Market Know-how: Untransparent Crisis

In Russia, anyone who has bought land and employed a couple of people proudly calls themselves a developer. Therefore the liquidity crisis, which has captured the world markets and corrected the strategy of foreign funds and investment banks in relation to real estate, will become apparent quite furtively in Russia. It is like, it is a big thing, but nobody will admit their problems publicly.

Where’s the money?

"The crisis has struck Russian bank’s brains no less than it has struck their purses, many of which who were previously willing to provide financing, are now taking a pause," says Grigory Takoyev, executive director of KomStrin. According to him, Russian banks had a constant inexpensive and long-term resource in the form of western credit and became accustomed to wide margins, having given credit to developers at more expensive rates, but are now compelled to suspend this approach to this sort of activity. "Now banks arrange mainly short-term liabilities, which are mostly related to urgent deposits of physical people (such funds are usually provided for a maximum of 2-3 years)," notes Takoyev.

Member of the board of directors at UniKredit Evgeny Retyunsky confirms that the long-term credit needed by developers, is now almost nowhere given, as "banks do not have the funds.” The emphasis today is mainly on short-term credit. But while the period of credit has reduced, rates, on the contrary, have grown: according to different estimations, by 2-6 per cent per annum. Developers admit that at Sberbank, even for the most reliable borrowers, the minimum threshold is now 12-13 per cent per annum, and other banks have started to talk about 15 per cent. And in fact, an increase in the interest rate of credit of just 2 per cent is a huge additional expense for the borrower.

For example, in the warehouse real estate market to cover this increase, the rental rate should grow $15 a year (this is approximately plus 10 per cent only on account of the growth in the cost of financing). The situation can have a negative "continuing effect": even if the market normalises, it will have grown accustom to financing at higher rates, and in the long term these rates will hardly fall. A downwards correction in rental rates id still quite probable. "Its not easy to stop the construction process once started, projects that started in 2008 will be completed by 2011-2013,” says Sergey Budlyin, general director of DC Development. “But the economic efficiency of projects was calculated from preconditions of the preservation of rental rates at a today's level. One script of development as a result of the crisis in the commercial real estate market is the stagnation of rental rates. The worst scenario is their collapse."

Alla Soloveva, executive director of International Logistical Partnership, adds that the ratio between own and additional funds has changed (not in favour of developers); now (for credit) the borrower should prove to the creditor that it has 35 per cent of the stated cost of the project, rather than 30per cent, which was previously required. The negotiating process takes much more time: discussions on the borrowing conditions for credit for a project belonging to International Logistics Partnership in Novosibirsk took three months, though earlier this process would only take about a month, says Soloveva as an example. Moreover, she continues, even when a contract has been signed it is not easy to get the money: banks invent additional conditions, new formalities, delay the decisions of current questions.

Retyunsky says that as the bond market, through it is also possible to attract funds, is not working, this is also aggravating the situation. The internal bond market is open only for large companies, analysts at Renaissance Capital recognize. For example, LSR group successfully placed 5 billion rubles at a coupon rate of 13.25 per cent. Mirax Group, having cancelled a 1-billion ruble bond in August, has announced that in the fourth quarter of 2008 it will again be ready to offer investors bonds. In the company’s widely distributed press release it was especially emphasized, that "there are no strict requirements," the only thing Mirax considers important is to be present on the public loans market.

IPOs, which were fashionable last year, apparently, have completely lost their appeal. Dmitry Shmelev, sales manager of at Snegiri Development says that because of the crisis in the world markets many companies that had planned IPOs, have received offers from investment banks, pension funds and hedge funds "with a significant discount in relation to their proven valuation, compelling the companies to make a decision on its transfer." This decision has also been made by Snegiri Development although Shmelev emphasizes, that the company has not rejected its previously announced plans.

