Last year transaction volumes in Russia rose significantly, while the outlook is generally considered stable, says Kristina Gorkovskaya

The outlook for the Russian real estate market is stable, with growth potential for prime office and retail premises, but secondary properties - notably those in the office sector - exposed to growing risks.

On the demand side we will see further segmentation of companies into high-margin, active players and bearish survivors, which will pursue different (if not opposite) real estate strategies. Supply will remain under heavy pressure, particularly in Moscow: financing is limited, and the current city administration has a less-than-favourable view of large-scale commercial developments in the city centre. Recent real estate investment activity, meanwhile, confirmed two recent and noteworthy trends, which are set to continue - firm and growing confidence from foreign investors and growing interest in regional assets.

Confidence returned to the Russian commercial property market in 2011 as investment volumes reached a record high of €5.4bn, almost double the €2.8bn transacted in 2010. This has been followed in 2012 by the largest deal ever recorded in Russia, when Morgan Stanley Real Estate Fund VII acquired the Galeria shopping centre in St Petersburg for €836m.

The year 2011 was an exceptional one for occupational activity in the office and retail sectors, while in the industrial sector activity was constrained by a lack of supply. Rents across all commercial property sectors came under upward pressure in the first half, before stabilising in the latter part of the year. Compared with the end of 2010, rents in the most sought-after shopping centres and office buildings have gone up by as much as 40%, with growth of 10-20% observed elsewhere. Prime yields for quality Moscow premises have moved in by 50-100 bps.

Demand for office space began to slow in the second half of 2011, as uncertainty surrounding the elections and the economic situation in Europe meant that many occupiers postponed expansion plans until the situation became clearer.

While the Russian economy is expected to maintain its momentum, the office market will be under pressure from external factors and demand will remain subdued before recovering in 2013-14. The social security tax rates which came into effect on 1 January might also affect activity. Employers are required to make pay-related contributions, and the introduction of a 10% rate for earnings above 512,000 roubles per annum will increase labour costs, which could force corporations to control their staffing levels.

Despite a growing trend towards consolidation and re-assessment of occupancy costs, office rents have held up in recent months and should remain stable, with moderate growth possible in the most sought-after locations. There are still a number of tenants with active requirements in the market, and a high rotation rate means that even with an overall vacancy of nearly 14% in the capital at the end of the first quarter, landlords will still have a chance to lease their buildings. Moscow is, in fact, still characterised by a lack of prime space, and the development pipeline is low. Although there are buildings under construction, no new projects have been announced in recent months.

Meanwhile, the investment market will remain active, although volumes might ease slightly towards the end of the year as the lack of available product may become more apparent. The development of ‘New Moscow' - a new administrative and financial centre to the southwest of the city - will boost supply, although this is unlikely to take place before 2014.

While there is a general preference among investors for offices, which are perceived to be the most well-developed and least risky property sector, the retail sector made a milestone comeback in 2011, with volumes increasing more than seven-fold compared with 2010. There is also growing interest for prime retail assets in Russia's regions, as the lack of investment opportunities in the capital forces investors to consider riskier but often more profitable options in the developed regional markets - as underscored by the recent acquisition of the Galeria shopping centre.

Retail sales have been growing continuously since the start of 2010, and occupier demand has bounced back from the 2009 slowdown. Last year was characterised not just by increasing interest in Russia's regions, but also by increasing retailer interest, with many players looking to establish a presence beyond Moscow and St Petersburg. In Moscow, vacancy in established shopping centres is close to zero, and due to restrictions on construction inside the third transport ring, development has virtually ground to a halt. No new projects have been announced in recent months, and only one new scheme was delivered in Q1 2012 - the shopping gallery in the Moskva hotel near Red Square.

Elsewhere, the pipeline is healthy - major schemes are under construction in cities including Ekaterinburg, Krasnodar, Ufa, St Petersburg, and Sochi - although some projects might be subject to delays. There are also several projects in the pipeline on the outskirts of Moscow, including three factory outlet centres scheduled for completion before the end of the year. While prime rents are generally expected to remain stable in the coming months, further growth is possible for centrally-located shopping centres in the capital. On the other hand, rents could edge down slightly for shops on less popular streets.

The warehouse and industrial sector in 2011 was characterised by stable demand and limited construction; despite a shortage of warehouse space, few developers were able to obtain project financing. Vacancy for class-A space in the Moscow region decreased from 3.9% at the end of 2010 to just 1% at the end of 2011. Supply levels are anticipated to rise this year with a number of speculative schemes due for completion; nearly 900,000sqm of space is expected to arrive on the market, which should keep rents stable. Regional development is also likely to pick up in the coming years as rents come under pressure due to a lack of space - and announcements about the resumption of construction projects and the appearance of new logistics parks in undeveloped regions are likely in the near term. With a positive economic outlook for the year ahead, occupier demand should remain healthy, with many retailers looking for high-quality, well-located logistics and warehousing premises in the Moscow region.

Cities such as St. Petersburg, Krasnodar and Yekaterinburg are also increasingly sought after, while the development of a tourist hub in the North Caucasus should have a positive influence on demand for quality warehouse space in the coming years, and development in St Petersburg and Kaluga should also lead to increased industrial activity.

Kristina Gorkovskaya is a research analyst at Cushman & Wakefield