Evgenia Vlasova: "Management market remains the most stable real estate business"

As there are basically no new construction projects being launched, the management of existing facilities acquires greater importance. How can expenditure streamlining be implemented without lowering the quality of management? Today we talk to Evgenia Vlasova, Managing Director, Sawatzky Property Management.

– Why is the number of vacant premises on the market increasing?

– The reasons why tenants are vacating premises are varied. They can conditionally be divided into several groups. Many companies have lately been trying to consolidate their offices, leasing a front office in the center and a back office in the outlying area. However, this trend was just developing and most major companies had several facilities throughout Moscow. When the financial situation in the country changed, the level of revenues changed accordingly and staffing was reduced. The need for multiple offices disappeared. Many tenants come to their landlords and indicate that they only need one office and that they no longer need the other spaces. This is one category of tenants. The second group of tenants are reversing plans for occupying space in new and planned buildings to which they early intended to move to accommodate a growing number of employees.

I believe that the major reason for everything that is happening rests solely on the global financial shifts that we are witnessing worldwide and in Russia in particular. This is why companies that were planning on expanding have suspended such plans.

– In your opinion, what is the best attitude for a landlord: avoid empty premises by leasing them at whatever rate possible or keep them vacant in hope of finding tenants that are willing to pay higher rates?

– The real estate market at the present time is made up of two kinds of landlords. One considers that a facility has to be profitable and is ready to adapt to the environment that develops on the market. They are ready to negotiate with each tenant on an individual basis, especially with those whose leases are about to expire. They are agreeing to substantial discounts in order to keep the tenant or to attract new ones. The discounts can reach as much as 30 to 50%. Other landlords are adopting a totally opposite attitude. They believe that they are positioning their facility in a specific class and refuse to lower rates. They don’t want to lower the level of their tenants and are dealing with vacant spaces.

I believe that it’s better to have some kind of revenue than nothing at all. Not only does the landlord have no revenue from these surfaces but he also has to cover the unavoidable expenses. We’re talking about operational expenses and public utilities which would have been covered had the premises been leased. Obviously with no tenants the expenditures do go down but there are expenses that have nothing to do with the number of tenants: property taxes, land leases, insurance. As far as the law goes insuring a facility is not compulsory. In Russia the only mandatory insurance is the compulsory civil liability motor-vehicle insurance (OSAGO) and some professional activities. Property insurance is not compulsory but in order to minimize the business risks, most landlords prefer insuring their capital assets. In our branch of business we no longer see landlords that doubt whether they should insure their buildings. Now the only issue is the quality of the said insurance. Insurance is available through multinational corporations with a good reputation and rating or through Russian companies that aren’t as well known on global markets. Looking back at the global financial situation, let’s not forget what happened to those major multinational insurance companies.

– Many experts are talking nowadays about a migration of tenants on the office real estate market. Some are moving from class A to class B business centers. Others are doing exactly the opposite. In which direction do you believe that the office migration is taking place?

– I cannot say that we felt a migration among the facilities that we manage. I have not witnessed any examples of companies moving from class B to class A. What we are seeing are changing rates and terms for high-class facilities. For instance, in the past the size of a leased areas totaled some 300-500 sq m, today developers are implementing tighter floor plans and blocks of 50-100 sq m, i.e., exactly those kinds of premises that lacked in the past. Obviously everything depends on the concept of the facility. There are facilities that from inception were accepting tenants with different area requirements. For instance, the Legion Business Center on Bolshaya Ordynka or Daev Plaza.

– Do you track in any way the financial state of the tenants at the facilities that you manage?

– We have four office buildings that belong to our company. Here we meet with every single tenant and discuss their overall situation. The true intentions of a tenant, whether he is planning on moving or not, come to light during negotiations, through his behavior and the progress made towards reaching an agreement and its commercial terms. In other facilities we are hired to fulfill the property and facility management, and consequently, we assume cost reduction initiatives as we are directly responsible for the operational results. Naturally, this is only possible within certain limitations, as the financial considerations should have no bearing on the quality. Windows can be cleaned once a year instead of the standard two, but do we really want our building to be dirty? That’s another question?

– What can be streamlined in a business center?

