As host to the 2014 Winter Olympics and 2018 World Cup, and with a strong demand for offices, residential and retail, Russia is experiencing an uplift in construction activity. Tim Robb from EC Harris reports
01 / Current background
With a total area of 6.5 million m2 Russia is the largest country in the world, encompassing nine time zones, bordering 18 other countries, and the Atlantic, Arctic and Pacific oceans as well as 12 seas. It is, however, worth noting that 80% of Russia’s population live in “European Russia” - west of the Ural mountains.
Russia has historically been proudly independent and not followed international trends, preferring to take its own unique path. This is evident culturally and politically but also financially and played to Russia’s advantage during the credit crunch that began in 2008. Although Russia suffered a downturn in its economy as a knock-on effect of the wider global problems, the underlying economy in Russia is in a stronger position to support recovery. Many of the countries affected by the credit crunch face massive sovereign debts and huge budget deficits, while Russia’s debt-to-GDP ratio of 8.5% is the lowest of any large country in the world. Russia’s GDP has shown consistent growth of between 4.3% and 4.6% and in January this year deputy finance minister Dmitry Pankin forecast that “the deficit will be 4.8% this year, 3.6% next year, falling to zero in 2015.” However, more recent figures suggest that this may be unduly pessimistic and the World Bank has predicted that Russia will have a zero deficit by 2012-13.
02 / The banks
Due to tight regulation and limited international business, Russian banks were not directly affected by “toxic debts” or the shoring up seen elsewhere of financial institutions deemed to be “too big to fail”. The state-owned giants Sberbank and VTB are such a dominant force in the Russian market that this year has seen the withdrawal of several major international retail banks including Barclays and HSBC, while VTB has created an investment banking division that has secured the vast majority of current privatisation and fundraising mandates.
03 / Employment
Unemployment in Russia is steadily falling and is at 5.5%. Salaries increased by about 4.2% in 2010 and in June 2011 were about 3.8% higher than a year earlier. But incomes are rising more slowly than they did pre-crisis and with inflation running at close to 9% earnings in real terms are well down.
Despite this, consumer spending continues to increase although not as much as some forecasts report. There is still a demand for malls and retail outlets in and around the main centres of Moscow and St Petersburg.
The government’s support for new technology has secured an impressive 4G wimax network and mobile phone reception on underground trains tin Moscow and St Petersburg.”
04 / Funding
The credit crisis has seen many international investors withdrawing from the Russian market. Foreign Direct Investment (FDI) fell by 41% in 2009 followed by a fall of 13% last year. This withdrawal of funding resulted in projects across the country remaining unfinished, and schemes being shelved before they started.
However, in the first half of this year FDI was up by almost 30% on the same period of 2010. Government funding of state projects and investment in many of the stalled schemes has led to faster growth than was forecast.
05 / Leisure and sport
Government spending is evident in the leisure and, specifically, sports sectors. Several events are driving the development of stadiums and infrastructure across western Russia in the next 10 years. This includes heavy investment in Kazan in the Republic of Tatarstan, host to the 2013 Summer Universiade (the University Olympics), the 2015 World Aquatics Championships and the 2017 Confederations Cup.
Work is also already underway in the South for the 2014 Winter Olympics in Sochi. The venue includes several sports complexes as well as the main Olympic stadium, a mountain complex and the Olympic village and broadcasting centre. The cost of the Sochi Games is about $10.9bn (£7bn).
Russia has also won the right to host the Fifa World Cup in 2018. Some of the new facilities constructed in Kazan and Sochi will be utilised and a number of stadiums in Moscow and St Petersburg will be upgraded with infrastructure improvements. The bid also included proposals for eight new 45,000-seat stadiums across western Russia. As part of the bid, the Russian Football Federation set a budget of $10bn (£6.4bn) to be spent on the tournament, of which just over $1bn would go on the construction and reconstruction of stadiums with the remainder on infrastructure.
Partly as a result of these major sports events, Russia’s 2010-2015 transport infrastructure development programme is expected to see an investment of about $450bn (£290bn) over the next five years. The difficulty of raising that kind of money means that the government has taken steps to secure funding such as the re-introduction of road funds. The latest infrastructure spending plans come as a follow up to the ambitious 2008 programme that was to be rolled out to improve the country’s transport infrastructure. Sadly, the tight budgetary situation resulted in cuts to that programme. Some analysts estimate the cost to upgrade Russia’s ageing infrastructure at over $5tn (£3.2tn) over the next 15 years.
