EUROPE NEWS: From Russia, with (some) love

PERE Magazine September 2009: So far this year, some opportunity funds for Russia have been launched, while others have been cancelled creating a confusing picture of investor appetite for the country. By Robin Marriott

It seems Russia is dividing hearts and minds in terms of thosewishing to make money out of real estate.

Over the summer, PERE revealed how public Moscow based residential developer, PIK Group, had closed down a fund, owing to “adverse market conditions”, that planned to invest up to $1 billion of equity from third party investors. Such a decision has not only been taken by local folk. Foreign groups too have axed Russia funds, notably Stockholm based Aberdeen Property Investors, which in March formally cancelled Aberdeen Property Fund Russia which was seeking €500m. A spokeswoman blamed lack of investor demand and also a wish to concentrate on lower risk, core or value added strategies elsewhere in Europe.

Yet in contrast, in June, VTB Capital, a subsidiary of Russia’s second largest bank SRV, announced the first closing of a €300

Yuri Soloviev

million Russian opportunistic real estate fund called VTBC-DB Real Estate Partners I. According to a press release, investors include Scandinavian pension funds Ilmarinen and Etera. SRV explained at the time that it expected to receive at least €200 million worth of construction contracts in Russia as it pursues development projects in major Russian cities. Yuri Soloviev, president and global chief executive of VTB Capital, and a Deutsche Bank Russian deputy chairman, said in a statement that western investors were “positive on the prospects” of the Russian market.

That’s not quite how others see the market. Like the rest of the world, the collapse of Lehman Brothers had a big impact on Russia. In the first few months, foreign and domestic banks stopped lending, the government stepped in to prop up major Russian companies (PIK included), and development activity stopped.

Scroll forward to September this year, and according to those familiar with real estate in Russia, financing is still extremely thin, which explains why construction activity is at a virtual standstill despite significant falls in construction costs. In Moscow City, for example, which is a major new office area, one can see an empty office tower without any glass and no labourers, yet all the materials are waiting at the site. It is being developed by Mirax Group, the company founded by wannabe astronaut Sergei Polonsky and which is behind the $400 million Rotating Tower of Moscow project.

Many foreign firms do not have Russia anywhere near their top investment priority so they will not be troubled by the challenge of helping Russians live more comfortably.

There are mixed signals about how quickly the sector will improve. David Ferguson, a real estate analyst in Moscow at emerging markets bank, Renaissance Capital, says equities in real estate companies are the best performing of all sectors so far this year, but this is off a crushingly low base. The rate of decline of asking prices for residential property is slowing, yet there is little to suggest mortgage volumes will recover any time soon and though an additional 30 percent of office space is currently planned, demand is unlikely to recover until the Russian economy does and the banks sees little  reason to believe in rental increases in the medium term. (They have fallen up to 40 percent since 2008).

Meanwhile, retailers have curbed expansion plans, yet concerns about excess warehousing could ease if the economy stabilizes. In the wider economy, there are confusing signals too. Some firms say there are sectors worth considering. In August, Aurora Investment Advisers noted in a monthly update that Templeton Asset Management announced it may increase investment in Russia five-fold to $10 billion over the next two years, pointing out the consumer sector was an area of growth into next year.

Contrasting with this, Credit Suisse reported in July that “Russia is more than ever a pure oil play, and we are cautious on the crude price”. With such a blurred picture it is easy to understand why some private  equity real funds are being raised, while others have been cancelled. Renaissance concludes a recovery in the real estate market will first be seen in the mass-market residential segment. Ferguson points out that there is a political will for the state to help residential developers. This is because of an acute shortage of modern accommodation, and the government wants new homes built in order to avoid social tension.

Many foreign firms do not have Russia anywhere near their top investment priority so they will not be troubled by the challenge of helping Russians live more comfortably. Yet others still see the fundamental shortage of real estate in Russia and current low valuations as reasons to get involved.