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PwC predicts Russia will be the leading European economy by 2030, but is the business case for UK investment in the Russian real estate market strong enough to outweigh the potential risks? Emily Wright reports from Moscow

Russia isn’t the easiest of countries to warm to. And not just because temperatures can plummet to -20°C. The fear of falling

victim to corruption still casts a dark shadow over a market which, in pure financial terms, is becoming an increasingly attractive investment option for foreign companies.

After being hit hard by the global economic crisis in 2009, the Russian economy has bounced back rapidly by European standards. GDP grew nearly 4% in 2012, a figure expected to be repeated over the next 12 months, according to the World Bank. The country’s property sector has followed a similar pattern, showing stable growth throughout 2012 thanks to a strong retail pipeline, a booming industrial sector and a steady increase in shopping centre, warehouse and office prime yields in

Moscow and St Petersburg. At the World Economic

Forum in Davos last month, Russian prime minister Dmitry Medvedev called for continued international investment in Russia generally and the country’s real estate market specifically, to fuel future economic growth. And just last week the Russian government revealed it has awarded a $500,000 contract to Goldman Sachs over the next three years to market the country’s development success stories to foreign investors.

With the 2014 Sochi Winter Olympics and 2018 FIFA World Cup just around the corner, it is clear that the door into Russia is wide open – the convoluted Visa process permitting – for overseas firms wanting to cash in on a growing property market worth more than $620bn. But the big question is whether the opportunities, twinned with promises of a crackdown on

corruption, will be enough to alleviate concerns and nervousness around entering a market that has not always had a shining reputation when it comes to transparency.

A PR drive from the Russian government to attract overseas interest is one thing. But whether it stacks up as a valid, sensible business decision without the hard sell remains another. Here Estates Gazette investigates whether the case for UK investment in the Russian real estate market is strong enough to outweigh the potential risks.

The investment conundrumFirst and foremost, the hard statistics cannot be dismissed – and they paint an undeniably tempting picture.

At a time when most European countries are facing painfully slow climbs back to economic health as they struggle with mountains of

debt, Russia, buoyed by high volumes of

natural resources, is in a considerably stronger position (see graph, p54) as the country’s public debt is no more than 10% of GDP. A report published by PricewaterhouseCoopers last month went so far as to predict that Russia will be the leading European economy by 2030 and could be one of the top 10 in the world by 2050.

Whether or not these predictions come to fruition – analysts and commentators have suggested they could be far-fetched – the noise being made around investment and development opportunities in Russia are becoming increasingly positive – particularly when it comes to real estate.

“A major transformation happened in Russia in 2012 that went unnoticed by many,” says Denis Sokolov, head of research and development

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Source: Cushman & Wakefield

consultancy in Cushman & Wakefield’s Moscow office. “We are no longer in the emerging market state. Russia became a solid real estate market last year, with Moscow ranked third in the list of top European property investment markets.”

Once again, the figures speak volumes, showing that investment in Russian real estate reached a historic high in 2012, hitting $8bn (see box, above right). Preliminary forecasts by Jones Lang LaSalle predict an annual investment volume of at least $7.5bn in 2013, of which around one-third will be from overseas investors.

The argument for investment is being supported by international and UK property firms already operating in the market, who stand to pick up work on the swathes of resulting deals.

“The more international investors there are, the more work there will be for international property and project management firms operating in Russia,” says Ian Chadsey, associate director of project and development at Jones Lang LaSalle, Russia & CIS. “Non-Russian investors are likely to want to deal with Westerners or very good English-speaking Russians. We usually work with American, British and German firms who know we abide by the UK Bribery Act and the US anti-corruption laws.”

RewardThe key to securing investment in Russian property and persuading more international property companies to join those already operating successfully in the country – including Jones Lang LaSalle, CBRE, Colliers, Cushman &Wakefield, Knight Frank and Aecom – will be the calibre of opportunities up for grabs.

There is a shortage of high-quality real estate in Russia, so development prospects remain good – but you do have to know where to look.

