Market Know-How: First Among the Few

“Any property, a business center in particular, is a commodity,” says Regina Lochmele, head of office real estate market analysis at Colliers International. “The key factors determining the likelihood of success are correct timing, location and assessment of the target audience. The project will be successful provided it is based on a correct assessment of the potential size of the market and the structure of demand, and meets the necessary requirements.”

Integrated Approach

Moscow’s real estate market is short of approximately 700,000sqm of office space, Praedium reports. Considering that in 2005 the volume of prime office stock in the capital reached 1 million square meters, most property analysts agree that for several years ahead office developers can rest assured their developments will not remain vacant.

“The city will have a shortage of office properties for another four to five years. Afterwards, the situation will stabilize as elsewhere in the world,” says deputy general director at KV Engineering, Ilya Shkabara. That transition will mean the demand generated by would-be tenants will drop while their requirements will grow. As a result, developers will have to consider the concept of their projects more thoroughly and focus on the development of highly competitive properties.

“The main criterion of success is competitiveness, and hence, low vacancy rates and high rental rates,” says Sergei Leontiev, general director at Vesco Realty. Although market experts expect strong competition on the office market, already today it is possible to distinguish between successful office centers and failed projects. The success of the project depends on a number of factors.

“There are a number of factors determining success in commercial real estate. The key role belongs to location, stable concept and professional property management,” says Aidar Galeyev, head of analysis and information at Miel-Nedvizhimost realty. “These days clients attach the utmost importance to top quality construction materials and equipment. The choice of solvent tenants and long-term tenancies are the key to success for all types of commercial properties.”

Property management companies insist that those factors help boost the rate of return and achieve payback much sooner. “The universal criterion of success is the rate of return, based on the size of rental payments, vacancy rate, the correlation between rentable and common space and the prime cost of development,” says Yevgeny Yakubovsky, general director at Novaya Ploshchad Property Management.

Aidar Galeyev notes that “the criterion of success is the same for any commercial property – achieving the goal set by the investor. As a rule, when putting up funds in that sector of the market entrepreneurs expect high returns in the long term.” The rate of return needed for an office project to succeed is set by most experts at approximately the same level. On the whole, says Ian Al-Nuri, commercial real estate consultant at Penny Lane Realty, “the project can be regarded as successful as long as its annual returns stand at 18-20%.”

Location, Location, Location

Like any other segment of Moscow’s property market, office real estate is closely linked to the distribution across the city’s districts, while the specifics of the sector predetermines development of business centers in zones of increased commercial activity. In Moscow, there are a number of territories that can be regarded as most suitable for office property development.

“Centrally located class A offices will always be in demand,” says Ilya Shkabara. “Historically, southwestern, western and northwestern parts of Moscow have been shaped as office districts. That stereotype will be preserved for a long time. Class C office development in eastern and southeastern parts of Moscow clearly makes no sense.”

“Downtown Moscow remains the most attractive site for office construction. But there are almost no vacant building plots left in the area. Zamoskvorechye District has good prospects. Although, recently Moscow has seen a trend of decentralization in office development,” holds Yevgeny Yakubovsky.

Offices in central Moscow are appealing to tenants because of their prime location and proximity to the offices of their business partners. A serious disadvantage is the heavy congestion in downtown areas. Transport accessibility is one of the key requirements developers have to keep in mind when designing office facilities outside the city center.

“Developers have to look into the transport infrastructure available in the area, as well as plans for the construction of road junctions that are likely to change the situation radically,” notes Ilya Shkabara. “For example, the reconstruction of Leningradsky Prospekt and Tverskaya Street is to be completed by 2008, which will have a profound effect on the prospects of those routes and alter tenants’ attitude towards the area.”

Outside the city center, office development is on the rise chiefly in western, southwestern parts and northwestern parts of the city, holds Sergei Lobkaryov, head of commercial real estate at MIAN. Most experts are unanimous in their assessment of the city areas that are most popular with office developers. “Leninsky, Kutuzovsky and Leningradsky avenues, Profsoyuznaya Street and Vernadsky Prospekt are the routes that still have the best prospects in terms of office construction,” says Irina Kuzlichenkova of Noble Gibbons / CB Richard Ellis. Proximity to the Garden Ring and the Third Ring Road is important, too, she says. “The Garden Ring, Leningradsky, Leninsky and Kutuzovsky avenues, as well as the Third Ring Road top the rankings,” Sergei Leontiev says.

The choice of a commercial zone is largely predetermined by the line of business of the would-be tenants. As a result, over the past few years Moscow has seen the emergence of specialized business areas. Thus, with the headquarters of Gazprom and RAO UES monopolies being situated in southwestern Moscow other oil and gas firms increasingly seek tenancies in that part of the city. In the western part of Moscow the situation is similar. Prime office facilities are concentrated mostly in western Moscow, on Kutuzovsky Prospekt, in particular. That is why Harley-Davidson’s offices can be found on Kutuzovsky, so as to be nearer to the target audience, says Ilya Shkabara.

Location does not always play a key role. “Location is not always the key to success; a competent marketing strategy and correct choice of target audience (would-be tenants) can render a project successful regardless of location,” Irina Kuzlichenkova.

As an example, most analysts mention Cherry Tower, an office center built at an address that can hardly be considered advantageous, 56 Profsoyuznaya. The business center is not a new construction but a redeveloped Dom Knigi book store whose construction was never completed. However, the current occupancy rate at Cherry Tower has reached 100% with Uralsib and Panasonic Russia among its tenants. Thus, in this case a well-thought-out concept has a played a more important role than location.

