Russian Shopping Centre Report 2009

Russian Shopping Centre Report 2009

2008 was a year of huge global upheaval. Real estate, like most other sectors of the economy, has been affected and went through signifi cant corrections. The Russian real estate sector is no exception. Although the effects of the crisis were not felt until Q4 2008, when they were, the effect was dramatic and occurred almost overnight.

This report looks at the shopping centre market in Russia and provides a review of 2008, the current situation and likely prospects for 2009.

On Point • Russian Shopping Centre Report 2009 2

Many sectors, including manufacturing and service industries, have now sharply slowed their expansion or downsized in anticipation of weaker demand. Moreover, the reassessment of Russia’s country specifi c risk in comparison to more transparent core economies has led to a change in strategy by many foreign corporations looking to focus on more risk-averse markets and therefore exiting from the Russian market.

As a result, in 2009 it is expected that the slowdown in the economy will continue and is likely to post negative growth of circa 5.0%, similar to many other major economies across Europe.

Over the last eight years increasing commodity prices have allowed Russia to amass signifi cant currency reserves of USD 500 bn and as a result of prudent fi scal measures, a further USD 140 bn as the Stabilisation Fund, set up in recognition that the economy was sensitive to future oil price movements.

Since H2 2008, declining commodity prices have worsened the terms of trade and depressed currency infl ows. However, it was the confl ict in Georgia that sharpened the pain infl icted by the unfolding crisis. It had a signifi cant detrimental impact upon investor confi dence resulting in capital outfl ows from the economy of some USD 130 bn in Q4 2008 and a virtual collapse of the Russianstock market.

As the situation worsened, the government had to step in and use the safety reserves accumulated during the time of strong economic growth to provide stability to the economy.

EconomyOver the last eight years, Russia has shown strong economic performance, with average GDP growth of around 7% per annum. Driven primarily by expanding exports and booming domestic consumption, economic growth accelerated to 8.1% in 2007 and 7.3% YoY in Q1-Q3 2008.

Foreign direct investment into Russia have also been on the rise, reaching USD 70.3 bn in 2008 compared to USD 55.1 bn in 2007. This provided signifi cant support to domestic activity, keeping overall investment growth above 10%.

Although oil and gas are Russia’s largest exports and account for some 22% of its GDP, the bulk of recent growth has come from non-resource sectors including construction, wholesale and retail trade, fi nancial and real estate services – showing increasing diversifi cation in the economic base.

High currency revenues, strong domestic investment and consumption growth, low consumer debt and limited exposure to the sub-prime and CMBS markets delayed the effect of the global crisis in Russia until around September 2008.

However, in Q4 2008, these positive market dynamics were interrupted by the fi nancial crisis, reducing full-year 2008 GDPgrowth to 5.6%.

Source: Rosstat, Jones Lang LaSalle

Source: EIU

1 Compound annual growth rate.

Macroeconomic overview

Comparative GDP growth dynamics and forecasts (%)

-3.5%

-1.5%

0.5%

2.5%

4.5%

6.5%

8.5%

2002 2003 2004 2005 2006 2007 2008E 2009F 2010F

ECE Euro area Russia USA

2008 2003-08 share CAGR1 Construction 5.6 11.3Wholesale and retail trade; vehicle repair 18.1 11.3Financial services 4.1 10.1Real estate services 9.6 9.7Transportation and telecoms 8.2 7.3Processing industry 15.2 6.3Agriculture, hunting and forestry 4.1 4.0Mineral extraction 8.1 2.1

Russian GDP by sector (%)

3 On Point • Russian Shopping Centre Report 2009

The focus of state initiatives has been to provide liquidity to banks and selected enterprises in key sectors. Around USD 150 bn of the Bank of Russia (CBR) reserves were spent on smoothing the rouble depreciation.

This year will be marked by a record fi scal stimulus package, and the federal budget will post a defi cit of 8.2% of GDP. Unlike many European economies, the Russian government can afford such resolute measures, having posted an average budget surplus of4% of GDP every year since 2000.

Low debt exposure One of the key factors that distinguish Russia in the current environment is the limited exposure to debt at both the government and consumer levels.

Source: Finanace Ministry, Jones Lang LaSalle * From 2008, the sum of the Reserve

Fund and the National Wellfare Fund

Source: Eurostat, Troika Dialog

As the global economy starts to pick up, Russia will be able to take advantage of its relatively low leverage compared to other major economies that will be slower to recover due to a need to clean up existing balance sheet and debt liabilities.

Russia, due to its low household debt level will also allow consumers to remain active shoppers. The total consumer debt is currently below 10% of GDP, signifi cantly less than in most European countries. As a result of the fi nancial crisis, consumer credit in most European countries is no longer freely available and has become signifi cantly more expensive, therefore reducing the amount of disposable funds available for consumption.

