Money Growing: Offices of Another Class

Office mansions are preferred by private investment companies, banks, and the holding companies of large oligarchic structures. Despite the uniqueness of supply of offices in former private residences in the center of Moscow, experts do not hasten to classify them as class A premises. Such buildings usually do not have the necessary engineering or underground parking. However potential tenants organize auctions for the right to have their office located in these large blocs. Every year supply becomes ever less, and demand increases.

"All old private residences are located in the historical center, which is one of the most important advantages in the rental market. For the same reason the number of office mansions is limited and to be located in one is somewhat beneficial. Therefore such areas are always highly demanded," Olga Yasko, regional director of the analysts department at Colliers International, describes about the specificity of the segment.

The complexity of definitions

The office private residence market is quite closed. This year in the open market no more than 10 buildings have been sold, and mostly all were after reconstruction," says Daniil Massalsky, an adviser in the office real estate department at Cushman & Wakefield/Stiles & Riabokoboylko. According to Kira Smirnova, head of the commercial real estate department at Vesco Consulting, in Moscow there are currently about 100 large, detached private residences used for office purposes.

"The boom in demand for office mansions was in 2001-2002, these days it is lower, but to have an office in an old, detached building has always been considered prestigious. As a rule, such buildings have an internal parking zone and their own fenced territory. And to look after the security in it is much easier than in a large business center filled with extraneous tenants," the expert says.

According to Smirnova, private residences for office purposes make up an independent segment of the commercial real estate market and do not correspond to the standard classifications. "Each offer in this segment is individual," she adds. "Existing classification does not reflect the specificity of the segment of office mansions,” agrees Boris Kiperman, president of CMI Development. According to him, for a small private residence to correspond to class A, it should be managed by a large, professional company, and in a one-storey building there should be a lift, which defies logic. "Therefore many advisers now allocate private residences in a separate segment and try not to classify them in order to not underestimate their class," he explains.

Representatives of the five leading consulting agencies of the commercial real estate market confirm this point of view. "For a former private residence to corresponded to class A, its area should at least 7,000 sq.m, it should be managed by a professional operating company, should have parking and optimum conditions for tenants," says Oleg Trofimenko, head of the sales department of commercial real estate at CB Richard Ellis. According to him, the market currently offers very few buildings that meet these requirements. Experts often come across private residences that are not large enough or not run by a professional operating company, or has no parking, or is lacking some other attribute to classify it class A, and prices are 10-15% higher on average for this class. For former private residences in the Central Adminstrative District (CAD), in which reconstruction is coming to an end, the price is overestimated by 10-15% in about 99% of them.

"In most cases the private residences that are entering the market, are historical buildings that have been valued under international standards concerning a separate category - H (Historical Buildings)," agrees director of development at Swiss Realty Group Ilya Shershnev. According to Maxim Zhulikov, a leading expert in the office real estate department at Penny Lane Realty, "the location and historical value give such premises more advantages and increase their value in the opinion of tenants."

"The market of office mansions is characterized by a serious deficit in supply, and therefore the period these premises are on the market for usually does not exceed 4-6 months. Although there are premises that have been on offer for a year and more. Usually these are premises with serious construction, legal and other problems," approves Kiperman.

Supply and demand

According to Yasko, in the Moscow office market the total area of quality class A and B former private residences that are now offices is 500,000 sq.m. "In the market there are also a further 200,000 sq.m on yet to be reconstructed private residences and it is therefore possible to raise their class," she says.

"Growth of the volume of supply in this segment happens only due to reconstruction," considers Olga Shirokova, director of the department of consulting, analytics and research at Blackwood. And the possibility of new premises entering the market after reconstruction is limited to these 200 000 sq.m. Restrictions on infill construction and the development of office buildings in the center also concern the creation of new private residence offices.

Moreover, according to the head of development at Thor group Elena Ferafontova, supply is limited by the fact that in 80% of cases companies buy and reconstruct private residences for their own needs and in only 20% of cases sell or lease them. "Companies of two categories are engaged in this: large organizations for which work with office mansions is a certain subsidiary activity, or small companies, which for objective reasons cannot be involved in more capital-intensive projects," she explains. If a new private residence comes on the market, in the opinion of analyst at GVA Sawyer Elena Gerasimova, it falls prey to a single tenant. To divide up such a small building is not worth it due to the high losses of the building - "there is a significant difference between the rented and usable area."

Demand for office private residences remains stably high and exceeds supply. "The main target audience is banking structures, insurance companies, embassies and consular departments, representatives of foreign and Russian regional companies," says Massalsky. In Shershnev's opinion, in most cases it is large Russian companies that plan to place their headquarters in a former private residence. "In the last few years many companies have reconsidered their strategies and moved into business centers, but demand for former private residences remains," he says.

"As a rule, office private residences are rented for representative purposes. A small building with unique architecture and history emphasizes the individuality of the company," Shirokova adds. According to Zhulikova, the majority of tenants are Russian companies: "Foreign players prefer to work with operating companies and have got used to being located in business centers." The secondary market provides a small resource. Trofimenko notes the increase in the quantity of secondary offers of private residences. "Proprietors increase the cost of rent, motivating the growth of rates by their location in the CAD, and as a result the price goes up, and some tenants leave. Often the proprietor is an unprofessional developer, most likely a Russian industrial company that obtained the private residence during the redistribution of assets. For them the building is a secondary business," the expert explains. Moreover, according to him, there is also a trend in the segment to conclude short-term contracts of 11 months. "This can be favourable for both the proprietor and the tenant. With short-term rental contracts the proprietor can reconsider the cost per sq.m, and tenants of small areas, as a rule, are right at the beginning of their development and may grow in a year, and are therefore not bound long-tem to the premises and can move into new, more favourable premises,” says Trofimenko.

