Investors target regional cities

Investment & Finance
The perceived oversupply on the Warsaw office market is leading investors to take a greater interest in regional cities. In 2017 they have similar amounts to spend as last year, but what is there to buy outside the capital – and how is the latter market likely to fare? We asked Michał Ćwikliński, managing director and head of the investment department at Savills, for the answers.

Ewa Andrzejewska, Eurobuild Central & Eastern Europe: The consultancies have just published their 2016 summaries of the commercial real estate investment market. The year ended with EUR 4.6 bln transacted. How much of this was spent on offices in total and how much was spent on offices in regional cities?

Michał Ćwikliński, director, head of investment, Savills: According to our analyses, investors’ total purchases in the office sector in 2016 came to app. EUR 1.875 bln, including app. EUR 710 mln for regional cities. In the case of office buildings in regional cities the figures were similar to last year’s – 13 transactions in 2016 (compared to 17 in 2015), with a value of app. EUR 830 mln. Many investors are now focusing on regional cities. The obstacle is not the lack of demand but the lack of available investment products. Some investors are even saying that they now prefer regional cities to Warsaw. There are two reasons for this.

Which are?

The first is the argument that we have been seeing an oversupply in the office sector in Warsaw, which I personally disagree with. Admittedly, we had a significant growth in stock in 2016, but in 2017 there will be slightly fewer completed projects. It is also worth emphasising that despite the dynamic growth in supply, the increase in vacancy was not as high as some expected because there is still a great deal of demand from tenants – both those that are entering the market as well as those that are expanding. Meanwhile, in regional cities the demand is significant, particularly when it comes to the large projects global companies are interested in. Right now they are determined not to open offices for just a few dozen people. Instead they are planning to dramatically expand their workforce from the outset and so they are looking for 3,000–5,000 sqm of office space. This large demand for offices in the regions is the other major factor for investors.

And what about the concern that after its lease expires a global corporation will vacate the building and move, for example, to another country while the owner is left with an almost empty building?

There is such a risk, but so far this hasn’t been a regular occurrence and there have been no economic signals suggesting that such a phenomenon will gather pace in the next few years. On the other hand, regional cities have grown so much that they are starting to be self-sufficient, such as Kraków, which is approaching 1 mln sqm of office space. There has been a steady increase in demand from current tenants who are expanding, as well as from those that are just entering the market.

Which cities are investors tending to focus on?

Certainly Kraków, because this is the most active leasing market. Property owners in the city are even able to afford to increase rents due to the lack of available space. There has been a visible interest in the TriCity too, as well as markets that have been passed over until now, such as Łódź and Katowice, where there was a shortage of modern office buildings a few years ago and rents were very low. Right now we are involved in a number of office leasing transactions in Łódź and there is little available space left there, while investors’ interest in the city is growing due to good PR and the innovative developments that have recently been completed, such as Nowa Fabryczna. We have closed a few of these transactions recently, including Fujitsu in University Business Park.

Many of the investors who used to acquire properties exclusively in Warsaw are now travelling around the country and ready for projects outside the capital city, whereas in 2011–2012 there was little interest in this option. There were very few transactions in regional cities and even fewer investors, such as PZU, Azora and RREEF. Now it seems that capital is flowing in from other sources. New players are emerging, such as Swedish investor Niam, which is buying two buildings in Katowice and two more in Kraków.

What type of investor is interested in purchases in Polish regional cities?

Generally, the same ones that are already buying offices in Poland. These can be divided into two types: the so-called core or institutional investors, who buy new buildings that represent the highest quality in each of their aspects, in terms of the location, the leases and so forth; and then there are also the opportunistic investors, whose strategy involves buying at the lowest possible price and making a profit quickly. There is a shortage of the middle type of investor, positioned somewhere in-between the two groups.

What is their time-scale in terms of investment?

The average is 5–10 years, whereas opportunistic players invest for 2–3 years.

A few investors from more exotic shores, such as Asia and South Africa, have recently emerged on the Polish market. Does this mean that strong institutional investors, from Germany and elsewhere, will disappear?

Absolutely not. One of the funds from Hamburg is negotiating the purchase of an office building in Poznań. And the Asians are indeed present, but this often cannot be seen because their purchases are made by specialised fund managers such as Savills Investment Management, Invesco or CBRE Global Investors.

And what kind of yields are they buying offices at?

Today I was asked: what are the yields in Łódź like? Well, business does not work the same way as before 2008. I cannot discuss the yields for a given city. Nowadays investors are looking closely at the location: you need to consider whether it is the best location in the city or a secondary one. In Wrocław the top shelf will be the area of the market square or pl. Grunwaldzki, while the outskirts are a completely different case.

Coming back to Łódź, what was the answer you gave to this question?

There was no single answer. Actually, there might have been – it depends... Every product needs to be assessed in terms of the location and whether it is an old or new building. Last year we closed a transaction in the city at around 11 pct, but I have also heard about another one at just over 6 pct, because it is the best location and the most modern office building in the conurbation with a long lease and a good covenant tenant. So the standard is similar to Mokotów. It turns out that investors are more eager to buy in regional cities than in Mokotów at the moment and they are paying much more despite the fact that Mokotów is after all in the capital city. Investors have had their fingers burnt by the fact that a few tenants have spread black PR about Mokotów, but it should be stressed that the district is being redeveloped and things will soon be much better there.

And is the secondary investment market now getting off the ground in regional cities?

I think that this year there will be a few secondary sales of buildings with quite a good profit. As little as two years ago cap rates were close to 8 pct in these cases, now they are closer to 7 pct or even 6 pct – particularly in the case of large volumes.

Which others are set to join the most active regional cities?

From the investment point of view we are still going to be waiting a while for cities that are not in the top six. Of course, there are single purchase transactions, such as in Szczecin or Lublin. However, these markets are too small for investors to be willing to take a risk.

To sum up: what should we expect after 2017?

I think that this year will be similar to 2016 in terms of the investment market volume. There is certainly a lot of activity: much is getting built, much is getting sold. I think that several pan-European portfolio transactions will also close this year. Another large German fund is selling a portfolio of office buildings across Poland..There will be a number of such portfolios changing hands, totalling several hundred million euros.

And finally, the forecasts for Warsaw?

This year could be slightly worse for the capital city for a simple reason: there is a lack of product. Warsaw Spire will most likely change owners in 2017 and the others will be smaller transactions. In addition to this, investors will only be looking at the city centre, where projects such as Generation Park and Warsaw Hub are now under development. Core-plus products, that is, buildings that are a few or a dozen or so years old, are waiting for their moment in the spotlight. They will be slightly cheaper, but refurbished and modernised – and they could change hands at yields of over 6 pct.