Investment Volume Soars on Russia’s Real Estate Market

Transaction Volume of US Dollar 4.5 Billion Expected Risks Compensated by Higher Returns New Regional Markets Being Developed

Hamburg/Kiel, October 8, 2007 - Investment volumes on Russia’s commercial real estate markets have perked up sharply in 2007, too. By the end of the year, the total investment volume is likely to top US Dollar 4.5 billion. This translates into a 41 percent increase compared to last year’s figure of US Dollar 3.2 billion. The growth manifests itself on the office market as well as on the retail and logistics property markets. In addition to the traditionally favoured locations of Moscow and St. Petersburg, other major cities with populations of more than a million are moving increasingly into the focus of investors. These are the findings of the survey “Real Estate Market Russia - More Opportunities than Risks?” that was just published by HSH Nordbank.

About 20 percent of this year’s entire investment volume are earmarked for major Russian cities other than the metropolises Moscow and St. Petersburg. Last year, these cities accounted for a share of just 8 percent. “The catch-up need in these regional markets is particularly high. We expect that office space will double by 2009, going up to 2 million square metres. However, even this increase will do little to satisfy an estimated demand of 8 million square metres. We seen the greatest potential in the cities of Samara, Yekaterinburg, and Novosibirsk,” says Claudio Lagemann, Global Head of Real Estate at HSH Nordbank. An even faster growth rate has been forecast for the retail sector. Driven by surging consumer demand, the shopping centre floor-space is expected to nearly triple between 2006 and 2011. In this segment, experts have noted above-average growth in the cities of Yekaterinburg, Samara, and Nizhniy Novgorod. On individual markets, such as Kazan, however, there is a chance of short-term saturation setting in.

Risks Sufficiently Compensated by Higher Returns

Initial net yields in Moscow dropped from between 17 and 20 percent in 2001, down to between 8.5 and 11 percent last year, depending on the sector. Outside the Russian capital, returns were about 1 to 1.5 percentage points higher. The IRR level, still high compared to Central European countries, is offset by a concomitant higher risk. Due to government intervention in the political and economic arenas, Russia does not compare to democratic market economies in Western Europe. Also, the real estate market continues to show a comparatively low transparency despite signs of progress. Frequently, long-term real estate usage remains subject to speculation, especially outside Moscow and St. Petersburg. “Our analysis suggests though that the heightened risk is adequately compensated by the comparatively high returns,” argues Claudio Lagemann.

Moscow the Key Real Estate Market

Notwithstanding the increasing importance of other large Russian cities, Moscow continues to be the country’s most important real estate market. Here, extant prime office stock totalled about 6.4 million square metres at the end of last year. In 2006 alone, 1.1 million square metres in new floor-space were completed. Add to this another 1.2 million square metres that are scheduled for completion by the end of this year. The vacancy for prime space is a mere 1.5 percent because of the high demand. Unless the Russian economy loses is growth momentum, demand for high-end office space will linger on a high level through 2010.

Over the past two-and-a-half years, the retail floor-space in Moscow almost doubled, now up to 3.3 million square metres. Before the background of a major catch-up need in this segment, even the increased supply was unable to satisfy demand. Accordingly, last year saw rent hikes between 15 and 20 percent. Considering new retail floor-space that will be completed before the end of 2008, the growth in rent rates may indeed slow, but it will still be in the two-digit range.

The market for logistics properties is developing at a similarly dynamic pace as the other two segments discussed. Estimates for the existing supply in class A floor-space range from 1.4 million to 1.7 million square metres for last year. “In 2007 alone, another 1.2 to 1.9 million square metres in floor-space will reportedly be added. As the supply in attractive logistics space has remained underdeveloped, the newly created spaces will be absorbed by the market. Assuming continued economic growth, the same will be true for the logistics real estate planned through 2010,” Claudio Lagemann elaborates.

Poorly Developed Office Market in St. Petersburg

St. Petersburg is Russia’s second-most important economic region. Compared to Moscow, however, the city’s market for office real estate remains underdeveloped as it consists in large parts of legacy stock dating back to the Soviet era. Not until recent years did construction of new space get under way on a major scale. 2006 saw the completion of 110,000 square metres in new office space, and another 175,000 square metres were added during the first six months of this year. Most keenly felt is the shortage in small and large venues below 100 and above 1,500 square metres, respectively. The growth in rent rates will most likely average 10 to 12 percent in the years to come.

St. Petersburg plays a key role in Russia’s logistics industry. The city is well networked via port, railroads, roads, and airport. Its convenient location caused companies such as Wrigley’s, Ford, General Motors, and Toyota to relocate here. The soaring demand is facing a limited supply in modern warehouse and logistics space though. Construction of 500,000 square metres in floor-space is under way. Another 2.37 million square metres are going through the planning phase. Supply in modern storage space could rise from 500,000 square metres today to 1.6 million square metres by the end of 2008. Growth might be retarded by the traffic infrastructure, which is unlikely to grow apace with the rise in storage capacity.

HSH Nordbank AG is a strong regional bank in Northern Europe with total assets of € 205 billion. Some 4,600 of the bank’s employees provide corporate and high net-worth clients around the globe with premium bank products and services. In its core region of Hamburg and Schleswig-Holstein, it is the market leader in the corporate customer segment. HSH Nordbank is an acknowledged partner of the capital markets and international sector specialist. Its main focus is on transportation and real estate. In fact, HSH Nordbank is the world’s largest provider of ship finance and covers the entire value chain in the transportation segment. In the area of real estate, HSH Nordbank is one of the strongest banks in Germany, acting as a provider of services relating to all aspects of real estate.

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