Business activity continues to grow in St. Petersburg, with expanding companies striving to abandon their long-inhabited premises in Soviet-era administrative buildings and relocate to new, modern offices. Moscow and Western companies are opening representative offices in the country’s so-called northern capital, thus rendering quality office space in very short supply. Consequently, developers are taking advantage of the boom in demand and are delivering increasingly more new office centers to the market, knowing that office space in the near future will be leased out even before construction has been completed.

Overview
St. Petersburg, as previously stated, is considered Russia’s second capital, and the city is currently experiencing sharp growth in all real estate segments, following in Moscow’s path. Accordingly, the office real estate segment is reacting to the city’s growth in financial indicators, as the development of the various business sectors requires a large number of modern office buildings capable of accommodating said businesses. St. Petersburg’s developer, in response to the growing demand, have increased their activity, and the growing market is also attracting new players, as several investment companies and funds this past half year announced their intentions to invest in Russian real estate overall and particularly in St. Petersburg’s real estate. Several significant purchase and sale deals were signed with the participation of large Russian as well as Western companies. Accordingly, the following important events on the St. Petersburg office real estate market can be noted:

• British investment company Ovental Investments has announced its intentions to invest around one billion dollars in Russian real estate, of which around $150 million will be earmarked for investment in St. Petersburg projects. The company plans over the next two years to deliver to the city’s market a business center and two shopping and entertainment centers, totaling around 40,000 sqm.
• Rutley Russia Property Fund Limited (RRPF) investment fund, created with the participation of GVA Sawyer, Knight Frank and Duet Asset Management, plans to invest around one billion dollars in Russian real estate. The fund is interested foremost in large office, retail and warehouse facilities in Moscow, St. Petersburg and other large Russian cities.
• One of U.S.-based Morgan Stanley’s funds, Special Situations Fund III, has acquired 24.99% of St. Petersburg-based construction holding RBI, having purchased an additional share issuance offered by the holding. As reported, RBI intends to use the funds obtained from Morgan Stanley (experts estimate the amount at $50 million) to increase the scale of its projects and realize its plans of expanding into the regions.
• Finnish investment fund Sponda Russia has acquired the 3,695-sqm class B Inform-Future business center at 12 Tambovskaya St., which opened in 1997. All of the center’s space is currently leased out to tenants.
• British investment fund Northern European Properties Ltd. (NEPR) has purchased from Swedish investment company Ruric two office buildings located at 19/21 Dostoevskaya St., totaling 7,200 sqm. One of the buildings is the functioning class B Gryphon business center, while the second building will be 4,500 sqm and is slated for delivery at the end of 2007.
• Metro Baltic Horizons fund has bought the 16,000-sqm Svetoch production factory complex located at 10 Bolshaya Pushkarskaya St. The fund plans to build around 24,000 sqm of office space on the factory’s territory.

The Okhta-Center business complex, known also as Gazprom City, remains a hot topic on the St. Petersburg office real estate, as the issue of the main building’s height remains open to debate, the public continues to protest the construction and UNESCO has sent a request to halt construction temporarily on the tower to study the project in more detail. However, developers are already showing increased interest in the territory adjacent to the construction site, with several ambitious projects announced this past half year for construction on the plots close to Okhta. Accordingly, the previously seemingly unattractive location for office real estate promises to become the city’s business center as a result of the contentious Gazprom project.

Supply
According to the results of a study conducted by the Business Port marketing agency, there are around 3.2 million sqm of leaseable office premises of all classes on the St. Petersburg market, with this total set to decrease as a result of redevelopment and the razing of old administrative buildings. However, despite the active relocation of companies from class C and D premises to modern business centers, as cited by market experts, class C space still plays a significant role in forming the face of St. Petersburg’s office real estate market, remaining in demand by most small-sized business representatives. Therefore, the class A, B and C segments must be reviewed to provide and accurate picture of the current situation on the office real estate market. According to data provided by GVA Sawyer, the overall amount of office premises in these three classes as of the end of this past half year was 1.2 million sqm, comprised of 94,000 sqm of class A, 537,000 sqm of class B and 597,000 sqm of class C. The amount o f modern office space on offer, meaning class A and B, is assessed variously by market analysts:

- According to Colliers International, there are around 480,000 sqm of class A and B premises in business centers, of which class A comprises 15%, or 74,300 sqm.
- According to Knight Frank, quality office space comprises 590,700 sqm, of which class A is 11%, or 64,400 sqm, and class B is 89%, or 526,300 sqm.

As of the past half year, new offers comprised from 69,000 sqm (source: GVA Sawyer) to 106,500 sqm (source: Becar Commercial Property SPb), with only two newly built class A office buildings being delivered to the market: the Apollo business center, at 12B Dobrolyuvova Prospect, and Forum, at 8 Blokhina St. Praktis Consulting & Brokerage cites 93,800 sqm (66,950 sqm of leaseable premises) as being the average figure for the past half year, noting the more active delivery of new facilities in the first quarter, at 65,500 sqm, exceeding by two-fold the amount of premises in business centers delivered in the second quarter.
According to data provided by Becar Commercial Property SPb, more than 40 business centers and mixed-use facilities, including offices, could be delivered to the market by the end of this year, totaling more than 394,500 sqm, in accordance with developers’ plans. Additionally, several large facilities originally slated for delivery this year have postponed opening until 2008. “Typically, around 50%-70% of the announced volume is delivered to the market,” notes the company. “Accordingly, another 197,000-276,000 sqm of office premises can be forecasted for delivery by the end of this year.”
According to the analysts at GVA Sawyer, the overall premises as of the beginning of July 2007 in business centers (taking into account those located in mixed-use complexes), at various stages of design and construction, are more than five million sqm. However, the figures for designed facilities could significantly change, while several projects may not be completed at all. The following business centers may be noted as being among the largest announced projects:

