared in analysts’ annual or half-yearly reports should be divided in half. In other words, where it says that as many as 200,000 square meters of storage facilities are to be commissioned by the end of the year, the true figure will most likely not exceed 100,000sqm. Out of 500,000sqm of warehouses slated to be commissioned by the end of 2004 only 300,000sqm was actually built.

Companies active on the warehouse property market themselves admit that many projects fail to meet their deadlines. Alexei Novikov, deputy head of industrial real estate at Knight Frank, publicly raised the issue at a recent conference in Moscow. But in most cases, developers shun publicity until it becomes clear that a project has ended in failure and concealing the fact no longer makes any sense.

But in the narrow circles of market players such information spreads quickly, becoming an issue for discussion during coffee breaks at conferences and presentations.

Will Pushkino Ever Exist?

Commissioning of the Pushkino warehouse terminal at the 16th kilometer of Yaroslavskoye Shosse [motorway] in the Pushkino District outside Moscow has been postponed for nearly six months. A top executive at a well-known construction firm, who asked for his name to be withheld, called Pushkino a disgrace and failure notwithstanding the aggressive publicity campaign launched by its owners who pledge to commission the second stage in winter even though the first stage shows no signs of completion.

Rumor has it that the work near Pushkino was, indeed, suspended after a nearby gas pipeline had reportedly been damaged during construction. However, the true reason for the delay remains unclear as neither Jones Lang LaSalle, the leasing agent for the project, nor the developers, Capital Partners and Lone Star Ventures, have managed to shed any light on the issue.

But the fact is still a fact: the first, 70,000-square-meter phase of the project was not commissioned in summer and the question remains whether construction will be completed by the end of the year. A photo report made in early September only rendered images of the frame of the building installed on the site, partially covered with roofing.

Market analysts know about the long-suffering project. Jone Lang LaSalle’s deputy head Vladimir Pinayev does not deny the delay either.

Ruben Alchudzhyan, an industrial property specialist with 10 years of experience, who was in charge of the warehouse department at Colliers International, says that the first to suffer in such situations are the tenants, being unable to move into the pre-leased properties, as well as the developers and investors who get no payback on their investment.

The participants of the project have had their funds frozen indefinitely. (With the minimum prime cost of warehouse construction today standing at $400-500 per square meter, the first phase of Pushkino is estimated to be worth $28-35 million. – Vedomosti.) The projected total size of the logistics park is 211,000sqm of office and storage facilities on a plot of 35 hectares.

In one of the impressive advertising modules Pushkino was presented as “a class A logistics park designed to international standards”. According to the ad its first phase was slated for commissioning in the summer of 2005, the second phase in the 4th quarter of 2005, and the third stage in the 2nd quarter of 2006. (Source: Vedomosti, Building Blocks of Business, July 2005).

Today, due to a delay in the first phase of construction, commissioning of all other phases, too, will have to be postponed. Vladimir Pinayev, whose company has been named an exclusive leasing agent for Pushkino, says that the first phase will be completed in the fall of 2005 or by the end of the year.

A spokesperson for the Pushkino district authority has confirmed that construction continues on the site. In late September, while hoisting cranes still stood idle “concrete was being mixed and builders were seen doing something on the roof”, the official said.

Thus, it appears that sooner or later the market will, after all, see the arrival of a new logistics park. But observers still doubt the project will be commissioned on time. Some say that by hiring a large army of workers that worked in four shifts the developers could make up for lost time. Others say that even if construction carried on 24 hours a day, the project is unlikely to be ready for commissioning in fall. Besides, with the onset of winter construction will become more complicated and costly, says Ruben Alchudzhyan.

Facing fines for the delay is hardly the worst consequence for the developers. Much worse is the prospect of spoiling relations with anchor tenants, such as, for example, DHL, explains Alexei Novikov of Knight Frank. Usually, tenants lodge their complaints against the developers who then take them to the general contractor, says Novikov. For example, a tenant may assert his right to occupy the property for free for each month of delay.

By signing an accord with a general contractor, developers sometimes demand a deposit, for example, in the form of a bank guarantee of several million dollars.

Tenancies signed before the property is commissioned are a good sign that the project is being implemented as planned, says Ruben Alchudzhyan. Where the landlord or his leasing agent says that “the names of tenants are kept confidential but the agreement with them has already been reached” it means in most cases that the project has so far failed to attract any particular tenants, and no agreements have been signed so far.

For quite a while DHL remained the only publicly presented tenant at Pushkino. Judging by JLL’s official statements the company was to occupy the first building of the terminal. Although, reportedly, the only tenancy deal signed so far covers an area of only 10,000sqm.

