Maria Kolbina
Analyst
VTB Capital

The good news generated by the broader economy has helped build confidence in the real estate segment. The industry remains substantially underserved, and therefore opportunities now exist for both investors and developers.

Though most international investors expected the Russian real estate market to become yet another victim of the global financial crisis, there actually weren't that many defaults. This was mainly because of top property owners and property developers restructuring their liabilities ahead of the downturn. As a result, pricing levels didn't drop substantially, and there wasn't a need for the fire sale of investment-grade assets that happened in other countries.

The Russian real estate market is concentrated in a few centers, with Moscow as the prime location. The capital was affected by the credit crunch less than other regional markets. In Moscow, there is still a strong demand for uniquely located properties in the central districts. Figures for 2010 indicate that the number of deals in the residential market nearly doubled compared with 2009.

The retail segment experienced a large increase in demand in 2010, and demand for offices increased 40 percent last year.

The recovery in the economy at the end of 2009 and into 2010 provided some encouraging signs. For instance, the growth of gross domestic product was 4 percent in 2010 compared with 2009 — again a sign of greater optimism.

Another key element in the recovery is that the real estate sector has shown strong growth potential in every segment. The market situation is somewhat different from what it was pre-crisis, as now it isn't just a matter of choosing a segment, investing and then waiting for the returns to roll in. Investors now have to be more selective and to identify the segments that will generate the best demand.

Investments in the Russian real estate market increased 52 percent in 2010 to $4.9 billion, almost reaching the 2008 level. The main contribution came from the residential segment, where investments increased 18 times to $956 million — 19 percent of the total — supported by government contracts in social programs. The Russian commercial market also showed  signs of a revival in 2010, with investments increasing 24 percent to $3.96 million (81 percent of the total) after a 32 percent correction in 2009.

Though Russian investments still dominate, the share of foreign investments increased to 21 percent in 2010 from 16 percent in 2009, showing the rebounding of interest in real estate.

We expect the share of foreign investments to increase further in 2011, supported by government attention toward residential sector and mortgage stimulation, as well as improving trends on the commercial market with better growth prospects for rental rates coupled with expected undersupply in the coming two years.

Investments in commercial real estate are expected to grow 31 percent  in 2011 to reach $5.2 billion, followed by a 26 percent increase in investments in residential real estate to $1.2 billion. Investments in the residential real estate remain more balanced in terms of geographical diversification with 33 percent dedicated to Moscow, 50 percent to St. Petersburg and the rest in the regions, mainly in cities with more than 1 million people.

In 2010 the Moscow residential market showed a strong rebound in the number of sale-purchase agreements as it climbed 54 percent, exceeding the pre-crisis level of 2007 by 11 percent.

D emand has shifted toward mass-market projects and, coupled with  improved mortgage terms and increased developer activity, leads us to believe that purchasing activity in 2011 will further strengthen.

Mortgages are a strong driver of volumes sales. Pre-crisis mortgages accounted for up to 50 percent of certain projects in developers' portfolios, while during 2009 they dipped to below 5 percent of total deals. Last year showed a step forward to a recovering mortgage market, as indicated by a 22 percent share of mortgage deals in LSR and 15 percent in PIK Group in December.

The appetite of banks for real estate risk has been on the rise. Recent mortgage rate cuts have already pushed rates below the pre-crisis level (about 8 percent in U.S. dollars and 10.5 percent in rubles) while at the same time lending requirements continue to ease, adding leverage to both developers and potential buyers. This can be seen in a 1.3-fold increase in transaction numbers in Russia. We must note that the main contribution came from the Moscow region, which showed double-digit growth in the number of mortgage transactions.

One more growth driver is that bank deposit rates are not sufficient enough to compensate for growing inflation. Therefore, the real estate sector offers significant potential for investors looking for growth in the medium to long term.