Eye on the Baltic

According to figures from CBRE Baltics, the average transaction volume of the Baltic States over the last five years has been over EUR 1.2 bln per year. This is equivalent to the investment volumes of Slovakia, Hungary, Romania and (in some years) even the Czech Republic. However, despite the economic challenges in many European countries, prime yields in the Baltics have proven more resilient than on larger markets. Retail has led investments in the Baltics for two consecutive years in a row. In 2022, the retail sector accounted for the largest portion of the total investment volume at 34 pct, followed by offices at 24 pct and industrial and logistics properties at 18 pct.

“In 2020, when the pandemic hit, we saw a slowdown and there were almost no new entrants to the market and the transactions that happened were mainly Baltic investors. But in 2021, we reached the highest-ever investment volumes in the Baltics at almost EUR 2 bln. We usually have around EUR 1 bln. This was mainly due to delayed transactions that finally went through in 2021. In 2022, we were aware that there wouldn’t be as much activity, but we still expected quite a good figure. However, then the war in Ukraine broke out. Over the first few months of this there were only a few transactions. And it was very hard to attract interest from any new investors. But we still ended the year with EUR 1.3 bln. Now, in all three countries there are almost no large-scale transactions in the post,” admits Agija Vērdiņa, the director of advisory services at Colliers in Latvia.

However, CBRE Baltics is far from pessimistic. “The current expectation is that the investment activity will rise again in H2 2023. Many buyers are hoping or looking for opportunistic deals to arise on the market as distressed sellers have to sell. We expect that such deals will not very likely in large numbers because: the vast majority of Baltic real estate has been financed by local (big Scandinavian) banks that remember very well the consequences of the global financial crisis for the Baltic property markets 14 years ago and have adjusted their lending policies accordingly; a tiny minority of Baltic real estate has been financed through the bond market, with less non-amortising debt to be refinanced; and real estate funds that have exit periods approaching can and have already extended their investment periods. All of the aforementioned reasons reduce the pressure on forced sales to happen,” argues Joel Armei, the associate director of investment properties at CBRE Baltics.

According to Colliers, investment in all three countries in 2022 was dominated by Baltic capital, although 2022 also saw increased activity from Nordic investors. Prime yields in all segments remained stable, while uncertainty continued to grow over the cost of debt. Higher interest rates started to exert upward pressure on yields and suppress investment activity by year-end. A slowdown in investment activity is expected in 2023, especially in the first half of the year, as buyers are adopting a wait-for-a-better-price attitude. The total investment volume in the Baltics for 2023 is expected to remain below the usual EUR 1 bln with the majority of transactions expected in the second half of the year. Local players are expected to dominate investment with a higher proportion of smaller-sized transactions.

Santa Rozenkopfa, the managing director of CBRE Baltics, claims that Riga has under-performed in the investment market. “The headlines that paint the investment prospects of Riga as lagging behind its other Baltic counterparts are related to particular cycles and do not represent its near-future growth prospects. While having a more moderate pace of take-up and development pipeline, the market has matured through improvements in the legislative and political framework paired with large ongoing infrastructure investment. This is something for both domestic and foreign developers and investors to monitor closely,” she says.

The office market: many new buildings in fierce competition

Figures from CBRE Baltics show that Vilnius has one of the highest ratios of certified office stock in Europe (63 pct of the total modern office stock in the city (with 34 pct in Riga and 30 pct in Tallinn). Total office stock passed the symbolic threshold of 1 mln sqm in both Tallinn and Vilnius in 2022. As for Riga, the modern office supply at the beginning of 2023 was close to 756,000 sqm. The volume of stock under construction is substantial at around 380,000 sqm of leasable office space across the Baltic capital cities. As of Q4 2022, the pipeline under construction came to 10 pct, 19 pct and 12 pct of total stock respectively in Tallinn, Riga and Vilnius. Demand differences among the Baltic countries are noticeable, as well. Following the prevailing trend in 2022, the take-up numbers have continued to rise steadily, with 2022 generating near record-breaking annual figures in Tallinn (49,000 sqm), Riga (50,000 sqm) and Vilnius (110,000 sqm).

Estonia

Despite all the recent challenges, the office market in Estonia’s capital city, Tallinn, has continued to remain active resulting in buoyant demand and strong development activity. According to Colliers, by the end of 2022, the estimated total stock of modern office space in Tallinn should exceed 1,160,330 sqm. New total supply delivered to the market came to 62,160 sqm in 2022 (after only 26,600 sqm in 2021). Around 59,160 sqm (ten projects) of speculative office space was delivered to the market in 2022, bringing the total speculative office stock to 856,060 sqm at the beginning of 2023. Due to growing construction costs, rent rates for newly built premises started to trend upwards from the second half of 2021, and continued to climb further in the first half of 2022. By Q4 2022, asking rent rates in Tallinn had somewhat stabilised. Lower demand coupled with new supply added to the market in 2020 led to an increase in the vacancy rate, which has since remained at around 7–9 pct. Around 150,000 sqm of new speculative and built-to-suit office space is expected to be delivered in the Tallinn market over 2023/2024, at least seven of which with a total of 44,000 sqm gla should be completed in 2023.

