Money Growing: Hostages of the Deficit Pay

In the first quarter of 2008 alone, the rent for quality areas increased 10 per cent. Experts give different reasons for the lack of supply: problems with financing, unprofessional developers, construction and administrative obstacles, the sad coincidence of circumstances. Up to 70 per cent of office premises are put into operation later than their announced date due to the untimely receipt of the ownership certificate, adds GVA Sawyer. In any case, a deficit of good offices and inflation stimulate the growth of rental rates. Should we be worried that proprietors will terminate preliminary agreements to then rent out the areas at a higher rate? Brokers say it is unlikely many will resort to such a way of business dealing, but where rental contracts are renewed after expiring, an adjustment seems essential.

An open book

Ashot Barsegyan, head of commercial real estate at MIAN Real estate Agency, estimates the increase in rental rates for class A offices in the center in 2007 at more than 40-50 per cent. According to Knight Frank Russia & CIS, in the first quarter of 2008, the rental rate increased on average by 4-7 per cent: up to $1,180 per sq.m a year for class A, $835 per sq.m a year for class B+ and $520 per sq.m a year for class B- premises. This is excluding operational charges and VAT. Rent for quality offices in the center of Moscow is $1,700-$2,000 per sq.m a year, and according to Barsegyan, the maximum rate here is $2,000-$2,500 per sq.m. It is no wonder that comparable-quality variants in the area of the Third Transport Ring or the MKAD are highly demanded by tenants, as they are several times cheaper ($450-$900 per sq.m a year).

Prices are continuing to grow in the Russian capital "in all respects": according to Andrei Dvoinykh, a leading analyst at consulting company Russian Research Group, the increase in rental rates in the first quarter was 10.8 per cent, and outside the Garden Ring was 15.9 per cent. As for the sale prices of offices outside the Garden Ring, they have also risen even more significantly than in the city centre, by 9.2 per cent and 7.7 accordingly. At the end of the first quarter the asking price per sq.m within the limits of the Garden Ring was $14,242, and beyond it was $5,313. "But on the whole for the year the rise in prices was only a little higher than in the center (56.6 per cent against 46.8 per cent)," says Dvoinykh.

Under the forecasts of Maxim Zhulikov, a leading commercial real estate analyst at Penny Lane Realty, in 2008 offices for rent will rise in price by 20 per cent. Knight Frank gives the same forecast. According to Olga Yasko, regional director of the analytics department at Colliers International, there is a big difference between the announced rate and the rate at which contracts are actually signed. It is still currently "a proprietor’s market," summarizes Barsegyan.

Proprietors of quality premises are even more often moving to the open-book system of payment, notes Knight Frank as an important trend in the way operational charges are calculated. "In this case operational charges are included in all possible payments, tenants are appointed an average rate, and at the end of year they are recalculated and deduced by actual individual expenses. This prevents unreasonable charges from both parties," explains Konstantin Losyukov, director of the department for work with tenants at Knight Frank Russia & CIS. However there is a flip side to this model: "Often the proprietor (the operating company) tries to include everything it can possibly imagine in the list of ostensibly given services. Tenants risk paying much more than planned, in fact they practically don’t manage this process."

Zhulikov, however, thinks that the open-book system is a good practice. "In composing working costs – variable things - reasons are given and quotations on these or those services to the tenants are known. It is not like at a restaurant where it is possible to get a bill double what was expected when the prices aren’t specified on the menu.”

The expert pays attention to the fact that developers are more often including unconditional adjustments in contracts. And if a rental contract signed several years ago at lower rates comes to an end, in the new agreement the rate will sharply be brought into accord with market prices. "If it was $600 per sq.m it will now be $1,500 per sq.m," says Zhulikov.

Also, in connection with the weakening US dollar, proprietors are more often setting an artificial dollar exchange rate in relation to the ruble, usually 24-28 rubles/$. Some even prefer to calculate the rate in euros, notes Knight Frank.

No vacant places

According to DTZ Russia, at the end of the first quarter of 2008 the total amount of quality offices in Moscow reached approximately 6.85 million sq.m (of which 1.25 million sq.m were class A and 5.6 million sq.m were B). In the first three months of 2008, 313,000 sq.m of class A and B offices were put into operation. "If all the projects announced for 2008-2011 will enter the market, the volume of quality office premises in 2011-2012 will double," considers Knight Frank.

About half of the new supply in the first quarter of 2008 were class A premises, according to Yulia Bogomola, an analyst in the research department at DTZ. This is connected with large buildings such as the West Tower, (rented office space – 80,800 sq.m), which is part of the Federation complex, the first phase of the Northern tower, (48,500 sq.m), and Silver Citi (38,500 sq.m) being put into operation. In the center the scales are more modest: Neglinnaya Plaza multifunctional complex with a rentable office area of 9,700 sq.m was completely rented out under preliminary contracts in 2007, adds GVA Sawyer. The construction of a business center at 11 Nikoloyamskaya has been completed (the developer was Borodino), and its total area is 10,000 sq.m.

