Dmitry Leus: " Virus" crisis and real estate market
How the Russian real estate market can change in 2020 in terms of investment attractiveness and in what segments it makes sense to invest, according to finance analyst, international investor, and the Founder of Imperium Investments Dmitry Leus.
The events of the last two months have already clearly affected the Russian real estate market. Against the background of the weakening of the ruble in the first quarter of 2020 and the reduced mortgage rate at the end of last year, the market has been moving in different directions.
On the one hand, these two factors contribute to the increase in demand and short-term speculative desire to win back the lower rouble value per 1 sq. m., which already showed a 7% growth in Q1.
On the other hand, taking into account quarantine measures and related global changes in the organization and conduct of business, the real estate market may significantly change, and the usual today's leading position of office and retail real estate may be reduced due to more active growth of logistics and warehousing real estate. But let's take it in order.
After 2017 with the volume of investments into the commercial real estate market of $4.7 billion, 2018 and 2019 fixed at $2.5 billion. The main distribution by segments at the end of 2019 shows that the leaders are such segments as office and retail real estate, which together occupy about 78% of the market, while foreign investors are gradually reducing their presence in the market and their share has decreased by 5%.
At the beginning of the year, the forecast for 2020 looked like keeping the volume of investment at $2.5 billion and increasing the share of domestic investors against the background of the state's support of the industry in the form of large objects. But the events of the last 3 months had a very significant impact (and will still have an impact) on the market.
What's going on now?
Many companies have forced to switch to virtual office remote mode. Some treat it as a temporary forced solution and already make plans, as after the quarantine will be organized more efficient operation of the office as a whole.
Many managers have realized that keeping everyone in the office is not appropriate, and with the correct organization of remote work, the efficiency is higher.
Many employees have calculated their time and material costs for logistics and have also found that by maintaining the same level or even a small reduction in pay, they are freed up additional financial resources.
This is a good compromise and new opportunities, but they are not yet ready to give up the office completely.
Others see it as a revolutionary method of transition to a new reality with a minimal attachment to the office, increased use of technological solutions in the field of project and time management, periodic so-called "report&brainstorm meeting". Such companies are now seriously thinking about completely abandoning the physical office and trying to continue working in a "virtual" mode. This will require new technologies not only in the organization of business processes, but also completely new technologies in recruitment and staff retention within the "virtual" office. And this is a challenge, coping with which companies will get a tangible competitive advantage in the market in case of recurrence of such a situation. And taking into account the fact that many people already speak about a certain cyclicality, this situation may become a new reality for the future business.
Where would that go?
Most likely, it will lead to an increase in the level of vacancy in the first place, low-quality office space and redistribution within the category "A". Companies, using the momentary market situation, will try to improve their location mainly at the expense of the "A" type office. On the one hand, this will lead to an overall reduction in rental rates, but to increased demand. The result of this may be new projects for reconstruction or construction of office premises of "A" category and almost complete rejection of low-quality office premises. At the same time, the total share of investments in the office property segment may decrease to $700 mln (compared to $1.1 bln in 2019).
Retail real estate
This segment shows a gradual decrease in the volume of commissioned retail space over the last three years. Against the background of saturation of Moscow and St. Petersburg markets, at the moment the main focus of new investment projects will be shifted towards regional construction. Entertainment and shopping centers with large food-court zones and small demonstration showrooms, which will be points of delivery of Internet orders, will take the first place.
Already now we can observe the increasing penetration of online into offline. And the first to start using it were electronics retailers, who significantly reduced their offline presence and placed emphasis on customer communication and logistics. Many 5 years ago they were surprised by this decision and said that such innovations are unlikely to be effective, but time has shown (and especially now) how these changes were by the way.
The "virus" crisis became a trigger for those companies that did not develop their presence online, but relied on the premium of their product and the special customer experience their customers received when visiting an offline store. They suddenly realized the fact that no one would come to them today, tomorrow or in the coming weeks.
This prompted them to take more active steps to bring their product online and try to build new relationships with their customers on the one hand. On the other hand, they will also eventually understand the best business model in terms of business, which is likely to be associated with a reduced offline presence.
If we talk about street-retail, then against the background of increased up to 10% vacancy and almost static volume of this market segment over the past 3 years, we can assume that it will be subject to another redistribution among network players without any significant growth.
Where would that go?
New market conditions may lead to growth and development of inter-regional entertainment and trade megastores, reduction of offline presence and closer integration with e-commerce, development and construction of online communication with its customers, courier delivery and faster regional logistics.
The so-called "adapted" shopping malls, which at one time were quickly reorganised from warehouses and former industrial buildings, will in the near future completely leave the market and are likely to be considered as land for residential or office properties.
Against the background of a slight decrease in the volume of new facilities commissioned in 2018, such a segment of the market as warehouse real estate shows, albeit small, but stable growth from year to year over the past 5 years.
Along with the highest capitalization rate, constantly increasing rental rates and the lowest (about 2.5%) vacancy rate, this is probably the most interesting segment for investment in the near future.
Everything we mentioned above cannot be realized without quality logistics, in which the name warehouse component has the greatest impact. This is also confirmed by the excess of demand over supply.
In contrast to speculative operations in the office and retail real estate segments, this segment provides for a more balanced approach with the prospect of a longer period and larger investment projects. But this allows to get a stable and liquid asset at the exit.
If we talk about the forecast of development of this segment, the year 2020 is likely to pass without much bursts with standard growth dynamics, but 2021 is likely to show growth of about 25% and, by analogy with the segment of real estate retail, the main growth markets will be the regions.
To summarise all of this:
- In general, the real estate market in 2020 will be subject to multi-directional fluctuations and its volume may reach about $2 billion, which is $0.5 billion less than in 2018/2019;
- the trend will be A-class office properties at more reduced rates. Many companies will want to take advantage of this situation and there will be a situational surge in the market;
- gradual reduction of retail space, strengthening of online presence and construction of a new digital channel of communication with clients. Development of delivery services;
- emphasis on quality logistics and gradual growth of the warehouse segment.