– We were able to considerably lower expenditures thanks to changes in exchange rates. All of our budgets were approved at the end of last year when the dollar was worth 28-29 rubles. At the end of the first quarter it was worth 33-34 rubles. Most of our expenses are in rubles, consequently, we gained some savings thanks to a difference of about 17%. As we implement an open book methodology, the savings from the budget are always accounted for and returned. We naturally initiated the return of the said savings to the landlord.

From a point a view of the number of services, we evaluated all of the buildings and determined the measures that we could undertake to cut costs. It should however be noted that monitoring and streamlining expenditures is part of our constant concern as a management service provider. We can for instance integrate some energy-efficiency measures. I am not talking about shutting down external lighting at night, but also such measures as reducing ventilation and air conditioning, which certainly helps reduce some of the costs. We do have to consider the working schedules of the tenants and whether they are working in the evenings or weekends.

But there are services that aren’t mandatory, for instance, decorative measures. We have facilities were flower arrangements are placed at the reception and the halls are decorated with plants. Flower bouquets are beautiful and very chic, but we can do without. This is an additional expense. There are some renovations that can be postponed without major impact. If a certain strip, basement or technical premise is not painted it won’t have any serious consequences. It is obvious that the paint would improve the overall image of the facility, but postponing it for a year won’t kill anyone. All streamlining measures are made in agreement with the landlord. Some property owners didn’t want to give up on certain things, even some small renovations, and some even offered us some new variations.

– If certain landlords aren’t ignoring their facilities’ condition and image, this means that their business is going well…

– There are many such cases indeed. And this goes along with what we were saying earlier regarding lowering leasing rates. Some are ready to lower them substantially while others are open to having vacant surfaces rather than compromising in any way.

– What new services were prioritized with the advent of the crisis and which ones were abandoned?

– The number of services that we offer has decreased substantially among all buildings under construction. We were often hired as consultants for projects that would eventually require our property management services. We provided consulting services for engineering and technical issues at the level of future exploitation, and also assisted in structuring leasing agreements, developed operational budgets, discussed future cooperation with potential tenants. The number of such projects has been seriously reduced. But this is normal, and we expected it following the suspension of many construction projects. The projects that were suspended are those that were just being developed and designed and no real construction work was actually initiated. Projects that were actively progressing and whose construction had surpassed the 60-70% threshold would cost more if interrupted rather than completed.

With regard to operating facilities, that are functioning and have tenants, the actual number of services being offered has not changed. As I mentioned earlier, we have streamlined the expenditures but the nature of the services hasn’t changed in anyway. The facilities remain as before and still require maintenance, tenants need to be heard and landlords need an account of our activities.

– Are there any facilities where you fulfill asset management functions?

– Indeed, but only for those facilities that we owe. As I mentioned earlier, there are four such office centers. We sold most of our assets back in 2006. On the rest of the facilities we offer everything concerning technical issues. We also handle all operational expenditure issues with the tenants. Our goal is that the landlord receives 100% coverage of expenditures. We also handle budgets and accounting with regard to issues related to insurance and losses and all relations with municipal authorities.

With regard to asset management in Russia, at least this is my opinion, the market hasn’t reached maturity. No facilities immediately come to mind where the asset management would be awarded to an outside management company. In developed markets this is rather obvious – handling lease agreements, collecting rental payments, and the provision of profitability for the landlord, accounting which is conditioned by legislation and administrative accounting. This not yet popular and we believe that the situation should shift once many investment funds come here, which by their structure alone outsource all of these service. But when this will happen is definitely an unknown.

– As a management company you work on an outsourcing basis. Are you worried that the outsourcing service market could no longer be in demand during the crisis?

– I really don’t believe so. This is obviously a popular point of view: that landlords will assume these functions themselves and will be more profitable. As a rule, all facilities that we assumed, in order to replace the structure of the landlord we actually achieved substantial savings. When a landlord manages a facility on his own, he is in a certain way closed to the market with regard to gaining access to information from outside. He develops methods and solutions that appear efficient but in reality aren’t really. A management company that works with several facilities and different kinds of buildings, various tenants and landlords has access to a wealth of statistical information. We do not stand still, we are always improving something and implementing new ideas. Our accumulated experience is transferred onto other facilities. If we learn about a new contractor that offers a way of streamlining part of the expenditures due to some innovative technology we can introduce it throughout all of the facilities that we manage.