Federal budget balance, international reserves and the Stabilisation Fund (% of GDP)

Government debt / GDP, 2008

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

2004 2005 2006 2007 2008

2009F -10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Federal government balance, R axisInternational reservesStabilisation Fund*

Source: Bank of Russia, Bloomberg

Debt levels in Russia, USA and France (% of GDP)

0%

20%

40%

60%

80%

100%

120%

140%

Government Household Financial Corporate

Russia USA France0% 20% 40% 60% 80% 100% 120%

Russia

Spain

Turkey

Poland

UK

France

Germany

Italy


Retail marketReal wages in Russia have been growing at an average of 15% per annum over the last eight years. This has lead to rapid welfare improvements and a growing middle class that has sparked a consumer-driven boom. Retail sales have expanded in line with income growth, and being the top performing sector in the economy over the last decade, has fi rmly shifted the emphasis of the economic growth into the hands of the consumer.

Additional support to retail sales growth has come from consumer lending, although the total debt has remained quite modest.

As a result of a slowdown in the economy, unemployment has risen and many companies have been forced to cut bonuses and wages. The majority of the layoffs occurred in Q4 2008, as companies made signifi cant redundancies early in order to limit future adjustments.

The roubleThe downturn in the economy has lead to the depreciation of the rouble. The CBR initially reacted slowly to the country’s worsening external position and orchestrated a gradual rouble devaluation, letting it end the year only 5.4% weaker against the USD in real terms. This was done in large part for political reasons, by granting local companies and households an opportunity to adjust to new realities and not to repeat the painful experience of 1998.

Taking a more resolute stance in January-February 2009, the CBR has let the rouble weaken to around 36.5 per USD and has explicitly indicated that this will be the peak of the devaluation for the time being. In fact, the rouble has bounced back to 33.5 in the recent weeks. Although the rouble weakening has been quite dramatic, it has been comparable with many other currencies, as the global fi nancial fl ows displayed a shift to US assets, seen to be more stable.

We believe that in the absence of external shocks – of which the oil price is the key – the external trade balance will remain positive and will support the rouble stability in the medium term. The main internal danger that may force further devaluation is the overall economic performance. If the economy continues to decline and does not stabilise by H2 2009, the CBR will likely use further currency devaluation to prop up the economy through import substitution.


Retail sales in Russia

Source: Bloomberg

Devaluation of selected currencies vs. USD,1 January 2008-1 April 2009 (%)

-40% -30% -20% -10% 0%

EuroNorwegian croneCanadian dollarAustralian dollar

Brazilian realMexican peso

New Zealand dollarRussian rouble

Polish zlotyBritish pound

South African randTurkish lira

Ukrainian hryvnia

0

100

200

300

400

500

600

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009F 2010F 2011F-5%

0%

5%

10%

15%

20%

Retail sales, USD bn Real retail growth, YoY

Source: Bank of Russia, Jones Lang LaSalle

The rouble

-10%

-5%

0%

5%

10%

15%

20%

2002 2003 2004 2005 2006 2007 2008 2009F 2010F 2011F 0

5

10

15

20

25

30

35

40

Real RUB appreciation vs USD Exchange rate (RUB/USD, end-year)

Personal income and loans (USD)

0

5000

10000

15000

20000

25000

2000 2001 2002 2003 2004 2005 2006 2007 2008Personal annual income Personal loans

Source: Rosstat, Bank of Russia, Jones Lang LaSalle


The correction imposed by declining incomes and rouble weakening will have a signifi cant effect on the market and will harm the consumer spending growth of the last decade. As a result, sales volumes in Russia are expected to decline by 5.2% in 2009. However, it is likely that the full effects of negative income and employment changes will take time to fi lter down into consumer spending and retail sales fi gures. We believe that it will not be until mid-2009 that the full extent is shown.

Nevertheless, the resilience of the Russian consumer – keeping retail sales growing in YoY terms until February – indicates that the downward adjustment will be relatively mild, and recent employer surveys and PMI reports already show signifi cant improvement in the sentiment since Q4 2008.

Infl ationThe consumer boom has kept prices high, and infl ation remains a prime concern. It defl ates welfare gains, particularly affecting the lower income population.


Unemployment rate (% of labour force)

0%

2%

4%

6%

8%

10%

12%

Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09F Sep-09F

Source: Rosstat

Consumer infl ation (YoY, %)

0%2%4%6%8%

10%12%14%16%18%20%

Jan-02

May-02

Sep-02

Jan-03

May-03

Sep-03

Jan-04

May-04

Sep-04

Jan-05

May-05

Sep-05

Jan-06

May-06

Sep-06

Jan-07

May-07

Sep-07

Jan-08

May-08

Sep-08

Jan-09

Since 2007, infl ation has increased due to growing global food prices and loose monetary policy caused by large currency infl ows. Although likely to ease in the near term, infl ation is expected to remain high.

