Money-Growing: Office Supply to Last for Three Years

No Chance to Fail

Investing in office development these days is seen as the most rewarding venture, says Zafar Umarov, head of the Akropol realty. The demand for new office space soars. Only a few years ago newly built prime office properties remained vacant while the demand was enormous. When the construction of first business centers began in the city most properties were snapped up by tenants long before those projects were finalized. “No wonder that so many companies moved to fill the vacant niche,” Umarov explains.

Only those who do not feel like it are not involved in office construction nowadays, Timur Tagirov, head of the Hermitage realty firm, agrees. Many developers are convinced that building office centers is fairly easy, much easier than, say, retail centers as there is no need to develop a concept, hold talks with future anchors or hunt out locations with heavy customer flows. Any building is likely to succeed as long as it is raised in a a central location or on a thoroughfare, they believe. No wonder that office properties hold the lead among commercial projects developed over the past years.

On the face of it, office projects may seem safer than shopping centers, says Oleg Lugovoi, president of the Siberian Guild of Managers and Developers (SibGUD). But in truth risks are by no means lower and arise from a variety of factors ranging from poor location to relations between landlords, changes in city environment (a new construction launched nearby, for example), etc. Today those factors are not crucial, as the market still has not reached the point of saturation. But in the future even one single negative factor may suffice to considerably undermine the positioning of a project and its returns.

Up until very recently (shopping centers Gigant (28,000sqm) and Moskva (22,000sqm were launched in December 2005), Novosibirsk developers opted solely for office projects, Sergei Sidorenko, managing partner at DSO Consulting agrees. In 2005, nearly 50,000sqm of office space were developed in Novosibirsk, excluding 20,000 to 25,000sqm of built-in properties (on first floors of residential blocks) redesigned for office use. But already in late 2006 -- early 2007 as many as 300,000sqm of new office space are expected to hit the market. Sergei Sidorenko believes that with so many office properties finalized simultaneously a decrease in rents is highly likely. To begin with, rates will stabilize and then, by late 2008 or so, reduction will begin. At first the decrease will be scarcely noticeable, as landlords will be offering additional services free of charge, he says.

Over the past twelve months office rents grew approximately by 10 to 15 percent, says Yelena Belanova, real estate specialist at the Doktor Klyuch realty. A psychologically important barrier of 1,000 rubles per 1sqm, considered exorbitant in early 2005, was easily taken last fall. The most expensive, centrally located office projects, between Lenin Square and Kalinin Square, are rented at 800 rubles per 1sqm per month, and over. Small offices in newly built office centers are increasingly often let at 1,100 per 1sqm per month; class C offices (Soviet-era administrative buildings redesigned for office use) are available at 400 rubles per 1sqm per month and over. Over the past years rental rates grew by no more than 10 percent, while sale prices grew 20-25%, says Sergei Ilyin of Akropol. Offices in projects under construction are sold at lower prices. For example, office space at the business center on Kalinin Square (to be finalized in 2006) is sold at $1,630 to $1,850 per 1 sqm; offices at business centers already finalized are sold at $3,000 per 1sqm, and over. A business center at 28 Derzhavin Street offers only two offices for sale, measuring 56sqm each, at $3,900 per 1sqm.

As sale prices grow faster than rental rates, landlords face lower returns as early as today, Zafar Umarov concludes. This pertains chiefly to small investors who have ventured on acquisition of office space with a view to renting it out, he explains. With cost of construction soaring developers of small office properties now have to wait longer for a payback on their investment -- 6 to 7 years, nearly as long as their Moscow colleagues, while earlier the payback period here took 4 to 5 years. The demand for office space in business centers is generated by small investors – apartment owners, who, instead of investing in more residential space, switch to office investment. While prices grow the number of tenants does not increase, Umarov says. The Zaeltslovskaya investment building firm involved in office development reports that investors who purchase offices with a view to renting them out afterwards, not for own use, account for over 60 percent of the company’s clients.

Class B

Most of the offices under construction nowadays fail to meet class A standards despite their owners’ claims and belong rather to class B properties of good quality, says Zafar Umarov. Poor location, inconvenient entry driveways and shortage of parking facilities, both for tenants and visitors, are the main reasons preventing those business centers from being upgraded to class A, Timur Tagirov agrees. Besides, to be ranked as a class A property an office center must be run by a professional management company, while most business centers in Novosibirsk are managed by small firms whose professionalism leaves much to be desired. For example, security services they provide turn office buildings into heavily guarded estates, creating serious problems for visitors, he adds.

