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Office Real Estate Heads West, Northwest, South

01.06.2011

If, in Russia, «all roads lead to Moscow,» then the capital itself has its own destination point. All subway lines run into the city center, four concentric circles of transport rings radiate outward from Moscow’s midpoint, and the price of real estate, with few exceptions, is determined largely by its proximity to the Kremlin.

Office real estate in Moscow, however, could soon begin to buck this centralization trend. As the echoes of the global financial crisis fade away and the city center nears its saturation point, companies are beginning to seek office space outside the Garden Ring but within the MKAD — and developers are following suit with new projects, according to developers and consultants.

The result will be a decentralization of office real estate in Moscow, they said, and possibly the formation of noncentral office clusters with large amounts of Class A and Class B+ office space. Possible new business hubs include the areas around Kutuzovsky Prospekt, the Gazprom headquarters near metro station Kaluzhskaya, and the corridor between the Belorusskaya and Sokol metro stations.

With space in the center limited and most new office space being built between the Third Transport Ring and the MKAD, or fourth and outermost ring road, the Moscow office real estate market can only become more dispersed, said Irina Florova, head of analytics at CB Richard Ellis.

«There is no other way for the market to go besides decentralization,» Florova said.

Similarly, developer Sistema-Hals, which is building the Class A office complex Sky Light on Leningradsky Prospekt in what consultants said is a burgeoning office corridor, said it selected that location near the Aeroport metro station because of the outward geographic shift in office construction.

«We chose this place because a kind of decentralization tendency exists» on the office market, said Natalya Mikhailyuk-Shugayeva, head of communications at Sistema-Hals.

The situation has come full circle since the real estate boom that preceded the crisis, when high rental rates in the central business district — roughly the area within the Garden Ring — drove companies to other areas of Moscow. During the crisis, rents fell to the point that many businesses relocated to the capital’s «CBD,» or central business district, for the same rental prices as outside the center. At the peak of the crisis, half of all office space deals were signed for sites in the center, which is remarkable given how small this area is in comparison with the rest of Moscow, Florova said.

«Now we see the opposite process,» she said. «In terms of deals [outside the center] we don’t see a serious increase for now, but it will soon appear because in the center there’s just no free space left, and companies simply won’t have any other choice but to again move outside the boundaries of the Third Ring.»

The free space that does exist is going for higher and higher rental rates, consultants agreed, even as rental rates outside the center are falling. Vacancy rates in the center will bottom out within the next two years, and rents could rise to as much as $1,500 per square meter, predicted David Godchaux, chief executive of commercial real estate consultant NAI Becar. Currently, the rates can reach up to $1,200 per square meter, he said.

«The rentals are going to go up. That’s another argument for the demand to go somewhere else,» Godchaux said.

Already, many office space clients are refocusing on areas outside the CBD. Godchaux maintained that his firm is currently observing a «shift» out of the center as companies move out of the CBD rather than pay a high premium for space there. Initially, companies will often come to his firm seeking Class A office space in the most prime area of Moscow, the center, he said.

«And then they see the rent … and they see it’s not going to be that easy to find the right type of office space,» Godchaux said. «And then they find out about the traffic jams … and start thinking, ‘OK, well, maybe I can get better rent for the same quality office slightly outside the Garden Ring, and I will commute better.'»

Shrinking Deals, Growing Exodus

In the first quarter of 2011, CBRE observed a shrinking number of deals inside the CBD and a growing number of deals outside the Third Transport Ring, Florova said. But Natalya Dementyeva, associate director of office real estate at Knight Frank, also pointed to the area between the Garden and Third Transport rings, noting in an e-mail interview that it is a particularly promising destination for companies given the decreasing vacancies and newly limited supply in the center.

«We think that this trend will promote a more-active uptake of premium-class office space inside the Third Transport Ring, especially considering the ban on new construction in the center of the city,» she said.

In the first quarter of 2011, major deals not located within or near the Garden Ring included the rental by ProfMedia Business Solutions of 5,200 square meters in the Danilovskaya Manufactory near the Tulskaya metro station; the rental by consultant Neo Centre of about 4,000 square meters in Business Center Chaika near the Mendeleyevskaya metro station; and the rental by supermarket chain O’Key Group of 3,500 square meters in Business Center Pallau-NK near the Baumanskaya metro, according to S.A. Ricci/King Sturge.

The rental market as a whole is growing: Vacancy rates are decreasing everywhere except outside the MKAD, where they remain static, consultants said. They did note, however, that the uniformity of this trend is caused by a lack of new supply, which stems from the slowdown in project planning during the crisis.

Fueling the increasing competition for office space in the center is the de facto freeze by City Hall since last year on new construction in the area, although existing projects will likely be completed, Florova said. Mayor Sergei Sobyanin has been tasked with addressing Moscow’s notorious traffic, and the fundamental step needed to curtail congestion is reducing office stock, she added, leaving the future for office development in the center bleak. On May 11, Sobyanin suspended the issuance of building permits in the center and ordered the review of all previously issued permits. As a result, no new supply will be built to meet the growing demand for office space in the CBD.

On the whole, the city’s urban planning policy will provide an «impetus for decentralization,» said Pyotr Isayev, head of the commercial property department at Capital Group.

«I think that in the midterm, this trend will be influential on the development of office real estate,» Isayev said.

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