JLL would not elaborate on the deal, which is quite understandable as a marketing agent is supposed to act in the interest of the landlords and investors, not against them. For their part, the developers - Capital Partners - avoid making any media statements whatsoever. An official press release issued in October reported that Knight Frank had brought another anchor tenant to Pushkino, Relogix, which is set to rent 70,000sqm of warehouse facilities in the second and the third phase of the complex.

According to the release, the company Relogix, represented by Knight Frank, is a new player on the domestic logistics services market, founded by Tablogix. Relogix’s general director Alexander Gutekulov says, that Pushkino is to become their first property on the path towards “developing the Russian market.”

Reports by warehouse market analysts cast doubt on the class of the Pushkino project. The tender for the construction of the logistics park was won by a fairly unknown general contractor who outbid all the others including Stroifaza, a company that has developed a number of terminals across Russia. In particular, it has built properties under a contract with Nestle, a warehouse facility in Lobnya (already in operation), and is currently involved in the construction of the Leningradsky complex, being developed by MLP Group on Leningradskoye Shosse (motorway).

Alexei Novikov assumes that obscure and inexpensive general contractors are usually hired by developers who are not versed in the market due to a lack of experience or if they are pressed for money.

When asked about the possible reason why his company’s bid had been rejected, Stroifaza’s marketing director Oleg Reshetilov surmised that it could be about the price the company charges for its services. “Usually, we agree with developers on a price of construction that enables us to build turnkey properties and meet deadlines,” Reshetilov explains.

“But the price we were offered for our work on that site barely covered the prime cost at which a general contractor is able to build a warehouse only to one’s own detriment, if we are to talking of a high quality class A property. All the money would be spent entirely on construction materials and even then we would have to economize. Nothing to say of the revenues a general contractor is entitled to. We rejected the offer, being unwilling to work for a thank-you note.”

The average price of building a square meter of class A warehouse property stands at about $500, says Alexei Novikov. A price of $400 to $450 (the cost of construction excluding the cost of purchasing a plot and electric wiring) is indeed very low. And this is not just about the contractor’s revenue.

While work on the site continues, the market prices for construction materials are growing. For example, over the past 12 months, cement has doubled in price, the price of concrete rose by 20-30%, steel by 10%, gasoline prices are rising, too. Therefore, experienced builders are playing safe, charging $480 to 600 per square meter.

At any rate, a price of $500 is quite plausible for construction work where high quality materials and technology is used. In the case of the Pushkino contractor JLL refuses to specify any figures citing the average weighted rates on the market in general.

Today it is still too early to say that Pushkino has failed to meet class A standards, says Ruben Alchudzhyan. That will become clear only after the property is completed. Warehouse terminals often have a variety of latent defects, he adds. But the manner in which the work at Pushkino is going is alarming.

Prehistory

The Pushkino project was first presented in the media during the summer. Market consultants described the future logistics park as an example of speculative development, i.e. a property that would be available on the open market. This is especially valuable as most storage facilities today are either custom-built or developed by logistics operators for their own use; properties in such complexes are offered to tenants under secure storage service agreements.

The development was launched by Lone Star Ventures; Capital Partners – a multinational investment, development and property management operator involved in major commercial real estate projects in Eastern Europe – joined in as an investor.

Lone Star Ventures is a partnership that was set up by two real estate investment professionals in October 2003. From early 2004 Lone Star Ventures focused on a logistics park project and secured a building plot.

Capital Partners, established in 2001, is involved in a number of residential and commercial projects in Kazakhstan and Moscow where it is developing the Ritz Carlton hotel on a site earlier occupied by the Soviet-era Intourist hotel (the project is estimated to be wroth $150 million), and a 311,950-square-meter multifunctional property on the site of the Radikon plant at 16 Leningradskoye Shosse (worth $300 million).

Swiss Realty Group said Pushkino would become one of the first projects in Russia where the hitherto rare triple net scheme would be applied, i.e. a standard procedure where tenants pay a base rental rate plus operating costs by the year’s end.

The annual rental rate for anchor tenants at a logistics park such as Pushkino was put at $110-115 per square meter, excl. operating costs, VAT and utility charges. The average rate at class A facilities stands at $150-160 per square meter.

Payback was expected in seven years, with a projected rate of return of 16-19%. However, none of the consultants failed to recall that Pushkino was Capital Partners’ first-ever warehouse project. Knight Frank described the project as “hasty”, because it was designed in a great hurry. Consultants put that haste down to the developers’ plans to sell the property, and expected Pushkino to become a state-of-the-art logistics park similar to western models, housing a variety of storage facilities on a common territory with a single network of communication and engineering lines and a single manager.

