Market know-how: Open to Investment

If You Have Cash to Spare Enter the Market

Private investors who do not feel good about speculative operations in housing but seek a stable income, are advised to opt for commercial properties, chiefly, on spaces suitable for various uses (detached, built-in annexes, first floor units providing a separate entrance, etc).

But the main challenge for the majority of would-be investors is the high threshold for entering the market. The investment required is at least $1 million, according to consultants. “That money can buy a unit measuring 100 to 160sqm not very far off from a metro station,” says Dmitry Roshchin, head of investment and valuation at the corporation Reskor. “But that option is by no means the best. For example, that could be an office situated somewhere between the Third Ring Road and the outer circular road (MKAD).” “The minimal investment required varies from district to district and also by type of property," notes Anna Guida, head of commercial real estate at Paul's Yard. “The closer it is to the city center the higher is its value. Shops are more expensive than offices.”

In 2006 even $700,000 could suffice for investing in retail, Vladimir Zhuravlyov, head of commercial real estate and investment at NAI Global, says. “In 2006 commercial property prices did not grow as rapidly as prices of apartments," Alexander Geniyevsky, deputy head of the Novy Gorod realty, agrees. “In spring those properties were quite cheap. Prices climbed up in summer and their growth continued through the fall, just as home prices stopped growing,” he explains. "Admittedly, even an amount of just $300,000 could buy something quite decent in the housing sector while commercial properties available for $1 million were of poor quality and returns on investment were low." Geniyevsky believes that the optimal size of investment required to enter the market is $2 to $3 million.

Returns on Hand

Returns on commercial properties acquired with a view of future re-sale could stand at 30% on average, and go as high as 40 to 50% for successful properties, Zhuravlyov says. “If he is very lucky the investor may secure returns of as much as 100% or higher, especially if he joins the project in early stages of construction," holds Maxim Zhulikov, leading commercial real estate expert at Penny Lane Realty. “The highest possible returns could be secured when investing in retail properties operating on first floors of centrally-located apartment buildings on busy streets of Moscow or in commuter areas within a walking distance from metro stations. In those cases location recedes into the background. What is truly essential is the shop’s proximity to bustling pedestrian zones,” Zhuravlyov notes. Thus, he concludes, high returns may be achieved by redesigning any favorably located property for retail use.

Returns from letting commercial properties stand at 12 to 13%, according to analysts at the company Blackwood. For example, the payback on shops in street retail is estimated at 3.5 to 6 years, they say. Geniyevsky believes this is the average and it is possible to achieve returns of 15% or even higher. But the market average is not a bad result for an investor. “In 2006 investors letting apartments could earn returns of approximately 5%, whereas commercial leases would bring them over 10%. A unit worth $9,000 per 1sqm could easily be rented out at $1,000, which is more than 11%," Geniyevsky says.

NAI Global estimates rents for street retail in 2006 at $500 to $1,500 per 1sqm per year. However, favorably located shops in Central Administrative District were let at rates as high as $2,000 to $3,500 per 1sqm. Sale prices ranged from $2,000 to $7,500 per 1sqm.

Anton Korotayev, leading marketing analyst at Russian Research Group, admits that with the market of built-in annexes remaining largely non-transparent the key players thereof are specialized firms or retailers.

Experts at Reskor are convinced that for tax optimization purposes and simplification of future resale acquisition of commercial properties by a registered legal entity is more advisable than by private individuals. After all the company may be founded by just one individual.

Reasons for Buying

Properties suitable for various uses are used chiefly for retail purposes. Clients willing to rent office space account for a relatively small share of applicants. Private investors follow the market trends. Shops are easier to let, rents are higher than the case is with offices, hence, investors’ interest. According to real estate companies’ estimates in 2006 up to 60 to 80% of small investors put up for retail.

Blackwood's analysts note that preferences are quite difficult to determine in each given case, but quite often investors buy into commercial properties. Their future use is determined afterwards, depending on location. As regards the properties situated in buildings facing the street, in main retail corridors, those units bring higher returns if let to retailers, although, certain companies, such as banks, travel agencies or notary's, willingly rent such units for office use.

