Coping out of the comfort zoneFeature
All this was taking place just when we starting to think that the economic pain inflicted by the pandemic was finally behind us. And so, we entered 2023 with the spectre of recession hanging over us once again, and if this transpired, it could have dealt a devastating blow to the real estate investment market. However, we seem to have dodged this doomsday scenario. The slowdown that has naturally occurred due to all these macro-economic and geopolitical factors has actually been more of a ‘soft-landing’, that resembles some of the more gentle recent examples of the investment cycle bottoming out.
“Last year, we predicted EUR 10–11 bln would be transacted in the CEE-6 region and our estimate has turned out to be pretty close – almost EUR 11 bln or even just over that figure,” reveals Kevin Turpin, the CEE regional director of capital markets at real estate advisory Colliers. “What made the difference (about EUR 300-400 mln) was a transaction in Slovakia with Penta’s transfer of assets to one of its former partners. But, like in the Covid years, volumes have still been 20–25 pct down on the peak years of 2018 and 2019,” he adds.
So, the situation is not perfect, but it’s hardly calamitous either. Should the real estate market in our part of the world breathe a sigh of relief that disaster has been avoided and now take the view that the only way is up? Or, given that there’s still no foreseeable end to the war and inflation hasn’t yet been reined in, have our troubles only just begun?
“We are currently living under this VUCA (a time of volatility, uncertainty, complexity and ambiguity), in unpredictable times – and investors are aware of that, but are also probing the different opportunities that are arising on the market,” believes Małgorzata Dankowska, a tax advisor to the real estate market and a partner of auditor and tax advisory TPA Poland. She goes on: “And because the situation is more unpredictable, we have to become more adaptive – to be able to pick up on things that happened as soon ago as the last quarter and adapt to the new circumstances.”
Wolfgang Molnar, the executive director and industry lead in the real estate division of Vienna-based banking group Erste, concurs with this view. “The Russian invasion of Ukraine and other economical and geopolitical issues have caused challenges for the real estate sector in the CEE region during the course of the past year. In particular, investors have had to review the extent to which these developments could harm their investment in the CEE region, while developers have faced problems with supply chains and the delivery of building materials, such as steel. While all players in the real estate sector have had to review and adapt their business models to some degree, on the whole they have managed to do so quite well. However, one consequence of this industry-wide reassessment has been a slowdown in overall loan growth and transactions,” he admits.
Volumes holding up - just
In Poland, one of the traditionally best-performing markets in the region, the impact has also been felt, but it is also showing some of the same resilience that got it through the aftermath of the financial crash and the pandemic, as Małgorzata Dankowska explains: “We are definitely seeing some changes as compared to the Covid period, when there was naturally a drop in the market. After the peak year of 2019, when about EUR 8 bln was transacted in Poland, the closure of retail premises had a clear impact on the investment market. Now we are seeing that the market has made something of a recovery, with a volume of EUR 6 bln transacted last year, split between office, industrial, retail (which has also made a comeback) and PRS,” she says.
When there is uncertainty on the market, financing always gets that bit tighter due to the increased investment risk. The knock-on effect of this is that yields on investment also move out. As Kevin Turpin points out: “Most of the clients that we’re speaking to are still keen to buy in this region, but the main question for them is the price. At the end of the last year and the beginning of this year, the pricing correction in the UK, Germany and Spain, for example, happened more quickly, with yields moving outwards by as much as 1 pct, which means that in our region we can expect at least the same or greater – a shift of about 100–150 basis points. In the Czech Republic and Poland last year, yields were at 4–5 pct for prime offices, but this year we expect them to move out to between 5-6 pct, mainly due to the increased financing costs.”