Not surprisingly, Moscow is home to the majority of development. The capital received 88% – around $6bn

– of total investment into Russian real estate in 2012. This is despite undergoing a period of transition as the new city government, which came into power in October 2010, has spent two years reworking its vision of the city’s urban planning policy. This has resulted in several key schemes being suspended, which has seen a slight slowdown in the Moscow office market. But with 12.5m² of office space in total in the capital and a 5% rise in investment into this sector in 2012, there are still plenty of opportunities for growth (see interview, p58).

Cushman & Wakefield’s Sokolov predicts a strong year for Moscow in 2013 despite the “restrictions imposed by the new administration” with take-up of offices remaining strong, steady hotel and residential sectors, and a boom in warehouse development.

JLL’s Chadsey agrees: “We are noticing a lot of investment in office fit-out in Moscow and a swathe of industrial work in oil and gas and distribution centres. A lot of international companies investing in Russia – such as Adidas, which is expanding and needs a new

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distribution centre – are looking at these sectors. Pharmaceuticals is another interesting sector for investment. It is now law that all pharmaceutical companies selling drugs in Russia must produce a proportion of their product here, so the companies are all building their own production centres throughout Russia. Industrial is big across the country.”

Other main future schemes include the Moscow International Business Centre;

the Federation Tower, planned for completion in 2016, which will become the tallest in Europe; and major infrastructure projects, such as the reconstruction of Gorky Park, the grounds of Luzhniki Olympic Complex, Dynamo Stadium and Petrovsky park.

And you couldn’t talk about the Moscow real estate market without mentioning Skolkovo. The Russian equivalent of Silicon Valley is just an hour’s drive from the capital – a 400-hectare site set to become

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RUSSIAN INVESTMENT MARKET: ON THE UP

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Source: Cushman & Wakefield

one of the world’s biggest high-tech cities. It is twice the size of London’s Olympic Park and will include a research university with 1,800 students, 40 corporate research and development centres and a “Technopark” housing up to 1,000 start-ups. The government has invested $3bn over four years into this mega project, which it hopes will modernise Russia significantly, making it a market leader in technology and research development. And you won’t find many potential investors arguing with that.

St Petersburg – though a much smaller market than Moscow – also continues to

perform well, particularly on the retail front, as it maintains a strong lead in terms of quality retail stock – 437m² per 1,000 inhabitants – with large-scale openings in 2011-12 including Leto (80,000m²) and RIO (52,500m²). The Galeria shopping centre sale here in 2011, for $1.1bn to a fund managed by Morgan Stanley, became the largest in the history of the Russian market.

Maxim Karbasnikoff, head of retail services at Cushman & Wakefield, says that retail across Russia will continue to be a strong market from 2013 onwards. Quality retail stock consisted of more than 500 shopping centres, with a total

gross leasing area (GLA) of 15.4m m² as of October 2012. About 100 projects are under construction in a retail pipeline that totals 4.6m m². One square metre is about 10.76 sq ft.

The major sports venues and infrastructure projects planned for the 2014 Winter Olympics and 2018 FIFA World Cup are all tied up in government contracts, but the planned improvements to transport links between airports, major cities and key districts should see more regional development and investment opportunities across the country in the long term.

RiskNo matter how impressive the economic figures or development pipeline opportunities, the threat of corruption still taints the Russian market. It remains a serious issue, despite the government’s attempts to dispel fears that doing business in Russia is difficult.

Having said that, the increase in international firms operating in the country and global giants such as Ikea making a public stand against corruption has seen a marked improvement, according to those with experience of operating in the market.

“If you choose to avoid it, corruption has become a pretty

much non-existent issue in Russia now,” says Charles Cresser, now a partner at IDC Consult but who spent two years growing JLL’s capability in Moscow. “You have to choose to avoid it, though. If you go out there thinking you might try your luck, then that option is still very much available. But I wouldn’t recommend it.