With the average nominal wage growth over last few years at above 25% per annum, the effects of infl ation have been negated. However, with the recent increase in unemployment and salary levels frozen – the effects will now be felt more strongly throughout the country and will reduce consumer spending.

ConclusionProlonged economic growth allowed the Russian economy to build strong fundamentals and to hold up initially against the pressure from the global fi nancial crisis. However, since Q4 2008, there has been a signifi cant slowdown in the economy.

Despite the current turmoil, Russia is well positioned to recover earlier than most and will again deliver superior performance relative to other major economies in Europe. The key distinguishing factors are low household debt, an undersupplied consumer as well as in active state support of the economy.

The consumer will remain the key player in the economic recovery and currency stability.


2008Despite market fears of a global slowdown, Russia continued to attract new retailers, keen to expand their international operations. In 2008 new brands entering the market included GAP (USA), Kiabi (France), Lindex (Sweden), Starbucks (USA), Principles (UK), Warehouse (UK) and Fridays Project (Spain) – all of which have signifi cant expansion plans for the coming years.

Retailers prefer entering Russia with local partners. We believe this trend will continue, as it is still a challenging market to enter alone due to language and cultural barriers and the complexity of the legal and fi nancial systems.

According to A.T. Kearney’s Global Retail Development Index, Russia was the 3rd most targeted country by retailers in 2008.

However, within the last quarter of 2008 the occupational markets witnessed a change in retailer demand and take-up as a result of the ongoing global fi nancial crisis. Initially this had been a result of the retailer’s inability to fi nance expansion plans – through deposits/advance rent payments, but more recently retailers began to claim that a slowdown in sales growth has also impacted upon their proposed expansion strategies for 2009.

The situation is mixed:1) Large international retailers.Most of the occupiers from this category, already present in the market, will maintain expansion plans throughout Russia in 2009, and in some cases, are even speeding up the process to take advantage of the existing opportunities. Brands from the group Auchan (Auchan, Attac, Decathlon, Leroy Merlin), the Metro Group, Castorama, OBI, Carrefour and Walmart are all eager to keep to their expansion programs, through a mixture of leasing, acquisition of premises and co-investment.

For international MSUs (major space users) – Tatum, H&M, Inditex, etc. – we see a similar situation. However, some MSU retailers being distributed through franchise agreements are re-considering their strategy. Recent examples of this are Mango and New Yorker who took back their franchises in 2008 from Arts Group and RAMO respectively.

2) Large Russian operators, MSU and large franchisees.This group of retailers have been most impacted by the credit crunch. Over the last fi ve years, they have been using easily available short-term fi nancing to aid their aggressive expansion programmes in Russia. From Q4 2008, fi nancing all but dried up. As a result many of these retailers have been experiencing short-term cash fl ow issues – having trouble paying suppliers and covering fi t-out costs in their committed future stores.

As a result, domestic operators have either dramatically reduced their expansion plans (X5 Retail Group, Detski Mir) or stopped them (Sportmaster, Maratex, FDLab, etc.) at least for the fi rst half of 2009.

3) Gallery.Mid market gallery retailers revised their expansion plans and reduced the number of stores they initially proposed for 2009. Maratex (Esprit, SMYK, River Island, Peacocks) recently announced they will only launch fi ve new stores in 2009, whereas previously they had plans for over 50 stores. The majority of these retailers have decided to put on hold any expansion plans and decision making until Q2 2009.

2008 Global Retail Development Index

0102030405060708090

100

Vietna

mInd

iaRu

ssia

China

Egyp

tMo

rocc

oSa

udi A

rabia

Chile

Braz

ilTu

rkey

Mexic

oAlg

eria

Malay

siaPe

ruInd

ones

iaBu

lgaria

Ukra

ineTu

nisia

Colom

bia UAE

Latvi

aRo

mania

Slove

niaTh

ailan

dMa

cedo

niaPh

ilippin

esGu

atema

laAr

genti

naHo

ndur

asLit

huan

ia

On retailers radar screen Retailers considering Low priority

GRDI

Sco

re

Source: A.T. Kearney

Source: Company reports

Store expansion of top-10 Russian retailers

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2004 2005 2006 2007 2008

Num

ber o

f sto

res

LentaM.VideoTehnosilaDixy GroupKopeikaX5 Retail GroupEldoradoSvyaznoyMagnitEvroset

CAGR 42%

Retailer demand


The luxury retail market has been hit hardest. Turnover of the premium class retailers fell by an average of 30-40% in 2008 in comparison with 2007. Again, the majority of these groups have put on hold any expansion plans for 2009 until Q2/Q3 2009. For example, the Richemont Group (Cartier, Van Cleef) have actually decided to postpone any new openings and concentrate only on their existing stores.

