Commercial Real Estate

New production complexes as well as a large number of Soviet-era factories and plants today can be considered industrial real estate. Moscow, which for a long time was an industrial city, today is ridding itself of its industrial heritage and is undergoing a restructuring, as enterprises are being moved from the city center to vacate space for the construction of modern offices, retail and residential complexes. New production facilities are essentially limited to the outskirts beyond Moscow, as the cost of land in the capital is prohibitively expensive for any industrial enterprise to operate profitably here.

Overview
According to Moscow mayor Yuri Luzhkov, over the past two years, the city’s production sector has increased by 22%-23% per annum. Naturally, various sectors have grown differently, with the main growth last year happening in machine manufacturing and electronics, while food stuffs and textile production have stagnated; therefore, Luzhkov believes that the state must lend support to these two areas. In any case, the shortage of land in Moscow is forcing the city to pay attention to territories currently occupied by factories and plants which long ago ceased activity and, in a base case scenario, are being leased out as class C and D offices and warehouses, while, in a worst case scenario, are simply lying vacant. The vast territories of the capital’s industrial zones are quickly reducing today, while existing production is consolidating, being transferred and is even ceasing activity.

The Moscow City government two years ago passed a decree according to which territories used for production must be reduced from 20,500 ha to 15,200 ha, while territories of 7,500 ha must have set boundaries for industrial zones on which there will only be “production facilities and infrastructure necessary for their operation.” “Land vacated as a result of reducing production territory will be used for a citywide center system (1,200 ha) for residential construction (1,900 ha) and for the rehabilitation of nature complex territories in Moscow (1,600 ha),” as stated by Valery Bekker, deputy director for urban planning economics at the scientific research and design institute (SRDI) of the Moscow general plan. Consequently, production will be concentrated in modern industrial zones. The Moscow Industrial City project was developed in 2003 to complete this goal, although the project is being implemented very slowly. Indeed, the Moscow Industrial City North pilot project is still at the design stages.

Developers and investors, in turn, are actively supporting the vacating of industrial territories, as many of the territories are located in the city center, so they are very attractive premises for the afore-said developers and investors. However, the process of replacing Soviet-era enterprises with modern buildings is not always simple, as many of the redesigned industrial zones came into the possession of their owners via so-called hostile takeovers. The peak of corporate raider activity was 2000-2002, but this is still a bit of a problem even today. The most vulnerable enterprises are those attractive for development and which were privatized with obvious violations.

New production areas are predominantly located beyond city limits. The Moscow Region district administrations are promoting the construction of industrial enterprises, as this develops the districts and provides the population with jobs while contributing taxes to the budgets.

Among the significant events on the industrial real estate market recently was Eurasia Logistics’ and Mulit-flex’s, Russia’s largest producer of packing material, signing in April of this year the first lease agreement for premises in the class A Northern Domodedovo production and logistics complex. Multi-flex plans to house its production facilities on 33,000 sqm in the complex. Knight Frank was the consultant for the deal.

Supply
There are more than 20,000 ha of industrial territory today in the capital, which is a bit less than one fifth of Moscow’s overall area. The industrial real estate market in the Moscow Region and Moscow proper mostly comprises obsolete production premises aplenty. According to Penny Lane Realty, around 70% of the Soviet-era industrial zones were spontaneously redesigned as warehouse, offices and low-end retail centers without any reconstruction whatsoever.

Moscow’s industrial zones over the past few years have been actively redesigned, with plots in the city’s center being of particularly high value to developers. Naturally, an investor would optimally prefer to acquire premises on which production has long ago ceased; however, these facilities – especially in the attractive centrally located districts of the city – have long ago been removed, as developers first completed projects in industrial zones with liquidated production. It should be noted that the attractiveness indicator of a specific territory changes each year, as, indeed, several years ago construction of the Third Ring Road expanded the zone of active construction, and this could not have come at a better time for the industrial zones located here. There are many modern business centers and retail and mixed-use complexes on the territory of said zones. According to the specialists at Praedium, the overall about of industrial territory in Moscow subjected to non-core redevelopment exceeds 1,000 ha.

Modern premises constructed for the most part by producers for their own needs are part of a quality sub-segment, with this type of production located predominantly beyond the city’s boundaries. According to specialists at Cushman & Wakefield Stiles and Riabokobylko, production located beyond Moscow’s borders is specified by the following features:

• low land cost vis-a-vis Moscow;
• presence of a work force among the population;
• close proximity to district populations, access to public transportation;
• presence of the necessary utilities and lines of communication, particularly electrical energy as well as gas and water;
• transport access;
• possibility to expand the production area;
• the local district administrations have policies to attract investment.