Debatable MKAD

When talking of Moscow highways that are attractive for office development, most property analysts tend to ignore the city’s outer ring road, or MKAD, which is hardly fair, says Nikita Yemets, head of marketing at Race-Communications. A number of large business parks are situated along that road. In March 2004, Race Communications commissioned the 19,531sqm Country Park on MKAD, between Leningradskoye Shosse and Svoboda Street. Coalco and the International Consulting Center are currently developing the class A business park Greenwood.

“Today, there are many vacant sites in the area; at the same time the concentration of retail and leisure facilities is high,” says Yemets. “On the whole, in terms of infrastructure the area is suitable for office and housing construction. Developers of residential properties were the first to arrive; for example, Kurkino district was built and commercial property developers followed suit.”

Office centers on MKAD are attracting increased attention from tenants. “Our tenants are Volvo, BMW, Porsche, Johnson & Johnson, TCL, and others, ” Yemets says. Offices on MKAD could be especially appealing to companies whose customers do not need to visit their head offices before making a purchase – car dealers, pharmaceutical concerns and manufacturers of home appliances, property analysts agree.

Although Country Park was commissioned less than 2 years ago, its occupancy rate stands at nearly 100%, says Nikita Yemets. “Today, we only have 200sqm vacant,” he says. MKAD has long ceased to be viewed as the capital’s border, separating Moscow from the rest of the country and is gradually turning into just another road within the city. “That brings about construction of new office centers. In the long run, MKAD will be built up just like Leningradskoye Shosse,” he says.

Aiming for Success

Irina Kuzlichenka names a number of criteria vital for the success of an office center. To begin with, the developer must enlist the services of professional realty consultants who have to take part in the project at all stages. Secondly, the concept of the project should be well-thought-out and meet market requirements in terms of location, positioning and target audience. Finally, the marketing campaign should be carefully planned and implemented on a professional level.

The general concept and size of a future office center is often predetermined by location. “For example, the Central Administrative District is most suitable for the development of low-rise office buildings, measuring 1,000 to 1,500sqm, for 2 to 3 tenants. Areas between the Garden Ring and the Third Ring Road are the best for high-rise business complexes of 30,000 to 40,000sqm, with developed public amenities, catering for 20 to 30 tenants. Sites along the Third Ring Road are most suitable for business parks, targeting back offices of large corporations,” say Sergei Leontiev.

The average size of a business center in Moscow today stands at 6,000 to 8,000sqm, says Aidar Galeyev. While a commercial property measuring 5,000 to 6,000sqm “can be conveniently located in the side streets of the historic center of Moscow, a property of 30,000 to 50,000sqm needs a large parking area and convenient driveways.” It is also necessary to determine the optimal size of floors so as to create comfortable conditions for the planned number of tenants. Property analysts insist that each floor should be occupied by no more than one or two tenants.

“Offices measuring 200 to 500sqm have the highest demand. Today, the rate of floor space per person stands at 7sqm on average. Several years ago office developments had 1,000sqm per floor, targeting major tenants. But such tenants are far less common today, their requirements grow, and quite often they can afford to build an office themselves. That is why floors have to be “sliced”, says Ilya Shkabara.

“The optimal size of an office floor is 700 to 800sqm, with 3 to 4 major tenants and 8 to 10 medium-size tenants per business center,” says Aidar Galeyev. Irina Kuzlichenkova says that recently there has been a rise in demand for buildings with floors of 1,000 to 2,000sqm and larger.

Selecting Tenants

Tenants have to be selected in advance, proceeding from the location and concept of the future business center, analysts say. “The office center should match the format of its tenants. Some tenants seek expensive offices, others prefer cheaper ones. Some seek prestigious central locations, others – such as travel agencies or direct sale offices – set a priority on transport accessibility. Companies that are not directly dependent on customers prefer a large space in moderately priced office centers on the outskirts,” says Ilya Shkabara. An example of a business center where an ideal combination of tenants perfectly blends with its concept is Tower-2000 on Taras Shevchenko Embankment, he says.

Tower-2000 is one of the first office complexes with a perfect composition of tenants, he says. Irina Kuzlichenkova shares that opinion. A perfect composition of tenants is not the only key to success; achieving high occupancy rates is important, too. The office complex must reach an occupancy rate of 80-90% within the first two years; if that figure is below 70%, the project is considered a failure by local standards, although it is normal for other countries.

The size of rental rates does not always play a key role. “The size of rentals, of course, is proof of success. The higher is the value of the facility the higher is the income it generates,” holds Aidar Galeyev. Most analysts disagree. “The rental rate does not necessarily speak for the success of a project,” Irina Kuzlichenkova says. The size of rental payments depends on the current market situation and a number of parameters, such as the class of the building, the level of tenants and terms of tenancy, she says. Ilya Shkabara and Sergei Lobkaryov agree. “The size of rental charges is not a factor of success. What matters most is returns. A good project may provide good returns regardless of the size of rentals,” says Shkabara. In Sergei Lobkaryov’s opinion, the occupancy rate and a stable income are the keys to success.

Winners’ League

A combination of three factors – location, concept and reliable tenants – is the key to the profitability and success of a project. Another important factor is a quick payback on the project. In Moscow the average payback period is five to seven years, according to market analysts.

“If a developer meets that deadline his project is deemed successful,” says Galeyev. In addition to a return on their investments and initial profits, an investor gets new opportunities. For example, he can raise a mortgage loan at a bank. Such schemes are widely practiced today to finance new projects.

Most market analysts name all the projects by Enka as examples of successful office developments. One of those is an office compound on Paveletskaya Square, Paveletskaya Tower in particular. Other successful projects are the Aurora Business Park and Millenium where small offices measuring 50sqm are available for rent, albeit at rates $100 higher than in other office buildings in the area.