– Morgan Stanley provides investment banking services to global real estate client base. What are you working on in the Russian market?
– The strategy followed by our Russian office is based on our understanding of the global situation as a whole. Real estate is a strategic direction for Morgan Stanley.
Morgan Stanley real estate business may be divided into three components: real estate investment banking, real estate lending and real estate investing.
Real estate investment banking is our key business line, given that Morgan Stanley is a leading global investment bank, with a long standing presence in Russia. We provide investment banking services to clients, work on attracting equity, debt financing, M&A transactions, we trade derivative products, and we structure various joint ventures and funds. Depending on capital market conditions, we focus on various products. For example, 2007 was a great year for the real estate IPO market, at that time we worked on the largest European IPOs, including Russian companies like PIK Group, AFI Development, RGI. On the other hand, in 2008 and 2009 we focused more on M&A and restructuring. Real estate lending business has not been very active in Russia, however we did manage to lend to Russian development companies, which we believed were successful.
Real estate investing is part of our Investment Management business. Morgan Stanley is managing over EUR 50 Bn in real estate funds, and the Firm is also a principal investor in the funds. In Russia our Special Situations Fundhas acquired minority stakes in several existing and successful development companies such as RGI, RBI, and RosEvroDevelopment.
It is important to note that in order to avoid a conflict of interests, real estate investment banking and real estate investing are managed separately.
All these three types of business have been present to some extent in Russia. We have invested into real estate and have provided loans to various companies in this sector. We saw success in the investment banking activity as well.
– Which areas of activity, that you are involved in, enjoy the greatest demand today in the Russian market?
– All three areas of our activity are in demand in the real estate market today. However, we are very keen on real estate investment banking, where we are seeing strong pick up in activity of our clients, where specialist real estate investment banking/capital markets advisory is critical. On the investing side we have been focusing on ongoing management of our portfolio, At the moment, Russia is not a priority for our real estate lending business, however risk assessment is changing.
– In your opinion, how interesting is the Russian real estate market, from the investment point of view?
It is important to note that, while working in the real estate market in Russia, we operate globally and on pan-European basis, being part of one pan-European team, therefore we focus on global investors investing across various sectors and regions.
The Russian economy is coming back faster than many others. The state is making significant investments into the economy. For example, in 2009 we saw a number of sectors in Russia quickly recovering from the crisis. These include the oil and gas sector, steel, retail and transportation, which have already seen capital markets transactions, where Morgan Stanley acted as the global coordinator, including offerings of Alliance Oil Company, Integra Group, Evraz Group, Magnit, GlobalTrans. We also did a large debt placement for Gazprom last year and most recently convertible bonds offering for TMK. These are the transactions that took place in the last six-eightmonths.
At the beginning of 2009 no one expected that the market would be restored so quickly. Now we expect the oil sector recovery will help demand return to the other sectors in Russia, including the real estate sector, which gradually is becoming more attractive for investors.
Already today it is easy to notice a growing interest towards Russian real estate companies, which are publicly traded. The greater activity on the stock exchange is a good indicator that the economy is starting to come back. The financial results being announced by the companies are better than what the analysts predicted, and accordingly the share prices have been growing in the last 7–8 months. But, of course, at the end of 2008 they fell sharply, since everyone seemed to be factoring in the bankruptcy scenario.
I am talking about the companies with the assets in Russia – LSR, PIK GROUP, AFI Development, Mirland, RGI etc. On average, their shares have experienced growth somewhere in the neighborhood of 400 to 500% over the last 8–9 months. LSR is one example – its shares increased in price by 900%, since the beginning of 2009.
This trend demonstrates that there is an interest in these securities. Earlier during IPOs these securities were acquired mostly by special real estate investors – professional funds organized to invest into real estate. Today they are primarily being acquired by emerging market funds. These are more risk-taking funds,. Such funds usually start to invest earlier, than sector focused funds. There is a risk that this money can leave as quickly as it came, however with improving fundamentals on the market this is less and less likely to happen.
In any case, it is a positive signal. I would also like to note that during the last nine months we have been observing the highest growths in the indexes of emerging markets - practically the greatest growth in their history.
– How interesting is the market to foreign capital?