Large Western producers such as Mars and Campina take advantage of these features, having located their factories in the Stupinsky district, while Danone has operations in Chekhov, and LG opened this past autumn an assembly plant in the Ruzsky district, etc.
As Colliers International reports, one of the main demands for industrial real estate are the requisite utilities and lines of communications, such as electricity (minimum of 1-2 MW), gas, water and sewage. A sanitary zone with a radius from 30-100 or more meters is also required for several types of production, thus complicating the selection of appropriate premises. In this case, according to specialists at the company, there are several variants to resolve the issue:

• select and acquire a land plot, and then construct independently or with the assistance of a hired development company;
• search and acquire industrial space with installed utilities and communications and existing buildings suitable for use or requiring reconstruction;
• search for a developer with an appropriated land plot and technical resources for constructing a facility in accordance with a client’s demands.

According to the specialists at Espro Development, new production is considerably easier to locate in existing industrial zones with standing infrastructure. However, Astera Oncor indicates that often the existing power supply, for a number of reasons, is not strong enough for the requirements of new production, and it is also often necessary to change the utility network, construct a new substation and boiler room, etc. Problems could also arise with ground contamination caused by previous production and complications with deconstructing the old structure, which typically is very firmly built. “Therefore, many companies prefer to develop bare land plots to avoid any surprises hidden in the ground,” the company notes.
Industrial parks are becoming increasingly popular, given that these projects combine warehouse and production functions under one roof. Accordingly, production companies can optimize the production and storage processes, while a developer can diversify his risks by having the warehouse premises account for generating a portion of a project’s profits. Cushman & Wakefield Stiles & Riabokobylko reports that these types of projects today are typically so-called land development ones. In this case, a developer transfers a land plot to industrial status and installs all necessary utilities and communications, upon which a client either acquires the required plot and handles construction on his own or the construction is entrusted to said developer.
Savant notes that the procedure for obtaining the required permission and approvals for constructing a production enterprise is similar to that for a warehouse facility. The exception to this is hazardous production facilities (HPF) and enterprises with a definite level of harmful emissions. For these facilities, protective sanitary zones are designed and implemented, with environmental analysis and expertise at the federal level. In terms of the timeframe for receiving the preliminary permission and approval documentation, according to specialists at the company, this is over a year in Moscow and from six to eight months in the Moscow Region.
The following industrial real estate projects are currently under construction (Source: Astera Oncor):

• The class A Northern Domodedovo production and logistics complex, being developed by Eurasia Logistics. The 360,000-sqm first phase is slated for delivery in the second quarter of 2007, while the overall project will be around one million sqm. A new factory is being built on the territory for PepsiCo.
• The class A Vostochny industrial park in the Noginsk district, being developed by Espro Development and Raven Russia investment fund. Built-to-suit warehouse premises and several production wings are earmarked for construction on the 197,000-sqm area, with a single concept for the territory;
• The Valio company’s factory and distribution center in Lobnya, located on a 15.1-ha plot.

Demand
When reviewing industrial territories in terms of their redevelopment or new construction, demand for them has not waned on the part of developers and investors. There are still enough former industrial zones in Moscow which would be successfully redesigned for the construction of commercial facilities as well as for residential buildings. Demand for these plots arises from investment companies for whom a good location of a former industrial zone, and one that is not too troublesome and expensive in terms of relocating production (should this be required), is important.
Moreover, this previously less-attractive market sub-segment, under conditions of a dearth of plots for construction, is subject today to escalating competition between developers, and this situation frequently leads to conflicts between companies during the sale of such facilities. Indeed, the Mirax Group was not permitted to participate in an auction with Proetei and Metropol at the end of last year for the right to purchase the property of the bankrupt Moskvich automobile plant. The latter company eventually won the auction and split the obtained territory with the Moscow City government, while the Mirax Group filed a formal complaint with the courts. Similar conflicts are quite common on the Moscow market, and the remaining undeveloped industrial zones will very likely continue to enjoy considerable popularity.
In terms of using industrial real estate for its intended purpose, developers have only managed to get their hands on one third of the premises on industrial territories intended for production, while in the outskirts of Moscow this situation is even worse, where a large number of abandoned enterprises are lying idle and their fate has not been decided yet. Nevertheless, despite these premises not conforming to modern standards, they are still in demand. Penny Lane Realty reports that interest in these territories comes from mid- and small-size businesses which are developing the following types of production:

• food stuffs and alcohol production;
• plastic and rubber goods production, such as dishware, packaging, toys and polycarbonate;
• production of various construction materials;
• woodworking industry, etc

Demand for newly constructed facilities is difficult to asses, given that there is an extremely limited supply, and those that do exist are generally built by large Western and domestic producers for their own purposes. Cushman & Wakefield Stiles & Riabokobylko reports that the main demand for industrial parks and construction for clients comes from Western companies, while Russian producers typically prefer to handle matters independently. “Moreover, in terms of preferred location of production, demand in the Moscow Region can be divided into the 10-50-km distance from Moscow and the 100-200-km distance from Moscow,” reports the company. “The main areas are in the southeast, south and southwest.”

