As the number of retail and office centers constructed in the Urals region increases, the contrast between successful and unsuccessful projects becomes increasingly more distinct. The sector players themselves cite a respective building having many owners – who are unable to reach a consensus on said building’s operation and development – as oftentimes being the major stumbling block to success. An additional bone of contention could be a disagreement on the concept and/or differing opinions when selecting materials for finishing a building’s interior.

Not-So-Bleak Stats

According to data provided by the Urals Chamber of Real Estate, currently 54% of the premises in commercial real estate buildings are sold at the construction stage, 13% are leased out, 9% are sold/leased, 19% are operated by the owners for their own purposes and 5% are operated for the owners’ needs and leased out. The statistics clearly show that developers in the Urals prefer to sell their premises as a result of a shortage in financial resources and to recoup more quickly on investments in facilities.

The specialists at Chelyabinsk-based Energoinvist say that the space in the company’s first business center, Slavyansky, was sold at the construction stage, but this was not to make a fast buck, but, rather the company did not have a credit history. “Of course we needed funds for construction,” notes Energoinvest. “However, we did not wish to attract firms whose goal was to resell the space once the center was constructed. Therefore, we invited reputable companies like Synterra Urals and Transleasing.”

“The early sale of premises by developer is called to generate investment for project completion,” says Andrei Braude, aide of CEO at RED MC, Yekaterinburg. “A buyer in this instance could be called a co-investor, given that he has invested funds at the early stages and assured himself of a future profit. In addition, he is dividing up the risks with the developer.”

Evgeny Melnikov, commercial director at Olips, says, “It is clear that the decision to sell commercial space at the construction stage is dictated by the fund-raising logic. However, given the current level of market development, an experienced developer may find the necessary financing for his project without attracting private investors, and the alternatives could be collaborating with banks, funds or institutional investors, which, of course, are time-consuming, but they are ultimately more advantageous for the developer. A project leased out entirely and generating constant income or one fully bought by an investor is many times more profitable than a project completed via selling offices by small units at the construction stage.”

Another reason for selling is when a developer has other more profitable projects, and he’d prefer to exit the current project and put it up for sale, oftentimes as per units or floors. “The overall cost of the third phase of the Antaeus shopping and entertainment center (SEC) was $150 million, which is a significant investment; therefore we decided to sell 40% of the premises at the construction stage to complete the project on time and obtain funds for completing new projects,” says Andrei Gavrilovsky, owner of the Antaeus SEC, Yekaterinburg.

Some regional developers may sell their premises for other reasons. However, such a BC frequently has multiple owners, which begins to resemble Soviet-era with constant squabbles between neighbors. “When a single building has multiple owners who are not a single legal entity, there is a risk of disagreement among them,” warns Braude. “In addition to generating a profit, owning a building also entails a lot of responsibilities concerning different spheres, such as cleaning, maintenance and legal ethics.”

Blunder upon Blunder

Developers in the Urals are fond of citing the Vostochny shopping center in Yekaterinburg as an example of an ill-fated shared apartment.

“A shopping center is foremost a union of various retailers who depend on the building’s program and floor plans. Retail operators must offer a compatible assortment of goods and services,” says Sergei Marinin, general director of SMT Developments. “The lineup of tenants must be comprised as per price categories, such as middle, upper-middle and high-end segments, and tenants are located in a shopping center accordingly. If this principle is not adhered to, a shopping center is likely to fail.”

The owners of Vostochny, in their haste to recoup their investments, neglected to take the afore-stated rules into consideration and ran into some huge nuisances.

“This was an unfortunate experience. The developer had to generate some funds, so he sold space chaotically. A furniture store must not be located next to a shop selling hygiene products. There must be a proper selection of tenants, and they must be in the right areas to prevent the retail mix from falling apart,” says Alexei Karavaev, director of Sistema management company, which operates the Sibirsky Tract in Yekaterinburg.

The disadvantageous placement of tenants could very likely have a negative impact not only on shopping centers, but also on office buildings. Indeed, as Andrei Yaroslavtsev, general director of MBM , operating the Zvezda SEC in Perm, says, tenants began to vacate the nine-story business center located on Kuibyshev St. in Perm as soon as the Gambling Machine company bought the first floor of the building. “Obviously, a gambling club should not be located in a business center; however, wishing to earn some cash by selling space, the owner lost some loyal tenants,” says Yaroslavtsev.

Incidentally, Yaroslavtsev also notes that there could be another reason for failure – the owners’ simply not agreeing on how to operate a building.

“The Aurora retail complex in Perm is a lamentable example, as it was built in a disadvantageous location from the very start, without the required flow of customers. The owners, having bought the premises at the construction stage, could not come to an agreement for over a year on how to attract customers. Each owner suggested his own idea for developing the building. As a result, Aurora looks miserable today” believes Yaroslavtsev.

