We are building! Are you buying?

Frankfurt-based open-ended fund manager Deka Immobilien, part of the Sparkassen-Finanzgruppe, has been actively involved in real estate investment transactions across Europe. According to Peter Heckelsmüller, the head of CEE acquisitions and sales at Deka Immobilien: "There are a number of interesting, well developed and further developing secondary cities in the CEE region - but these are mainly located in Poland. In such cities we see a growing supply of good class 'A' office space due to the growing demand from national and international tenants."

Tempting, but ...
According to Peter Heckelsmüller, it is the fundamental data that is drawing investors to look beyond the capitals, such as the economic growth, the available labour force and the availability of class 'A' office space: "These secondary cities are attractive for real estate investment and acquisitions. This is even more the case for retail and industrial/logistics investment, where the majority of transactions have been done outside of Warsaw and Prague," he says. But how easy it is to sell such properties on? "When you look at the office transactions done in the CEE region in 2012," says Peter Heckelsmüller, "you rarely find any institutional office transaction outside of the capitals. This is an indication that the secondary cities are only interesting for a limited number of investors."

Poland now!
Let's take a look at Poland - eight office buildings have changed owners in the TriCity, Wrocław and Kraków over the last three years. The value of the transactions amounted to a total of app. EUR 120 mln. Is this a lot? By comparison, at the end of 2011 the Focus Filtrowa office building in Warsaw was sold by DEGI to RREEF Real Estate (which manages the property funds of Deutsche Bank) for EUR 117 mln - a mere a trifle really. This shows the extent of the gap between investment purchases on regional markets and in large cities. It does not automatically mean that projects in smaller towns will remain on the fringe of the market, as we can see if we take a glance at some recent transactions. "The sale of Skanska's project in Wrocław - Green Towers - is currently in progress. There is also an office building in Poznań with an area of app. 10,000 sqm which is expected to be sold, and the sale of a building with an area of 6,000 sqm in TriCity should be finalised in May," says Tomasz Puch, the national director and head of the Polish office and industrial capital markets department at Jones Lang LaSalle. And Skanska is also to sell Green Towers to an undisclosed international institution for EUR 65 mln.

No difference?
Office buildings developed in regional towns are no different from those built in large cities, because local developers maintain the same high standards in such locations. And this translates into tenants, usually international corporations. Interestingly, the rent levels are not much different from those in large cities, either. In Kraków they range from EUR 12.5 to EUR 14 per sqm. Similar rates are offered in Warsaw's Mokotów district, where rents average at around EUR 14. However, local projects are smaller with an average area of app. 15,000 sqm. On the other hand, they tend to have additional features, such as dual powering, which improves energy security. "We adapt our projects to the expectations of the local market while maintaining the same profitability levels. Admittedly, this is achieved with lower rents, but it is nevertheless possible thanks to the less expensive land prices in regional towns," explains Waldemar Olbryk, the president of Skanska Property Poland. Skanska's business model of being both general contractor and a developer allows it to profit from the optimisation of the investment process. "Regional markets are exceptionally demanding in terms of obtaining value for money, but there is a lot of demand there for modern office space. Our buildings are adjusted to tenants' needs while still providing high quality. The demand for top quality office buildings in such locations will continue over the next few years," believes Waldemar Olbryk.

Third time lucky
Obviously it is much easier to obtain higher margins on a project in Warsaw. However, large cities, especially capital cities, are more difficult markets if only because of the problems of purchasing good land at a reasonable price. On the other hand, there is still not a lot of interest in finished projects in regional towns. "It is not easy to sell an office building outside Warsaw. In addition, the number of buyers is not on the increase. For example, out of the eleven German funds that could have potentially invested in Polish office buildings there are only three or four left," remarks Tomasz Puch of JLL. These include Deka Immobilien, Union Investment and REEFF. Regional towns are not treated as priorities by the funds and investors prefer Prague or Budapest to a property, say, in Łódź. For a building to be attractive to a fund it has to offer more, such as a very good location or a long-term tenant. In Łódź or Katowice there is still the issue of market liquidity. When you buy a project with an area of 15,000 sqm there, you actually buy a substantial share in the local market. It also needs to be taken into consideration that yields are completely different on regional markets. They currently amount to app. 6.25 pct in Warsaw for the best projects, whereas in the regions it is 7.5 pct," adds Tomasz Puch. However, some business entities are interested in local markets. "Poland offers very attractive conditions for the diversification of property portfolios, which involves plots, cities and ownership types. Outside Warsaw we have been active in Katowice and Kraków since the end of 2008 and early 2009. Last year we completed our first transaction in Łódź. Our next step will involve purchases in the logistics and wind farm sectors, which will be included in our new infrastructural portfolio," says Fabian Hellbush, the head of marketing at Union Investment.