When deciding on the use of their investment properties owners proceed from their characteristics. “Although properties designated for free use are not subject to any classification they may be divided into properties more attractive for investment and less," says Alexander Novikov, head of office real estate at Prime City Properties. “More attractive units are to be found in central locations, facing busy streets, in proximity to metro stations. Their price climbs even higher if they have presentable entrances, large showcase windows, convenient floor plan, high-end air conditioning and engineering systems. Those advantages push up the rent, and the project may back sooner.” Favorably located properties, for example, near metro stations, are usually let as shops; projects with poorer prospects are put on the market for sale, he concludes.

According to Miel Nedvizhimost’s estimates, 90% of landlords opt for letting their properties. The demand for built-in annexes exceeds supply significantly as investors are reluctant to get rid of their assets. “The company Miel, when planning to launch new sales offices in 2007, encountered difficulties when looking for suitable units," Aidar Galeyev, head of commercial real estate analysis and appraisals group at Miel Nedvizhimost, notes. “We see a solution in acquiring a unit on the first floor of an apartment house and having it reclassified for commercial use, with a separate entrance."

In 2006, the price of first-floor office space in residential estates grew 95.1%, according to Miel. By January 2007 the price of 1sqm of space in such buildings reached $5,667. Shop rents climbed by 80.1% while the average sale price grew to $5,672.

Targets and Timing

The most sought-after in 2006 were small units measuring 100 to 200sqm in favorable locations with good transport accessibility.

Properties on the outskirts of Moscow were especially attractive for investment, according to Russian Research Group. The highest increase in prices was registered for retail space on Yaroslavskoye and Varshavskoye motorways and office properties along Varshavskoye and Dmitrovskoye roads.

Investors with $0.7 to 1.3 million at their disposals are advised to focus on the less riskier secondary market where the threshold is lower, Zhuravlyov says. For major investors with $2 to $5 million to spare it is more appropriate to join new mall projects in construction stages, as modern retail centers remain competitive for a long time and guarantee stable returns.

Guida emphasizes the importance of the source of financing. “If the investor has received a low interest loan at a foreign bank his returns will be high both on the primary and secondary markets. But if he raises cash at a Russian bank, at high interest, the servicing of credit is likely to tell negatively on returns. In this case, it would be better for him to go to the secondary market,” she warns.

The stage of the project where the investor joins in is also important. If he bought a newly built apartment on the first floor, had it re-registered as a non-residential property, obtained permission for changing floor plans, built a separate entrance to the property, his returns would be higher than those off an investor who buys a ready-made unit on the secondary market, Galeyev says.

“Everything hinges on the investor’s propensity to risk," Blackwood's analysts are convinced. Investing in the project during construction stages brings higher returns but the secondary market is less risky. Anna Guida agrees. Pyotr Zharov, deputy head of commercial real estate at Sesegar Investment Group, believes that the times of high risks investors faced when joining projects in construction stages are gone. These days those risks are minimal. The rate of return on such deals has changed too “While several years ago the price of a completed development differed from its value before construction is completed many times , in 2006 a project with a 50% margin was considered a success,” he says.

When choosing between a completed property and or a completed projects with leases in place the investor proceeds from his potential, Novikov adds."For example, where a retail properties is still under construction pedestrian flows are not yet formed. But returns, too, depend on amount of risk,” he says. “Investments at construction stages bring higher returns, but these days such properties rarely go on the market. Properties on the secondary market are in colossal demand which exceeds the supply 3-fold. As a result, rents grow, as well as returns," Galeyev adds.

What Is in Store

Analysts do not expect the market of office and retail space to reach the point of saturation this year. Investors will show interest in both segments. The choice will depend on location, competitive environment and preferences of investors. Miel Nedvizhimost's analysts do not expect property prices to grow at the same rate as in 2006. Commercial real estate prices will increase by 20 – 25%, rents will grow by 15 - 18%. The demand for both office and retail properties will remain high. In these circumstances analysts advise investors to stick to their assets and direct efforts towards optimization of their portfolios.

Capitalization rates dropped in 2006 to 10-13%, Penny Lane Realty reports. Further decrease is anticipated this year.

Analysts at Russian Research Group believe that general trends will be preserved in 2007 but prices will not grow as rapidly as last year. The supply will grow gradually and new residential estates and projects for redevelopment and regeneration of industrial territories are finalized. Projects located outside the city center will still be the most attractive for investors, despite high risks.