Great real estate returns were probably not what Nikita Khrushchev, the 1960s-era Soviet leader, had in mind when he predicted that his country would eventually bury the West. But as far as shopping centers go, Moscow now seems to be making good on his threat.

In a new PricewaterhouseCoopers/ Urban Land Institute report on real estate trends in Europe, 485 real estate professionals ranked Moscow at the top of 27 European markets in both investing and development. And within the major property types, respondents rated Moscow retail the hottest market of all. A total of 81% rated Moscow retail a buy, in sharp contrast to the average European retail market's buy rating of 38%.

Why so hot? Real incomes in Moscow are growing at an annual rate of 7% to 10%. In fact, the average income in Moscow reached $1,241 per month per capita in September 2007, about three times higher than the average Russian's income of about $460 a month.

Although only 10 million of Russia's 141 million citizens live in Moscow, their relative wealth accounts for 21% of the country's retail spending, reports Jones Lang LaSalle (JLL), a fact not lost on furniture retailer IKEA and the other major chains that have opened up shop there.

Shoppers squeezed for space

The market's strength is based on the fact that despite nearly two decades of capitalism, consumers remain badly underserved. At of the end of 2007, Moscow offered 1,840 sq. ft. of high-quality retail space per 1,000 Muscovites, much less than elsewhere in Europe.

Even in Eastern Europe, the ratio is more like 4,305 sq. ft. per 1,000 people. But that pales in comparison to Paris, where Parisians can take advantage of 7,534 sq. ft. per 1,000 people, says Alexei Yazykov, equity research director for real estate at Renaissance Capital, a Russian investment bank.

All that demand is making the market highly profitable. Cap rates in Russia's 59 prime retail shopping centers were a healthy 10.5% as of the third quarter of 2007.

London's West End, by comparison, enjoys cap rates of 4.65%, according to the report. In 2007, prime properties posted a vacancy rate of less than 1% and 7% annual rental growth. Prime rents have risen over $340 per sq. ft. in some areas, making Moscow prices the second highest in Europe after London.

“Despite the continuous growth of shopping floor space, the supply of quality shopping stock still doesn't meet the demand,” says Olga Strelets, head of retail research for JLL in Moscow.

A waiting game

Although the double-digit annual cap rates have attracted many European developers and construction companies, surprisingly few have been able to build. Strelets says that large parcels are actually scarce and expensive in Moscow.

Weak infrastructure is holding development back, particularly power and utilities. It limits demand in other ways too, according to Yazykov — you don't put a mall in if there isn't a suburb to support it. Yazykov says that there are huge projects in the works now to provide the city with more power and other infrastructure, but these will take time to complete.

The city's restrictive planning regime serves to constrain development and keep prices up in onion-dome territory. “Planning restrictions are always the best recipe to inflate prices,” Yazykov says. Federal tax restrictions, such as duty on concrete imports, are constraining growth as well. Local developers also manage to gum things up all by themselves too, says Strelets, due to their inexperience.

Nor is supply likely to become less constrained anytime soon. Nearly 20 million sq. ft. of high-quality shopping centers are in the pipeline now, and slated for completion by 2009.

Despite the grumbling about taxes and planning, political risk doesn't seem to be a major concern among real estate professionals looking at Vladimir Putin's Moscow. Although the survey gave Moscow the worst marks for risk, respondents seem almost as enthusiastic as ordinary Russians about his vision. “Mr. Putin has made a decision to be very strict and manage Russia in a strong-handed way,” as one respondent said, “but we think that is what is necessary to get Russia back on track.”

Bennett Voyles is a veteran commercial real estate reporter and National Real Estate Investor's Paris correspondent. For questions or comments, e-mail benvoyles@yahoo.com.