Residential Property News, September 2004

Interview by Tatyana Lomakina

For the past several years, Moscow real estate has been considered an incredibly profitable investment. Last year, prices for individual residential projects rose by as much as 50 percent. Given this surge in prices, it is not surprising that not only Russians, but foreigners as well, are happy to invest in residential real estate in Moscow. This year, a number of political and economic events have caused many Western businessmen to doubt the future of these investments. How justifiable is their apprehension? Is it still profitable to invest in luxury projects in Moscow? What will happen to high-quality residential prices in the near future, and how will price changes affect the overall profits to be made on high-end real estate? We put these and other questions to Anna Levitova and Karina Heifetz, both managing partners at Evans Real Estate.

Residential Property News : How profitable is it to invest in luxury residential real estate in Moscow today compared to other large cities of the world, such as London or New York?

Karina Kheifetz : There is no doubt that today Moscow can compete with the leading cities of the world in the profitability of investing in real estate, and this is true even though homes in London, New York and Tokyo are substantially more expensive than in Moscow. We have not reached world-class prices yet -profit on real estate units here is fairly high, often higher than in Europe and the United States. There are several factors that tell us that it is profitable to invest in Russia. First, the market is still very young and is still developing. Real estate prices in Moscow have grown at an incredible rate. Based on this growth, many foreign investors still believe that the situation will not change and that if they invest in real estate today, they will reap a good profit immediately and be able to pay off their investment in 5 to 10 years. This opinion is partly based on the European experience. During times of rapid market expansion in the leading capitals of the world, many experts said that such rapid price increases were not justified, and forecasted a correction in the market. In the meantime, the market continued to grow, and it is still continuing. This is one of the important reasons why Europeans and Americans look with optimism at the Moscow market.

Anna Levitova : The second important factor that may explain why foreigners invest capital in Moscow is the difference between the sale price and the lease price for an apartment. In Europe and in America, the yearly income from residential real estate rental is from 2 percent to 5 percent of its value. This means that the difference between the lease price and sale price is huge, and it takes much more than a decade to pay off an apartment. In Moscow, the increase in the sale price is also related to a decrease in profit, but the situation is far from that in Europe. Just two years ago, you could pay off a Moscow apartment in two to three years. Depending on the location, quality, and condition of a flat, income from rent could be 20 percent to 30 percent of the price per year, disregarding the fact that real estate prices are constantly increasing. Today, the return on real estate is coming down, and is now at an average of 10 percent per year. Investment projects should now be looked at more carefully, but investments in real estate still bring in high returns.

RPN : What kinds of investments in real estate do foreigners prefer? Do they buy residential units for resale or with the intention of renting them out?

KH: I think that most foreign investors who buy apartments intend to rent them out. The return is still high, as we said, an average of 10 percent, but it can be as high as 20 percent to 25 percent or even higher, depending on the unit. The type of investment depends on many factors. We had one client who bought a communal apartment for $1,300 per square meter. After the sale contract had been signed and while the former residents were looking for other places to live, moving their belongings and changing their residence registration, and while we were getting authorization for the reconstruction of the flat, the price of the apartment increased more than twofold. When the investor found out, he started to think about whether it was worth pouring a lot of money into remodeling and waiting several more years, if he could sell the apartment immediately and still make a fantastic profit.

AL: Just two years ago, the difference in price between a remodeled apartment and an unre-modeled one was quite substantial, so it was deemed profitable to remodel it before reselling it. But today the difference is not all that great. People today approach investing more intelligently. They are not ready to overpay for remodeling that may not be to their taste and that will probably be redone.

RPN : How demanding are foreigners about the quality of housing, generally speaking? Real estate market specialists have frequently noted that elite Russian housing does not have the characteristic of luxury-class real estate. Do you agree with this assessment?

