Russian Warehousing Property Market Forecast

Russian Warehousing Property Market Forecast

The challenging situation in national economy forces us to review once again the demand driving factors, both in the commercial real estate market in general and in the warehousing segment in particular. The outflow of capital, volatility on the foreign exchange market, deteriorating relationship between Russia and EU influence all national markets, but given below are the factors affecting the activity in the warehousing segment.

Factor # 1. Banking sector in crisis

The dependence of industrial developers on the banking sector is obvious, since most commercial real estate projects are financed by 70-85% via bank loans. Problems in the banking sector become increasingly apparent. In particular, 3 leading retail lenders in Russia reported performance deterioration. On the example of The Russian Standard Bank that reported a loss of 4.7bn rubles in H1 of 2014 (seven times as much as in 2013), experts foretell a downturn in both retail and corporate lending. The refinancing problems of state-owned banks and some commercial banks in the wake of the Ukrainian crisis are widely known. The access of Russia’s biggest banks to cheaper credit resources of the West has been limited. The interest rates are already growing both on deposits and loans, drawing certain development projects very close to the breakeven point. In summer the Central Bank’s refinancing rate rose to 8% (one-day REPO rate – to 9% p/a), which in turn forces banks to raise their interest rates on loans by 1-2%. Sberbank and VTB, crediting more than 50% of residential and commercial real estate development projects, will most likely be forced to increase their loan rates from the current 12-13%. For foreign investors, whose share in the investments of 2014 tends to zero, another factor of uncertainty is the unstable ruble exchange rates that make them hedge their portfolios against currency exchange risks and revise their financial models.

Factor # 2. Stagnation in consumer sector

It is retail that has enabled developers to fill both new retail and warehousing areas in recent years. Leading chain players in the food segment like X5, Magnit, Dixy, Auchan, Lenta and others keep on growing and improving their performance both due to regional expansion and to more efficient logistics schemes. However stagnation in other sectors of the consumer market is getting ever more notable. The main reasons include the falling personal income (98.8% compared to January-April of 2013) and insecure consumer behavior that further degraded in 2014 against the backdrop of the Ukrainian crisis. The forecast of the MED that at the turn of the year expected the personal income growth at the level of 3.3% has been corrected down to 0.5-0.9%, which is not the final estimation.

Factor # 3. Logistics sector

Geopolitical risks negatively affect the activity in the logistics sector, one of the biggest consumers of warehousing areas. Transportation companies have to build new transportation-logistics schemes minimizing the aftereffects of both the European sanctions and the Russian backlash, which inevitably reduces the yield. Thus the loss of proceeds by some logistics companies in January-August of 2014 exceeded 10-15%, while the freight flows have not been redirected towards the “friendly nations” yet. Logistics experts forecast significant contraction of freightage volumes along with quality deterioration, abstaining from precise estimations. This will decrease the load of warehousing areas and logo-parks in the industrial parks.

Factor # 4. Contracting western investments

Traditionally, western investors in Russia were active in the commercial real estate market, where direct western investments accounted for about 30% of their total volume. With geopolitical risks on the rise, western investors in 2014 have been investing only in the transactions planned prior to the Ukrainian crisis. Preliminary estimation of their investments in the Russian commercial real estate market does not exceed 10% of total investments in 2014. The “substitution” of Chinese investments for Western ones is only planned for now; this can be explained by the fact that the Chinese tend to develop the territories in the east of Russia.

Factor # 5. Imbalance of demand and supply in the warehousing market

Commercial real estate analysts estimate the market situation with cautious optimism, despite the 59% reduction of investments in the sector (total volume – $1.4 billion) as compared to 2013, noting that even before the sanctions were imposed the slowdown of national economic growth had caused the plummeting of investments. Given the Ukrainian crisis, sanctions and dwindling liquidity in the months to come, the market will see further contraction of demand, opines Finam analyst A. Vakulenko. By the commissioned space volumes, industrial real estate development in 2013 drew near to the record level of 2007 and the developers’ plans promised the delivery of 1.8m sq m of storage space to the market in 2014. However, the Ukrainian crisis entered corrections to the level of demand that shrank twice in the first half of 2014 and went on contracting in the third quarter of 2014. Vacancies in the storage market of the Moscow Region reached 4.5% and the prevailing trend might cause them to hit the mark of 8-10% by the end of 2014. “Notwithstanding the predictably widening imbalance between demand and supply, the odds are high that the commercial real estate market will get off cheaply. The only thing needed is positive GDP growth rates in 2015. The flow of negative statistics from the real estate market will likely continue until the second quarter of 2015. Yet 1-2 strong positive geopolitical signals are capable of setting the trends toward dwindling vacancies and market stabilization. In the worst-case scenario the opportunities of tenants to press for low rental rates over the mid-term horizon won’t be limited to the first half of 2015, but will follow the theoretically possible fall of GDP in 2015,” comments Valentin Gavrilov, director of the market research department at CBRE.

Executive summary

The growing cost of term loans, financial crunch coupled with lower demand for industrial real estate from investors will force developers to suspend projects in the initial stages of their delivery. It should be noted that during the previous crisis of 2009 the activity of developers sagged dramatically (by four times). It is but logical for warehousing developers to get ready for new construction in late 2015 – early 2016, when the recovery of demand will lead to the reduction of vacancies. Given the now prevailing mood on and state of the market, late 2014 – early 2015 might be a good time for investment deals. The prices of the assets with long leases will remain rather stable. In times of economic uncertainty owners will be inclined to sell not only low-yielding, but also medium-yielding properties. However, there won’t be many buyers in times of investment bust.