The desire for deals remains
The financing taps haven’t been completely turned off and – as any regular reader of ‘Eurobuild CEE’ will know – investment deals are still going through, so the demand for product and the ability to carry out transactions are still very much there. But market turbulence also leads to uncertainty about how properties should be valued, which can lead to an impasse when it comes to finalising deals, while some investors will go into stand-by mode, waiting for the pricing to normalise, as Kevin Turpin of Colliers goes on to explain: “Everyone still has the desire to do deals, so there’s money about, although there’s a degree of uncertainty about where prices are actually are. If you own a property, you naturally don’t want to sell it for a huge discount if you don’t need to. So, while some are holding out, there could be some big deals in H2 2023. Some deals that were in process from last year have been slowed down by the wider effects of the war, so we could also still see some transactions in Q1 and Q2, but we have to be realistic about the current challenges the market faces,” he admits. “But,” he continues, “even if we look at the impact on the market of Covid, since when volumes have been 20–25 pct lower, given that shopping centre deals and hotels were removed from the equation – and these are usually big – then this is not such a bad result. And last year we advised on a NEPI deal with Union Investment, so even the retail market could make a comeback after some repricing – and there’s some ground for optimism there. Logistics is still highly sought after, but there’s currently a lack of available product in this market, and it’s a similar story for PRS and similar living products. Each sector has its challenges and it’s difficult to predict where we will be at the end of the year. The pessimistic forecast is for volumes in the CEE region of EUR 7–8 bln, but the optimistic view is that the figure will be more like that of 2022.”
As regards the real estate sectors for which financing is still very much available, logistics continues to shine in our region, given the boom in e-commerce and the trend for nearshoring of Western manufacturers as they shy away from Asian locations due to the geopolitical turbulence and the recent disruption to supply chains. However, in Poland office transactions are still making up the lion’s share of the investment volumes, perhaps partly because of the above-mentioned lack of logistics product to buy. Retail, meanwhile, has been making a post-pandemic comeback, mainly thanks to the growing popularity of the retail park format.
“Last year’s investment volume in Poland breaks down into about 36 pct for office, 33 pct for industrial and 24 pct for retail. Two big deals made up about half of the office total: The Warsaw Hub to Google and Generation Park Y to Hansainvest,” points out Małgorzata Dankowska of TPA Poland; while the breakdown for the CEE region as a whole is provided by Kevin Turpin: “Office deals still make up a lot of the volume (app. 38 pct), followed by retail (app. 27 pct), particularly the retail park format and logistics (app. 26 pct) – which would be higher if it were not for the limited availability. PRS is also in high demand, but the volumes have been low (app. 3.5 pct), again, because there’s still not much of it.” Wolfgang Molnar confirms that the activity in the main segments remains robust and that his group is still very much engaged in financing them: “Erste Group commercial real estate remains very active in the logistics sector, which is currently the most favoured asset class among investors. However, we also address the office segment and have been rebalancing our retail portfolio. We have recently arranged two syndicated loan transactions of more than EUR 400 mln for retail portfolios in Romania.”
Finding their niches
As for the other emerging investment niches of the living market that have still yet to reach Western levels of institutionalisation in our part of the world, Kevin Turpin highlights student housing (PBSA) and senior care: “We all want to be looked after when we are older. In the CEE region, this is becoming more institutional, like in Germany or the UK. People need to prepare themselves for the cost of this, but they are also asking themselves whether they can rely on the state and is what it can offer going to be enough?” he asks.
For the private rental sector, the main activity in the region so far has been in Poland, where it has actually been given a boost by the current high cost of financing, as Małgorzata Dankowska explains: “PRS and PBSA in Poland have substantial investment potential when compared to Western Europe and our southern neighbours. People these days are less willing to own their homes, while there has been a generational shift towards the idea of the sharing economy. And then there is the current high cost of financing, which has not only been affecting investment funds but also individuals. Not everyone is able to obtain the credit needed for home purchases, so they have been postponing their demand to own and renting apartments instead,” she says. However, while there may be significant demand for this product, there is still a shortage of it, which for the moment is preventing this segment from booming. “Developers have also been reducing their activity on the supply side. But there could come a time when that need for housing turns into real demand, and the market will need to be able to respond to that. Maybe in two or three years we could be seeing a real PRS boom,” adds Małgorzata Dankowska. The last quarter of 2022, saw the first full life-cycle closure of PRS projects in Poland – Pereca 11 in Warsaw and Trio Kraków, which were acquired by institutional investors in Austria and the Netherlands for more than EUR 60 mln from German property group Catella. “This proved that investors can earn good money from PRS transactions,” insists Małgorzata Dankowska. Catella then followed this up by exiting the Polish market with the sale of 63 apartments in the Złota 44 residential tower in Warsaw city centre to another German group, Livos. Swedish resi-specialist Heimstaden has also been actively building up its Czech and Polish portfolio, which includes both PRS and units for sale.