2009 In 2009 we expect to see further expansion by new international brands – with openings in Moscow and to a lesser extent St. Petersburg, followed by leading regional millionniki cities. Retailers expected to enter the market this year include amongst others French Connection (UK), Mamas and Papas (UK), Salomon (France), Walmart (USA), H&M (Sweden) and River Island (UK).The French hypermarket operator, Carrefour will also open their fi rst store in Moscow in 2009 at the Filion shopping centre andhave plans for further expansion in the leading regional cities.

At present any slowdown in consumer spending is diffi cult to assess as the economy is only just beginning to affect the wider consumer and retail sales volumes – which were buoyed by the New Year spending and has continued into 2009. Should there be a signifi cant growth in the rate of unemployment across Russia in 2009 and further deterioration in consumer confi dence then we expect to see a signifi cant slowdown in retail, with sales of non-essential items suffering particularly.

However, retailers consider Russia as a strategic long term market and have not been put off by a potential downturn in the economy thus far – in fact as already discussed it is expected that those able to fi nance their new expansion will see the current situation as an opportunity to negotiate better fi nancial conditions and gain a foothold in the market.

The market is also likely to witness a consolidation of franchise companies. Those without support of the government and with immediate short-term liquidity issues are likely to loose distribution rights with foreign retailers moving towards more fi nancially secure and experienced companies.

It is also likely that 2009 will see more retailers taking back their franchise agreements and operating directly.

This is due to:current fi nancial situation of several domestic franchise companies;• existing retailers becoming more comfortable in the Russian market;• concerns over operational effi ciency in times of falling;• consumer expenditure. •

Operating the brand directly ensures not only enhanced profi tability, but greater control of the outlet and the brand performance. In 2009, Hennes & Mauritz (H&M) opened its fi rst store in Metropolis Shopping Centre in Moscow without a partner; Uniqlo is expected to open shortly, and both will look to expand directly. We believe this willbe an increasing trend in the market.


Retail supply

Supply

Despite this, the country is signifi cantly underserved in terms of stock per capita relative to other markets.

Project delays remain widespread. In 2008, just over 20% of the announced supply for Russia (5.1 mn sq m) actually reached the market. In Moscow 65% of projects announced for delivery werenot completed, whereas 15% of the forecast supply was cancelled.

Project fi nancing for new developments has been severely restricted and since October 2008 all but stopped. As a result, only those projects that are currently under construction and have committed fi nancing will reach completion in 2009 or early 2010. With a number of large shopping centre projects due to open in 2009, completion volumes in Moscow for this year will see a slight increase to 2008 levels, at around 0.8 million sq m.

Due to the complete lack of available debt, it is unlikely that any new shopping centre projects will be started until 2010. Taking into account

the average construction cycle of at least two years – and around four years for large schemes – the pipeline for 2010-2012 will be drastically reduced.

As a result, the market will remain signifi cantly under-supplied for the next 2-3 years. Only then it is likely to see a pick up, fi rstly in Moscow and then gradually in St. Petersburg and then in the major regional cities.

The development of the retail market in the Russian regions has lagged behind Moscow and St. Petersburg. These markets started from a position of literally no modern retailing provision. Due to the size of these cities and lower per capita incomes their market size is signifi cantly smaller than that in Moscow. Despite a recent increase in retail provision, they remain considerably underserved. However, the large expected development pipeline has put these cities at risk of becoming quickly saturated and over-supplied. Most of these development projects have now been put on hold. This will provide for a more sustainable retail environment in the medium term.

Source: Jones Lang LaSalle


Shopping centre stock in major Russian cities (‘000 sq m)

Shopping centre stock per 1,000 inhabitants (sq m)

Moscow shopping centre completions (‘000 sq m)

Moscow St.Petersburg Millionniki

0

1,000

2,000

3,000

4,000

5,000

6,000

2001 2002 2003 2004 2005 2006 2007 2008

0 100 200 300 400 500 600 700

Prague

Warsaw

Frankfurt

Berlin

Budapest

St.Petersburg

Moscow

0

200

400

600

800

1,000

1,200

2007 2008 2009F 2010F 2011F

'000 sq m

Announced completions Adjusted completions

Quality retail stock dynamics

050

100150200250300350400450500

Nizhny

Novgoro

d

Yekateri

nburg

Novosib

irskKaza

nSam

ara Ufa

Chelyab

insk

Omsk

Volgogr

ad

Rostov-

on-Don

Perm

000' sq m

050100150200250300350400

sq m per 1,000 inhabitantsPipeline projects, 2009-2010

Ex isting stock, 2008Ex isting stock per 1,000 inhabitants, 2008



Russia has the largest development pipeline in Europe and over the last fi ve years the supply of modern retail space increased more than ten fold.


