Money Growing: How Deep is the Bottom

Tenants, owners and potential buyers have waited in expectation for when the market will hit bottom. Some want to buy favourably fallen in price assets, others want lower payments, and yet others want to survive these difficult times. The reports of consulting companies testify that all key figures are moving downwards.

The financial crisis has done what nobody could do 10 years: the seller’s market has turned into a buyer’s and tenant’s market.

Private falls

In all segments of commercial real estate owners are offering discounts. Their size depends on the category of the premises, the quality and readiness of the project and how much cash the proprietor needs. While discounts on rental rates in the warehouse real estate market average 7-10%, much greater discounts have been observed. According to Andrei Bushin, general director of MIEL Commercial Real Estate, discounts for class B- and C warehouse premises reach 15-20%.

In the office market the correction of rental rates and sale prices is 10-15%, and in some cases discounts reach 30-35%, says Elena Gerasimova, an expert in the consulting department at GVA Sawyer. Asking prices and rates remain at the current level – proprietors are in hurry to reduce them officially.

According to the results from the third quarter of 2008 the average rental rate in the Central Administrative District (CAD) for class A premises was $1,300 per sq.m a year (excluding VAT and operating costs), in class B+ premises was $900 per sq.m a year, and in В- premises was $750 per sq.m, according to GVA Sawyer.

In the retail real estate market, according to Astera, the average rental rate of high-quality premises in the center is $2,600 per sq.m a year, with the highest rates reaching $10,000 and more. In the third quarter of 2008 prices stopped rising and at the beginning of the fourth quarter fell 10-35%, notes Nataliya Davidenko, head of broker services at Astera. Olga Shirokova, head of research and consulting at Blackwood, confirms: officially rates have not fallen yet, however discounts at a level of 15-20% on many premises have already been given.

In the hotel segment, according to Mikhail Feldman, the sales manager of the Azimuth chain of hotels, fillability in the best business class hotels in Moscow and the regions has decreased slightly to 65%. In some cities, for example Astrakhan or Kostroma, the level of fillability has fallen by 7-10%. Out-of-town hotels are in the worst situation, according to him, where demand has decreased by 10-12%.

Slower growth rates in the average price have caused, according to GVA Sawyer, a decrease in profitability to 15-18% pa from 20-25%, which has been characteristic in the last 3-4 years.

The recoupment time for all categories of real estate is growing, but more exact figures will only be available in spring 2009 when the level of reduction in prices for building materials and the level of demand will be clear. According to Jones Lang LaSalle (JLL), the cost of building materials has fallen from 15% to 45%, and the price of cement by 50%.

The market has risen

"The renting of retail areas has now practically stopped," says Davidenko. According to her information, tenants have stopped looking for premises and this trend will continue until at least February. It is natural that rental rates for retail areas are falling. Proprietors, afraid that their premises will sit idly and make financial losses, agree to practically any conditions of those rare tenants that are still prepared to rent something, she notes. The same trends are also being followed in other segments.

In October, compared with September, in rental commercial real estate market supply grew 45%, RRG says in a report. Meanwhile the number of transactions concluded has considerably decreased. The market has taken on a waiting attitude, Shirokova summarizes.

Potential tenants expect a further reduction in prices for premises on the one hand, and on the other are not expanding their businesses and optimizing costs. Tenants are optimizing their expenditures, including by reducing rented areas and moving, for example into lower class warehouses, says Bushin. According to Vladimir Pinayev, managing director of JLL, the total volume of demand for warehouses will probably decrease by up to 30% in the near future.

According to Michael Knoll, a partner and head of M&A Lead Advisory at PricewaterhouseCoopers (PwC), in the first nine months of 2008 investments in Russian commercial real estate reached about $6 billion, which is much more in comparison with the same period last year. Approximately 60% of real estate transactions took place in the office sector.

Now the number of sale and purchase transactions in the commercial real estate market has fallen by several times, notes Bushin. At the same time the volume of supply of premises for sale has grown by several times. "In the summer 7-8 new projects for sale would come in in a week, now it is 10-15," says Feldman characterizing the situation in the hotel market. Kirill Irtyug, general director of management company RosInvestHotel, confirms: six months ago 2-3 sale premises would come in, now it’s that many in a week.

In the retail real estate market at the moment there are liquid premises on offer at average market prices that have not been rented or bought for more than five years, Davidenko says. According to RRG, in Moscow in October in comparison with September the market for the sale of commercial real estate premises increased 13%. Within the limits of the Garden Ring, since the beginning of October 2008, sale prices for office real estate have decreased by more than on 12%, having reached $12,621 per sq.m; outside the Garden Ring prices have decreased by 2.4%, having reached $6,067 per sq.m. But this discount is still insufficient for potential buyers. Everyone is waiting for the best prices.

Brokers do not have completed projects with big discounts in their databases. In the warehouse real estate market there are premises with discounts of 40% but these are still the exception to the rule. In Pinayev’s opinion, for non-liquid premises the discount in the next six months will reach 50-90%, but nobody needs poor-quality projects at any price. Oleg Mamayev, executive director of PNK Group, agrees: the company refuses to consider sale offers. "Why would we need a premises worse than the one we already have?"