– Of course, Russian real estate market used to be very interesting to Western capital. We saw a substantial stream of money flowing in back in 2007 and up to the middle of 2008.
For the moment, foreign direct real estate investors have not yet returned to the Russian real estate market in large quantities. This is because for many investors who specialize in direct purchases (for example, buying office buildings or shopping centers) the risk reward balance in Russia is not as attractive as in other European cities like London or Paris. In addition, there is more debt available at these markets, so investors can increase equity returns using financial leverage. Furthermore, historically in Moscow there has been shortage of investment quality projects, which is now changing. Gradually the situation is changing and we will see more direct transactions with foreign investors soon.
On the other hand, we are seeing increased interest in Russian real estate stocks from the foreign investors, so the positive sentiment is coming back, nevertheless the preference now is to own relatively liquid stocks.
Personally, I feel that the situation in Russia is attractive today. Typically all processes in Russia occur much faster than they do in other markets. Rent rates in the office and retail segments have fallen sharply, residential prices have also dropped significantly since mid 2008. However, Russian consumers are not carrying such personal debt loads as their American or European counterparts, so the recovery is much quicker. This is what we have been seeing lately –on the residential side in particular, there is a strong demand for completed or close to completion apartments. Demand for retail space is also coming back, while on the office side we would need to wait longer for the recovery given the large supply. Typically the office sector would lag around 12-18 months from the time of the pick up in the economy. As a rule improvement in market fundamentals creates investors demand as well.
– Where is the foreign capital today in the commercial real estate market? Who is investing today into the Russian property markets?
– After the financial crisis, cash much more prefers liquid investments, rather than long-term closed ended funds, which are usually arranged for 7-10 years. Therefore, we are seeing demand for Russian real estate stocks, alongside overall positive sentiment in respect to Russian listed companies. Shares are simple to acquire and quite easy to dispose. As mentioned ealier the main buyers are typically global emerging market funds. As for direct acquisitions, throughout 2009 we saw local capital in action – Russian companies, groups, which were able to capitalize on the market opportunities Western funds are slowly coming back to the market as well, so we should see more direct deals in 2010, especially that sellers/buyers expectations gap has been narrowing.
– What do you think of the risks of this market?
– At Morgan Stanley we are analyzing them to have best understanding. With a relatively weak leasing market, the key to mitigate business risk is to find the right entry price while purchasing a project, taking into consideration market leasing rates, buy mid-size assets, which are liquid, and secure long-term financing. This is an ideal scenario. In practice the situation might be different, however reflecting risks in the entry price is critical to achieve the desired returns. Successful real estate investing to a large extent depends on where we are in the cycle. The rest is to choose a quality property with a good location and transportation access and with market leasing rates, and wait for the market to recover. From the business cycle perspective now is a good time to be looking at the market. Exit is also critical, and it has been an issue for many Russian property owners. Until mid-2008 most of the market players seemed to believe that prices can go only in one direction. Everyone should consider that not selling a property at a given time means the same as buying the same property at that time. In other words, if we don’t feel like buying something assuming that prices are too high at a given time, we should consider selling what we have.
– Which market sectors could then be of interest to investors?
– Today we see that there is once again demand in the mass housing accommodation segment. In the business class segment everything depends on the construction stage. Retail in Russia is always in demand. Certainly, here everything depends on the location and quality of the project. After all, new shopping centers continue being opened today. Maybe they are not 100% occupied, but still they are operating successfully. The situation is more difficult with the offices in Moscow. We think that demand will reappear, but it is necessary to wait. The hotel segment in Moscow seems to be a successful niche, too.
- Today there is almost no project financing on the market. Why? When will the banks be able to revive this kind of lending?
- Project financing is starting to come back. Some Russian banks and a few foreign ones are considering and discussing the possibility of providing project level financing. The fact is that most state-owned banks have accumulated huge funds, and these need to be invested. Of course, the banks will lend first to residential developers, which is also the government priority.
-
- How well developed is the M&A market today in the real estate sector of Russia?