Current pressure on rents is also due to the weak fi nancial position of the retailer / franchise groups as a result of their expansion plans. Landlords, in order to alleviate the need to tie up cashfl ow for long periods, are reviewing the level of deposits and advance payments. Traditionally these have been dealt with on a 3 & 3 basis –ie. three months rent deposit with three months advance rent. However, some landlords are now willing to negotiate accepting one month security deposit with one month advance rent with retailers paying on a monthly rather than quarterly basis.

With retailer demand slowing against a signifi cant fall in the future supply pipeline, we believe that the market is more likely to see a stabilisation of rents as opposed to the strong growth rates witnessed over the past three to fi ve years. Other commentators have predicted falls of circa 30-40% over 2009, however we believe that this is from the forecast rents for 2009-2010 that included 20-25% YoY growth rather than actually achieved rents current in the market. Where new schemes were looking to achieve average rents of circa USD1,200-1,400 per sq m per annum we believe these will actually remain in 2009 at the current average of circa USD1,000 for prime shopping centres in Moscow.

However, for secondary schemes in Moscow and for shopping centres located in the regional cities, in particular those “one industry” towns that have been subject to signifi cant wage cutsand unemployment, it is likely that rents will see a 10-20%decline in 2009.

Moscow shopping centre completions (‘000 sq m)

Average prime shopping centre rents in Moscow (USD/sq m/year)

200

400

600

800

1,000

1,200

1,400

2002 2003 2004 2005 2006 2007 2008 2009 F 2010 F

Post crisis rental forecast Pre-crisis rental forecast


Source: Company reports

Rental levels

Retailers have been stating that a fall in consumer confi dence is affecting turnover. It is clear that the luxury market has been affected as consumers have become more price-conscious. However, many of the top domestic retailers have shown growing sales fi gures and the offi cial Rosstat statistics show YoY retail sales growth until February 2009.

Despite these positive statistics, most retailers are now looking for rent concessions claiming the current economic environment anda slowdown in consumer spending.

Retail gallery tenants since the latter part of 2008 have looked to renegotiate terms with landlords and seek rental discounts, of in some cases more than 25%. Whilst landlords are attempting to maintain their rental budgets by resisting such requests, they may become more fl exible during the year in order to secure lettings to the best retailers. Landlords may seek to avoid reducing headline rental levels by offering incentives such as rent free periods or capital contributions/enhanced fi t outs.

Rental levels for large anchors have remained robust in recent months as retail performance has been, by and large, sustained, with a severe defi cit of good quality space to house their large modern retail formats.

Retail chain

Profile Turnover in 2008,

USD bn Turnover growthto 2007 level

X5 Retail Group Grocery 8.30 57% Euroset Electronics 6.80 22% Magnit Grocery 5.32 46% Svyaznoy Electronics 2.94 26% M.Video Electronics 2.73 43% Lenta Grocery 2.34 50% Kopeika Grocery 2.10 38% O’Key Grocery 2.00 70% Dixy Grocery 1.94 36% Seventh Continent Grocery 1.76 22% Vester Grocery 0.67 97% Beliy Veter Electronics 0.38 36% Rosinter Restaurants Grocery 0.34 28% Systema Region Mart Grocery 0.33 66% ABK Grocery 0.11 33%


Capital markets ― 2008 review

2008 reviewUnlike most countries in Europe that have been affected by the global fi nancial crisis since 2007, it was not until September 2008 that the effects were felt in Russia. However, when they were, the effects were dramatic and occurred virtually overnight.

Out of 13 shopping centres that were sold throughout the year, at a total capital value of circa USD 1.2 bn, only two were traded in the last quarter of the year.

The commentary below provides a review of the shopping centre investment market in two distinct phases: Q1 to Q3 2008, in which Russia still had a relatively robust investment market and then Q4 2008 in which Russia, like most other countries around the world, was subject to the fi nancial crisis. The subsequent effects on the shopping centre investment market are analysed along with the prospects for the investment market in 2009.

Q1 to Q3 2008In H1 2008, shopping centre investment volumes increased by 40% compared to H1 2007. In Western Europe for the same period investment volumes fell by 20%. During this period, Russia was still relatively protected with less direct exposure against the initial fi nancial downturn.