• JFC fruit importer has announced plans to build a class A office center, as per the plans of the English architect Norman Foster, at the current location of the Frunzensky department store at 56 Moskovsky Prospect. The overall area of the new building to be constructed at the location of the razed department store (the Committee on State Control, Utilization and Protection of Historical and Cultural Landmarks (KGIOP) has not yet approved the removal) should be 65,000 sqm.
• The eight-story, 32,000-sqm class A Aeroplaza office center is slated for construction in the Pulkovo-3 business zone, on plot 4 on Startovaya St. Nevsky Prospect is the project’s developer, and the building is set for delivery at the beginning of 2008.
• The Becar group of companies plans to finish construction on the 10,000-sqm class B+ Bazen business center the group has acquired at 4 Shaumyana Prospect, with the building set for delivery to the market at the end of 2007.
• Moscow-based investment holding Kvartira.ru plans to deliver to the market at the end of 2008 a class B business center at 6 Reshetnikova St. Praktis Consulting and Brokerage designed the concept of the future 16-story, 22,300-sqm business center.

Avtomir trading house plans to build an elite business center, in excess of 10,000 sqm, next to the Primorsky district administration, on Savushkina St., with construction slated for completion at the beginning of 2008.
According to the specialists at Becar Commercial Property SPb, the city’s historical center (Vasileostrovsky and Central districts) remains the leader today in terms of new class A and B office premises delivered to the market. However, the trend of moving outside the city center continues as a result of land shortages and limits to reconstructing buildings in the center as well as transport issues, as attested to by the locations of many announced new projects. The most attractive territories for forming business districts are Petrogradskaya, Aptekarskaya, Vyborgskaya, Sverdlovskaya and Ushakovskaya Embankment, as well as the territories adjacent to Obvodny Canal, Moskovsky Prospect and Pulkovo airport.

Demand
According to the analysts’ estimates at Knight Frank SPb, the increase in demand in the first half of 2007 was mostly a result of companies’ wishing to improve the quality or expand the area of their existing offices in St. Petersburg. Moscow and international companies opening representative offices in the city is also a noticeable share in the overall demand. GVA Sawyer reports that the share of demand for companies expanding this past year rose by 20%, while the share of Moscow and Western companies today is more than one third of the demand for office premises.
Colliers International reports that in addition to continued demand for office space of 100-200 sqm, the number of requests for large blocks from 1,000 sqm has increased, which is particularly associated with companies planning on moving from class C business centers (which, in turn, are being closed for reconstruction) searching for vacant space. Colliers also notes that there is a high level of tenant turnover among those companies leasing office space in the city’s historical section, and this fact is associated with the said companies not always being able to recoup the lease expenses.
According to the marketing agency Business Port, the share of vacant premises is around two to three percent, with only class B (around one percent) being lower. According to market experts’ estimates, the occupancy rate of most quality premises is long ago near 100% capacity, while vacant space originates as a result of facilities delivered in the first half of the year not being full. However, preliminary lease contracts are a fairly widespread practice resulting in many facilities being fully occupied prior to the building being delivered to the market.

Lease Rates, Investments
According to GVA Sawyer’s estimates, the average yield from the purchase of finished office real estate in St. Petersburg is 12%-13% per annum, while the yield of developers’ activity is traditionally higher than the purchase of a finished facility, given that the internal rate of return (IRR) when completing investment projects, in the event of using only one’s own funds, is at least 15%, while using loan resources could push this figure to 35%, the company reports.
According to data provided by Colliers International, the required lease rates for the first half of 2007 for class A and B office premises rose on average by 3.3%-3.6%, totaling $500-$940/sqm per year for class A and $300-$580/sqm per year for class B, including operating expenses, but excluding VAT, for the reviewed period. However, the cost of operating expenses on average is around 15% of the net lease rate.
In terms of the cost for constructing office buildings, according to Becar Commercial Property SPb’s estimates, prices can vary from $1,000 to $1,500/sqm, depending on a facility’s location.

Trends

• Required office premises will continue to strengthen, as supported by many local companies striving to house their subdivisions in one office center.
• The locating of business centers beyond the city center, as a result of land shortages for construction and heavy traffic in the city center, was reconfirmed this past half year by the number of construction announcements for large facilities beyond the city’s historical center.
• The appearance of a new classification system for office buildings, as developed by the specialists at the Moscow Research Forum (MRF), resulted in class B buildings being divided into two sub-classes. The appearance of the additional class B+ standard was also dictated by the significant discrepancy in prices in class A and B buildings.

Forecast
Demand for quality office premises, on the part of St. Petersburg, Moscow as well as Western companies, will continue to increase in the coming half year, while the amount of vacant space will remain at a low level, although market experts do not anticipate a significant rise in lease rates. Investment deals are forecasted to rise in the mid-term, which, in turn, will require developers to be even more fastidious in their approach to the design and completion of projects for further sale. The number of large-scale business centers and mixed-use complexes delivered to the market will continue to increase, including office space. Previously announced large projects entering the market will alleviate somewhat the pressure on the office premises market; however, market saturation with subsequent growth in the amount of vacant space and a decrease in lease rates is not forecasted for at least the next decade.

Olga Lobacheva
16.08.2007

Saint Petersburg // Commercial Real Estate, #16 (76)
http://cre.ru/journalnews/1650/