RUSSIAN COMMERCIAL REAL ESTATE: DAY OF RECKONING

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 000709

SIPDIS

STATE FOR EUR/RUS, EEB/IFD
TREASURY FOR TORGERSON AND WRIGHT
DOC FOR 4231/MAC/EUR/JBROUGHER
NSC FOR ELLISON

E.O. 12958: DECL: 03/23/2019
TAGS: ECON EINV EIND EFIN RS
SUBJECT: RUSSIAN COMMERCIAL REAL ESTATE: DAY OF RECKONING

REF: 08 MOSCOW 2868

Classified By: ECON M/C Eric T. Schultz for reasons 1.4 (b, d)

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Summary
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1. (C) As the bottom falls out of Russia's commercial real
estate market, developers are scrambling to refinance
hundreds of millions of dollars of debt to complete projects
in the face of disappearing cash flows. Tight financing and
lack of demand have halted commercial development projects
throughout Russia, including showpieces such as Moscow's
Russia Tower, once slated to be Europe's tallest building.
Many developers will not survive and banks will likely end up
acquiring collateralized assets instead of receiving loan
repayments. End summary.

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Rental Rates Plummeting
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2. (SBU) On the back of explosive growth, which saw rental
rates for commercial property double from March 2007 to March
2008 and quadruple from 2001, developers and banks poured
money into developing commercial space in Moscow. As Moscow
commercial rents overtook those of New York, Tokyo, and San
Francisco and pulled even with London, developers took out
hundreds of millions of dollars in loans to construct office
buildings throughout central Moscow.


3. (SBU) Even before the crisis hit Russia in September, it
was becoming clear that the fundamentals did not support the
rate of construction. According to Jones Lang Lasalle,
Moscow commercial vacancy rates more than quadrupled over the
course of 2008, from 3.2 percent to 14.3 percent. This trend
initially led to a stabilization of prices in the first part
of 2008 and then a sharp drop of over 26 percent in the
fourth quarter of 2008 as the economic crisis took hold.
Analysts expect that the situation will worsen in 2009 as
corporate tenants throughout Moscow cut staff, go out of
business, and/or use market conditions to renegotiate the
terms of their leases.

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Construction Immobilized
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4. (C) One of the first casualties of the economic crisis in
Russia was the construction industry, which ground to a halt
in September. (Reftel) Subsequently, the news became
grimmer by the week, with developers announcing an
ever-lengthening list of suspended projects. Theoretically,
developers with cash on hand were able to take advantage of
lower prices and the greater availability of building
materials and labor. But, Sergey Kanukhin, President of the
Russian Realtors Guild, told us that the lack of demand for
their final product caused many to think twice about using up
their cash resources.


5. (U) Figures from December 2008 show that the y-o-y
increase in construction activity from December 2007 was 0.1
percent, essentially zero. While construction firms are low
overhead affairs, they have disappeared at a prodigious rate,
along with many jobs primarily filled by migrant labor.
(Note: Human Rights Watch estimated that of the 9 million
migrants that worked in Russia, approximately 40 percent of
them were employed in construction. As these migrants have
lost their jobs, remittances to the Central Asian countries
they come from have fallen. End note.)


6. (C) Julia Gordeyeva, Deutsche Bank Real Estate Analyst,
told us that construction was an engine of growth. She noted
that related sectors, such as steel, construction machinery,
advertising, and design (exterior and interior),had all seen
job losses resulting from the building halt. Aleksandr
Andreyev, Deputy General Director for Strategic Planning of
Raspadskaya, said that the coking coal company also relied on
construction activity and was "waiting until the end of
winter" to see what the construction market looked like
before taking any decisions about reducing jobs.

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Vanity Projects Mothballed

MOSCOW 00000709 002 OF 002


7. (C) Vanity projects also have not been spared, even if
sponsored by well-connected oligarchs. A good example is
Shalva Chigirinsky, the billionaire owner of the S T Group
whose wealth comes from Moscow real estate, which has
enviable connections to the Moscow City Government and
Inteko's Elena Baturina (Moscow Mayor Luzhkov's wife),and
from the oil and gas conglomerate, Sibir Energy. (Note:
Baturina herself is in trouble and has been rebuffed in her
efforts to obtain government financial support -- septel.)


8. (SBU) Chigirinsky was poised to execute three Moscow
landmark projects: Russia Tower, touted as Europe's tallest
building and the world's tallest "green" building; Zaryadye,
a luxury multi-purpose complex on the site of the former
Rossiya Hotel adjacent to St. Basil's and the Kremlin; and,
Crystal Island, a luxury city in what was to be the world's
largest building, a pyramid intended to be four times the
size of the Pentagon. All three have been quietly mothballed
and Chigirinsky must now sell his real estate interests to
pay back a USD 325 million "advance" that he took from Sibir.



9. (C) Kanukhin maintained that either the federal or Moscow
government would find some way to complete at least Russia
Tower, the centerpiece of Luzhkov's showcase Capital City
office and apartment complex. The project was too far along
to be abandoned. Moreover, it was a matter of Russian pride
to complete it. President and CEO Michael Belton of the PIK
Group's Storm Properties, however, disagreed, pointing out
that only the foundation had been laid and that neither the
financing, nor the demand for the completed space was there.

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Mirax Owner Sells Yacht to Stay in Game
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10. (C) The completion of Russia Tower has become a rallying
point, however, for Mirax owner Sergei Polonsky, who recently
refinanced a USD 200 million loan from Credit Suisse. After
telling the media that businessmen had to be "responsible",
he sold a number of luxury residential properties and his
yacht and announced himself able and willing to finish Russia
Tower. Gordeyeva was unsure how Polonsky would be able to
finance even a "shortened" Russia Tower, but speculated that
the Moscow government would step in. David Simons, Director
of Development for Giffels Russia, told us that Polonsky's
chief goal was to ensure that he remained a player in
Moscow's lucrative real estate sector once the crisis eased.

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But Banks Will Be Left Holding the Bag
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11. (C) According to Gordeyeva, beyond a few wily developers,
the only other players left in the commercial real estate
market would be the Russian banks (primarily Sberbank and
VTB) who had refinanced the loans. She told us that many
developers had been forced to use their hard assets (e.g.,
buildings) as collateral. Since it was likely that many
developers would ultimately be unable to repay their loans,
the banks would acquire the assets, which they intended to
hold until the market turned around and they could sell them.

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Comment
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12. (C) Given the dropping demand for commercial property
even prior to last September, it appears that commercial real
estate may be slower to recover than other sectors once the
downturn stabilizes. Banks that end up holding the assets of
liquidated developers therefore will not be able to
capitalize on an upturn in the market anytime soon.

BEYRLE