Colliers "unexpectedly" names the state commissioned Citidel business center on Zemlyanoi Val which will be put into operation in the second quarter of 2008 (earlier planned for the second quarter of 2007 and then the first quarter of 2008).

In the first quarter of 2008 the average level of vacant premises in class A buildings was 5.4 per cent (compared with 7.1 per cent at the end of 2007), in class B+ buildings it was 3.6 per cent and in class B- buildings was 3.2 per cent (the same level in comparison with the end of 2007), says Yasko. Knight Frank estimates vacant areas in class A premises at 1.05 per cent and in class B at 5.4 per cent.

"The level of vacant areas may grow by the end of the year by 1-2 per cent in connection with an increase in supply, however the situation will not radically change,” assumes Dvoinykh. “It will be 2-3 years before the market becomes saturated." Even though by the end of the year about 1.3-1.5 million sq.m of office space is expected to be put into operation, demand will grow at practically the same rate as supply, specifies Barsegyan, who does not expect saturation earlier than in 5-7 years.

To take the lead

On entering the market, premises are swallowed up in an extremely short period of time. In the opinion of experts, it is especially difficult for companies that need large areas from 10,000 sq.m. However, demand for offices measuring 200-300 sq.m also considerably exceeds supply.

As a result the number of transactions concluded at the stage of construction are increasing. A preliminary contract may be signed at any time from the moment planning permission has been received, explains Anastasiya Khomenchuk, head of the department for tenant relations at DTZ. For example, last year PricewaterhouseCoopers rented 32,450 sq.m in the Belaya Ploshchad office complex on Lesnaya ulitsa (to be put into operation at the end of 2008 to the beginning of 2009), and Procter Gamble has rented 18,000 sq.m in the Metropolis business center on Leningradskoye shosse (to be completed at the end of 2008). According to DTZ, almost half of the volume of offices are swallowed up under preliminary rent or sale contracts.

In the first quarter of 2008 the largest rental transaction for office space in Moscow, according to GVA Sawyer, was the preliminary rental of 37,000 sq.m in the class A Western Gate business park by multinational corporation ВР. The complex will be constructed by the first quarter of 2009. According to the company, the largest preliminary sales transaction also happened in the first quarter of 2008: German investment fund KanAm Grund Kapitalanlagegesellschaft bought the office segment of a multipurpose complex on Kozhevnicheskaya ulitsa (approximately 101,000 sq.m of 110,000 sq.m), which is currently under construction, from Otkrytiye-Nedvizhimost (Open Real Estate). Construction will come to an end by the second quarter of 2009. The deal was estimated to be worth $900 million. Quality offers rarely appear, and prices are growing, Dvoinykh says as an explanation for such haste.

The financial crisis has helped: even large developers are prepared to consider offers of investment in projects, on the sale of a share of new projects that earlier were not observed, says Irina Dzyuba, the sales manager of MR Group.

"Undoubtedly, renting a premises in a building under construction, a company bears additional charges for furnishing the premises (in the best case scenario the landlord will cover a third of furnishing expenses), and there is a serious risk of additional costs connected with a delay in the completion of construction," says Bogomola.

But, as a rule, tenants don’t lose if the preliminary contract is drawn up correctly, experts consider. "At the stage of construction the price is 15-25 per cent lower," reminds Barsegyan. Rent in a completed premises can be 30-50 per cent more expensive than in a building under construction, says Khomenchuk.

If the completion date is postponed the tenant can theoretically refuse to rent it, but more than likely the proprietor will prefer to terminate the rental contract concluded in advance and rent the areas out at a more profitable price, assumes Losyukov. But, as one broker expresses, "there are no such ugly creatures."

Zhulikov is sure that when an owner announces the completion date at the stage of construction, it does not do it casually and understands that there will be a certain discount in comparison with the market. The presence of well-known, large tenants involved at the design stage, can raise the investment appeal of a premises, and help position the project as a high-status, high-quality product, Yasko adds. It also opens up additional ways of financing construction, says Khomenchuk. In refusing a specific tenant, the proprietor may come across difficulties in renting out those premises to another company.

However, such cases nevertheless happen. At the end of 2007 the conclusion of a rental agreement announced by STS Media for 12,000 sq.m in the Profiko business center (promised to be commissioned in the second half of 2008) collapsed, one consulting company says. The press-service of STS says in brief comments about the fact that the company will not be located on the 14th-26th floors in the business center at Krylatskiye Kholmy: "This is nothing unusual. The conditions of rent have changed and are now not interesting to us." That means: rates have dramatically increased. And Siemens may lose its headquarters in the still uncompleted building on Leningradsky prospekt if it refuses to pay more: under a contract in 2005 the price was $187 million, now it is $305 million, Sistema-Gals, the develop, has announced on a valuation by Cushman Wakefield/Stiles Riabokobylko. The reason is a rise in the price of building materials. "The cancellation of preliminary contracts to obtain additional profit rarely happens. A proprietor who is not on its first or has only one project, values its reputation and the trust of its potential tenants,” summarizes Khomenchuk. “Empty, completed premises incur losses and at high rates in the market."