Bankers recognize problems with financing. On the condition of anonymity one says that many banks in general refuse to give credit to developers. "The situation is so difficult that there now actually remains only one way of attracting funds - to find a partner which will buy either the project, or part of it. This year the number of sale transactions of projects has increased several times in comparison with the last few years," said the source. Irina Dzyuba, sales manager at MR Group, notes: "Earlier developers reluctantly left land plots, now practically all of them are considering the possibility of selling the projects or their joint development with a partner." Takoyev says that the number of sites offered to his company by various intermediaries has recently increased by approximately a third. But the starting volume of investments in the purchase of a project is unfairly large, which frightens off potential buyers. Shmelev states that Snegiri considers 20-30 various sites a month.

Who buys?

Analysts at Renaissance Capital say that in the first half of the year alone there were a minimum of 33 large institutional transactions for a total sum of no less than $5.1 billion (published cost). Most of the buyers were foreign companies or funds. According to the estimations of JLL, in the first half of last year investments in Russia totalled $1.3 billion and in the same period of 2008 grew 242 per cent to $4.45 billion. The results of a survey of the heads of foreign companies carried out recently by analysts at PricewaterhouseCoopers testifies: Russia, and above all, Moscow, is still tasty for potential investors; the greatest interest for them is in the retail real estate sphere, although other segments are also rather attractive. "Here there are huge opportunities, but greater risks," one of the interviewees said. According to JLL, the average profitability, for example, of quality office assets in Europe in the second quarter of 2008 was not much more than 5 per cent, while in Moscow this parameter is equal to 8 per cent.

Who has problems?

Developers do not say how they solve their problems: as one of them expressed, this knowledge has now become a very expensive skill. Some are compelled to build in the hope that they win a share of the market, some to get credit to reinvest in other objects, some more successfully struggle with banks and some reject new projects. Developers who do not have their own funds are compelled to look for a buyer early on in the stages of realization of the project, says Maxim Gasiyev, regional director of retail real estate at Colliers International. Fifty per cent of the investor’s funds are paid immediately, and the other fifty per cent are paid at the end of the project. Gasiyev admits that Colliers is now conducting three such projects. According to him, when a foreign fund does a forward purchase, he doesn’t allow the developer to raise the rental rates: the developer rents out the premises and leaves the project, and the proprietor remains and will be forced to bring the rates, if necessary, into accord with the market.

Sergey Gipsh, managing partner at Colliers International admits that the rental market of offices is currently speculative. Unprecedented growth in rates is leading companies to reject prestigious and expensive offices, in preference for simpler and cheaper places. ADG Group, had planned to occupy more than 1,000 sq.m of office space in the new class A Metropolis multipurpose complex (Leningradskoye shosse, developer - Capital Partners), but has refused to move,” informs director of marketing Vadim Vasilev. The company has remained in the premises of the Moskva furniture factory, reoriented offices outside the Third Transport Ring, which are more than twice cheaper to rent.

According to Oleg Ivanov, general director of Dekra group, developers who, being guided by the growth of the market, have started projects, and are either completely or to a large degree counting on attracted funds, have suffered the most: "Banks willingly gave out credit, and there was an opportunity to start semi-liquid projects that are not unique in the market and not thoroughly thought through, and thus expands business."

What will happen with market?

The absence of financing has already affected the market. Retyunsky notes: "In Moscow this year the speed of construction has decreased and some projects have frozen." The words of a banker at Rosstat confirm this: in the first half of this year alone the volume of housing commissioned in Moscow decreased by 50 per cent.

As for commercial real estate the forecasts of analysts are also far from optimistic. Instead of the planned 1.2 million sq.m of warehouses in the Moscow region in the best case scenario a quarter of that – 300,000 sq.m – will be commissioned, consider experts at International Logistics Partnership and Evrasia Logistic. More than likely the capital will not expect the promised 2 million sq.m of offices and 1.5 million sq.m of retail space. According to analysts at Colliers International, in the first half of this year 840,000 and 131,000 sq.m accordingly, were commissioned. Experts estimate the potential space of new shopping centers at a level of 700,000 sq.m.

Of course, the crisis is not only to blame for changing plans – planned timelines of projects are often delayed because of a whole host of problems (with documents, with contractors, etc.), however the question of finance for any business is always the most significant.