While it is clear that international investors haven’t been entirely put off by the CEE region due to the proximity of the war, has the current situation on the market finally given local players the chance to take a more leading role? “There has been something of a change in the role played by CEE-based funds. Alongside international institutional investors, domestic funds in, for instance, the Czech Republic have become more active. That is also true for Hungarian players, but they are facing challenges due to exchange rate fluctuations. Czech funds are now active across the CEE region, as are those in other CEE countries. This is a new development, as these domestic funds have been able accumulate money, reflecting the interests of their governments and laws allowing local funds to be supported. Poland remains an exception, because the country still lacks a law allowing domestic funds to be active,” explains Wolfgang Molnar. Of course, what he is referring to is the failure of the Polish government to bring real estate investment trusts (REITs) onto the statute book. Kevin Turpin puts it this way: “In Poland, 98 pct of investment capital still comes from outside the country, since it is missing either central bank qualified funds, as exist in the Czech Republic. REITs, for example, still don’t exist in Poland for people to invest in real estate. And when international capital slows down, domestic capital becomes much more important.” Małgorzata Dankowska adds further to this that: “We don’t have REITs in Poland, but they do have a fund regime in the Czech Republic and it works in terms of helping to accumulate equity. You could imagine high net-worth individuals in Poland wanting to do the same, but they don’t have the legal environment and tax vehicles able to make the decisions. In Poland there is more emphasis on stock and money market investment, and so we don’t have a nice tax regime for real estate collective investment,” she says. This situation is unlikely to change this year, as the upcoming parliamentary elections will not provide the room for the necessary legislation to take place. The present government might not be ready for REITs, but the market certainly is.
Sustainability comes into sharp focus
Another major current issue for investors, as can be seen in several other articles in this month’s issue of ‘Eurobuild CEE’, is environmental and social governance, which is being driven not just by the sector’s own concerns over these issues, but also by ever-stricter EU Taxonomy regulations, which in turn affects the attractiveness of certain real estate for investors. “ESG considerations have become ever more important drivers and have changed the approach that banks take when financing projects,” stresses Wolfgang Molnar of Erste Group, who goes on: “With regard to the real estate sector, these considerations involve assessing the ESG factors that a real estate asset displays. These attributes may vary depending upon the asset type, the sector, size, the geographic location and the stage in its life cycle. Addressing these ESG factors is important, as according to EU statistics buildings account for more than one-third of global energy consumption and greenhouse gas emissions.” He also points to a growing trend that will have a crucial influence on the financing available for properties and their valuations – a growing split beginning between ‘green’ and ‘brown’ assets: “Brown assets that fail to fulfil ESG criteria and don’t have a transition strategy are finding it more difficult to find refinancing. In contrast, there is heavy market competition for assets that are already ESG/Taxonomy-aligned and this trend is likely to speed up in the years to come. The owners of older assets will have to find ways of imposing ESG criteria, normally in the form of heavy CAPEX measures, to ensure that they don’t end up with assets that have no chance for refinancing,” he says. This will be crucial, because as Małgorzata Dankowska of TPA Poland also points out: “Conservative investors may sell older assets and buy A+ class properties in CBDs with good ESG profiles. ESG is particularly important for German funds, who have embedded ESG requirements into their investment policies.”
As for the prospects for the rest of this year and into the medium-term, the final word goes to Kevin Turpin of Colliers: “To quote Monty Python, I always look on the bright side of life. But as always, there are factors outside our control – particularly Ukraine, which is the big one. At the moment it’s like there’s some good news, and then some bad news comes along and spoils it. However, there have been some green shoots of optimism in the US. Where the Fed finally sets interest rates should give us a better idea of how long or how bad any possible recession might be in other parts of the world. But in the CEE region we still have very low unemployment overall and so people still have jobs. What we don’t know is how the cost of living crisis will impact that. And then there is Putin’s control over certain energy supplies, but the positive aspect of this is that it has brought us all together to find alternative solutions to it. Realistically, we should see things improving towards the end of the year or in 2024. MIPIM will be a good indicator of the current mood and where we are actually at right now. ‘Comfortable’ would be the wrong word to describe how I feel, but there is in general a greater understanding of the situation we are now facing than a year ago and we are in a better position to make decisions. So I can say that I’m cautiously optimistic.”