BPOs driving the regions
Good leasing contracts can often be concluded with companies from the BPO sector, which lease large areas for long periods of time. Such firms are attracted to regional towns because of the lower rent rates. According to Colliers International, the cities with the biggest potential for the BPO sector in 2013 are Białystok (average rent of EUR 7-10), Gliwice (EUR 8.5-11), Kielce (EUR 9-11.5), Lublin (EUR 10-12), Olsztyn (EUR 9-12), Opole (EUR 8-9.5), Radom (EUR 9-11), Rzeszów (EUR 8.5-11), Toruń (EUR 9.5-11) and Zielona Góra (EUR 8.5-10). "Our projects are not huge, but they usually range from 15,000 sqm to 25,000 sqm. This, among other things, makes them attractive to funds and allows them to diversify their investment portfolios. As we have observed during the sales process of our projects over the last few years, a high quality product in a good location will always hold its own and there will be parties interested in buying it," claims Waldemar Olbryk, However, each time there is talk about BPOs, everybody wonders how much longer such services will be concentrated on the Polish market. Could regional cities become office ghost towns due to the vacancies left behind by this sector when it opts for cheaper labour in other countries? "We believe that Poland will be the leader in the region over the next few years, or even for more than a decade, because of our strong macroeconomic fundamentals, the stability of our economy, and our current growth dynamics. In addition, we benefit from having the same time zone as the majority of Europe and the availability of an educated labour force. These factors will not change, which is why Poland will remain an attractive market for the BPO/SSC sector," concludes Waldemar Olbryk.

Meanwhile in the Czech Republic
And what is the situation in the other countries of Central and Eastern Europe? Alexander Rafajlovič, an associate in the capital markets group of Cushman & Wakefield in Prague, agrees that the Czech investment market for office properties is rather embryonic outside Prague: "Brno saw some transactions pre-boom. Local capital will be more important, as firms look to establish new local HQs and maybe rent out the rest of the building. Unless the product is a triple grade ?A', this will be difficult, but it is a chance for local money to get active. One day they will be attractive markets for international companies, but at present Brno is the closest to being this." Brno and Ostrava are current the two main office locations outside Prague, catering mainly for IT companies, the BPO sector, call centres, as well as research centres connected with the local universities. Developers are being attracted by the potential of these cities to build office projects there, such as CTP's Spielberk Office Centre (90,000 sqm) in Brno, Passerinvest Group's Nová Karolina Park (25,000 sqm of offices and 4,000 sqm of services) in Ostrava and Skanska's Nordica Ostrava building (12,000 sqm of leasable space). But still more than 97 pct of class 'A' office space is still in the capital.

Life outside the capitals

In Slovakia the situation is even more pronounced. "In Kosice, CTR and HB Reavis are active," says Alexander Rafajlovič of C&W. "This city is a little like Ostrava but with a pinch of Brno - demand is mainly coming from the IT sector connected with the local university. On the other hand, VaV Invest, who built the Europa shopping centre in Banská Bystrica, was reported to have been able to sell its Europa Business Centrum office tower in the city for an 8.6 pct yield." Can such yields be expected for other transactions in secondary cities? "It is different for shopping centres and industrial properties," explains Peter Heckelsmüller of Deka Immobilien. "Due to the lack of transaction evidence, yields are difficult to estimate. We would assume that office yields are quoted at around 100 basis points higher than in Warsaw," he says. Which cities is Deka Immobilien itself looking at? "One investment criterion for Deka is that the location to invest in must have a reasonable size. So for office investment only cities like the top five after the capitals would be interesting. For Poland these are cities like Kraków, Poznań, Wrocław, the TriCity and Łódź. In the Czech Republic we would only concentrate on Prague. But for shopping centres it is more important to find investments in locations with a good catchment area and a dominant position - therefore smaller cities would also work," claims Mr Heckelsmüller. Alexander Rafajlovič of C&W agrees that "there is definitely life in these markets, but they are very specific and there is nothing that you could call a trend. They are not very liquid and local knowledge is needed. Institutional office investors are not going to be convinced out of Bratislava and especially Prague. And if they are ever going to be attracted to the regional cities, then they have to be attracted to the capital first," he concludes.