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Russian economy

Russia has enjoyed eight years of robust economic growth and declining inflation. Russian GDP grew on average by 6.7% per annum in real terms, driven by expanding net exports and booming consumption.

Strong investment performance has reignited economic growth. Foreign direct investment into Russia is increasing at a rapid pace, reaching USD 36.1 bn in Q1-Q3 2007 vs. USD 28.5 bn a year ago.

The country’s abundant oil and gas reserves give Russia an enormous competitive advantage and provide the resources for the country to diversify.

Russian long-term credit is rated investment grade by all three rating agencies and has improved significantly since 1998.

At the same time, inflation remains a problem. Double-digit price growth in every year but 2006 creates additional pressure on consumers and complicates the fulfilment of social goals.

Yet, despite high inflation, social indicators have been strong, with wages growing at a double-digit pace (16.2% in 2007). This has maintained the consumption boom over the last four years, benefiting retail trade, services and, construction industries.

Over the recent years Russia’s tax system underwent a comprehensive reform, aiming to ease the tax burden on individuals and companies and to simplify the national insurance system. Income tax is at the uniform rate of 13% for individuals. The maximum corporate tax rate on profit in Russia is 24%, one of the lowest in the world.

Figure 1.  Russian GDP per capita, USDFigure 2. FDI, USD bn
Source: Rosstat, Bank of Russia, Jones Lang LaSalle

Overview of real estate market in Russian regional cities
Economic overview

Moscow and St. Petersburg are Russia’s two largest cities as well as its economic and political centres. Their real estate sectors are relatively well researched. Yet the country has a further 11 lesser known cities with populations of 1 to 1.5 mn, the Millionniki. Even for these relatively large cities the available information is quite scarce. This review offers a snapshot of the real estate markets in the millionniki cities, which have emerged as the next development frontier for developers and investors, both domestic and foreign. These markets display higher yields than the two Russian power cities and often provide significant additional incentives to investors.

Most of the cities rely on strong industrial bases; some also possess large resource sectors (oil, gas and metals). The overall development of local businesses is particularly important for the office sector and for hotel operators.
The development of the consumer-driven industries is more relevant for the retail and warehouse sectors. A key factor determining the level of development is personal income. There is a strong correlation between personal income and retail trade turnover, and incomes in large cities have grown to levels that support high retail turnover.

Overall, the economies of major regional centres have recently followed a similar trend to that of Moscow or Russia in general. The key distinctions between the Millionniki and Russia’s capital is a lag in development, reflected in particular in income levels, and heavier reliance on resource and manufacturing enterprises.

On the other hand, development of local service sectors will likely create a partial repeat of the Moscow experience. Although no local city will rival Moscow’s concentration of financial, telecom, insurance companies, their expansion to the regional cities will likely be quite substantial, thus driving the office and – in the most prominent cities – hotel markets.

In all the segments, the key is to evaluate the balance between expanding demand and the available as well as announced supply of real estate properties.

Figure 3. Retail turnover, 2006 (USD bn)
Source: Rosstat

Regional office market


Due to increasing competition in Moscow and St. Petersburg and the growing economic potential of regional cities, more and more companies are entering Russia’s regional markets, generating demand for office space. However, the office market in Russia’s regions is still at an early stage of development. Regional supply of quality office space is limited, and all markets are undersupplied, albeit at different levels.

Although some cities boast more than a dozen quality office buildings, the supply is usually low and, more importantly, the quality of it lags behind that observed currently in Moscow. Just like in Moscow a few years ago, the quality is a ‘chicken and egg’ issue: local tenants are not yet ready to pay for quality locations while developers are reluctant to build Class A premises in anticipation of future demand.

The regional market is quite diverse, as projects differ significantly, thus complicating market valuation and classification. Yet, each city market is highly centralized; decentralization in some markets (Samara, Yekaterinburg, Novosibirsk, Nizhniy Novgorod, Omsk and Kazan) is just emerging.

The bulk of existing, low quality office space is represented by premises on the ground floors of residential buildings, in academic institutes and in old administrative buildings.

Figure 4. Existing and future office supply
Source: Jones Lang LaSalle

New projects by large Russian developers are beginning to enter the market. Quality office stock in Millionniki cities is projected to more than double by 2010.

However, the majority of projects are built by local developers, which lack a great amount of appropriate experience. Therefore, it tends to take longer for announced supply to reach the market.


Currently representative offices of large Russian companies and international businesses are the main source of demand for quality office space. Growing local businesses are catching up, but still mainly prefer Class C due to low sophistication and often limited budgets.


Rents for prime office space in Russia’s regions have reached Moscow Class B+ levels and already exceed most European rental rates. Leasing terms are not standardized, and each owner follows its own leasing policy. Building owners typically use simple arrangements: there is no VAT, lease terms are less than 12 months. However, this situation is beginning to improve.

Both developers and the majority of local companies prefer to sell/buy offices rather than lease them. The scarcity of property management companies contributes to this. However, as the market develops, more space is being offered for lease.

Figure 5. Average rents (USD/ sq m/ year) Figure 6. Average price (USD/ sq m)
Source: Jones Lang LaSalle

Regional retail market


Despite recent dynamic growth, per capita supply of retail space in the regions remains modest.

