It is just after 3 pm in Moscow, and Lee Timmins is being driven in Hines’ company car to the firm’s downtown office on Gasheka Street. The traffic has made the senior vice president late, as so often happens, prompting him to make calls from the Audi A6 as it crawls along, jostling for position among other foreign-made cars.
Holding business calls from the backseat of a chauffeur-driven car is a frequent occurrence given Moscow’s jams, but it is something Timmins has grown accustomed to, having relocated from the American Southwest to Russia in 1993. Since that time, he also has come to grips with Moscow development, having overseen a number of projects including Pokrovsky Hills – the first gated community in Russia, located 15 kilometres outside the city centre, where residents typically are employees of international companies operating in Russia, such as Shell, Conoco, Ikea and Ernst & Young.
Russian reality
As he looks out the backseat window at Moscow’s streets, Timmins reflects upon the fate of some of the international real estate development companies and funds that set up in the mid-2000s, when Russia was hot. For sure, there are less of them nowadays because many failed to control costs adequately, he explains. Others chose the wrong Russian partner or fell into the trap of paying too much for sites.
With such a reduced field, Timmins is confident about Hines’ ability to make money for investors from real estate development. In fact, he says Hines is starting to see much greater interest from institutional investors for completed assets. That view is emboldened because the firm is selling an office project owned by a Hines emerging markets fund that is coming to the end of its life. “The interest we have from potential buyers is very high right now,” he adds.
There are some positive indicators for Russian real estate funds operating in the country, despite Russia being perceived in a negative light due to political considerations. In August, Cushman & Wakefield said there had been a “record level of tenant activity” of late, partly explained by delayed demand of the recession period. That leasing ‘vibe’ is certainly being felt by Hines.
Timmins says the developer’s tenant base continues to grow pretty rapidly, whether it is office tenants like Goldman Sachs or warehouse tenants supportive of the retail sector. He observes how French hypermarket operator Auchan Group and various electronics firms are seeing their businesses grow fairly rapidly. So, if tenants are growing, rents are going to improve pretty significantly.
Aware of the way investors often criticize Russia for being risky and holding little product for institutions, Timmins points out that Russia has seen at least as much, if not more, institutional activity on the buy-side than other markets that Hines operates in, such as India, China and Brazil. “Notwithstanding a bad reputation, AIG, Deutsche Bank, London & Regional and Sponda have all invested here,” he adds.
In addition, Timmins notes that the cost of finance for construction deals in Russia is much lower at 6.5 to 7 percent compared to Brazil or India, where costs are closer to 15 percent. This is a big difference that is at odds with the perception of Russia being a riskier place.
Not only that, even Russian banks are beginning to lend to sponsors of property funds. Many lenders got burned making property loans to Russian companies, so they are now only willing to do business with quality international sponsors. The only downside is that the Russian banks don’t always have the structures available that international investors may want, and consequently they may not be as tax efficient.
As Timmins warns his mobile phone might “die” at any moment, he summarises: “Russia is a complex place, but what we have found over 20 years here is that, if you have the ability to deliver good quality projects at reasonable cost, you can get very high cash-on-cash returns.”
New markets
Of course, Russia is not the only so-called ‘emerging market’ in Europe. Smaller neighbouring markets are seeing renewed activity as well, albeit in a muted sense rather than with a big bang.
David Allen, advisor to the Chayton Capital Property Funds that focus on Central and Eastern Europe, says it is logical that investors should seek new markets for returns and opportunities. He explains that investors initially opted back into the UK property scene after the global financial crisis, amid a big fall in values and subsequent cap rate compression. Next, investors looked towards the established Western European countries of France and Germany, before moving further east towards Poland and the Czech Republic.
“What we are seeing is that people are now beginning to look again at the next destination, such as Romania, Hungary and Bulgaria,” says Allen. “We have seen some interesting transactions in those countries, with Europa Capital Partners buying a retail park in Bulgaria and a South African fund investing €100 million in a Romania office building. It is clear that people are looking for that kind of product; the issue is there is a limited amount of that. There is demand coming back, but it is more for the secure product rather than for the very opportunistic speculative product.”