Lithuania

The Vilnius office market remained buoyant over 2022. Take-up in 2022 was the highest for the last fifteen years, at around 108,000 sqm with newly delivered office buildings adding a further 111,300 sqm of space. The ICT sector accounted for around 30 pct of the take-up, with around half of these companies originating from Belarus. Rises in fit-out costs in Q2 and Q3 2022 impeded the signing of some new leases however these costs began to fall in Q4 2022. Average rents remained roughly at the same level, with upward pressure coming from high-quality offices in central locations. Hybrid and remote work are still strong factors in shaping office demand.

Latvia

Over 2022, office development activity in Latvia remained high, as several large-scale projects were under construction with one being delivered during the year. Although Russia’s invasion of Ukraine disrupted the development market, no project under construction was stopped and two new projects were launched. Regional instability along with rising construction and energy costs resulted in the scheduled completion dates of several office developments under construction being put back while some projects at the planning stage were put on hold. Leasing activity was low compared to the previous year. A strong development pipeline started to add large-scale office projects to the total stock in the second half of 2022. Colliers forecasts that over 145,000 sqm gla is to be added to the office market over the next two years. However, this space could prove difficult to fill. “This is the data for Latvia but it applies to all the Baltic states. When companies move, they are taking 30 pct less space. Most of the current deliveries are projects approved prior to the pandemic. Now entering the market more tenants are needed so it takes longer to fill up these buildings. What we are seeing is that older B2 buildings that are not adjusted to the market are being forced to exit and find new usages. We’ve already seen two buildings in Lithuania being turned into schools as well as some being turned into residential facilities in Estonia and medical centres here in Riga,” states Agija Vērdiņa of Colliers.

Retail: the rise of the discounters

According to CBRE Baltics, the density of modern retail space in the Baltics is among the highest in the region, at around 650 sqm per 1,000 inhabitants. The post-pandemic vacancy rate in retail schemes has been slowly absorbed, with prime locations being the most wanted by players active on the market. In comparison, CEE countries have a retail space density of app. 440 sqm per 1,000 inhabitants. However, according to Agija Vērdiņa of Colliers, the retail landscape is changing. “Mostly our markets are discounter-led. And discounters are also spending outside the capital cities, which was previously not the case. Lidl as a discount grocer is actively expanding after their first year of operations in Latvia and have managed to take around 10 pct of the market. Now they have also entered Estonia,” she explains.

Estonia

By the end of 2022, Tallinn’s stock of retail space (shopping centres, department stores, hypermarkets and DIY stores with over 5,000 sqm gla) came to a total of 765,700 sqm (1.67 sqm per capita), after an increase of 35,870 sqm in 2020 and no new supply in 2021-2022. Following the pandemic, inflation, declining purchasing power and rising energy costs were the key concerns for retail tenants throughout 2022. In 2022, the segment saw some recovery as shopping centre sales and footfall improved considerably by around 30–40 pct compared to 2021, with growth of even up to 70 pct in some locations. In 2022, turnover per sqm almost reached and in some cases exceeded pre-Covid levels, while footfall remained slightly below that of 2019. Shopping centres have continued to diversify their tenant mix to move more from retail properties to mixed-use social and business centres. Various discount stores are taking up a growing share of the take-up in all types of shopping centres across Estonia. By the end of 2022, total vacancy in Tallinn shopping centres stood at 4 pct. Around 30,000 sqm of new retail space is currently under construction and is expected to be delivered to the market over the medium term, driven by the scheduled opening of the Porto Franco complex.

Latvia

As expected, 2022 was a quiet year in terms of new professional retail centre development in Latvia, however, the grocery sector continued to grow and several shopping centres started partial redevelopment. Just as the market started to recover from the pandemic, new disruption arose from both the energy crisis and inflation. Shopping centre turnover in 2022 mostly returned to pre-Covid levels although footfall is still lagging. As expected, discount retailers remained the most notable generators of demand. High street retail continued to suffer from a lack of tourists and fewer people overall in the city centre. This has resulted in a significant increase in vacancy levels. No new large traditional-style retail developments are expected in the coming years. The retail market is to be dominated by refurbishments, re-positionings and conversions of existing centres. Segments such as medical and coworking are expected to be added to even more projects. Further closures can be expected as retailers now face continuous pressure for a third consecutive year, first due to the pandemic restrictions but now due to the energy crisis, inflation and indexation. This is having a stronger negative effect on smaller family-run businesses. Inflation in Latvia is running higher than salary growth, so the risk arises that people will postpone or reduce purchases of non-essential goods and services and this in turn will hurt retailers. The stronger retail chains – especially discounters – will continue to expand outside Riga.