There was also relatively good debt availability in H1 2008, with both western and domestic banks providing fi nancing. Although margins had moved out from 275 basis points to circa 400-600 basis points for standing, income producing assets, the dollar swap had signifi cantly fallen, keeping the overall cost of fi nancing at 2007 levels.

Compared to other markets, LTV and DSCR terms were not hit as much as those in other European countries. In other countries, prior to the banking crisis LTVs of 80-90% were possible that were brought down to 65-70%, signifi cantly increasing investors’ equity exposure and negatively impacting on investment returns. Within Russia,these terms remained relatively stable.

Retail continued to dominateIn 2008, as in previous years, retail was the most traded real estate class by number of transactions, accounting for 37% of all investment deals. This was in line with the average of 38% over the last three years. In the regions the retail share was circa 80%, as the sector continued to be the predominant asset class being developed.

Source: Bloomberg, Jones Lang LaSalle


Source: Jones Lang LaSalle Source: Jones Lang LaSalle

USD 5-year SWAP, Bank margin and Interest rate for standing assets in Russia (%)

Retail investment volumes in Russia, USD mn

Retail investment volumes in Western Europe, USD mn Number of deals by segment, 2008

0200400600800

1,0001,2001,4001,6001,800

2005 2006 2007 2008H2 H1

+40%

010,00020,00030,00040,00050,00060,00070,00080,000

2005 2006 2007 2008H2 H1

-20%

Office30%

Warehouse6%

Hotel15%

Mixed9% Retail

37%

Residential 7%

1.02.03.04.05.06.07.08.09.0

10.011.012.0

Jun-07

Sep-07

Dec-07

Mar-08

Jun-08

Sep-08

Dec-08

interest rate

USD 5 year SWAP Bank margin


YieldsQ1 to Q3 2008 was witness to further yield compression to a prime rate of 8.25 – 8.5%. This was not only due to an increasing confi dence in the retail sector but also due to the lack of supply of prime assets. This benchmark was set by the sale of Filion shopping centre in Q1 2008, a 55,000 sq m city-centre shopping mall. Filion has recently signed Carrefour as an anchor (their fi rst store in Russia).

As a result of greater investor focus towards prime assets, 2008 for the fi rst time witnessed a clear distinction in pricing between primary and secondary assets. The sale of London & Regional’s “Sun Paradise” portfolio comprising well performing but relatively small neighbourhood schemes, indicated a difference of about 50 – 75 basis points between prime and secondary assets.

Moving into 2009, we believe the gap between primary and secondary assets will continue to widen as investor demand increases for schemes that will dominate their catchments overthe medium to long term.

VendorsAs in previous years, domestic developers have continued to dominate sales transactions and were accountable for over 90%of all shopping centre disposals in 2008.

Moscow focusedIn 2008 there were signifi cantly fewer transactions within the Russian regions. In 2008 transactions in the regions accountedfor 25% of the total number compared to 47% in 2007.

Foreign investors accounted for 57% in 2007 but 0% in 2008. Investors, showing a clear change in focus, concentrated their attention on the core markets of Moscow and St. Petersburg. This has been the result of a “fl ight to prime” but was also a result of more product in Moscow and St. Petersburg coming onto the market.





Regional split by number of retail transactions in 2007

Regional split by number of retail transactions in 2008

Russian real estate investment transactions bynumber of deals

Shopping centre weighted initial yields in Russia

0123456789

Moscow and St. Petersburg Russian Regions

Foreign Investors Russian Investors

0123456789

Moscow and St. Petersburg Russian Regions

Foreign Investors Russian Investors

0

5

10

15

20

25

2006 2007 2008Retail Office Other sectors

33% 47%

22%36%

22%

30%

46%

31% 33%

18.00%

14.58% 14.20%13.50%

10.33%9.54% 8.65%

7%9%

11%13%15%17%19%

2001 2003 2004 2005 2006 2007 2008


Property name City Vendor Purchaser Deal type Investment volume, USD mn

Filion

Moscow Rubin Development Orco Property Group

Forward purchase 353

Leto St. Petersburg Sistema Hals Sistema/Apsys Development joint venture

Development joint venture

150

Sun Paradise, I & II

Moscow L&RP Sponda Russia Investment 109

Mozaika Moscow OST Group Tri Granit 59

PurchasersForeign buyers accounted for 62% of the total acquisition volume in 2008. The majority of buyers were European-based property companies and developers.

Although the fi gures are similar to 2007, the country origin of the investors was signifi cantly different, highlighting a widening source of capital and an increased confi dence in the Russian market.

Q4 2008Since Q4 2008 investment activity in Russia signifi cantly slowed,in line with other real estate investment markets.

In September-October there were still a number of equity investors looking closely at the Russian market. However by November, due to continued market uncertainty, anticipation of re-pricing and lack of access to fi nancing, most investors and nearly all foreign ones put acquisitions in Russia and across Europe on hold.