No doubt, each market has its own set of specialist players who believe they can offer golden opportunities, such as Copenhagen-based BPT Asset Management. Bettina Knudsen, head of investor relations, says BPT has been operating in the Baltics as a value-added manager for 10 years and also has a Russia fund. Their fourth Baltics fund recently bought an office asset in Tallinn, Estonia.
“The biggest obstacle for the Baltic market is its small size,” Knudsen says candidly. “That makes it difficult for investors to relate to because of natural concerns about issues such as the exit. Yet Russia, despite being a huge market, is not as mature as say the Baltics or Poland. Many associate the Baltics with Russian mentality and myth – I’ve even been asked if foreigners need bodyguards – but it is completely different.”
Shopping in Turkey
While the Baltic nations begin to see some investment activity, another new hotspot – Turkey – continues to market itself as a place for opportunistic real estate funds.
Before the financial crisis, the country received a lot of investment, mainly from international real estate funds buying into shopping centres. Indeed, Merrill Lynch raised a Turkey-specific fund called Bosphorus and went heavily into retail.
Frank Roccogrande, a partner at BLG Capital, says investing in the country is still about its large population of around 72 million, 45 percent of which are under the age of 25. There is a growing middle class as well.
“When you put that and its growth against what is going on in Southern and Western Europe, which has a much older population, it is an interesting market,” Roccogrande says. He adds that Turkey has done a good job in finding new economic markets with which to trade, such as Russia and the Middle East, given it has had to wrestle with the economic slowdown of its main European bloc trading partner. “It is looking increasingly like the China of Europe,” he boasts.
Reality check
That is an interesting comparison to make, but limited partners need to beware of all the new markets in Europe, however they are described.
One very large European investor summed up its attitude towards the different locations. “There is hardly any institutional product, and the market is not looking for any foreign money,” the investor says of Russia, which he labeled a “no go” area. “The market and pricing are very non-transparent.” On the whole, Central and Eastern Europe “is an over-estimated small market, except for Poland,” he adds
On Turkey, the investor was more enthusiastic, but with an important reservation. “For economic and demographic reasons, Turkey is a very interesting market to invest in, but it is still difficult to find the right product,” he says.
This is one of the big obstacles fund managers face in these new markets, but one that many believe they can surmount.
Emerging market folly
What is an ‘emerging market’ anyway? Experts say, in some cases, their fund falls between definitions
Institutional investors in real estate funds – some of the largest and most sophisticated among them –call certain countries ‘emerging markets’ even though the concept was created some 30 years ago by World Bank economist Antoine van Agtmael to shake off the lowly ‘third-world’ tag.
Powerful voices in asset management such as Jim O’Neill, chairman of global asset management at Goldman Sachs, who famously invented the term “BRICs” in 2001 to denote the growth countries of Brazil, Russia, India and China, say it is “pathetic” to call only those four markets emerging. At the same time, the tag is unhelpful because it encompasses countries with too great a range of economic prospects.
O’Neill has proposed that countries should be described as “growth economies” if they already accounted for 1 percent or more of global GDP. Turkey stands at around 1.6 percent, so perhaps it should shake off its emerging markets tag. Countries contributing less than 1 percent of global GDP should continue to be regarded as emerging as they are smaller and more illiquid, he notes.
One senior professional at a real estate fund manager that is focused on small, as well as larger, emerging markets, says: “We are struggling with the definition of ‘emerging’ too, but when you start quoting the kind of returns possible, the investor begins to think that it might actually fit within its emerging markets definition.”
The more important thing, the fund professional notes, is what kind of strategy the investor is looking for. Is it looking at a core strategy in an emerging market or a more opportunistic strategy in perhaps a more developed market? “Rightly or wrongly, the markets are priced differently, so when you look at the strategy of a fund such as ours, it is possible to fall between definitions,” he adds.
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