Cooler but still warm

The SUN CONTINUES TO SHINE ON the real estate MARKETS OF Central and Eastern Europe – ALTHOUGH The TOTAL value of finalized contracts WILL NOT ACHIEVE THE LEVELS OF 2006. this, paradoxically, is also a good sign

It was the credit crunch in the USA that had the most significant impact on the situation on the investment market in the region in 2007. The shockwave is being felt most painfully in Europe, especially in the UK where virtually the entire investment market was put on hold in August, with transactions that were about to be completed having to be renegotiated. In this part of Europe investors have been approaching purchases with greater care, while banks have been taking a closer look at lending possibilities, changing the structure and costs of real estate financing. But, surprisingly, the impact of these events should not necessarily have a damaging effect on our region.

Wojciech Pisz of Cushman & Wakefield is convinced that Central European investments are both profitable and attractive, since investment servicing standards are the same as in the West and the investment risk is noticeably less, especially now. The Western European market has been thoroughly penetrated and very few opportunities exist there to achieve above-standard profits at a similar risk. Such opportunities are much easier to come by in our region, which is why the situation in the US influences investment decisions to a greater extent in Western European countries.”

Cushman & Wakefield estimates that Poland invested EUR 2.83 bln in commercial properties in 2007, while the figure was EUR 4.75 bln a year earlier. But there is really no cause for alarm, believes Aleksander Loster of Cushman & Wakefield: “This figure could signify an almost 50 pct slump compared with 2006, but it would be wrong to take that comparison as an indicator. Poland registered a similar result two years earlier, which was then seen as a brilliant - even spectacular - performance. In short, 2006 was an exceptional year, while 2007 was cooler but nevertheless excellent as well.”

Although there was less investment in 2007, Poland still attracts the greatest number of transactions in Central Europe. In the Czech Republic EUR 1.85 bln was invested in commercial real estate, whilst in Hungary the figure was EUR 2 bln.

Having said that, the nervousness generated by the US situation has also transmitted itself to investors in Central and Eastern Europe, who then took a closer look at market developments in the second half of 2007, spending their money with much greater care. This resulted in a drop in the number of finalized transactions. Wojciech Pisz feels that: “All the indicators suggest that investors were not so much pulling out of transactions, but instead were putting them off. Some of these may be finalized in early 2008, but we shall have to wait a while to see if that comes about.”

Eastern neighbours are entirely dissimilar

Central and Eastern European countries differ widely from one another, in effect creating two distinct markets. Poland, the Czech Republic, Slovakia, Hungary and Lithuania, as well as the two new EU members Bulgaria and Romania and several other smaller countries, can be put into one basket. Here, the level of risk is quite low, with procedure transparency and the quality of investor services being similar to those in other highly developed countries, while the growth histories of their property markets have proceeded along the same lines to a large extent. The more eastern markets of Russian and Ukrainian function in a different manner, with greater profits available for real estate but at a much greater risk and with the market growing at a tremendous rate.

According to Aleksander Loster: “The eastern markets exhibit a different growth rate. They got off to a late start, but are rapidly making up for lost time. Yields in Russia are rapidly approaching those in Poland. It must be borne in mind that the Polish market grew over more than 10 years, while the Russian market has been developing for half that time, which is why investor expectations cannot be the same. The Eastern market has not yet been through the whole cycle of rent rises being driven by speculation, followed by a correction, with a stability level then established, which is in turn followed by rents rising once again. It would be difficult to pin down the current rents in Russia, since they are still on the upswing.”

Increased profitability

Out of all the Central and Eastern European countries, Russia attracts the largest amount of capital. Jones Lang LaSalle’s research shows that in 2007, 27 pct of the value of all transactions in Central and Eastern Europe concerned Russian real estate. Second place went to Poland with 24 pct. This small difference only goes to show the scale of Russia’s potential. The two markets of Poland and Russia, with their similar value of concluded transactions, are incomparable as regards size of population, area and requirements.

Yields are stable in Poland in both the office and retail sectors. The best office properties were sold at around 5.5 pct in Warsaw and 6 pct in regional cities with retail selling at less than 6 pct. The Wola Park shopping centre in Warsaw, which was bought by its new owner at a yield of 5.7 pct can serve as an example. It went from the Ivanhoe Cambridge portfolio to the Luxemburg PBW II Real Estate Fund for EUR 140 mln.

Although a large volume of space came online in the warehousing and logistics sectors in 2007, the total value of transactions amounts to only 6 pct of the entire investment volume. The best yields for these properties were between 6.75 and 7 pct. One of the most important transactions in this segment of the Polish market was the sale of City Point in Warsaw for EUR 71.6 mln. The previous owner was Europa Capital LLP, with the new one being Teesland iOG. The quoted yields just about bring Poland in line with Western Europe. JLL’s research indicates that these rates will remain at the same level in 2008. The rise of interest rates changes the structure of investors to some extent. The principal investors today are institutions employing their own capital to a greater degree, as well as funds which specialize in active real estate management.