Debt fi nancing became more expensive and signifi cantly more restricted. Many of the western banks with exposure in Russia temporarily suspended new fi nancing. Most were looking to protect their internal fi nancial position and to re-capitalise their own balance sheets.

The Russian government acted quickly in response to the economic downturn and in December published a list of 295 “key” companies from different sectors of the economy to whom support would be provided. The state controlled banks (VEB, Gazprombank, VTB and Sberbank) started to provide certain levels of fi nancing to support, among others, the real estate and retail sectors. Loans were mainly provided to companies with greater “social importance” including residential developers PIK and Don-Stroy and a number of major national retailers looking to refi nance short-term debt from their ambitious expansion programmes.




Retail investments by investor origin, 2007

Retail investments by investor origin, 2008

Austria13%

Ireland10%

Denmark6%

Russia17%

Canada35%

UK9%

USA7%

Germany2%

Global1%

Finland9%

Hungary5%

Luxemburg29%

Russia38%

France12%

Canada7%

Main shopping centre transactions in 2008


The combination of reduced capital seeking opportunities in Russia and a considerable increase in retail stock on the market offered by distressed sellers, led to a very quick and dramatic re-pricing of the retail investment market.

By the end of Q4 2008 yields moved out by circa 300 basis points, approximately 100 – 200 basis points more than in most European countries.

The severe outward movement in yields was also exacerbated bya number of other contributing factors:

The Georgia confl ict in August/September reduced the • international business community’s confi dence in Russia and its perceived stability and free market principles. With investors re-evaluating their risk exposure in a fragile global economy, adding another layer of political risk on top resulted in several investors reviewing their short term real estate strategy in Russia, despite strong economic fundamentals and a robust retail market. Additionally, with a sharp outward movement of yields in the UK • and signifi cant re-pricing in continental and central Europe, the returns achievable in the core markets became more attractive. Investors used those to benchmark pricing and their required returns for Russia taking into account the perceived country specifi c risk.

Overall, the Russian investment climate was negatively affected by geo-political as well as international and domestic economic factors. The resulting market uncertainty put upward pressureon capitalisation rates that led to a signifi cant re-pricing of assets.


Due to the severely restricted availability of fi nancing, the retail development pipeline was also drastically affected and essentially “stopped in its tracks.” Financing almost completely stopped within the Russian regions and was diffi cult to obtain even in Moscow. As a consequence, developers were placing projects onto the market with the aim of attracting a strong international fi nancial partner who could provide the development funding required or, through the reputation of such an international partner, attract some form ofthird party fi nancing.

As another option, developers and retailers were also looking to sell a number of their existing assets to release equity in order to re-fi nance their existing debt commitments (real estate or within other areas of their holdings), to aid expansion or to complete their existing development pipelines.


Loans provided as the government support during October 2008-January 2009, USD mn

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000

Hi-tech

Transport

Car production

Retail

Construction

Natural resources

Banking

Prime shopping centre yield movement, percentage points Q3 2007-Q4 2008


Shopping centre stock available for purchasein Moscow ( 000 sq m)

0100200300400500600700800900

1,000

H1 2008 H2 2008

3.00

2.50

1.501.25 1.25 1.25

1.00 1.000.75

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5Ru

ssia

Fran

ce

Spain

Germ

any

Portu

gal

Gree

ce

Nethe

rland

s

Turke

y

Belgi

um


Reduced debt availability will restrict transaction volumesin 2009

As of today there is still little fi nancing available. The state • controlled banks are continuing to provide loans to a few selected market participants to support the real estate sector. However, there are signs that these banks are beginning to get more active and are expanding their client base to those outside of the government published list. The western banks have indicated that they are looking to re-enter the market by mid 2009, although withsignifi cantly reduced budgets. Any fi nancing provided will be to high quality institutional grade•

Aaassets and to established developers / investors with a strong track record or with whom the banks have existing relationships. In addition to increased margins, any fi nancing provided will be on much stricter terms including lower LTVs and shorter loan and amortisation periods. The large average investment lot size of assets (USD 150+ • mn) in Russia will also restrict the available fi nancing. With the syndication market completely closed most international banks are not able to lend over USD 100 mn per asset. Any transaction involving a large shopping centre will require a pool of several banks to provide fi nancing as a “club deal”.

Prime assets in Moscow will be the focus of investor demandBased on current market conditions, investors in 2009 will be looking to purchase the best and predominantly income producing assets in Moscow – the most liquid and transparent market in Russia.

Prime assets are more likely to maintain existing income streams • and have minimal vacancies. They will also provide the best opportunities to achieve fi nancing from the banks.Due to the sharp outward movement in pricing many opportunistic • funds, who over the last few years have focused more on development projects to achieve their target returns, are now able to reach these returns with standing income producing assets.

