As games of chance go, Russian roulette is among the most lethal. To lose means certain death. Investing in Russia also carries some obligatory wealth warnings. Every now and then the country goes through political spasms, which demolish the value of domestic assets.
Since the last big financial meltdown in 1997, most of the wobbles in Russian markets have been of political origin. There was the wilful destruction of the Yukos Oil Co by the state and the imprisonment of its boss Mikhail Khodorkovsky, forcing Shell to sell down its stake in the giant Sakhalin gas fields and a warning shot about taxes fired at local metals group Mechel, which halved its share price.
Most recently, it was the military attack on neighbouring state Georgia and the political recognition of two breakaway states in that country. This last action is particularly worrying for investors as it has a strong global dimension and pits Russia against the rest of the world. But in the words of President Dmitry Medvedev, the country is ready for another cold war.
Prior to the attack, Moscow’s commercial real estate market was a good place to be compared with the now moribund West European markets. According to Frank Knight, prime office rents city rose by 15%–20% during the first half of 2008. And though tenant demand remains strong, yields had softened by 50 basis points to a very attractive yield of 8.5% due mainly to uncertainty in global financial markets.
Some 800,000 sq m of new office space was absorbed without too much difficulty during the first half of this year. Meanwhile, business parks and gated developments have become a particularly popular concept and can be good investments.
Real estate prices have been riding high on the back of very favourable economic fundamentals, with GDP growth of 8.5% in the first quarter of 2008. Household consumption has been running at a rate of 14.1% during that period.
However, events in Georgia are quite rightly unnerving investors and are pushing up borrowing costs for projects, in some cases by hundreds of basis points, as lenders factor greater risk into their lending equations. Loan tenors have also shortened significantly.
In terms of symptoms, it’s a little like letting in the credit crunch through the back door. For a capital driven asset like real estate, this spells price falls. But if bargain hunters are tempted, they should consider the risks carefully.
First, they must appreciate that Russia is quite ready to sacrifice economic development to satisfy geopolitical goals and no doubt the interests of foreign investors as well.
While other emerging market countries take a pragmatic view towards foreign investors, Russia often appears to merely tolerate them. Supported by surging oil and gas revenues, Russia feels quite safe in its belligerent stance.
There is also a concern that there could be more Georgia-like incidents over the coming years. Prime Minister Vladimir Putin and his cabal seem determined for Russia to reassert its dominance over neighbouring former Soviet republics.
A resurrection of the cold war would see Russian assets crash in value. And if such a scenario were to materialise, just how safe would Western-owned assets be from state-sponsored expropriation? Russian roulette is best left to those with the highest of risk appetites.