No Russian roulette

“We estimate that quality retail shopping and leisure stock will triple in and around Moscow over the next three years and that demand will absorb the leading projects,” said Michael Lange, managing director of Jones Lang LaSalle, in a recent Moscow Times report. “The next area of development is already on the go in the regions, whereas developers and occupants are entering the markets primarily with populations greater than one million people.”
Jones Lang LaSalle’s forecast on Russia is not the only positive rating coming from market analysts in recent months. As shown by reports from AT Kearney and Deloitte, the good word on Russia is out. Indeed, Russia is one country in central and eastern Europe whose economic indicators present an attractive flashing blip on retail radar screens. The figures would tell the story: GDP growth in 2003 was 7.3 per cent with retails sales growing by eight per cent in the same year. Annual average GDP growth expected from 2004 to 2008 is estimated at 4.8 per cent, trailing only the growth rebound expected from the Asian Tiger economies like Malaysia, Thailand, Singapore and South Korea (Economist Intelligence Unit). Russia’s real disposable income is also projected to grow by 46 per cent by 2010 with many analysts predicting that personal spending, aside from oil revenues, will fuel the country’s economic engine.

Beyond Moscow
Russia’s retail sector has a market volume estimated at US$ 160 to 200 billion annually. One distinctive development in 2004 was the growth of retail chains not only in cities like Moscow and St. Petersburg but also in other large cities. While personal income levels per capita in Moscow are around US$7,800 annually, the disposable income of around 80 per cent leads to a total retail expenditure exceeding that of most leading European capitals. Jones Lang LaSalle said Moscow’s current quality shopping and leisure centre stock of about 810,000 m² adds up to around 75 m² per 1,000 inhabitants. In comparison, cities like Prague and Warsaw have averages of around 150 m² up to 350 m² per 1,000 inhabitants, but with smaller overall retail expenditure in overall financial value.
Jones Lang LaSalle estimates showed that quality shopping centre stock is expected to increase fourfold by 2010 in Moscow, reaching more than 3.2 million square metres at an average of around 205 m² per 1,000 residents, a figure still trailing most European centres.
Dmitri Baranov, strategic planning director of the Vremya Group of Companies, however, said that average retail space numbers could be deceptive in getting a true assessment of the Russian market. “Investors need to understand and evaluate very thoroughly the difference between centre and regions, and to remember that the retail estate market in Moscow is near saturation. In Moscow, there is growth potential only for shopping centres outside the downtown area,” he said.
Baranov said there is a strong demand for quality retail space outside Moscow where consumer orientation and shopping expectations are closely similar to their western counterparts. “The ‘second wave’ cities (with a population of more than one million) offer the most potential to develop large-scale shopping and entertainment centres supported by smaller shopping centres (10,000 m² to 20,000 m²) in remote city districts,” he added. Baranov added a continuing major trend in secondary or second-wave cities will be the development of retail and entertainment centres (60,000 m² to 70,000 m² incorporating a hypermarket, electronics store, home accessories, fashion chains and extensive entertainment areas). Vremya, for example, initiated the move for quality shopping centres when it developed its first Park House in Samara in 2000. The Park House format, according to Baranov, has become the most attractive for regional populations due to its novelty and semblance of western-styled shopping and entertainment. In 2003, Vremya opened its second Park House in Volgograd, which has earned a reputation as Russia’s largest shopping entertainment complex outside Moscow.

St. Petersburg on the rise
The St. Petersburg retail sector, however, stands out as the most dynamic in Russia and offers investors high returns. In the first half of 2004 alone, total retail space in St. Petersburg was more than three million square metres, with the retail sector witnessing the launch of multi-functioned shopping centres that feature food stores, clothes vendors, cinemas, gyms, and bowling alleys. The share of leisure space within such complexes is expected to continue to increase. Further, a number of large-scale shopping centres have recently appeared in the city such as Perinnye Ryady and the multifunctional shopping centre Pik. Monthly rent averages from US$45 to US$100 per square metre in major shopping districts. Rental rates, however, are expected to stabilise, increasing at seven per cent to ten per cent annually. The year 2005 could prove to be a milestone year for St. Petersburg, making rating assessments even more crucial. But although the profitability rate is around 25 per cent, risks are still rather high, according to industry insiders, a point that scares off many potential foreign players.
In 2004, St. Petersburg saw the entry of foreign retailers such as IKEA, Germany’s METRO and Ramenka. Active players in the city also include Patterson, Perekryostok, Sport Master and M-Video. And though there are only some western operators in St. Petersburg, a number of them have occupied niche positions such as Finnish supermarket chain Stockmann and Italian clothing chain Benetton. Other foreign players exploiting the franchise scheme are McDonalds, Lego, Berghaus Yves Rocher and Kettler, among others.

Emerging cities
Ekaterinburg, some 2,000 kilometres from Moscow, is Russia’s third major city in terms of overall number of large retail projects currently underway. Major shopping centres are Dirigeable, Ekaterininsjy, Uspensky and City Center. The number of shopping centres is expected to double within the next five years. Other high profile retailers are Sport Master, M-Video, Tvoi Do Dyr, Tekhnosila and L’Etoile. IKEA has also started to build its first 150,000 square-metre mall and plans to open it by 2007. Just 406 kilometres outside Moscow, Nizhny Novgorod is high on the agenda of many retailers due to the high-income population and its proximity to the Russian capital. The city’s retail turnover is around US$1.4 billion with street retail represented by more than 2,646 stores. There are seven shopping centres in the city with a total size of 424,000 m². Landmark projects include the Torgovy Kvartal (Shopping Quarter) at 30,000 m², Chocolate (21,000 m²), Novaya Era (12,000 m²) and Etazhi at 18,600 m². Retailers such Seventh Continent, IKEA and METRO are expected to launch their operations in the future.

Understanding Russia
Clearly, many potential investors and retail operators are keenly watching developments in Russia’s political front, and even Baranov himself admitted that the cautious stance shown by foreign investors was largely due to the government’s handling of the Yukos case. “The wariness or even recent downgrading by some analysts was obviously linked to the notorious Yukos affair viewed by many as an attempt of politicians to ‘apply force’ to private business,” he said. He dismissed concerns over regulatory obstacles (land ownership issues) or any infrastructure deficiencies, which he said, are relatively easy to overcome.
“The risks in the Russian market are now at a minimum (Poland, Romania or Ukraine are more risky in many aspects) and the chance of political reverse are actually non-existent. The biggest challenges for retail real estate developers and investors are, firstly, when to enter in time with the proper formats, and, secondly, overcoming the stereotypes and to understand that Russian consumers now live by the expectations of the future rather than by the compunction of their past. Their expectations are very similar with those of the rest of Europe,” Baranov said.
Still, the major food retailers such as Wal-Mart and Carrefour are still nowhere in sight in Russia’s retail landscape, although the former has been often reported to be sniffing around for the most advantageous entry point.
Baranov remains confident that in due time the prime retail movers will step into the Russian retail game. “Wal-Mart and Carrefour will have to come to Russia, but when that happens there will be a well-compacted fertile earth instead of virgin land. They are not making profits by becoming a first-comer; their policy is to enter a well-surveyed field where they already know where the pay dirt is. They want to be on the very safe side, and to me, that is a very valid concern,” said Baranov.

Sources: Jones Lang LaSalle, A.T. Kearney, Moscow Times, Deloitte’s “2005 Global Powers of Retailing” Report, Colliers,www.scrussia.ru, MAPIC

Source: www.scrussia.ru