Figure 7. Shopping Centre Stock Supply per 1,000 inhabitants, sq m
Source: Jones Lang LaSalle

Retail market development has generally progressed from Moscow and St. Petersburg eastward, to other Millionniki cities, and now begins to involve smaller regional cities.


Personal incomes in Russia have been increasing recently by 13-15% annually in real terms, reaching around USD500 per month in 2007. 

The target audience for the retail market is the middle class: those earning above USD600 per month in Moscow and above USD300 in the regions. According to Jones Lang LaSalle estimates, the middle class constitutes up to 45% of population in Russian regions, and the size of this group increases by 3% annually.

The average Russian citizen spends about 73% of personal income on retail consumption, and this share varies from 66% in Omsk to 86% in Novosibirsk, very high proportions by international standards. This is due to the fact that most families own their apartments and houses without mortgage obligations. Also, consumers have gotten a strong taste for shopping over the last five years of economic growth.

Major retail chains have already begun expanding into the regions. The number of brands that have either entered the regional market or are seriously considering the move constantly increases.

At the next stage, established logistics bases in large cities will allow for easier expansion into neighbouring areas and into smaller regional cities.

Regional warehouse market


Active development of warehouse markets in the regions has started only recently, and all markets are at an early development stage. Major warehouse developers, having realised their first projects in Moscow, consider regional expansion.

Currently all regional markets are considerably undersupplied. Specific factors defining the warehouse potential of the regional cities are retail sector turnover and a location suitable for development of a logistic hub for the adjacent regions. Cities with both of these factors in place are the most attractive for warehouse development.
However, the potential for warehouse development in regional cities is much lower than in the capital, and Moscow will remain the major logistic hub for Russia.

Figure 8. Major Logistic Corridors and Potential Hubs
Source: Jones Lang LaSalle

One of the factors limiting warehouse market potential is location close to Moscow or other large distribution centres. This is the case for Kazan and Nizhny Novgorod. These cities are located less than 1,000 km from Moscow, and most companies distribute goods to these cities directly from Moscow; they either do not need warehouse space in the cities or use small areas in non-prime facilities.

Another limiting factor is that companies are not ready to pay high rents in the regions. Class A warehouse rents in regional cities are not much lower than in Moscow, mostly because construction costs are equally high. Besides, some companies have not yet appreciated the advantages of storage in quality warehouses and prefer to lease old warehouses at a lower rent. This situation will change with market development and growth of larger companies operating in the regions.

Other restrictions common to Russian regions are inadequate transport infrastructure, non-transparent land markets, long processes of getting necessary approvals and permits, difficulties with getting necessary utilities on site (gas, electricity etc.) and escalating construction costs affecting project profitability.

Nevertheless, developers have ambitious plans. The major players are Eurasia Logistics, Megalogix (a joint project of Raven & Avalon), RDS Development (Quinn Group), and RosEvroDevelopment. The first Class A projects were completed in 2007 (the first phase of Logopark Pyshma by Eurasia Logistics in Yekaterinburg).

Regional investment market

Investment volumes

Regional investment volumes are constantly increasing. Since the end of 2004, more than USD1.4 bn has been invested in regional commercial real estate. At the same time, the regional real estate market is currently characterized by a limited stock of modern properties, which restrains the expansion of the investment market.
A buoyant capital market is quickly reshaping local practices. Regional investment markets are proving to be increasingly attractive to international and domestic investors alike. With the arrival of professional investors interested in institutional quality premises, local developers are quickly adapting and implementing exit strategies. This has encouraged the adoption of best practice techniques and has led to the standardization of lease agreements, increasing transparency of cash flows and higher quality of construction.

As a result, the attractiveness of regional markets increased and so did the competition over limited numbers of assets. International investors are increasingly considering higher risk alternatives to competing for standing investment grade assets.

Competition is likely to increase further in 2008-2009. However, the Millionniki will still offer a considerable yield premium over Moscow, the possibility of freehold land tenure and an increasing emphasis on investment incentives from local governments. As the attraction of growing local markets for developers and investors and the number of quality assets increases, investment volumes will continue to expand.

Sector breakdown

The regional retail sector is currently the most attractive asset class for investment. Most investment-grade retail properties are located in the Millionniki cities. Deals have been already completed in Volgograd, Yekaterinburg, Samara, Kazan, Ufa. Office and logistic investment markets in the Millionniki are expected to emerge over the course of 2008-2010.


In the last five years prime yields in Moscow compressed from 20% to 8%. A similar trend is now occurring in Russian regions, where prime investment yields are now at 10-11%. However, as investment grade assets are delivered to the market, investment yields are expected to approach those of Moscow and St Petersburg. At the same time, rental rates will likely grow considerably in many regional cities.

As in Central Europe, the key to acquiring quality real estate assets in Russia is to focus on sustainability. While exposed to lower competition and yield compression, a decisive feature of Russia’s regional markets is the freehold tenure. It strongly influences development decisions by allowing investors a familiar and more secure title on their investment.

From Jones Lang LaSalle
Exhibition operator - FORMIKA

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