Private residence offices and their inhabitants

According to Yasko, "office private residences are more often owned by the companies that occupy them and are the investor simultaneously." "A classical example are bank buildings that are the investment project of the bank," she says. In particular, according to her, Sofia Bank rents a private residence at Building 2, 32/2 Kadashevskaya Naberezhnaya, McCann-Erickson has a private residence at 11 Boloshaya Karetnaya, Consulting МBХ has got a private residence on at Building 2, 30 Bolshaya Kommunisticheskaya, and Russkaya Investionnaya Gruppa (Russian Investment Group) owns a private residence at 14 Nashchokinsky pereulok.

"Often companies in private residences are "themselves" engaged in the development or realty business. For example, the main office of Vesco group is located in a 4-storey private residence in the historical center of Moscow within the limits of the Garden ring," says Smirnova.

Office real estate such as private residences is popular with various embassies, legal or financial companies. According to Kipermana, the offices of Vneshtorgbank are located in a private residence on Pogorelsky pereulok, and Bayer’s offices are in a private residence on Bolshoi Trekhgorny pereulok. Otkrytiye rents a complex of private residences on Potapovsky pereulok and also a separately standing building on Kalanchiska," Zhulikov adds. Moreover, according to his data, MRSK Tsentr is the tenant of a private residence on Glukharevy pereulok, and Transmashholding rents a private residence on Ryuminy pereulok.

Periodically in the market there are sale transactions of office private residences, however, according to experts, they are mainly between companies-partners. Petrovsky Dom measuring 6,000 sq.m on Krasnoarmeiskaya Ulitsa can serve as an example. Vasily Anisimov's company Coalco bought this business center in 2005, for, according to the estimations of market participants, approximately $20 million. After reconstruction Coalco sold it to metallurgical company Mechel for almost twice the price.

"The majority of companies are prepared to not only rent private residences as offices, but also become their proprietors. However the cultural-historical importance of this or that premises plays a role. For example, if a private residence has the status of being a nationally valued monument, a long-term rental period of 49 years only is stipulated,” says Yury Sinyaev, marketing director at Konti.

Small and expensive

Rental rates in former private residences are always higher in comparison with rates in usual office centers with a similar location. For example, rent in a class B- private residence office located not even in the historical center but in the area of Baumanskaya metro station, will cost nearly $800-$850 per sq.m a year. In class B+ buildings in the area of Kropotkinskaya metro station the rate will already be $1,850-$1,900. In some cases it can reach up to $2,500," says Yasko. In Massalsky's opinion, the average rental rate is $2,000-$2,500 per sq.m a year. "Rates depend on the quality of the premises and the expectations of the proprietor in terms of the level of profitability," he says.

In general, the level of rent can differ considerably. According to Trofimenko, in new office private residences in the CAD with a good location, the pure base rate will be $1,500-$2,300 per sq.m. "Rates are within the limits of the rates for other comparable premises adjusted for the fact that the areas in private residences are used much less effectively and so equate to higher rates of rent per sq.m of pure area," says Shershnev.

According to Kiperman, "with other things being equal the rental rate for a private residence is higher than an office with a similar area in a business center." "In particular, it is possible to organize a storehouse in the basement of such premises, which is an additional factor for their higher market cost," says the expert. However, according to his data, a prominent feature of this kind of real estate is high operating costs which develop the necessity to create your own safety/security and operating service.

"The sale price of such buildings is also above the market average at $10,000-$12,000 per sq.m, and in some cases reach up to $15,000-$20,000," Gerasimova approves.

However there is also another opinion. "The rental price of such offices is lower than characteristically similar offices in class A business centers," considers Smirnova. According to her, despite the elite status, such offices have a number of big and sometimes critical disadvantages. "For example, as a rule, the useful area of office private residences averages only 65-80% of the total area of the building," the expert says.

To become charmed

In the opinion of experts, in the near future demand for office private residences will not fall. "This segment, of course, is promising, if we are talking about private residences that do not require significant repair. In Moscow there are less and less land plots remaining, and companies are more often wanting to own their own private residence offices," Trofimenko notes. According to Sinyaeva, "renting a private residence remains prestigious and is a certain symbol of respectability, reliability and success."

The prospects of satisfying existing demand are not so good. According to Yasko, at present in Moscow approximately 50,000 sq.m of private residences are being reconstructed or newly constructed. "This is little considering the general scale of office construction in the capital. Projects with more distant deadlines up to 2012 have also been announced,” she notes. In general, according to her, the main prospects for new offices-private residences coming onto the market are connected with the reconstruction of already existing lower class private residences.

It is true that some experts see the resource for saturation of the segment. "In Moscow there are a lot of private residences, which over time have been forgotten about by both the authorities and businesses because this direction of development is unprofitable. Now the situation has changed: by investing $1.5-$2 million, it will be possible to sell a private residence for $15 million. Demand for such real estate is steady," says Ferafontova. "Everyone will be uncomfortably satiated with skyscrapers, and the charm of the center will return,” the expert hopes.