Lithuania

In the first half of 2022, the retail market in Lithuania was in a slump. Restaurants and cafés also saw a drop in footfall and an increase in utility bills. The third and fourth quarters of 2022 saw a slight recovery, although utility costs forced several market players to withdraw. Shopping centre expansions and renovations are expected with a large entertainment and social component. Smaller retail formats such as retail parks will see further development not only in Vilnius, but also in towns and cities with populations of more than 10,000–20,000. Brands such as Pepco are expected to be able to start expanding, while economy brands such as Sinsay and Lidl will remain active while new brands are expected to enter the market. Rental rates and vacancy levels are likely to remain stable in 2023, although there may still be some pressure and uncertainty in the future due to the ongoing war in Ukraine.

Warehouse and industrial: a game of local players

According to Agija Vērdiņa of Colliers, the warehouse market has not yet seen major international development: “The market is domestic demand led. There are no international companies coming into any of the three markets. There are big differences between them. Estonia has many small-scale centres. They have these industrial parks where companies build their own premises. In Riga there are two active speculative developers. Demand has been higher than supply so a very low vacancy rate. Lithuania is doing well. Special economic zones are having a big impact. The SBU sector is very popular in Estonia and has also become popular in Lithuania and many such projects have been developed over the last two years with many also in the pipeline,” she says. Due to the inflation rate as well as the uncertain economic and geopolitical situation, prime rents have risen in all three Baltic countries compared to the same period last year. Prime monthly rents are at around EUR 6.25 per sqm in Tallinn, EUR 5.0 in Riga and EUR 5.5 in Vilnius.

Estonia

According to Colliers, the warehouse and industrial property market in Estonia remained stable over the 2020–2022 period in terms of new developments and vacancies. By the end of 2022, the estimated total stock of modern industrial space in Tallinn and the surrounding region was more than 1.91 mln sqm (of which 674,850 sqm or 35 pct is speculative). Almost 134,000 sqm is expected to be added in 2023 – 60 pct on a built-to-suit basis and 40 pct speculatively. Rental rates are forecast to remain stable, although rents for newly built premises will depend on construction costs, which are expected to stabilise or decrease. Due to rising construction costs, rental rates for newly built premises started to trend upwards in the second half of 2021 (starting from EUR 5.5 per sqm per month) and continued to climb until Q3 2022. Vacancy has fallen below 3 pct due to the high demand and came in at 2.7 pct at the end of 2022.

Latvia

The war in Ukraine froze market activity in Latvia. High uncertainty among tenants and developers resulted in temporary delays to development and leasing. Energy prices raised concerns about the availability of natural gas in the winter season and high utility costs. However, the situation stabilised before the end of the year. High demand and the low availability of new speculative industrial projects led to unprecedently low vacancy levels. Rental rates, especially for new developments, continued to rise and has reached EUR 5.2 per sqm for prime premises.

Lithuania

New supply in 2022 in Lithuania hit a record high, mainly due to projects that had been delayed or put on hold. Demand for modern warehouse space remained robust, while the vacancy levels in the Vilnius and Kaunas regions were at their lowest throughout the year. The forecast for 2023 is more active than for 2022 in terms of new warehouse deliveries. Demand is expected to be less than in previous years, but will still remain strong as it will continue to be fuelled by fast-growing e-commerce, supply disruptions, and the need to store stock to absorb fluctuations in future supply. The rental rate in Lithuania is likely to see some slight correction over the coming year, as the market is expected to become tenant driven. Vacancy is expected to rise in Vilnius and Kaunas with new speculative supply, while the Klaipėda region is expected to see vacancy gradually fall.

PRS: looking to the future

According to Agija Vērdiņa of Colliers: “The private rental sector is very, very new in the Baltics. We have a few projects in Tallinn where we have also seen some investment transactions, some in Lithuania over the last two years. In Riga, I would say we have seven buildings with the last two having entered the market this month. This market is very small now. We still do not know how large the demand is from households.” Denis Rein of CBRE Baltics also agrees that investor interest in the PRS sector is high: “We are seeing increased interest from the investors in PRS, which was not really present in Lithuania as a product before the pandemic. However, it is becoming extremely difficult to find the ‘right deal’ while the construction prices as well as the residential acquisition prices soared, while residential rental market did not experience such a comparative hike long-term (there was a short to mid-term hike in rental prices due to people and companies from Belarus migrating as well as refugees from Ukraine), however rental prices have shown a slowdown since,” he explains. “In the PRS sector, the dominance of institutional investors will grow as tightening financing conditions together with higher apartment prices are more tolerable to them compared to private investors who have diminished debt ability and smaller buffers. In addition to local institutional investors, the first Nordic investors have also entered the market,” adds Joel Armei of CBRE Baltics. There have already been several partnerships between developers and institutional funds to expand PRS portfolios and the trend is expected to continue. The demand from private individual investors significantly outweighs the supply. This has been particularly evident in core locations, where newly constructed apartments have been sold before completion. With a lack of residential supply, prices in the Baltic states, Vilnius and Tallinn in particular, have soared (10–15 pct over 2022).