Umarov anticipates harsh competition between those business centers in the future. Offices there are usually rented at 800 to 850 rubles per 1sqm. The rate of 1,000 to 1,100 rubles is exorbitant. The most expensive offices in class B segment are Golden Plaza and Novograd where monthly rents stand at 950 to 1,100 per 1sqm, says Sergei Ilyin. Landlords at the 6,600-square-meter Golden Plaza, a project by Sibakademinvest, a development firm affiliated with Sibakadembank, put down high prices to quality of office space. “By many key parameters the building is nearing class A standards, which is highly appreciated by our tenants, with such firms as Ernst & Young, Sibakadembank and Soci?t? G?n?rale Vostok among them,” says Yelena Mamoshkina, rental manager at Golden Plaza. “Most tenancies are long-term deals, for up to 5 years.”

The Novograd company has already lowered rental charges at the office and retail center of the same name (where offices occupy five floors out of seven) from $50 set initially to 850-1,000 rubles per 1sqm per month. The company explained the move by discounts for major tenants. “Where a tenant takes up a large office the rent drops, while 80 percent of offices at Novograd are rented by seven large companies,” Roman Medvedev, deputy head of Novograd, has explained. But, real estate consultants point out, the major shortcoming of Novograd is the lack of a guarded parking lot. “Spaces are available only on the adjacent Yermak Street where no one can guarantee your car’s safety,” Sergei Ilyin notes. “Nonetheless, offices at Novograd are in demand given its unique location, on Krasny Prospekt, with direct access from the street.”

Oleg Lugovoi believe that the future belongs not just to advantageously located business centers but to those run by professional management companies. Business centers owned by a single landlord have more chances to withstand competition. “Co-owners fail to agree on their tenant policy or hire a professional manager for their estate; they can hardly avoid conflicts,” Lugovoi says. “Nowadays we see a high demand for office freeholds encouraging developers to sell, and the number of owners goes as high as 100 [at some of the business centers]. Later they will no longer be as attractive to tenants.”

Business Center at 52 Lenin Street, owned by the Transservis oil trading company, is, perhaps, as one of the best among class B developments in the city in terms of price/quality ration, says Sergei Sidorenko. The complex is conveniently located, near a train station and belongs to a single owner, who provides management services. Offices are rented at affordable rates of 800 to 850 per 1sqm, Sidorenko notes. The 9-storied office project measuring 10,000sqm and estimated to be worth 140 to 150 million rubles, at 52 Lenin Street, was finalized by Transservis in October 2004. Offices were rented by the Kuzbassrazrezugol coal mining company, Kelly Services human resources agency and others.

Originally, Transservis had planned a prime residential estate on the site but its proximity to a busy motor road could create inconvenience for would-be tenants. After all, the location on a square near a train station is more suitable for a shopping mall or an office center, Alexander Boiko, the company’s chief executive explained. Transservis is set to pursue more office projects in the city. The company has launched construction of its second business center of 30,000 to 35,000sqm, on Krasnoyarskaya Street. The projected cost of construction is $20 million. The new development will feature a spacious parking area – seen as the key competitive advantage of the project – providing 1 car space per every 53 square meters of office space. With offices to be rented at 850 rubles per 1sqm, the company expects a payback in six years.

Availability of parking space is likely to play an increasingly important role for office tenants, developers at the company Mustang Invest believe. Mustang Invest has built the 6,000-square-meter Parus business center on Ippodromskaya Street. The development is designed to meet the needs of those who travel there by car: to begin with, it is situated on one of the busiest city roads; secondly, it is possible to get to any floor by the means of a special drive-in facility adjoining the building, says Natalia Ponomaryova, director of the company. “The investment amounted to $2.8 million, all offices were sold out at early stages of construction,” she says. The company is now looking for new building plots to develop analogous projects.

The Zaeltsovskaya company, too, continues to build offices across the city. In 2003, the company finalized a 14,000-square-meter office project on Derzhavin Street. These days, Zaeltsovskaya is about to finalize the development of its second business center, on Frunze Street, measuring 6,000sqm. Offices in both projects were offered for sale before the end of construction. The last properties available on Frunze were sold at 40,000 rubles and over, the company reports. Zaeltsovskaya’s next project is a 9-storied office center, with a 90-space car park, at the corner of Kropotkin and Ippodromskaya streets. The first three floors will provide retail areas, upper floors will provide class B offices measuring a total of 4,000sqm, to be rented at 700 to 900 rubles per month, according to realty experts.

