The crisis in Ukraine and ongoing geopolitical uncertainty will ensure Russia’s listed property sector remains marginal for the time being, Lynn Strongin Dodds writes.

Before the recent turmoil in the Ukraine, the slowdown in economic growth and ensuing exchange rate volatility, there was hope that a few new entrants would boost Russia’s nascent publicly quoted property market. Not surprisingly, plans have been put on hold and few are willing to predict when firms will be ready to test the waters again.

The main reason is the geopolitical risk. Sanctions are beginning to bite on an economy that was already struggling. The International Monetary Fund slashed its previously modest 2014 growth forecast for Russia from 1.3% to just 0.2% this year in its fourth downward revision in a row. The European Central Bank maintained existing borrowing rates in August as it warned that the Ukraine crisis was threatening an EU economic recovery. 

Against this backdrop, the country’s listed real estate market is likely to remain minuscule, with only three listed companies: PIK Group, the country’s largest homebuilder company; Etalon Group, property developer; and LSR, a real estate development, construction and building materials company that also has a global depositary receipt listed on the London Stock Exchange. Their main focus is on the residential sector while the other quoted group – Raven Russia – is only traded on the London Stock Exchange and specialises in logistics.  

There is a reason why activity in the public arena is limited mainly to residential. The sector has proved to be more resilient than other categories. “The residential market was booming and still offers high internal rates of return for developers,” says Maria Kotova, partner, executive director, Knight Frank Russia & CIS. “This is mainly because buyers are still ready to pay for a flat in the first stage of construction and this is not the case with security deposits for offices under construction. Also, the economic and political situation has had an impact and there is more supply than demand in offices, where there are many empty buildings and the vacancy rate is running to 20% in Moscow, which is the biggest market. As a result, developers are looking for new residential options as well as changing their focus on infrastructure projects and hotels.”

According to Knight Frank figures, interest from wealthy buyers in prime Moscow flats of over 200sqm reached pre-recession levels last year, with demand exceeding supply. At the same time, residential property sales under $2m in the prime new-build country market rose 13% in 2013.

The other area that has remained resilient is logistics, according to Glyn Hirsch, CEO of Raven Russia, which acquires and develops Class-A warehouse space in major Russian cities including Moscow, St Petersburg, Rostov-on-Don and Novosibirsk.

“The current political situation in Ukraine has yet to have any tangible effect on the operation of our business other than the impact on the market value of our listed instruments. Warehouses have remained robust and stable because there is an undersupply of properties. Unlike in the rest of Europe, it is a growing and stable asset class that generates double-digit returns of 11% to 12%.”

The country also has a long way before it catches up to its Western European counterparts. Figures from JLL show that increased consumer spending has translated into a corresponding need by retailers for storage and distribution. But Moscow, the main logistics hub, only has 9.6m sqm of quality space. This translates into 0.6 sqm per capita versus 5.4 sqm for the much smaller city of Paris.

Looking ahead, industry experts expect other companies to join the public fold when market conditions improve for a sustained period. There had been talk only last March that O1 Properties, which owns and manages 13 business centres in Moscow as well operates three development projects, would revisit its initial public offering (IPO) plans in London after being involved in the biggest commercial office deal in the country. The $1bn deal to purchase Moscow’s White Square office complex for $1bn, home to the local headquarters of Microsoft, went ahead but the rumour mill ground to a halt due to market volatility.

The timing was off, just as it had been in 2012 when O1 pulled its $425m IPO after equity prices slumped due to renewed fears over the fate of the peripheral countries in the euro-zone. However, O1, whose assets are valued at around $4.5bn, can afford to bide its time. Earlier this year the company received a new infusion of cash from Goldman Sachs which bought a 6% slice for $100m.

“O1 says that it will come to the market sometime in the future,” says Andrey Novikov, head of capital markets in Russia at CBRE.

“You need to be large and have a very good story, though, to list in London and not everyone has that story. At the moment, events in the Ukraine have impacted the property investment market and in the first quarter we only saw $400m-worth of transactions followed by $1bn in the second quarter. We had been forecasting $6-7bn for the year but we have recently revised that figure downwards to $3.4bn.”

Although recent events are acting as a deterrent for companies seeking a listing, it is not the only barrier, according to Tom Mundy, head of research at JLL. “This is a nascent market, only having started in the early 2000s. Residential had a head start because they had their financing in place early on but, overall, this is a tough market to list on because the windows for launching an IPO are limited. It does not operate on a full 12-month cycle and the best times are in June, late September or October, or February. I think this is, to an extent, a throwback to the Soviet era when there were, and still are, a lot of public holidays, but also because, since 2008, the market has been very volatile.”

Kotova notes: “It will take a long time, but I do think we will see initial public offerings as well as other investment tools being developed once the market stabilises. This is because there are only two players – Sberbank and VTB – who are actively lending and providing finance for projects. The rates are not that attractive, though, and developers want to have a wider choice of funding.”