“When I was working in Moscow it wasn’t hard to find a good supply chain who were all paying their workers and where everyone was paying their taxes. And, ultimately, if people want to go to Moscow to work with the likes of JLL or any of the similar international companies then they have to

Moscow: 12.5m² of office space

● Leave enough time to arrange a visa before travelling to Russia as there are reams of forms to contend with. A visa application costs around £119, but you can pay more for help from an agency to speed up the process.● Once in the country, carry your passport or some form of official photo ID with you at all times. You will need this to get into most office buildings and you will be fined if you are unable to provide it if you are stopped by an official.● Navigating the underground system signs and stops – which are in Cyrillic – is made a lot easier by downloading the Moscow and/or St Petersburg Metro apps, which translate the signs into standard script.● Always negotiate taxi fares at the start of the journey. Waiting until the end could result in a hiked up price.● Do not turn down vodka. Whether in a business or a social environment, shots (it is unlikely to ever just be the one) of vodka are a key part of Russian living. If a bottle is put on the table, it is traditional that no one leaves until it is empty. Eating something small like a piece of meat is advised in between each shot. Mixing the spirit with any other form of alcohol is not.

TIPS FOR A COLD CLIMATE OUTSIDE THE BOARDROOM

“If you choose to avoid it, corruption has become pretty much a non-existent issue”

BY GEOGRAPHY

Foreign investors MoscowDomestic investors St Petersburg

Regions

British Embassy, MoscowSmolenskaya Naberezhnaya 10Moscow 121099Tel: +7 (495) 956 7486

British Consulate-General, St PetersburgPL Proletarskoy Diktatury 5191124 St PetersburgTel: +7 (812) 320 3220

www.ukti.gov.uk/ukti/russiawww.ukinrussia.fco.gov.uk/en

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Government gross debt, % of GDP

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Source: International Monetary Fund

show they are squeaky clean.”He adds that it has been

helpful that giants such as Unilever, HSBC, Ikea, Debenhams and Adidas are all currently rolling out ambitious expansion plans in the country despite not always having trouble-free experiences.

To make a stand against corruption, Ikea famously put a freeze on expansion in June 2009 after investing $4bn in Russia over 10 years as it refused to pay bribes to safety inspectors.

“What Ikea did proves that you can now work in Russia and avoid corruption if you stand up against it and refuse to work in a certain way,” says Cresser. “It wasn’t easy for them, but they did it and that has paved the way for other foreign firms to expect the same sort of transparency.”

Chadsey adds that working for an international firm significantly reduces

Nevsky Prospekt, St Petersburg

REX FEATURES

● Be on time for meetings, but do not expect your Russian counterpart to be. Though a good indication of how serious a meeting is taken is how punctual they are.● Pitches and presentations should be simple. Visuals and PowerPoint presentations are

not favoured in Russia as a rule.● Presenting or holding a meeting in English is usually acceptable.● Negotiations are tough and can involve a degree of theatre. Caving early is a sign of weakness, so standing your ground despite loss of tempers

will, more often than not, be viewed positively.● At business dinners the most senior attendees sit in the centre of the table. You should be sat opposite your immediate counterpart.● Refusing a dinner invitation is considered exceptionally rude.

DOING BUSINESS IN RUSSIA

corruption issues: “I have hardly seen any evidence of corruption in the two years I have been here. All I heard before I arrived was ‘Russia is corrupt, you have to be really careful, there are so many issues.’ Personally, I don’t see it. Working for an international firm is likely to have something to do with that. Most of my clients are international, so I am not dealing directly with Russian government or companies.”

The hope is that, with such a countrywide push to attract overseas investors, the next step will see Russian firms that have yet to embrace a new way of doing business cracking down on corruption. Dmitry Mints, chairman of O1 Properties, one of the country’s leading property firms, says his company purchases all of its buildings using English law.

Russian rouletteWhile taking all of the reports about Russia’s new, clean transparent approach to business at face value would be foolish, it seems that working on the right projects with the right companies has genuinely helped to unlock a market that is on an upward trajectory.

“Moving to Moscow was much harder than I was expecting,” says Chadsey. “But once I got used to it I realised just how important this market is. The economy is much better here than in the US or the rest of Europe and the best part is that Russian and international companies have responded well to companies like us – global property companies – and everyone either wants to work for us or with us.

“It is a huge culture shock but, even though I hate the cold, dark and snow, I am convinced that there has never been a better time to be in Russia.”

DMITRY MINTS INTERVIEW, PAGE 58

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