Region-Rezerv continues to develop vacant areas in downtown. In early 2006 the company finalized the second phase of a business center on Gorky Street – a 10-storied building of 4,200 sqm, where all the units were sold out at 37,000 to 60,000 rubles per 1sqm. The first stage of the complex – a 7-storied tower measuring 2,780sqm – was commissioned in 2004. The Sayl company has put up for sale offices in its 14-storied development measuring a total of 6,000sqm, at the intersection of Krylov and Shamshins Street, at 39,000 to 50,000 rubles per 1sqm. Earlier, Sayl was involved solely in housing development. Valery Aksyonov, chief executive at Sayl, says that only 50 percent of bids come from companies seeking properties for own use. Others are investors who plan to let offices afterwards.

Aware of the demand for office space in the city, the Russkiye Oteli (Russian Hotels) company reconsidered its plan to build a 4-star hotel here. Originally, the company planned a 10,000-square-meter hotel providing 150 to 200 rooms, estimated at $10 to 12 million. Six months later the company revised its plans and decided to build a 16,000-square-meter office complex providing 10,000sqm of class B office space and a 4-star hotel. The project is estimated at $13 million. The business center will pay back quicker, within 4 to 5 years, the company explained, as the demand for office space is stable and high, whereas the payback on the hotel project is expected in 8 to 12 years. The project is to be finalized in 2007 to 2008. Offices will be let at $30 pre 1sqm per month.

Non-real estate companies, in particular, the local energy company Novosibirskenergo, too, have been attracted by high returns on office projects. Stroitel, Novosibirskenergo’s 100 percent owned subsidiary, acts as developer and co-investor of a class B business center on Sverdlov Street, measuring 50,000sqm and estimated at 26 million euros. The project will be partially financed through a loan by Nova Ljubljanska banka, Slovenia. Slovenian unit of the Swiss firm Smelt Intag is a general contractor for the project. The future business center will provide a 2-level underground parking lot for 250 spaces. Construction works on the site began last fall and are to be completed in 2007. Originally, the developer planned to sell all the units in the complex but then revised the plan. Most offices will be let, says Olga Filipenko, head of investment at Stroitel. First deals will be signed in 2007. The management company will also be named next year. Stroitel does not rule out establishing a management company of its own, she adds.

Banks, too, have shown interest in office construction. The Novosibirsk branch of Lanta Bank has built an office for own use, featuring a class B business center. The bank plans to build a 16-storied office center (18,800sqm) next to Lanta Bank’s office on Kirov Street. The project estimated at $19 million is currently on the drawing board. The general contractors are Lanta Bank’s subsidiary Otdel Razvitiya and Bars 98. One-third of the offices will be sold, other units will be let. The bank plans to establish a property management company to run the building.

Class A

Three major development companies have been active in class A office development, a niche that remains largely vacant in Novosibirsk. In early 2005 RosEuroDevelopment announced plans to build a class A business center in the city. RosEuroPlaza – a 16-storied building of 30,000sqm – near the Krasny Fakel theater is to be finalized by late 2006. The project is estimated at $35 million, Natalia Korotayeva, commercial director at RosEuroDevelopment, told Vedomosti. 15 percent of office properties have already been let at $410 per 1sqm per year.

RosEuroPlaza is likely to face competition from a local developer Trud, involved in construction of two class A business centers – a 22-storied complex of 15,100sqm, worth $20 million, to be finalized in late 2007 and a 14,500-square-meter business center, developed as part of the community and commercial center Manhattan (60,000sqm, $65 million). Both projects will be run by a professional management company to be elected through a tender scheduled for 2007, Trud reported.

Moscow-based ST Group Region is planning a class A development in the city. “The ST Plaza complex will measure 45,000sqm, including 30,000sqm of office space. It will be built on a site of 0.34 ha on Kondratyuk Square,” Dmitry Shmelyov, commercial director of ST Group Region reported. Building works are to begin in mid-2006. The project to be finalized in late 2007 will cost at least $27 million. Offices will be let at $400 to $450 per 1sqm per year. “Novosibirsk needs top class offices, existing projects are not likely to satisfy the demand,” Shmelyov says.

Head of consulting at Knight Frank realty, Konstantin Romanov, believes that business centers ST Plaza, Kobra and RosEuroPlaza will face no open competition in Novosibirsk. The demand for class A office space is growing as investors from the capital and other regions arrive in the city. But, in order to prevent a market collapse those centers should be launched at least with a 6-month interval, for projects already launched will provide enough space to satisfy the market demand in the course of three years to follow. Still, the demand is growing and the city is short of approximately 130,000sqm of prime office facilities.