Guiding Lines: Growth of Expectations and Prices

The situation with the cost of renting offices in 2007, reminds us of the situation with prices for apartments in 2006: they are growing at surprising speeds to analysts. According to the results of the third quarter, Cushman & Wakefeild / Stiles & Riabokobylko (CW/SR) say that the asking rental rates for the best, just constructed spaces have reached $2,000, and in office blocks where tenants have left, proprietors have offered new clients prices of $2,500 already.

At Jones Lang LaSalle (JLL) the situation is assessed as more calm – according to their data, the maximum cost of rent in October has remained at a level of $1,500 per sq.m a year (excluding VAT and operating costs).

It is difficult for investors to adequately assess the market, Bruce Gardner, partner of International Logistical Partnership, complained at Vedomosti’s IPO and Borrowing Tools conference last October. According to him, what we call the commercial real estate market in Russia represents a certain virtual model. Players – already operating or only just entering the market – calculate the potential profitability more often from prospective figures, rather than from the currently existing state of affairs.

For example, in 2006, it had been announced that 2 million sq.m of office space would enter the market – in the end it was somewhere around 0.6 million sq.m. A deficit, and even more circulation in the press and consultants’ reports of data about the not decreasing unsatisfied demand, has affected rental rates. By the end of the third quarter of 2007, JLL says that rental rates had risen on average by 25 per cent, and by the end of the year an increase of 50 per cent is expected. Status premises like Voentorg, which is expected to be put into operation in this period but has been delayed, will be much more expensive to tenants for unclear reasons. Probably, it depends on the agreement between "late" tenants and the proprietor.

Analysts at Colliers International go one higher than their counterparts - in their opinion, in October there was an average 30 per cent rise in the price of rent, and on occasion, rates have increased 50 per cent. Colliers also do not doubt that rental rates will increase to the end of the year. It is obvious that the time of record prices in the office real estate market has not ended. Demand remains high - this phrase is from a report by CW/SR analysts, and in their opinion, will not change until 2010. At Russian Research Group (RRG) potential demand is calculated using the “modern measures" of the average provision of office space in the city. According to them this should be 9-10 sq.m per person. Now in Moscow the office segment is calculated approximately for 3 million employees. "And the population of the capital is 10-12 million, plus 2 million visitors and the personnel of western companies entering the Russian market," Denis Kolokolnikov, general director of RRG, calculates. And then he corrects himself: "This, of course, is a rough calculation."

Nevertheless now "the market remains purely profitable for owners of office buildings," says CW/SR. According to their data, in the third quarter of 2007, 345,000 sq.m of office space was bought or rented, and from January to October this figure stood at 1.2 million sq.m – the amount for the whole of 2006.

The supply of modern office space, says JLL, from January - September has increased by 950,000 sq.m. CW/SR specifies that in the third quarter alone more than fifty new office buildings have appeared in the capital, which is approximately double the typical amount of construction. The number of vacant premises has increased from 2.3 per cent at the start of the year to 3.2 per cent in October, and for class A and C to 4.5 per cent, and to 6.5 per cent for class B. "The amount of vacant class A space is growing because of the high rental rates," recognizes Denis Sokolov, a leading analyst at CW/SR. Rental rates in 2007 became the defining factor for clients in choosing new offices, taking over popular requirements a year earlier such as prestige and location.

Sokolov predicts that eventually tenants will economize even more often. And the first victim of such economizing is quality: preference will be given to lower quality and therefore to cheaper premises. The result of this will be accelerated growth of rates for class B offices and a deceleration of growth in the rental rates for class A premises.

Knight Frank names an increase in transactions for the sub rent of offices as another trend that is gaining strength. Analysts at JLL emphasize that demand for small premises is constantly growing. In the Moscow market a new type of business has been formed: individual companies rent large premises to divide them into small areas, which they then rent to subtenants. Vladimir Pantyushin, head of the department for economic and strategic research at JLL, advises developers to not close their eyes to the needs of small tenants and to provide the possibility of "partial allocation of space" in the realization of projects for their needs.

Decentralization of the office market also remains one of the main tendencies. Although Knight Frank notes that in the capital there are still areas that have not been demanded by tenants and consequently not developed by developers. These include quiet areas near the MKAD, the east, southeast and part of the north of the city. But quality offices, including those for Muscovites, are under construction in the Moscow suburbs.