Commercial Real Estate

The situation with warehouse real estate in Russia’s northwest varies considerably, given that whereas there is considerable dynamic development of logistics complexes in St. Petersburg, there is a very obvious lag in the development of this sector in other major northwestern cities, such as Murmansk, Archangelsk and Kaliningrad. According to experts, thus situation will continue in the upcoming years; however, the region today already requires a completed logistics hub. So, which of these cites will be the main contender to play this role?

Banking on St. Petersburg

The dynamic retail and industry growth in St. Petersburg, as well as the increase in freight and cargo turnover, requires the corresponding development of the warehouse segment. Accordingly, rapid growth is anticipated in the upcoming years on the part of developers. Furthermore, Western investors have shown increased interest in this segment, but they are mostly interested in quality facilities which so far are in short order; therefore, investors must be involved in development independently.

According to data provided by Knight Frank Research, around 400,000 sqm of high-end warehouse complexes are earmarked for delivery by the end of 2007, while this figure is slated to increase by nearly two-fold to around 750,000 sqm in 2008. Table below outlines the warehouse facilities set for completion in the second half of 2007. It is worth noting that nearly half of the warehouse premises under construction will be located on the Shushary territory.

In the first half of 2007, the number of offers for quality warehouse space rose by 5%, with around 40% of the premises delivered being complexes for one’s own purposes. Meanwhile, the warehouse real estate market remains characterized by the postponement of delivery dates for the majority of class A projects. Thus the PNK project in Shushary and the Staraya Derevnya warehouse terminal on Mebelnaya St. have been postponed for delivery.

According to Colliers International’s calculations, 57% of the class A and B operating warehouses are located within the confines of the city, while 43% lie beyond the Ring Road, including logistics complexes and speculative warehouses, but excluding warehouses for one’s own purposes and refrigerated warehouses. Specialists forecast that given the dearth of vacant space and the high cost of land plots located within the city, construction on warehouse facilities will continue to increase beyond the Ring Road.

The overall city has zoned areas for facilities to preserve the city’s character. Particularly, around 80% of warehouse real estate projects are concentrated along Moskovskoe Shosse, leaving this area rather saturated with offers. Developers should realize that all of these companies are geared toward Moscow exclusively. Many tenants’ activities are associated with internal logistics; for example, they are interested in Vyborgskoe Shosse, where there is a shortage of space.

“Over the past year, the situation has changed a lot, and one can already lease high-end warehouse complexes on the St. Petersburg market. Indeed, 90% of these premises are currently geared toward large tenants; however, in three to four years, there will be two to two-and-a-half million sqm of storage space delivered to the market, and among this space will be projects aimed at smaller tenants,” believes Maksim Melnikov, senior consultant of the industrial and warehouse real estate department at Knight Frank, St. Petersburg.

However, according to most specialists, the dearth in this real estate sector will remain, and there will not be enough high-end warehouses. Tenants have become more demanding and fastidious in their selection, as many companies, in addition to quality premises, require an excellent concept and convenient location. Furthermore, there is an acute dearth of utility-ready land plots suitable for the construction of warehouses, and the cost for such territories are very often inflated, which does not reflect favorably on the warehouse real estate market structure.

Western Approach

However, despite all of its difficulties, St. Petersburg is the leader in the warehouse segment in Russia’s northwest region, as the situation with logistics complexes in other cities of this region is rather depressing. Although the increase in transport costs should provide an incentive to local businesses to build up local warehouse capacity, it is very unlikely that this matter will be resolved thoruhgout the contry’s northwestern region in the near term.

A review of the warehouse segment in Archangelsk reveals that the market for leasing storage premises remains underdeveloped, consisting of a number of facilities from the Soviet-era and belonging to previous industrial enterprises. Of the overall amount of warehouse real estate, there is an acute dearth of facilities with railroad lines and junctures, and it is problematic to lease warehouses with developed infrastructure. The average lease rate in this sector is $60/sqm per year. The local warehouse market was unprepared for the arrival of national commercial structures in the city and the increase in goods’ turnover of the local retailers, so the shortage will remain.

Murmansk’s current situation is similar to the one in Archangelsk, with the warehouses also comprising Soviet-era production bases, old fruit and vegetable storage buildings etc. There is a shortage of 500-1,000-sqm warehouse premises, and lease rates in unheated warehouses are $30-$150/sqm per year and up to $320/sqm per year in heated warehouses. Naturally, demand for quality premises has increased substantially with the arrival of Moscow players. Large retailers prefer to build their own storage facilities, as they are not satisfied with the existing offer.

Nevertheless, London Consulting Management believes that Murmansk – as the only city in the northwest region with year-round ice-free ports as a result of the Gulf Stream – can also compete to be a logistics hub in the region. In addition to this advantage, the city is close by such Western countries as Norway, Finland and Sweden, with the lion’s share of the city’s industrial and warehouse complexes located in the pre-port zone, where the railroad lines are extended. This concentration of transport routes of all types in one location renders Murmansk strategically strong and competitive.

Kaliningrad is located at some distance from the other cities in the northwest of Russia.