- Ironically, 2009 was an active year from the M&A perspective. However, the main reason for these transactions was debt restructuring. As a rule, these transactions were forced by banks. Looking at the entire real estate sector in the past 12 months, we see that of the 5 – 6 largest real estate companies at least in respect to 3-4 there have been significant changes in the ownership structure.. Examples include Systema Hals , Don-Stroy, PIK Group of Companies, and this process is not yet completed. There also have been many forced changes of control on a project level. I would expect that 2010 should be active as well, however would be driven more by consolidation of the sector, rather than forced by the banks. Overall real estate companies are not expensive at the moment, usually a few times cheaper than they used to be before crises, capital markets have tendency to overshoot both way on the way up and on the way down, therefore it is a good time to be looking at purchases of companies and projects.
- In June 2009 Morgan Stanley and Marshall Capital Partners created a joint business, Mayak Corporate Real Estate (Mayak), to provide services to the owners of non-core real estate portfolios. Please tell us at what stage is this project now? And what is the potential of this market - from your point of view?
- Mayak is a company that will provide real estate asset and portfolio management services. The company will be oriented at non-core assets of large corporations, as well as on large real estate owners. In Russia we can see a big market for asset management services, and an opportunity to provide value-added services, which would result in increasing values of portfolios and creating more transparency.
-
Morgan Stanley has successful experience in respect of creation of similar asset management platforms. In Germany we created a joint venture, which had been widely recognized and managed over EUR 8-10 Bn of third party real estate assets.
In Russia we see that such services will also be in demand. And we think that, taking into consideration our experience in other countries, we are bringing new value-add quality to the market..
- Today there are very few investment transactions happening on the Russian market. Do you agree with this? Why?
- There are not many transactions, however the market is improving and the gap in price expectations between sellers and buyers is narrowing. In 2H2008 and 2009 everyone was looking for distressed projects. I remember when I was at Expo Real 2008, the word “distress” was the most popular for all market participants “We want to purchase distressed projects, loans etc.”… "We want to create a distressed fund”. Eventually, even though the crisis was very severe, the market was not flooded with distressed projects. If we look at the Russian real estate market, there have been a number if distressed transactions, mainly in respect of development projects, when a developer could not finance completion. However, there have not been many distressed transactions with completed and fully leased projects, as the buyers were only ready to pay distressed prices. In addition, limited availability of leverage makes it difficult to achieve 20%-25% IRR returns expectation for foreign opportunistic funds operating in Russia.
-
It is also worth mentioning that the banks, which have taken over some projects, are not ready to sell them now cheaply. Having received support and funding from the government, they have no problems with liquidity. They do realize that asset prices could have decreased by 30%-40%, but still they are not planning to sell them now and are waiting for the market to recover. As the accessibility of debt financing improves, we should see more investment deals. I am positive that 2010, especially 2H2010, will see more and more investment transactions, given that there is new capital being raised for real estate emerging markets funds.
- Sochi – how much is your company interested in the Olympic Construction projects there?
- I have been to Sochi many times, and I love that city, its landscape and climate. But it seems to me that it is the Russian government who should bear the main burden for financing of the Olympic projects. Most clients of the resort are Russian and CIS citizens, and this is quite a large market – about 250 million people, with strong purchasing power. Investors also must be local. Personally, I struggle to see Western investors investing there. Foreigners do not understand this market.
- How do you see the situation in the Russian real estate market today, and what can we expect in the near future?
- At the moment we are definitely in a recovery mode in Russia, and are already observing slight increases in prices for residential real estate. Soon improvement in fundamentals should reflect in increases in NAV valuations of real estate companies and increased interest from investors. At the end of the day, real estate is a great way of investing and preserving capital, especially in the economy with the right demographic dynamics. Russia does not probably have the best demographic profile in the long term, however in the medium term, especially in the large cities, there is a shortage of quality real estate projects across all market segments, which creates great opportunities for dynamic growth for real estate developers and investors. Fears of inflation in the long term, given that various governments injected significant amounts of money into economies, are actually positive for real estate investing, since real estate is the best inflationary hedge, especially through quality projects in the right locations.
- Russia is very well positioned to capture global growth in 2010 with strong local capital base and right human capital in place, relatively low leverage and large undersupply of real estate.
Ekaterina Krylova
How get here