Equity investors will dominate The shopping centre investment market in 2009 will be dominated by cash-rich buyers. Most likely investors will include a number of German open ended funds – some of which are now open for trading, sovereign wealth funds from the Middle East and Asia, international retail groups and certain pockets of domestic capital seeking distressed opportunities.

• International retail operators such as Carrefour, Walmart, Auchan and Ikea have strong expansion plans across the country. In the Russian regions, where development has virtually stopped, fi nancing their own expansion pipeline will be the only strategy available to them to increase market share. Alternatively or in parallel they will also be looking at opportunities to acquire any of the larger domestic chains at discounted pricing. Russian capital seeking distressed opportunities will focus on • development sites and half completed projects at pricing levels refl ecting a signifi cant discount to cost. Generally, these groups will be looking more at returns achievable than quality of the asset and will be targeting IRRs of at least 30%.

Greater transparencyIn order to obtain some form of debt, developers will look more • closely at the quality of their shopping centres. This will include using established international architects, legal and tax advisors to make sure their projects have clean and marketable title and effi cient holding structures. Russia will continue to be a major focus for retailers due to the • huge market potential and signifi cantly under-supplied market. The retail market will also be one of “change” and is likely to witness a consolidation of franchise companies, an increasing number of international retailers going direct and a potential move towards an increase in tenant incentives and more turnover denominated lease agreements. Russian developers will continue to focus on attracting • international partners. They will look to take advantage of their existing relationships with banks to aid fi nancing but also use their expertise to improve the quality of the developments. Joint Venture partnerships also suit international investors as the value of “local expertise” remains high especially at the project origination and permitting stage of development.

Prospects for 2009


Developers will look to complete under-constructiondevelopments Developers who are currently mid-construction will look to complete their projects to maximise the benefi ts from the low competition as a result of the supply shortage. Within the retail sector, fi rst mover advantage plays a key role and often contributes to the success of shopping centres amid increasing competition. Those who have already secured fi nancing will proceed as normal and reap the advantages. However, those without fi nancing and subject to sudden liquidity pressures will look at all available options in order to benefi t from this “fi rst mover advantage” in a signifi cantly under-supplied market.

Change in focus to smaller shopping centredevelopment projectsIn 2009 and 2010 we believe developers will look to build smaller shopping centres with more focus on their target catchment and its relative purchasing power. With current fi nancing restrictions, the development of smaller shopping centres will create a more liquid market and allow developers not only the possibility to constructbut also exit.

This will put less pressure on the existing large regional shopping centres, as they will benefi t from lower future competition and will see their position strengthen further within the market.

Yields to stabilise and potentially compress by mid 2010Investment activity is likely to remain low during 2009. However,with such a sharp yield movement in Russia we are of the opinion that the market is now close to fair value. There will be some high quality investment grade assets coming to the market at pricing levels at circa 30-40% discount to H1 2008.

Against a background of an expected pick up in investor activity in Q2 / Q3 2009, combined with the forecast economic upturn, it is likely that yield compression will return from mid 2010 onwards. According to the Urban Land Institute and Price Waterhouse Coopers “Emerging Trends in Real Estate Europe 2009” survey of industry experts, Moscow is the most favoured city for investment in retail amongst the major European cities – showing that investors are aware of the potential that the retail market offers. However, the critical issue is getting investor confi dence back into the market. The continued strong economic fundamentals and increasing transparency in the retail market should help to counteract the perceived increase in country risk and instability. Those investors that make the fi rst step in 2009 are likely to gain fi rst mover advantage and the highest returns.


COPYRIGHT © JONES LANG LASALLE IP, INC. 2009. No part of this publication may be reproduced or transmitted in any form or by any means without prior written consent of Jones Lang LaSalle. It is based on material that we believe to be reliable. Whilst every effort has been made to ensure its accuracy, we cannot offer any warranty that it contains no factual errors. We would like to be told of any such errors in order to correct them.

www.joneslanglasalle.ru

Vladimir PantushinNational DirectorHead of Research, Russia & CISMoscowtel: +7 495 737 [email protected]

Jones Lang LaSalleRussia & CIS Headquarters52/3 Kosmodamianskaya Emb.115054 Moscow, Russiatel: +7 495 737 8000fax: +7 495 737 8011

Peter HensbyAssociate DirectorCapital Markets, Russia & CISMoscowtel: +7 495 737 [email protected]

Maxim KarbasnikoffEuropean DirectorHead of Retail DepatmentMoscowtel: +7 495 737 [email protected]

Documents

Russian Shopping Centre Report 2009