Inefficiencies in the Moscow market for prime office space and the role of the local government

Abstract

The Moscow market for international quality office space has been expanding rapidly since the onset of the market. The growth in office stock has not been sufficient to satisfy demand for the past 7 years. Disequilibrium conditions in the Moscow office market have persisted over the typical period of a real estate cycle. With a yearly average shortfall of 200,000, the Moscow office market has sustained rents of over USD 1,000 per square meter per annum. Demand is driven by foreign firms in the trade and services sectors, looking for class-A office premises in the city center. The purpose of this thesis is to examine the inefficiencies in the office market for quality office space in Moscow during the period of 1991 to June 1998. In doing so, the thesis focuses on the effects of the local government on new office development in Moscow. Although there has been no shortage of eager developers looking to enjoy yields of 25 to 30 percent, the difficulty of setting up operations in Moscow, the lack of properly defined property rights on buildings and land, the inability to secure development financing and to repatriate profits, the instability of the taxation system, and the constant willingness of local officials to intervene at all stages of the development process have all undermined the development of an efficient market for quality office space. The recent crisis in the Russian economy has reversed market conditions in the Moscow office market, resulting to an oversupply of quality office accommodations. Many international tenants are shrinking their operations in an effort to reduce operating expenses. With rents falling by 25- 30 percent and with no indications for a possible economic recovery in Russia expected for the next 18 months, office construction has-at best-slowed down if not stopped. Difficulties associated with office development in Moscow, combined with weak market conditions are likely to hold back plans for new office construction for the period until June 2000. This will give the local government the time to make all necessary reforms and provide the appropriate legal, regulatory and institutional framework for an efficient office market operation in Moscow. In the presence of strong long term real estate market fundamentals and a total stock of prime office space 30 times less the office stock of London or Paris, it is only a matter of time until office demand pick ups again in the Moscow region. And this time the city must be ready.