According to Mikhail Khorkov, a specialist in the Urals Chamber of Real Estate, numerous owners of the Vesenny shopping center in Yekaterinburg have run into the same problem, as they have been trying unsuccessfully for nearly two years to determine the building’s concept.

“Vesenny is approximately 4,000 sqm overall, of which around 35% of the retail and office premises are now vacant, and there is no commercial activity on this territory. I believe that office and showroom space is in greater demand in the center. Leasing out retail space is not very practical,” says Dmitry Makutin, commercial director of Vesenny, but he could not pinpoint the main problems of the complex or suggest a proper concept.

Coming to the Defense

Taking into consideration the bad experience of operating a building with multiple owners, developers in the Urals are trying to find various means to avoid possible difficulties at the management stage by keeping the building in full ownership and hiring a professional management company, by selling the building completely or by drawing up legal documents with numerous terms and conditions. Accordingly, Olips, Yekaterinburg, decided to lease out 100% of the premises and retain a single owner.

“As of today, we are completing two business center projects, with the first being a class B building on Metallurgov St., slated for delivery at the beginning of 2009, and the second being a class A building in the center of Yekaterinburg at 13 Repin St., earmarked for delivery at the end of 2009. Knight Frank designed the concept of the latter business center, but, naturally, a project of this level must have a transparent ownership structure and a sole owner, who could be either Olips or an investor who would buy the entire project,” says Melnikov.

Melnikov also confirms that Olips is transferring buildings in its ownership over to Competent Trust Management (CTM). “Each company should be involved in its own business, and a development company should not manage a building – this is the responsibility of a separate company,” says Melnikov.

Tyumeninveststroi is following along the same path, and its facilities include the Ermak and Serebryakovsky business centers, respectively.

“We construct commercial real estate and immediately sell it completely; thereby relieving ourselves of management risks. Each company should be involved in its own business, and we build well, while others manage buildings well,” says Svetlana Tyukova, deputy commercial director of Tyumeninveststroi. “We have reviewed retaining full ownership of our buildings and hiring independent Moscow management companies; however, it is only profitable for such companies to take on projects of 50,000 sqm or larger, but we do not have such facilities, thus far. Additionally, we prefer not to assume the risks associated with managing a building with tenants or even several owners.”

Gavrilovsky, the afore-mentioned owner of Antaeus, has developed his own strategy to thwart potential difficulties: “I adhere to a strict rule, whereby I retain more than 50% ownership of a building to control the process and the minority owners. Accordingly, 25% of the overall space in the first and second phases of Antaeus were sold, while 40% was sold in the third phase. Otherwise, a building could become chaotic, with each owner having an equal share and insisting on his way.”

According to Gavrilovsky, a developer should also operate his building.

“I am certain that the developer who constructed a building should continue to operate it, given that he already knows all the specifics of the building. Hiring a company to manage the building could lead to difficulties, resulting in chaos.”

Tyumen-based Sibintel holding company, whose facilities include the Premiere, Goodwin, Troika and Daudel, also believes that the developer should operate his own buildings, given that he knows their peculiarities and the market better. Consequently, Sibintel has set up its own management company, Premiere Development.

“There are several owners in our buildings, but no problems have arisen among them, thus far. In the ideal situation, all terms and conditions stipulating collaboration are laid out in the contract, even joint investment in developing the adjacent territories and operating the parking lot. In the worst case scenario, all issues are resolved in working order, and the owners always reach a compromise,” says Mark Dobryansky, PR specialist at Sibintel.

Experts also confirm that problems can only be avoided in the future by paying very close attention to the established investment contract.

“The main conflict arises when there are several owners, and each investor has his own plan for development, and these plans are incompatible. Therefore, a developer must draw up an intelligent investment contract, set up a management company with the joint participation of the investors developing the facility, as well as coordinate joint promotion, sales programs, etc,” says Svetlana Ionova, director of the investment attracting department at DVI Group.

Polina Zhilkina, deputy director of Jones Lang LaSalle, disagrees: “The greatest objection to selling commercial premises to several shareholders is potential problems when the building is sold for a profit. In this case, the majority owner cannot influence the decision to resell the premises to another company or lease them out to another retail operator. This situation can only be avoided by including a specific clause in the investment contract.”

Experts are certain that the best variant for the majority owner is to include a clause in the investment contract stipulating that said majority owner has the priority right of premise selling and subletting.

Market participants generally agree that in the best case scenario, companies must diversify their activities among themselves, concentrating on specific ones: a developer must build and a management company must run a facility. The ideal variant, according to the opinion of most market players, is when a building has one owner who renders all final decisions. Should responsibilities have worked out differently, experts recommend stipulating the minutest details of collaboration in a contract, starting with which party will set the development strategy to which party will choose the materials for finishing a building’s interior.