A lack of space of the size and format that is currently in demand resulted in the decline of available areas in all sectors and as a result rental rates are starting to increase, particularly in the most successful properties.
Not only snow but also the commercial real estate market is thawing with the coming of spring, vacancy rates are melting away and the rental rates are very similar to blossom kidneys. It sounds romantic, but let’s get to the point!
As we have already noticed, the market has gradually come out of its ‘no pulse’ state. Vacancy rates continue to break through historical lows, and the selective rental rate growth is starting to appear.
Despite the fact that 350,000 sq m of office premises are expected to be completed in 2019, the real figure could be less considering the postponement of the completion of certain projects. For instance, in Q1 2019 only 27,500 sq m were completed, 26% lower than the Q1 2018 indicator. At the same time, office take-up increased by 15% YoY in Q1 2019, according to the preliminary estimation.
This imbalance between the volume of supply and demand continued to ‘eat’ available space, the average market vacancy decreased by 0.5-1.0 ppt, to 9.3-9.8%. The most significant vacancy decline was in Class B+. Geography wise, the largest shrinkage of available space on the market was recorded in the area from the Garden Ring to the Third Transport Ring (TTR). Given the shortage of premises in the CBD and Moscow City, we expect a further decline of the vacancy rate outside the Garden Ring.
This has stimulated the growth of rental rates in the Moscow office market, which continued to increase in Q1 2019. Among the three major segments, offices are leading in terms of the dynamics and prospects of rental rates’ growth.
Flexible spaces with rapid development have already become a strong competitor to traditional offices. The role of flex space on the market has increased because not only startups, but also large companies are interested in such format for more efficient and flexible use of leased space. For office market this fact has already become a disruptor which makes its analysis more complicated. The appearance of this format may raise question of vacancy rate calculation – although the space is occupied by the operator on a lease, it is simultaneously available in the co-working market
On the back of no retail completions in Q1 2019 in Moscow, shopping centres exhibited a decline in the vacancy rate to 4.6%. It could be a temporary phenomenon, as we expect the completion of Salaris SC in the next three months which will add 110,000 sq m of GLA to the market. If we assume the property will open with 50% occupation, its completion would increase the market vacancy rate by 1 ppt to 5.6%. Further decreases in the vacancy rate will depend upon the leasing up of relatively new properties, which is where there are higher levels of vacancy. Older, more established properties tend to have much higher occupancy. Almost all shopping centres, though, have some inefficient areas where there is a higher turnover of tenants and higher vacancy.
Growth of retail rental rates does not depend on market average vacancy rate but rather on shopping centre location and sales volumes. Many shopping centres, which were completed in 2016-2017, are reaching the third year of lease now, when the rates are expected to grow, as the leasing agreements often assume a step-up rent during the first two-three years of lease. In addition, there is also a natural rental rate growth due to increase of tenants’ turnover in key properties.
Finally, warehouses, which often exhibit individual market tendencies, are showing the same dynamics as offices and shopping centres. The Q1 2019 completions were 340,000 sq m instead of the expected 500,000 sq m. As a result of relatively small completions, which were 68% occupied, the vacancy rate declined by 0.5-0.7 ppt to approximately 3.8-4.0%. Such dynamics will inevitably lead to the growth of the base rental rate in the near future, although rental rate growth has been slower to respond than those in the office and retail sectors.
What does it mean?
All real estate segments demonstrate similar dynamics and trends, because the Q1 2019 deliveries were low, leading to vacancy rate decline and the start of rental rate growth. We expect the acceleration of development activity in the coming future, which may slow down the further decline of availability, but is unlikely to significantly impact the growth of rental rates, which we expect to continue. The market has come out of a coma, and new formats of spaces in office and retail sectors – flexible, entertaining, gastronomic spaces – are actively developing.