“Kaliningrad in general is accidentally located in the Northwest Federal District (NFD), given that it is on a completely isolated territory and does not share a contiguous federal border with either the NFD or Russia. The Kaliningrad Region should be considered separately from the other cities, as business here is completely independent of the country’s other regions. The issue of our participation in the NFD is most likely inappropriate, as Kaliningrad by itself is a logistics hub, and its users and transporters are local,” comments Oleg Zdradovsky, general director of Paul’s Yard, Kaliningrad. “As a logistics hub in the northeast of the European Union, our city could compete to play a significant role here, given that it offers market participants several competitive advantages, like location, an enclave part of the Russian Federation convenient for those trading with the country, the current law on an open economic zone offering huge tax benefits, the ice-free port, the short distance to wide railroad tracks, etc.”

However, retail real estate sector development in Kaliningrad is hindered by the ignorance of many market participants of the advantages the region offers and the possible risks associated with possible changes in status and policies in relation to the region’s format on the national and EU scale, as well as the possible changes in the current NFD law on tax and custom benefits. However, specialists believe that warehouse operators can still fight for this market.

“The Kaliningrad warehouse market simply must be modernized, as the region and transit freight require quality warehouses and handling. I believe that the situation will change within the next few years, with the arrival of large warehouse operating companies to the region’s market to organize freight and cargo flow,” says Zdradovsky. “According to data provided by Paul’s Yard, Kaliningrad specialists, lease rates for warehouse premises range from $70 up to $120/sqm per year.

The Future is in Unions

The situation in the northwest of the Russian Federation has developed in such a way that only St. Petersburg today could compete to fill the role of a regional logistics hub, as development in this sector is at the initial stage in other large NFD cities.

“The matter is that a large distribution center requires significant capital investment, and business today is particularly not up to the level of Moscow, as companies have become accustomed to using the warehouse infrastructure built during the Soviet era. Also, although there is a construction boom of modern logistics complexes in St. Petersburg today, Murmansk and Kaliningrad, not to mention Archangelsk, are very unlikely to close the gap between themselves and St. Petersburg in the near future,” believes Alexei Shaskolsky, director and analyst of the real estate valuation department at the Institute for Enterprise Issues (IEI).

In the meantime, St. Petersburg is the most important Russian logistics point as a result of the city’s location, and the main flow of freight and cargo passes through the city. Indeed, the shortest sea route from Europe stretches through St. Petersburg and the Leningrad Region to the intensively developing markets of Russia and the CIS. Moreover, private production and retail are quickly growing here, causing the development of warehouses along with the transit of freight. New highway construction projects (the Ring Road and Western Expressway) are also stimulating the development of warehouses. “St. Petersburg is being reorganized from primarily a port city to a logistics and distribution center as well, by developing both the dockside unloading of freight and cargo and their continued shipment generating added costs via rendering additional logistics and distribution services for the freight projects developed in the city,” believes Shaskolsky.

However, there are hindrances to the full-scale development of a logistics complex, associated with the city’s political and social specifics, such as the lag in developing transport and road networks; the lack of capacity and handling at the ports and airport; the delay in setting up new industrial zones (reserving territory for logistics and setting up their infrastructure); the divvying up of property in former industrial zones, which interferes with their redevelopment; and the opaque nature of lease relations in old storage and idle production facilities, which allows their owners to squat, thus preventing redevelopment. At the same time, Shaskolsky notes that, “I believe the potential of a prospective direct supply organization is important. One can assume that the transshipment of freight – with warehouses as the middlemen, requiring expenses and delayed income – in the future will begin to cede ground to direct shipment. None is writing about that here, but, in the West, this is already fully understood.”

Overall, however, St. Petersburg’s economic and geographical situation is favorable for setting up a distribution center.

“However, it is rather difficult for private investors to complete such projects themselves, without the support of the government. Therefore, until the initial market saturation with high-end warehouses, we shall not see a lot of interest on the part of investors and developers in setting up a hub. Several companies have tried to develop something like this, but, while there is demand for dry warehouses, it would be financially inadvisable today for developers to build specialized facilities, meaning less universal. Another issue regarding the development of a hub is the lack of a high-end industrial real estate as well as low-temperature warehouse markets, and the offers in these segments are very low, while, in turn, the lease rates for such facilities are, putting it lightly, overpriced. The main supply is geared toward the dry warehouse segment. In two to three years, once this segment has been saturated, developers will turn their attention to low-temperature warehouses, and only then will production be developed. However, it is worth noting that any hub will be more competitive than separate warehouse complexes,” notes Melnikov.

Analysts believe that if such a project is ever completed, all aspects of the infrastructure must be studied during preparation, such as how well developed the plot is in the engineering plan and whether there is a railroad line and juncture and access to a railroad station and easy access to a port. Also, a logistics hub does not need to be located close to the city, given that it would be geared toward specifically external logistics, so it would be fine for the said hub to be situated five kilometers from the city.

In conclusion, market players realize that a fully functioning and operating distribution center must be created in the northwest of Russia; however, its completion has been postponed for now for an undetermined period of time. Also, St. Petersburg is naturally the one and only contender for the role of logistics hub in this area today.