The real estate revolution

Fifteen years after the dissolution of the Soviet Union, Russia is re-emerging as one of the most powerful countries in the world. Perhaps for the first time since the country sloughed off communism in the early 1990s, a sense of stability and economic opportunity has pervaded the national consciousness—even if political freedoms remain in check.

The largest country in the world by landmass, Russia has seen huge economic gains over the past few years on the back of rising oil and natural gas prices. With GDP growing in excess of 6 percent per annum and multi-national firms moving into the country, the wealth that was once enjoyed by a few powerful oligarchs has begun to trickle down to a burgeoning middle class, who are demanding a higher standard of living in the form of modern housing and Western goods. At the same time, much of Russia's existing housing stock is antiquated, prime office space is limited and a huge swath of the country's retail and industrial market remains untapped by investors. In a country with 140 million people, opportunities in the real estate market appear as vast as Russia itself.

Fifteen years after the dissolution of the Soviet Union, Russia is re-emerging as one of the most powerful countries in the world. Perhaps for the first time since the country sloughed off communism in the early 1990s, a sense of stability and economic opportunity has pervaded the national consciousness.

Over the past 12 months, some of the world's largest private equity real estate firms, including Morgan Stanley, RREEF and JER, have been looking to take advantage. Though Moscow and St. Petersburg are drawing most of the attention, opportunistic investors are also fanning out accross the country, where modern real estate is non-existent and the demand for property is growing. (In addition to the country's two main cities, there are approximately 11 other cities with populations of 1 million people or more and an additional 35 cities with a population of over 500,000—see map.)

Yet investing in the Russian property markets does not come without significant challenges. Unusual and often opaque tax, legal and regulatory systems make Russia a difficult place to do business. Corruption is another thorny topic. And, as in most emerging economies, finding the right operating partner is absolutely critical. One private equity real estate pro active in the country told PERE that a number of his deals have fallen apart because a background check on a prospective seller or operating partner turned up something unsavory.

Yet at the same time that corruption poses a problem, so too does increased competition and capital flows. Yields on certain properties in Moscow, for example, have fallen from the mid-teens two years ago to single-digits today. And many large institutions remain uncomfortable investing in Russia— Jon Hodnett at JER noted that his firm had to tap a different group of investors to raise their Russia-focused vehicle.

In the pages that follow, we take a look at some of the most interesting developments in the Russian real estate market. First, we explore the various strategies that some of the largest international firms are pursuing— far from investing in single assets, many firms are building up large platforms, either via minority stake investments or partnering in sizeable joint ventures. Next we go to St. Petersburg, which is experiencing a bit of a renaissance. More than 300 years after the city was founded—and nearly 100 years since it lost its central prominence in Russian politics—the country's second largest city is booming, with a roaring economy, increased foreign direct investment and what many view as a relatively stable real estate market. And Finally, we talk with Clive Tilley, the founder of gaming concern Tilly Entertainment, who gives us his take on the opportunities and challenges of doing business in Russia, be it casino development or finding suitable real estate for his operations.

As the events of the past few months have demonstrated—the mysterious poisoning of a former KGB agent in London, the murders of prominent journalists—Russia is still stumbling towards its newfound place on the world stage. The glare of the international spotlight may be intense, but the country is now established, once again, as an economic and political powerhouse. Opportunistic investors are hopeful the country's real estate market will follow suit.