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Gazfond, which is the largest nongovernmental Russian pension fund, bought the Mosenergo business center for $160 million in 2009.

Worldwide, pension funds rank among the largest investors in commercial real estate, but Russia's pension funds account for only a small percentage of real estate investment. Consultants predicted that pension fund investment in real estate will rise, however, as the Russian pension fund market matures and reserves grow.

Although the market has considerable growth potential, the small volume of total pension fund reserves, artificially high yield expectations among funds and a limited supply of quality real estate are keeping a lid on the number of investment deals for now.

In research presented in June by Jones Lang LaSalle, analysts predicted that the amount of pension money that could be invested in real estate will rise from $20.3 billion in 2011 to $24.1 billion in 2012. Of these figures, $2.5 billion and $3 billion could be invested directly, as opposed to through mutual funds. Direct pension fund investment in real estate in 2010 was $1.83 billion, according to Russian ratings agency Expert RA.

"We expect average growth of the pension reserve to be 14 percent per annum, and for pension fund investment in real estate to increase by 18 percent per annum," said Jones Lang LaSalle executive board member Andrei Postnikov.

One factor driving the trend of increasing investment by pension funds is the current volatility of the equity and securities markets, which tends to push pension funds toward real estate and other fixed-income investments, he said.

"In Russia, pension funds are looking at real estate as an investment possibility and a good way to diversify," said NAI Becar chief executive David Godchaux. Although there won't be a boom in investment, it will continue to increase in scope, he added.

Investing With Reserves

According to Russian federal law, only private pension contributions can be invested in real estate. Up to 10 percent of pension reserves can be invested directly, and up to 70 percent can be invested indirectly through closed-end mutual funds. No single management company can receive more than 25 percent of a fund's total reserves.

Nongovernmental Russian pension funds held 612 billion rubles ($20.7 billion) in total reserves in 2010, a number that is insubstantial compared with pension-fund holdings in other countries. Government pension fund reserves, which can't be invested in real estate, amount to about $30 billion. The largest of the Russian nonstate pension funds is Gazfond, which controls nearly half of the total reserves on the market, with $9.25 billion.

"These are not big numbers," Postnikov said at the June press event. "Even compared with Kazakhstan and Poland, there are fewer pension fund reserves in Russia, and compared to developing countries, they are 20 to 30 times smaller."

In 2009, pension assets made up 73 percent of gross domestic product in the United Kingdom and 67.8 percent in the United States. They accounted for only 3.1 percent in Russia.

Pension fund reserves are growing, but there is no guarantee that Russian pension funds will invest all of their eligible money in real estate. Currently, Russian nongovernmental pension funds allocate only 5 percent of their reserves to real estate investment, according to Jones Lang LaSalle figures.

Currently, just a handful of big investment deals have been completed by Russian pension funds. The Norilsk Nickel Nongovernmental Pension Fund bought the Marr Plaza business center for $130 million last year, thereby placing about half of the fund's reserves in real estate. Russian Railways' Blagosostoyaniye Nongovernmental Pension Fund also invested in office real estate, purchasing the Domnikov business center through its management company RWM Capital for $230 million in 2010.

Gazfond owns the Aerobus shopping center on Varshavskoye Shosse, which opened in 2008, and it bought the Mosenergo business center opposite the Kremlin on Raushskaya Naberezhna for 4.7 billion rubles ($160 million) in 2009.

Notably, one of the tenants in the Mosenergo business center is Gazprombank, of which Gazfond is the controlling shareholder, helping assure the pension fund of reliable rental income. In addition, Russian Railways has offices in the Domnikov business center, and the Norilsk Nickel fund said upon purchasing Marr Plaza that it would move its headquarters there. A main reason pension fund deals remain few in number is the lack of high-grade buildings where rental income is guaranteed through long-term rental contracts, consultants said.

Looking For Quality Properties

"Pension funds can't afford to buy an unreliable building that doesn't offer a stable income in the long term," Sergei Chagin, deputy director of investment sales at NAI Becar, told CRE Magazine earlier this year. A lack of investment-grade buildings also keeps pension funds from buying real estate, according to consultants.

"You don't have that many institutional-class buildings in Russia, or you have them but they're not priced properly," Godchaux said.

If the capitalization rate of a prime building in Moscow is less than 10 percent, pension funds are unlikely to be interested, he explained. Currently, yields here rarely reach this figure, partly because most buildings were constructed before the global financial crisis, when prices were higher and yields were lower.

Even though Russian pension funds are not investing to their full legal potential, there are still not enough high-grade buildings to meet the investment demand, said Tom Devonshire-Griffin, national director for Russia & CIS at Jones Lang LaSalle.

"There's a difference between what the market can offer and the artificial expectations of the player," Devonshire-Griffin said.

These artificial expectations stem from the level of risk involved in playing the Russian real estate market, Postnikov said. When pension funds convert this perceived risk into an expected purchase cost, it can be difficult to find a suitable building at this price, he said.

"When it comes to comparing [potential investments] to real estate as an alternative investment, they consider this to be a higher risk profile and immediately expect a premium in terms of returns," Postnikov said.

In addition, conservative investors such as pension funds are usually not allowed by their bylaws to take out significant loans, which limits their buying power unless they have significant reserves.

"Without leverage, the whole real estate story is far less exciting in terms of returns," Postnikov said.

Nonetheless, there is potential for increased real estate investment as nongovernmental pension funds develop in Russia. Postnikov said there is a "growth trend" in the pension fund market, both in the number of funds and the total amount of reserves. Currently, there are about 130 nongovernmental pension funds in Russia, and Postnikov said reserves are accumulating faster than funds are spending them.

The quality of commercial real estate is also improving, creating a more favorable climate for investment by pension funds, he added.

The market is immature and will continue to develop, Godchaux said. Although pension fund managers in Russia are highly qualified, "the experience and the track records are not the same" at Russian funds as in Western Europe or the United States.

"It's still a relatively young market," Godchaux said. "That's an overall explanation of why it takes time for them to come to real estate."