Aleksander Loster remarks that: “The balance of the influx of investors to Poland is positive, with long-term investors interested in stable and mature markets having arrived here several years ago. This is, obviously, a positive trend, since by using their own capital they are less sensitive to market fluctuations. They commit their own capital to a greater extent and expect a shorter financial lever, resulting in a much more stable market.”

German, Austrian and Dutch funds connected to insurance companies and banks are the largest and most stable investors in Poland. The Irish, Spanish and Portuguese also operate aggressively, but the important thing is the advantage - especially as regards the banks - enjoyed by companies which are self-financed or take out loans to a smaller extent. The largest sums were spent last year by Deka, DEGI, SEB, Union, Meag and ING, Australian investors such as Macquarie, as well as local investment funds AIB Polonia, Arka BZ WBK and BPH. There has been no apparent change of the nationality of capital entering the region. What is changing is the size: the largest global investors from the industry in Central Eastern Europe are already present, and now the time has come for smaller companies.

The tempting scent of money

It comes as no surprise to find out that shopping centres generated the largest profits, since they have been doing this for the previous 2 to 3 years. Last year, transactions on this market amounted to EUR 6.336 bln throughout the whole of Central and Eastern Europe, compared with EUR 5.164 in the preceding year. The demand is so great that in Romania, for example, twice as many centres as the market actually requires are to be developed in the next three years. It would be surprising if none of these projects come a cropper. In Poland, 56 pct of all transactions are for retail properties, 39 pct for office investments and a mere 5 pct for warehousing.

Aleksander Loster points out that: “Rents in shopping centres have two elements: a fixed base rent and fees which depend on turnover which is paid when a specific ceiling is exceeded. The excellent economic situation, improving prosperity and the resulting growth in consumption have led to more importance being placed on the second rate in established centres. These are taken into serious account today, even though this type of payment was treated as speculative income a few years ago. And this translates into the present market value of such properties.”

A clear trend towards smaller investments outside major cities has emerged throughout the whole of Central and Eastern Europe. Investors no longer think twice about projects in towns with populations even as small as 50,000, and this is why there have been fewer spectacular events on the market. A total of 77 transactions with an average value of EUR 37 mln were agreed in Poland last year, compared with 97 transactions at an average value of EUR 49 mln in 2006.

Dorota Latkowska, the head of Knight Frank’s investment markets department, sees it this way: “A group of small individual investors is becoming increasingly active on the market. They buy up chains of local retailers with a dozen or so outlets, about which information is revealed at the moment of selling. Their value is never significant – between EUR 15 and 20 mln.”

Office titbits

The best office investments are to be found, naturally, in the centres of the largest cities. The demand for such properties is high throughout the region - a motivating factor for investors. Sales of class ‘A’ office buildings in Hungary in the whole of 2006 brought in EUR 319 mln, with this figure being easily exceeded in only the first six months of 2007 when the total was EUR 405 mln. The unsatisfied demand for office space in large cities has created a situation in which office buildings cannot be expected to shoot up in large numbers in smaller cities. Rents will also rise. Investors spent EUR 2.382 bln on such properties in 2007 in Central and Eastern Europe.

Aleksander Loster had this to say on the subject: “The office market is narrower than that of retail. In Poland, office buildings generate business in the eight largest cities. Yields for modern retail are comparable in major cities and Warsaw and stand at around 5.5 pct for the best properties. But in the case of offices, a bonus can always be counted on in smaller cities, since such projects carry a greater risk of tenants being unavailable. The yield in Warsaw is 5.25 pct for the best properties but is 1 pct greater in smaller cities.”

The driving force of enthusiasm

In Ukraine, the number of outstandingly profitable transactions fell away last year compared with 2006. In spite of all the political turmoil, real estate acquisitions have been and will continue to be profitable - especially in larger cities during the next few years. Yet another argument in favour of supporting the country’s western-looking ambitions is provided by the Euro 2012 football championships being held jointly with Poland. But what lies ahead in 2008? In short, the volume of investments will be similar or even slightly better to that of 2007, while yields will become stable. Less spectacular transactions are likely to be favoured by investors.

Aleksander Loster remarks that: “The number of transactions will increase, since some of those planned for 2007 have been put back to 2008. There will be no more spectacular upsurge in their volume, which is why investors who want to sell their properties should do so in 2008. Sensational price rises are also not to be expected. The first signals that owners are freeing up their properties to start selling have already been noticed.” The structure of sector profitabilty should remain the same in 2008, with the best profits being ensured by shopping centres, followed by offices and warehouses.

According to Dorota Laskowska’s analysis of the situation: ‘Stability on the real estate market is to be expected in 2008, with greater activity from new investors in H2. Only a few large transactions in which negotiations began in Q3 of 2007 will be finalized in the first quarter of the year. Some funds with a 5-year investment perspective will start selling their properties. Even so, the number of investment products will be restricted, while our activities will be more frequently focused on forward funding transactions, where capital is committed at the initial stage of the project, and on forward purchasing where contracts are signed at the initial stage of the development or with the payment made after the premises are delivered for use.” n