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Not too many years ago, Moscow’s skyline consisted of little more than the onion domes of the Kremlin and the Gothic spires of the Stalin-era buildings known as the Seven Sisters. But today, a forest of cranes dominates a 250-acre stretch along the Moscow River, where the 93-story Federation Tower—soon to be Europe’s tallest—is rising. A few blocks away, the European Trade Center, with 160 stores, a nine-screen cinema, and a swimming pool, is nearing completion. And on the city’s outskirts, the 54-story Triumph Palace last year began offering luxury residences to wealthy Russians. All across Moscow, new office towers and apartment blocks are transforming Russia’s capital.
While much of the boom is due to oil money, overseas investors are getting in on the action, too. This year, foreign investment funds are likely to sock as much as $1.5 billion into Russian real estate projects, nearly double last year’s level, according to real estate consultant CB Richard Ellis Noble Gibbons.
"Russia is clearly a key market for us," says John Carrafiell, global co-head of Morgan Stanley Real Estate, which in July bought 10% of developer RosEuroDevelopment. The Russian group plans investments worth $3 billion over the next five years, including office towers and shopping malls in major regional cities, and a $500 million campus for high-tech firms in the Siberian city of Novosibirsk.
The attraction? Booming business and rising personal wealth mean that demand is up for all types of property. Top-quality office space in Moscow now rents for $95 a square foot—two-thirds higher than in Midtown Manhattan. That’s bad news for Moscow’s business tenants, but it’s a boon for real estate investors, who are seeing annual returns that top 10%, vs. 4% to 5% in Western Europe and the U.S.
Morgan Stanley (MS) isn’t alone in trying to cash in on the growth. Austria’s Meinl European Land in March paid $508 million for four Moscow hypermarkets. British fund Raven Russia raised $266 million for Russian real estate last year. And London-based Fleming Family & Partners three years ago launched a $60 million Russian real estate investment fund with money from U.S. investors such as the General Electric Pension Trust (GE). Now the group is raising a second fund, worth at least $150 million, and hopes to invest $1 billion in the country over the next two years.
Russia "gives substantial upside compared to Western Europe," says Nikolai Karetnikov, Fleming’s asset manager in Moscow.
One problem, though, is finding projects that meet Western standards. Investors remain concerned about the quality of Russian construction and the reliability of partners. Until recently, foreign investment funds put money into completed buildings only, steering clear of the risks connected with construction and development—a murky business in Russia. Construction projects typically require more than 300 separate permits and licenses. It’s a red-tape barrier that opens up big possibilities for corruption.
But as property prices rise and bargains grow scarce, investors are starting to take on greater risk for higher returns. They’re now keen to fund construction, where annual returns of at least 20% are the norm. They’re also targeting smaller cities such as Novosibirsk, Ekaterinburg, and Krasnoyarsk, which are largely virgin territory.
"The Russian regions are now much more attractive for investors than Moscow," says Natalia Korotayeva, commercial director of RosEuroDevelopment. "You can still buy a very good site and build a very good project at low cost."
Indeed, as Moscow real estate prices continue their ascent, there are growing fears that the market will overshoot. Russia’s reliance on volatile oil heightens the chance of unexpected shocks. But analysts play down the risk of a commercial real estate bubble. Demand continues to outstrip supply by a wide margin, says Irina Florova, head of research at CBRE in Moscow. While Paris and London each have 300 million to 400 million square feet of modern office space, more populous Moscow has just over 50 million—much of it Soviet-era construction that lacks air conditioning, sophisticated communications, and sufficient space for parking. Says Florova: "We don’t think we will have any crisis soon."
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