Money Growing: Offices for Cars

Frequently the keystone to success of such premises is a growth in the number of potential clients. One of the largest groups in Russia is motorists, and owners of service centers can use real estate belonging to them with maximum benefit.

“Such companies almost always have idle premises that can be leased, for example, as parts shops or as other premises from offices to beauty salons,” Yuri Eremin, head of the financial examination group at Finam, says.

According to him, "for potential investors investing in these assets, receiving a guaranteed flow of money from a car service business is stable enough, but the growth of an auto park guarantees its further development.”

In addition the expert notes that the potential investor becomes the owner of a liquid asset, which at their desire can always be re-orientated, for example, as a shopping complex.

Guaranteed demand

A car service center is, strictly speaking, a service center in which it is possible to receive a full set of services for the repair of your four-wheel friend. Therefore the popularity of such centers is directly connected with the popularity of cars. For the last 10 years, according to analytical agency Avtostat, the volume of the Russian car market has more than doubled from $12.8 billion to $34 billion. In 2006 alone in Russia, more than 1.7 million cars were sold, and in the first 10 months of 2007, 1.91 million new passenger cars have already been sold. This is almost one third more than the same period in 2006. In October, Russian motorists bought more than 230,000 new cars, which, in the opinion of experts, testifies to the fact that Russia is becoming a major player in the European car market. Only Germany sells more cars monthly with 282,000 cars, and in other large countries such as the UK, Italy or France, these figures are already less.

The share of the Moscow region now makes up more than one third of the total sales of new cars in Russia. Experts name the second largest market as St. Petersburg. In third place is the Samara region, and then the Sverdlovsk and Tyumen regions, with Tatarstan following. In total, the top ten regions make up about 90 per cent of car sales.

According to Merrill Lynch, this year Russia may become the second or third largest car market in Europe. According to their data, the volume of the Russian market by the end of 2007 will total 2.2 million cars, having increased this year by more than 25 per cent. Therefore, according to director for development at Swiss Realty Group Ilya Shershnev, "in Moscow there are now hundreds of car service centers of an average and large format.”

Difficulties of life

"To operate a modern car service center is a rather expenditure-high business. There are a lot of problems connected with the ecological instability of the business, for example the recycling of needless parts. The Moscow government earlier developed a special program to create recycling points, but has since abandoned it, and such enterprises do not offer the service any more. Bodywork centers dump tonnes of crushed plastic. All over the world plastic is used and then recycled, it is possible to create a secondary business. We don’t have such an opportunity,” says Boris Arzhannikov, technical director of the Avtopost-2000 auto service centers.

According to him, the difficulties of the business also depend on whether the auto service center is a chain dealer.

"In recent times it has become difficult for auto centers not to become dealers, because large auto-companies demand that any work on a car is done with equipment made by that company. Basically, they only want people to use dealer centers. Therefore if a large auto center opens in Moscow it tries to become someone's dealer. In return, the center has to adhere to some general rules, internal orders, properly organized customer service, and follow the requirements on equipment.

“Basically, some of these requirements are not always necessary to perform the work and do not affect the quality in any way,” the expert says. But, according to him, if you compare the prices of a dealer and non-dealer centers, the dealer will be several times more expensive because of its large expenditures. On the other hand, in Arzhannikov’s opinion, only dealers can receive the tools required for work on expensive western cars. However in any case, both dealers and non-dealers require additional financial resources.

Experts name one of the ways of attracting resources as the sale of non-profile assets, for example, the buildings of auto service centers. "Auto service centers can be assessed from the point of view of pure operational income, i.е. income minus all expenses, the assessment of the quality of the rental contract and the assessment of the quality of the tenant.

An important role is the possibility of replacing the tenant in an extreme situation, which for the given market can become a problem. Proceeding from these parameters the rate of capitalization is defined. “I think that for auto centers, taking into account all the risks, the rate of capitalization is about 11-12 per cent,” says Arzhannikov.

Examples of sale

Russian auto service centers have been a subject of interest to foreign buyers for a long time.