Pushkino Is Not the Only One

Lately, Moscow has seen a number of warehouse projects comparable to Pushkino in terms of scale. So far none of them, according to market analysts, has been fully commissioned.

Summing up the results will not be possible for another 18-24 months. Among the giants is the Leningradsky terminal by MLP Group under construction on Leningradskoye Shosse, and the 1-million-square-meter White Park by Coalco, its first phase of 145,000sqm is slated to be commissioned in late 2006. A 600,000-square-meter facility southeast of Moscow is to be developed by TLK Tomilino.

The National Logistics Company, or NLK, plans a 300,000-square-meter storage facility, worth $200 million, in Krekshino near Moscow. Belaya Dacha, too, announced ambitious plans to build a 320,000-square-meter complex, though later its owners cut the project.

Then, there is RIGroup, developing a 160,000-square-meter facility in Narofominsk District. The well-known developer Kulon plans to construct a major industrial park entitled Kulon-Istra featuring 100,000sqm of storage facilities to be built on Novorizhskoye Shosse, 25 km from Moscow. But at least half of all the projects face serious problems at the moment.

Some consultants familiar with the practice of protracted construction are cautious in their forecasts as to the completion of those projects. For example, Penny Lane Realty expects the projects by Tomilino and NLK, as well as all the other major projects to be commissioned between 2005 and 2007.

Marina Mazur, marketing director at Kulon, has reported that the 8th March complex and Kulon-Yuzhny have already been completed. The Kulon-Baltia complex, already fully leased out, is currently being commissioned. Kalinka-Stockmann has rented 8,700sqm, Schneider Electric 9,200sqm, Pragmatik Express 6,600sqm; tenancy agreements are signed for a term of 5-10 years. The Istra project is still on the drawing board.

However, several sources have reported that Kulon-Baltia took longer to be completed than such projects usually require. Knight Frank agrees that construction was dragged out. Kulon is one of the few developers involved in building speculative warehouses.

Mikhail Gets, head of the commercial real estate department at Blackwood, assumes that developers exercise different approaches towards the promotion of their projects on the market.

“We should mark out several strategies,” he says. “One of those is where a developer immediately announces his grandiose plans but builds in stages or even puts off the launch of construction in order to interest more would-be investors, say, for the sake of prepayment.”

That approach is also exercised with the intention of attracting applications from potential tenants and thus gauging demand for the property. Such surveys may even result in a revision of the concept, as was the case with Belaya Dacha. So, it often happens that projects are declared well in advance and take years to be built. But there may be more serious reasons impeding construction, such as the time-consuming process of reclassifying land.

Gets cites AIG/Lincoln’s project in Altufyevo, announced two years ago. Construction work still hasn’t begun. What is known is that the developer has already secured almost all the necessary permits from government bodies.

Alexei Novikov agrees that AIG/Lincoln’s Northpoint Distribution Park has been on the drawing board for too long: nearly three years. The cause of the delay in development is the costly operation of relaying utility lines before construction begins. Another project, the Sherland warehousing complex near the Sheremetievo II airport, faced a different sort of problem – poor flooring that took time to be changed. As a result the tenants could not move in.

Erroneous Thrift

Delays in construction – whether intentional or forced – are usually brought about by a variety of reasons. Novikov believes that quite often developers err by choosing a building plot (the market is short of suitable sites for warehouse development).

For example, if the communication lines are far from the building plot, developing a warehouse there makes no sense, as the cost of laying engineering and communication lines will be very high (1 megawatt alone costs 1 million rubles).

Novikov mentions three other grave mistakes often made by developers these days. To begin with, they lack knowledge of the situation on the market, for example, new development firms are not versed in prices and know-how. As a result, they seek to economize by hiring cheaper contractors.

The second mistake is made by developers who try to cover the entire plot with storage facilities while it must be kept in mind that there should be enough room for trucks to drive in and out. The third aspect is about the flooring, which must be even and durable to ensure the stability of shelf stands which may be up to 12 meters high. There are very few skilled specialists, as well as designers capable of developing a proper concept for a warehouse, let alone experienced developers.

“Everything depends on the developer’s expectations and plans,” says Novikov. “If a company is set to build a large terminal, and more than just one, there is no sense getting involved with unknown and cheap contractors who will most likely fail them.”

Oleg Reshetilov believes that resorting to cheaper techniques is the biggest mistake a developer can make. As a result, construction is delayed, the quality deteriorates and properties are downgraded to a lower class. So far there are few companies willing to take over the running of such properties.