Lease Rates
In terms of cost and construction technology, industrial real estate is most similar to warehouse real estate, although there are a number of significant differences. As reported by Cushman & Wakefield Stiles & Riabokobylko, production companies require the following specified features as part of industrial premises.

• Individual technical demands for specific producers, such as increased floor load capacity, an overhead hoist crane, building height, building layout and form, sewage disposal and treatment, fire safety;
• Specific demands for utilities and communications – typically this encompasses an increase in electrical power vis-a-vis warehouse facilities: whereas a class A warehouse requires on average 200 kW per 10,000 sqm, production on the same amount of space would require 10-20-fold more.

According to date provided by Knight Frank, expenditures on constructing production facilities from the ground up could be around $700/sqm. Savant notes that the total area, type of support used and enclosing structures as well as the complexity of the construction and mounting work completed by the contractor are all pertinent in determining the average cost. Therefore, the cost of fully refurbishing a production building could be more than the cost for a standard warehouse building constructed from light metal materials. The exception would be assembly and packaging production which requires minimal equipment and sufficient light metal structures. Accordingly, the construction cost for one square meter would be comparable to similar indicators for warehouse premises.
According to data provided by Penny Lane, the cost of land in Moscow and the city’s outskirts varies according to the following parameters:

• within city limits, 100 sqm costs $50,000-$100,000, thus rendering virtually all production unprofitable;
• on the border with the MKAD, prices reach $35,000 per 100 sqm;
• at a distance of 10-20 km from the MKAD, land costs $8,000-$12,000/100sqm;
• at 20-30 km from the MKAD, near the TsKAD, the price is $,000-$6,000 per 100 sqm;
• At 30-50 km from the MKAD, 100 sqm costs $2,000-$4,000.

Espro Development reports that for 2006, land increased significantly in cost, with individual territories increasing two-fold. Moreover, construction materials increased by 20%-40%, while installing and hooking up electrical power increased by 30%-40%. “As a result, the average prime cost for development projects in 2006 increased by 25%-40%,” states Espro. “This means that construction costs depend directly on the duration, thus any postponements in completing a project could increase costs significantly.”
Furthermore, according to data provided by Praedium, lease rates in Moscow range from $50-$300/sqm per year, while in the outskirts of the city these figures are $30-$160/sqm per year. The sale price for a square meter of production premises, according to the company, are from $150 in Moscow, when a buyer purchases a large amount of space, for example, a full complex with buildings, to $2,500, for modern production and warehouse premises. The purchase price in the Moscow Region ranges from $50-$2,500/sqm.

Trends

• Moscow’s industrial zones will continue to be redesigned and reconstructed for other purposes, often retaining the historical facades, although a building could be razed completely for new construction;
• The issue of hostile takeovers and acquisitions of enterprises is still a problem. Accordingly, the most attractive industrial facilities already have owners, while corporate raiders will turn their attention to mid- and small-size enterprises;
• Western companies have been actively entering the industrial real estate market over the past few years. The said companies are interested in acquiring their own premises and combining production, offices and warehouse storage in one area;
• Some of the production facilities relocated from Moscow, as well as new industrial enterprises, are setting up in the neighboring Moscow regions. This is a result of more favorable terms and conditions for business development, such as a relatively inexpensive work force, reasonable lease rates and the cost to acquire real estate, etc. Consequently, production is more profitable beyond the confines of the Moscow Region.

Forecast
Growth of the modern industrial real estate market depends on factors affecting the development of the industrial sector in Russia overall an in the Moscow Region in particular. Moreover, continued economic development in conjunction with initiatives implemented on the part of the Moscow City and the Moscow Region governments, respectively, will very likely entice Western and Russian companies to begin production activities here in the short-term.
The volume of built-to-suit construction will increase in the mid-term, and this will concern both resulting sales to producers as well as for long-term leasing.
In terms of redesigned and reconstructed industrial zones, developers will very most likely place more value on those zones which will be within close proximity to the planned Fourth Transport Ring slated for construction in Moscow. The construction of new industrial enterprises in the Moscow Region, in turn, will very likely be concentrated in the short-term near the engineered Central Ring Road.