Institutional investors simply interested in receiving constant income and large profile players are both interested. In particular, St. Petersburg’s Olymp group has sold part of its business to English company Inchcape PLC, the assignee of which is MacKinnon MacKenzie Company. The company has started to sell off its automobile assets in the last year. In July 2006, Evgeny Voitenkov, the owner of Olymp, sold 75.1 per cent of shares in Aksel Car to Inchcape PLC for $72 million, which included Toyota and Lexus dealer and service centers in St. Petersburg. In February 2007, it became known about its intentions to sell the whole of Olymp for $200 million. Negotiations with Inchcape started at the beginning of the year, but no agreement could be made regarding price, and therefore Voitenkov has continued to sell the business in slices. In October 2007, he sold a 75 per cent share in his Peugeot and Audi centers for $43 million.

"As far as we know, such deals rarely take place. For now proprietors of such assets prefer to keep their property rights. There are cases of sale by this model of various independent auto centers, but they each have an individual character,” comments Eremin. Until now in the Russian market only one such transaction has been concluded.

British fund Rutley Russia Property Fund (RRPF), which focuses on investments in Russian real estate, has bought automobile and service centers belonging to Mercedes dealer M-Promservis.

The first deal on the purchase of such a center was signed in Aprelevka (Moscow region).

The fund has agreed to pay $20 million for it. RRPF then bought four more centers: two in Moscow, one in St. Petersburg and another one in Samara. Furthermore, RRPF has announced plans to invest up to $200 million in the construction of 30 new centers for М-Promservis in large cities of Russia. М-Promservis has retained the long-term rental rights of the former premises for a period of 15 years.

М-Promservis refused to make comments on its motives for the deal. As Eremin assumes, "for owners of auto centers such a sale is a way of receiving funds that can be directed on the expansion of the business or other purposes. The company is located in its own building, and is satisfied with the construction standard specifications. But its profile business has wider prospects of development and higher profitability in comparison with the real estate market. Then the company decides to "withdraw" the funds invested in the building to reinvest them and as a result receive more profit, but continues to stay in the building.

It is necessary to find an investor who will want to buy the premises and only lease it to the company-seller. For this purpose, of course, the building should be commercially attractive, and the seller - a reliable and stable company,” Sergei Kolegov, general director of Prime City Properties, says.

Sale and leaseback transactions are quite popular mainly in the retail real estate market. In the opinion of experts, owning real estate for an auto dealer as well as for a retail chain, is not a profile business, and it can invest obtained funds in the development of the chain.

Such transactions are popular among automobile chains in the West, however the majority of companies treat them rather conservatively. "Foreign practice differs from Russian a little: companies attract credit for the deposit of real estate, the release of bonds, and direct investments. However, abroad, franchise schemes are actively developing, which in Russia are not yet widespread,” Eremin says.

According to Shershnev, "sale and leaseback transactions are not popular yet. Unfortunately, there are not many well-structured assets and sellers that would like to use such financing.

But competition is forcing a large number of market participants to look for new ways of financing. I am sure there will be significant growth of return sale transactions in 2009-2010,” the expert says.

RRPF explains its interest in Russian auto service centers in the investment appeal of this business. "Many western funds buy offices, shopping centers or warehouses, but we are interested in real estate which not all potential investors are interested in but which has high income.”

Western players usually buy projects in Russia with a rate of return of 9-10 per cent. The profitability of our purchase is more than double that at least. Now it is an asset from which we pay only rent. But in seven years time when our fund is calculated to end, we will look at what we want to do with this asset - sell it or not. In the future we plan to conclude more of such transactions. This is a good investment of funds,” shares Khaiko Davis, the director of investments at RRPF

According to Eremin, as a rule, the value of the business is assessed based on the rent received for 6-8 years.

"Institutional investors need to invest in reliable assets. Reliability is guaranteed by the contract and paying capacity of the tenant. Institutional investors become mediators in the Moscow market with their own conditions. In turn, owners sell real estate to receive money. How they spend it will depend on their strategy, here there is no uniform practice," Shershnev says.

