By Julian Evans
The CIS real estate market has come of age. In the last year alone, it attracted around $4 billion for Russia-focused real estate funds, on western equity markets. These deals have been among the most successful of all Russian initial public offerings (IPOs).
John Coast Sullenger, real estate adviser at Gaia Resources, says the “massive growth in interest” has taken place in the last two or three years. “Historically, the sector has traded at a discount to its peers in European markets. Now, however, the sector trades at a very high premium to its peers, despite the huge amount of capital-raising taking place.”
While real estate has been a successful asset class in Russia for some years – with rents from retail centres giving investors around 9.5% interest, and returns from commercial real estate development as high as 30% – it has to date been a closed sector, and dominated by a handful of local investors. That’s partly because some local players enjoy particularly strong political connections. The Moscow market is completely dominated by Inteka, for example, which is owned by Elena Baturina, wife of Moscow mayor Yuri Luzhkov.
In contrast to central Europe, Russia has petrodollar wealth, which means that there have been no shortages of rich local investors to finance projects. For example, one of the most successful developers in Russia is CMI Development, which has a $3 billion project budget, mainly provided by Roman Abramovich’s Millhouse Capital.
Until recently, while foreign funds could cherry-pick the best deals in markets like Poland or Hungary, in Russia they were left scrambling for whatever was available. The problem was that foreign funds, such as Raven Russia or Fleming Family & Partners, tried to follow a business model where they just bought and sold finished projects, rather than getting their hands dirty with development. But there were simply too few tradable projects around. All the money was in development.
New opportunities
The situation has changed in the last year, with many more opportunities for foreign capital opening up.
Firstly, local developers are seeking western portfolio investment, including:
• Open Investments, the first Russian company to seek foreign equity investment, whose majority shareholder is Vladimir Potanin’s Interros. It raised $64 million on the RTS, the local stock exchange, back in November 2004. It has turned out to be one of the best performing of all Russian IPOs, with shares rising from a $50 opening price to a present price of around $300. It raised a further $325 million in April.
• Sistema-Hals, the real estate company of Sistema Holding Group, which followed suit in November 2006, raising $400 million in a GDR offering on the LSE, in a deal which was five times oversubscribed.
• Ukrainian real estate companies, such as XXI Century, which raised $121 million on the AIM market back in December 2005, and others such as TMM, who say they are also considering floating. The sector in Ukraine is perhaps five years behind Russia, but is growing just as fast. Residential real estate prices, for example, have increased by around five times in the last three years, while commercial real estate projects are offered for sale at prices that reflect initial yields of approximately 10%.
Russian market
The second impetus for market expansion is that foreign funds are now getting more comfortable with developing projects, and are also increasingly looking beyond the rather closed Moscow market to other regions of Russia.
For example, Austrian investor Meinl European Land, which has previously mainly invested in central Europe, has ramped up its Russia exposure over the last 12 months. At the end of 2006 it had purchased four properties in Russia for E263 million, but it has since agreed to 13 other projects, for a total of over E1 billion in investment.
Meinl’s spokesperson, Francis Lustig, says: “Russia is now at the heart of the company’s investment activities – a development considered absolutely correct given the country’s yield potential. In Russia it is still possible to achieve yields that significantly exceed those prevalent in more established markets such as the Czech Republic or Hungary.”
Commercial real estate yields in those markets are around 5%, while yields in comparable projects in Russia are still around 8.5%. Meinl has been very actively raising capital through the Vienna Stock Exchange. It raised E770 million in September 2006, and a further E1.48 billion in February.
ImmoEast, another Austrian investor with experience in central European real estate, has also taken big steps into the Russian market in the last year. A company in which it has 25%, TriGranit Holding, signed a deal with state-controlled Gazprombank to develop $5 billion in projects, which the company says is “one of the largest property deals ever concluded in central and eastern Europe”. The company’s shares, also listed on the Vienna Stock Exchange, rose by more than 40% last year.
Other foreign funds have ambitious capital raising plans. An Israeli real estate company, Africa Israel – which also trades in African diamonds – is planning an IPO of its Russian subsidiary, AFI Development. It hopes the deal will raise around $1 billion, making it the biggest Russian real estate IPO so far.