This is why I believe that the outsourcing market is here to stay. I can also add that in order for a landlord to provide the same spectrum of services on his own, he has to put in a lot effort, time and money on administrative and management processes. It’s not enough to just hire the people and contractors, he has to constantly keep an eye so the work is accomplishment properly and that everything is done economically. And he cannot avoid hiring a whole staff of managers, which represents additional expenditures. Consequently, a professional approach develops when people concentrate on just one thing.

– Certain landlords believe that an outside property management company can only provide a standard kind of service and that buildings with unique concepts can only successfully be administered by themselves.

– Indeed, there is a definite logic behind the idea that something is always better cared for by the actual owner. He knows all the uniqueness and specifics of the facility, but from a practical point of view I cannot remember any facility where this principle is embodied in practice. Everything depends on how the motivation of the management company is constructed. If an agreement with a management company is properly designed, if this is a professional company with qualified professionals, then I fully disagree that the approach will be typical and standardized.

The motivation of a management company is basically the same as that of a landlord. These are two entities with an equal interest that the facility be successful. Architects, developers, consultants, with all due respect, are essentially involved for short periods of time in comparison with the full life cycle of a building. A management company is interested in both the landlord and the tenants being satisfied with its services. And this why a landlord has to choose a management company that will understand his requirements and that he will motivate: structure an agreement and compensation. If there are any claims, penalties and fines, they also have to be within reason.

– I am aware of certain companies that have recently entered the property management market. What is it that guarantees this market’s interest?

– The management market is the steadiest sector of the real estate market. We obviously also depend on the overall market environment. We do see a drop in the volume of business, a reduction in expenditures and an absence of development. In the past there were many tenders for new facilities. Today most tenders are for existing facilities that are switching to outsourced property management services.

Today’s business development perspectives for management companies are related first of all to real estate that is mortgaged to banks. Obviously, one has to understand that we are simply talking about developing trends as very little time has passed since October and the banks are not yet legal proprietors of the said facilities. But it is clear that regardless of the restructuring of debts, certain facilities will come under the ownership of the banks and they will have to assume them. They will have to understand and review what exactly they have inherited and determine how to safeguard it and increase its revenues.

However, these new opportunities definitely won’t substantially affect the market. The major competition for management companies remains the actual landlords. The management companies control perhaps some 20-30% of the market. And this is for the overall market, not just class A and B facilities.

– Experts are coming to the conclusion that the market is no longer dictated by the landlords but by the tenants. How is this specifically illustrated?

– Besides the declining rental rates, the lease terms are also turning in favor of the tenants. For instance, the first three months free of charge was standard for any lease, but now it has extended to six. In certain cases it can be even longer. The lengths of lease agreements have also changed. In the past the high-quality business centers offered terms of some 5-7 years, but now they can be 2-3 years, and sometimes even one. This has become normal and the landlords are accepting such transactions. Yearly indexations are being applied with greater frequency. Agreements have become more flexible and many landlords are giving in to tenants in order not to lose them. Those that keep their tenants today will certainly feel more secure in the future than those that lose them.

At one point or another the crisis will finally come to pass. I don’t know how long it will take, and it’s even hard to predict as it depends not only on Russia but also on the global economy. But it certainly will pass and the successful facilities will be those that are filled with tenants and generate revenues. Potential buyers will keep an eye on such buildings. A building is always valued by its revenues and not by the bricks and mortar.

– Are you optimistic about the future?

– The stagnation that has set in will linger until the economy stabilizes. Developers have no access to funding for the development of new projects, as the available funding is being provided at such interest rates that the potential for profitability is close to nil. No one is going to develop new projects that only bring losses and this is why the business of development will resume only once the economy has stabilized. With regard to the future market as a whole, our market was only developing and we didn’t reach the level of developed markets. And consequently there is plenty of room for improvement and further development. What’s ahead? We would like to believe that difficulties only make us stronger and that if there are no problems we being thinking that everything is OK and we become vulnerable. And now we are all facing such conditions that we have to take a good step back and engage in some retrospection, make some improvements and adjustments.