Many companies are having to look for more compliant buyers. In conditions of high debt burdens and the almost complete absence of financing, proprietors are being compelled to sell assets. According to investment bank UBS, the sum of Sistema-Gals’s debt (as estimated at the end of 2008) is comparable to the value of its portfolio of projects, with the difference, according to UBS, standing at only $100 million. In order for the company to continue to build and pay off its debts, it is necessary for it to sell both projects and constructed premises, analysts at UBS consider. RTM Group plans to sell a number of premises making up 16% of the total area of its portfolio. The money from the sale of the premises will be directed first of all at reducing its credit portfolio. Samokhval group, as stated in mass-media, has sold six shop premises measuring a total of more than 14,000 sq.m for 862.5 million rubles SMP Bank and IstKommerts. The obtained money will go towards paying the debts of the company.

According to Knoll, in the last few months a significant decrease in the activity of mergers and acquisitions in the market has been observed. "Many owners of real estate are abstaining from selling premises. On the other hand, buyers are also in no hurry to conclude transactions, counting on the fact that prices should decrease," he explains.

Freeze or sell?

Many developers prefer to freeze projects and try to sit out the adverse times. For example, as Konstantin Zabrodin, deputy general director of OPIN, has told, the company is more likely to postpone the realization of the Bolshoye Zavidovo project (1.5 million sq.m with $1.5 billion of investment) than sell its share. The majority of developers do not share these principles and actively look for co-investers in order to complete projects. For example, as MR Group has done. According to Irina Dzyuby, sales manager of the company, external financing totalling $60 million is necessary for the construction of a business complex on Skladochnaya ulitsa. The company has informed us that negotiations are currently taking place and the project has received interest from potential buyers.

In the hotel business the volume of offers for co-investment has also grown. According to Irtyug, RosInvestHotel in considering such offers: "First of all we are prepared to take 3-4-star projects under management, and secondly we are prepared to consider projects for co-investment.”

The general trend in the market is for started projects to be realized and those at the design stage o be frozen. In the office segment among those that have suspended projects are Mirax Group, Peresvet, Sistema-Gals, etc.

In the warehouse segment in the second half of 2008 Eurasia Logistics postponed the construction of complexes at the design stage, Sergey Vereschagin, sales manager of the company has informed. International Logistics Partnership holding, according to Alla Soloveva, its executive director, plans to complete a project in Podolsk. International Logistics Partnership has not started any new projects yet.

But not everybody can wait. The most vulnerable appears to be retailers. The decrease in consumer activity and outflow of consumers to cheaper shops has pushed some of them to the verge of bankruptcy or has forced them to seriously reconsider their plans. Retail chain 12 Mesyatsev (12 months) has closed three stores: on Festivalnaya ulitsa, on Kashirskoye shosse and on Kulikovskaya ulitsa. These shops have been operating for less than a year. The decision to close them was made in connection with the low profitability of the retail premises, says Davidenko. Х5 Retail Group, Kopeika, Lenta, etc, have already announced plans to reduce the number of opened shops.

Knoll considers the crisis a good time to prepare assets for sale. To undertake financial reporting under international standards and carry out the necessary re-structuring, according to PwC takes at least 4-6 months. In December 2008 it will be possible to talk about the purchase of practically any development project as proprietors will be unable to realize them, Alexander Vagin, president of Otkrytiye-Nedvizhimost, is assured. The sale of a share of their assets will allow developers to realize projects that remain theirs. This will be the result of the situation that has developed in the market, he considers. The most demanded projects by buyers are those at th approval of construction stage. At this stage the main risks have been settled and the sale price may be equal to the expenditures or below average.

Lose or fall

Knoll predicts a growth in the number of M&A transactions in 2009. "Many real estate owners will have no choice but to sell," he is assured. Under PwC’s forecasts, next year there will be heightened interest in residential and warehouse real estate, especially premises in the Russian regions. "We are observing interest from potential strategic buyers from countries in the Asian region (Japan, China), and also from large foreign direct investment funds," Knoll continues.

In Vagin's opinion, in 2009 more than 50% of all development projects will be offered for sale.

Shirokova predicts that proprietors will be more loyal to tenants and buyers of offices and will give them at additional discounts – up to 15-30%, and on some occasions more.

In the warehouse real estate market, even though rates will fall by 3-5% in comparison with current levels ($145-$165), they will remain rather stable, believes Vyacheslav Kholopov, director of the industrial and warehouse real estate and land department at Knight Frank. But as this segment of the market was not saturated when the crisis hit, demand for premises will remain stable, says Pinayev. According to Knight Frank, even in conditions of decreasing activity of logistics operators and large retailers, in 2009 demand in the market will stay at a level of 1.5 million-1.7 million sq.m.

There will be a more defined deficit of premises in the hotel real estate market - demand for hotel rooms in Moscow is still twice as much as current supply. The largest deficit is for 3-star hotels. In the opinion of Veronica Kartasheva, an adviser in the hotel real estate department of Cushman & Wakefield/Stiles & Riabokobylko, there will be very few quality hotels in the average price segment.

Irtyuga thinks that next year the fillability of hotels may fall 15-20% depending on the segment, and many hotels will experience a shortage of visitors. In the last few years the tourist branch has grown 15% annually, "It would be good if in 2009 we reach the results of three years," he says. Prices in Moscow will not fall significantly, as it is both the financial and tourist capital of Russia, Feldman says optimistically about the prospects of the segment. Currently, the average price for a hotel room is the highest in the world.