KH: Even though I lived in America for two and a half years and have traveled a great deal, I will not try to professionally judge the quality of Western housing. However, in my opinion, the quality of our real estate is on a par with, and even outdoes its Western counterparts in certain categories. We at Evans really like pre-Revolutionary houses and Old Moscow. I think the architecture of the turn of the century, pre-Revolutionary buildings is so lovely, and historical European buildings have nothing on them. There are very few old houses in the United States, and they are very highly priced. What is immediately apparent in Russia is the quality of the podyezd, or entrance to the building. Russian entrances leave a lot to be desired. People put a lot of money into their own apartments and are ready to spend a fortune on interior design, but they will not invest even one percent of that amount in improving the entryway that is right next to their apartment or the land around the building or anything else.

AL: I think that all new buildings have one important disadvantage: they lack the charm of the old structures. Many foreigners, who have to choose between a new building and one that is 150 years old, with an ancient facade, will most probably opt for the latter. Older architecture, like everything else that is unique, is appreciated much more abroad, while among Russians the preference is for new buildings.

KH: During the early stages of construction, you can buy apartments for the same price as you would pay in a pre-Revolutionary building. You can buy a new apartment on Leontyevsky Pereulok for $4,000 per square meter, while unre-modeled apartments in an old building at Maly Patriarshy Per., 5 cost $4,000 to $5,000 for one square meter, provided, of course, you can find one for sale there. Apartments in old buildings cost $3,000 to $5,000 per square meter, some unique older houses may cost $6,000 or even $7,000, and new buildings that originally sold for $11,000 per square meter have gone down to between $4,000 and $7,000 per sq.m.

RPN : Though many expatriates are actively investing in Moscow real estate today, there seem to be enough Western specialists content with renting. Even though they have the opportunities to invest in elite projects, they stubbornly prefer to lease apartments and spend tens of thousands of dollars a month. Is this ever justified and when is leasing more advantageous than buying?

KH: Lately, with the increase in prices, profits have decreased, and in many cases, leasing may be more profitable than buying. At the same time, many Western specialists have a chance to invest their capital in more profitable sectors of the economy. Once again the question of alternative investments arises. Where can you earn more: in Moscow with elite housing, by investing in your business or in the stock market? The attractiveness of an investment is not calculated in absolute profit factors, but by comparing one investment project with another. Another reason why companies lease rather than buy housing has to do with the tax law, which states that expenses in the form of housing allowance paid to employees are deductible from the company's income, while the purchase of real estate does not fit into this category of expenses. If a company's assets include real estate, it has to pay tax on it.

AL: And it should also be noted that when some large financial corporations, such as banks and investment funds, bring Western employees to Moscow, they give them monetary compensation in the form of a salary increase, which allows the employee to choose whether he wants to buy or lease. Some people prefer to lease an apartment, but the majority chooses to put the money toward a real estate purchase.

RPN: Demand for apartments with short-term leases is increasing. Why is housing that costs several hundred dollars a day so popular;

AL: The reason is extremely simple: the lack of hotels in Moscow. You have to admit that the hotel business is underdeveloped for a city this size. In addition, a number of inexpensive hotels were demolished recently, and this gave people no alternatives. Tourists and guests who had previously stayed at the Moskva, the Intourist and the Minsk now have to stay somewhere else in Moscow. Not everyone can afford the Ararat Park Hyatt. Those who are used to staying in three-star hotels are now looking for short-term apartments, and this trend will continue to exist until a sufficient number of affordable hotels are built in Moscow. But even when the hotel situation improves, short-term leases will continue to exist. In many European cities with well-developed hotel services, privately-owned boarding houses are in demand, and tourists from all over the world stay in them. I think that privately-owned apartments will be in demand specifically among this category of tenants, i.e., tourists who prefer to stay in apartments with kitchens and the comforts that private housing affords.

RPN : What kind of real estate, in addition to luxury apartments, are Western businessmen looking at as investments?

KH: Foreign investors are obviously interested in land suitable for building, as well as land that has to be reclassified as to purpose. Investors will often buy the first floor of a residential building with the intention of turning it into a non-residential, or commercial, space. Lofts or attics that increase the size of the top-floors apartments are also popular.