Africa Israel listed on the Tel Aviv exchange in 2001, and since then its share price has risen by 1,194%. Its CEO, Lev Leviev, is a former Soviet citizen and a canny regional investor. He says the company has $4 billion invested in Russian real estate, which would make it the biggest Russian real estate firm.
These funds are particularly active in building shopping centres around Russia. Meinl, for example, has recently opened a $71 million shopping centre in Kazan, the capital of the Republic of Tatarstan. Incomes are up 20% in Kazan, which is driving a consumer boom in the region. Ikea has also developed two Mega shopping centres in the region, and is busy developing six others around Russia. It now has around $2 billion invested in Russia.
Office buildings
The big Russian cities also lack quality office space, so foreign funds are actively investing in class A office blocks. Rates for good office buildings are rising by up to 15% annually, and the pace of growth is not expected to slow any time soon. Christopher Peters, director of the research department at Cushman & Wakefield Stiles & Riabokobylko, says: “We expect that supply and demand on the market in the next few years will show the same rate of growth until 2010, when lease rates there could stabilize.”
The big funds are also looking into the Ukrainian market. Coast Sullenger of Gaia Resources says: “We expect the likes of Meinl and ImmoEast to acquire local players like XXI Century or TMM, so there could be an acquisition play there for equity investors.”
There is an even more serious lack of quality office space in Ukraine than in Russia. It can be shocking to see the shabby offices in which international firms are forced to work in Kiev. With the economy growing at around 7% this year, and many multinationals moving into Ukraine, analysts believe the office market will continue growing strongly for at least five years.
Another way foreign investors are getting exposure to the market is through lending. A pioneer in this market is Eurohypo, which has lent around E1 billion in Russia over the last 12 months, both in Moscow and in regions such as Krasnodar in the south. Eurohypo has been lending to projects in the Black Sea resort town of Sochi, one of the CIS’s hottest areas for real estate.
The town is making a bid to hold the 2014 winter Olympics, so the state and Kremlin-friendly businesses including Gazprom are pumping in around $10 billion to overhaul the resort’s infrastructure and build new hotels.
Investment bank interest
Western investment banks are getting very involved in real estate too, none more so than Morgan Stanley. The firm’s Russia head, Elena Titova, says: “We own stakes in local developers RBI and RGI International, which we recently helped to float, as well as 10% of RosEvroDevelopment. We also lend to local developers. And we own CityMortgage Bank, a leading provider of residential mortgages.” Titova says Morgan Stanley is looking to increase its Russia real estate exposure to about $1 billion.
Deutsche Bank is also committing billions of dollars to the sector. For example, it is financing the $600 million reconstruction of the Moskva Hotel near Red Square, and intends to float stakes in the project on the LSE after completion. Just 100 metres away, construction is finishing on the $200 million Ritz-Carlton Hotel, which was financed by Merrill Lynch and Aareal Bank.
Western banks are following the lead of local banks, which have been active lenders to real estate development. Sergei Riabokobylko, executive partner at Cushman & Wakefield Stiles & Riabokobylko, says: “Russian banks like Vneshtorgbank have pioneered this technique of lending to real estate developers, then cherry-picking the best projects in which they can take equity stakes.”
Kazakh banks are also big players in real estate both in Kazakhstan and throughout the CIS. One of the biggest developers in Russia, for example, is Capital Partners, which is owned by KazKommertsbank. Many of these local banks have recently done or are doing IPOs in London, so investors can get exposure to the real estate market through them as well.
Caveat
But investors need to be careful: it’s become a commonplace of CIS business that the residential markets in cities like Moscow, Kiev and Almaty are bubbles, with many small investors and some banks speculating in apartments, for want of other assets in which to put their money.
Residential rental prices are clearly overvalued in these three cities. Sullenger of Gaia Resources says: “How can you justify $5,000 per square metre for unrenovated apartments in Kiev? I could buy a nice place in Berlin for less than a flat in Kiev.”
Even in commercial real estate, there is a risk that some markets could become oversupplied. Take Kazan: five shopping malls opened there last year, so the city now has more square metres of shopping centre per capita even than London, where GDP per capita is over three times higher.
And of course, there is the risk that natural resources prices, particularly oil and gas or metals, will go down, which would put a dampener on the real estate markets in Russia, Kazakhstan and Ukraine.
Still, most analysts are optimistic that some areas of the market are a good bet – particularly offices, because demand is so radically outstripping supply.