Back to the future

The future of auto centers is in sale and leaseback transactions, in the opinion of experts. "An important factor in increasing such transactions in the market may be competition. Auto centers need investments for development, and this type of financing may be one strategy,” considers Shershnev.

According Anastasia Litvinova, a consultant in the department of investment services at СB Richard Ellis/Noble Gibbons, sales and leaseback transactions can be important for all segments of commercial real estate. "In Russia, such transactions are not as popular as they are in European real estate markets.”

Proprietors of buildings, who occupy the whole building, basically built the premises "for themselves," prefer to invest "superfluous" money in real estate. But sales and leaseback transactions have certain advantages: they assume the transfer of future risks connected with real estate to the potential investor.

The sum obtained from the sale allows the owner to reduce bank loans and direct funds into the development of the business, and the tenant continues to supervise the operational activity of the building,” says the expert.

Sales and leaseback transactions have already taken place in all segments of the commercial real estate market in Moscow. "In 2003, Ericsson sold a building it constructed measuring 8,800 sq.m at 8 Marta ulitsa to Perm financial-industrial group but has remained there as the tenant. Also, in 2005, Fleming Family Partners bought an office-shopping building measuring 7,500 sq.m on Lesnaya ulitsa from Coalco and then rented the premises,” says Kolegov. There are also examples of such deals in the retail segment too.

According to Kolegov, last year Sedmoi Kontinent sold 4,000 sq.m belonging to it in the Atrium shopping center, and concluded an agreement with the new owner on the subsequent long-term rent of approximately 3,000 sq.m. Sedmoi Kontinent had bought these premises at the stage of construction of the shopping center. Among the first well known sale and leaseback deals Sayan Tsyrenov, an analyst in the Stock Market department at Cushman Wakefield/Stiles Riabokobylko, names the sale of the premises of the chain of drugstores 36,6 and the Tinkoff restaurants to Troika Dialog at the end of 2005 and at the beginning of 2006.

According to the expert, Troika paid about $10 million for the Tinkoff restaurants. There was also the deal on the sale of the building of hotel Heliopark Country to London Regional Properties for $20 million at the end of 2006. One of the largest of such transactions is the widely known sale by McDonalds of the building at Gazetny pereulok to Eastern Value Partners Ltd for $38.4 million.

"Generally speaking, until 2003 leaseback was obscure to Russian proprietors of real estate and their activity in this sphere was stimulated by the example of western companies. The main problem is that Russian companies are not in a hurry to sell real estate as such assets almost everywhere are continuing to rise in price making the transaction now appear less profitable than the transaction tomorrow," says Roman Phillipov, director of the corporate finance department at investment holding Finam. According to him, there is also a psychological aspect: the owner of real estate always feels more confident than the tenant. "In addition, it is necessary to consider the fact that leaseback is only one way of attracting investment," the expert says.

However, in the opinion of experts, for car service centers share financing is not a relevantly important way of attracting additional resources. According to market participants, such companies have only two ways: attracting direct investors with the sale of a share of the business or a sale and leaseback transaction. Therefore it is quite symptomatic that in this market two such large transactions have been concluded.

"However the returns on a premises acquired through sale and leaseback, are rather low, which reduces the appeal of such investments although it guarantees stable income from the premises. Therefore, first of all, investment funds act as buyers in them, says Tsyrenov.

Considering how many western funds have announced entering the Russian real estate market, in the opinion of the expert, the future of this segment looks rather promising. "Now leaseback is most relevantly important for retail chains for who additional resources are necessary for the maintenance of high rates of growth. They can be used in the office real estate segment," lists Phillipov.

Experts also think that the growing popularity in sale and leaseback transactions in the auto service center segment will be promoted by the popularity of such transactions in the automobile market. In particular, already many European companies offer lorries under this scheme. GE Equipment Services of General Electric buys and leases lorries in Germany, and at the moment its park already totals more than 2,000 cars. There are also such schemes in other European countries. However in Russia, this segment like many other segments of the market, is not developed yet.