06 / The property market
Unlike the leisure sector, the corporate real estate fit-out market is dominated by private capital from international firms who have recognised the potential in the growing economy and investments in Russia, and Russian firms with international interests or western-influenced business plans. Companies from the oil and gas sectors, IT, electronics and investment banks are expanding their operations to capitalise on Russia’s growth.
An improving economy has resulted in strong demand for offices, particularly in Moscow, and recent figures from Jones Lang LaSalle indicate that take-up of office space in Moscow in the first half of 2011 was the second highest in Europe. Completions are low but the office pipeline remains high with some 2.5 million m2 to be completed in the next three years. Rental costs for prime space reached $1,200/m2 in the second quarter of this year, up 20% on Q1.
One of the challenges for international firms wanting office space in Russia is finding commercial developments that have been constructed to meet the quality expectations and environmental requirements identified in their corporate governance. There is therefore often a gap between the client requirements and the availability of suitable base build developments.
07 / Residential
The demand for residential properties in Moscow and St Petersburg keeps resale and rental values at a similar level to London. This attractive return means banks are refunding and restarting schemes in Moscow and St Petersburg. Due to the scale of public housing and limited land, the redevelopment of existing dilapidated stock is a massive undertaking and the Moscow authorities have approved a five-year program to erect 12.7 million m2 of housing space. The planned volume to be put up by private investors - 8.9 million m2 - is included in 500 investment contracts. The city’s investment in the programme will be about $24bn (£15.4bn).
The official forecast is that the total area of housing completed in 2011 will be 63 million m2, 8.4% up on last year. The forecast ahead is equally upbeat with increases in output of 6.3% in 2012 followed by rises of 6% and 11% in the next two years. However, the pace of housing construction in Russia has slowed significantly this year.
08 / Retail
Retailers are starting to regain confidence, with sales up by 4.8% in the first half of 2011. Occupancy rates in the most recently opened shopping centres in Moscow are higher than for some time and stand at 60-80%, well up on the 40% occupancy of the previous two years.
Investment in shopping centres picked up considerably in Moscow during the first half of 2011, after years of frozen or abandoned developments, and demand for shopping centre space is expected to continue to be strong. However, developments in the sector will be hindered by restrictions on construction projects in Moscow city centre and by newly introduced requirements for shopping centre developers to build transport infrastructure around the centres they develop on the Moscow ring road. Nevertheless, the growth of the Moscow shopping centre market is forecast to continue, with 14 centres planned to be delivered in 2011-12.
09 / Materials
Some indication of the uplift in construction activity can be gained from the growth in cement consumption, which increased by 10% in 2010 with a further 12% growth expected in 2011. Many of the suppliers of cement are in the former Soviet CIS countries and the latest figures represent a bounce back from the 20% cut in consumption that occurred in 2009.
There are challenges in all sectors when meeting international standards when sourcing materials. Many multinationals have international design standards and environmental policies to which their projects must conform. Due to the costs and logistical difficulties in setting up manufacturing bases in Russia, some key materials that are regularly requested by clients are often unavailable in Russia. The client can then either choose to import the relevant material or find a local alternative. The costs and time associated with importing non-certified materials can be prohibitive. For example, if the item procured is mechanical or electrical plant, not only does the plant have to be transported to site, which can be very expensive due to the size of the country, but customs duty has to be paid and the item also needs to be certified from a fire safety point of view. These costs can add up to 50% on to the standard costs, and weeks to the programme.
As mentioned above, Russia is a huge country where most of the development, investment and construction is in the western, “European” region. However, the construction industry depends on labour coming from distant countries including Tajikistan, Kazakhstan and Turkey. As a result there is a large low-cost labour force to deliver the above large-scale projects.
10 / Forecasting
Forecasting construction tender prices in Russia in the long term can be problematic, due to wider economic fluctuations. Inflation peaked in mid-2008 at 15% then dropped to a low of 4% in mid-2010 but now has levelled off at around 9%. However, based on the increased demand within the Moscow market and the large number of significant government projects (not least the Winter Olympics and the World Cup), there will be pressure on available resources, resulting in higher prices. This will be particularly acute for the large international contractors that have the experience and capability of delivering international standard venues that meet either International Olympic Committee or Fifa expectations.