Leaping into the gap

During the worst days of the sovereign debt crisis last summer, the feeling was that this was another grim episode in the seemingly never-ending gloom that has been enveloping western economies since the financial crash. Now that the Greek rescue package has finally been ratified, fears of a euro zone break-up are receding - but the picture is still far from rosy. The austerity measures being implemented across the EU to deal with government debt carry with them the threat of not just another recession, but also dampen the prospects for economic growth for years to come. For a real estate sector badly burned by the credit crunch, however, the euro zone crisis may turn out to be a blessing in disguise. As a consequence of all the recent sovereign debt crises, government bonds - once seen as one of the safest forms of investment - are now providing much lower returns. Yields for prime European property, on the other hand, have fallen only marginally, in the process widening the yield gap between government bonds and real estate to a historically high level.

Reading the signals
A rush towards investing in real estate in the euro zone therefore might therefore have been expected. In October, Michael Haddock, CBRE's head of EMEA capital markets research, was quoted as saying that the gap between real estate and government bonds "is a strong buy signal for real estate, particularly in the euro zone. Long-term investors, who are able to look past the current uncertainty, should therefore be using market volatility as an opportunity to buy prime real estate rather than paying for liquidity that they do not need in government bonds." A similar response to the yield gap might also be expected in CEE markets whose government bond yields closely follow those of Germany and euro zone countries, such as euro-candidate countries Poland and the Czech Republic. Since last summer there has certainly been increasing investment in such markets - but is this all down to the yield gap?
According to Richard Wilkinson, the CEO of Austrian real estate investment bank Erste Group Immorent: "In 2011, investment volumes in ?Central and Eastern Europe picked up versus 2010 and 2009 - and this was mainly driven by the Polish, Czech and Russian markets. One reason for the strong interest could be the low level of interest rates on government bonds." But, as he points out, this wave of money has not been coming from government bond investors alone. "What you can see, however, is that people are trying to re-balance their portfolios, and this also leads to some gains in the real estate sector. Markets work in cycles: there are periods when government bonds are more expensive than property - and the other way around. At the moment, the difference between German government bonds and property yields is quite high. On the other hand, real estate is also sought after as inflation protection due to the indexation of rents," says Mr Wilkinson.

The spectre of inflation
"Investors have been burned on the stock markets, with gold, and later with government bonds - so now real estate seems to be a reasonable alternative. It is tangible and safe from the current risk of inflation," claims Karol Bartos, the Poland country manager of investor MGPA. However, he stresses that it is the inflation risk that might be the more important factor rather that the yield gap in attracting investors to Poland and our part of the world: "Recently there has been an increase in investment from, for example, Middle Eastern sovereign wealth funds, who are moving into real estate investment in places like London and Paris, but one of the main the reasons for this is the risk of inflation from the quantitative easing measures. Real estate is relatively immune to inflation. In our region, however, the presence of such funds is so far negligible, so I can only conclude that it is the inflation risk rather than the yield gap that is responsible for the increasing investment in Polish and CEE real estate," explains Mr Bartos. According to him, "there is a lot of investor-interest in the region, but those who are increasing their activity are generally the same crowd."
Stuart Bloomfield, the head of capital markets of CBRE in Prague, while admitting that it is the case that bonds and equities are not giving good returns at all, is also doubtful about whether it is the yield gap that is fuelling the current wave of investment in CEE real estate. "The third quarter was the most active in the history of the Czech market," he says, "but any connection with the euro zone crisis is most likely coincidental, especially when considering the long lead-in times for investors to decide on strategy and ?execute a closed transaction."

Fundamental decisions
Is it possible, therefore, that the historically high yield gaps in the euro zone could be having a negligible effect on current CEE property investment? Richard Wilkinson of Erste Group Immorent does not go so far, but stresses the relative importance of macro factors: "I can see increasing investor demand for quality products, particularly in Poland, the Czech Republic and Russia. This might be connected with the current turmoil in the euro zone area, but is also due to the attractive combination of higher yields than in Western Europe coupled with good fundamentals on property markets in these countries," says Mr Wilkinson. Karol Bartos of MGPA admits that "the yield gap is having some impact," but that it cannot on its own explain the current investor interest in Poland and other countries in the region. "It could be a reason why investors are moving into real estate or not, but not why they are coming to Poland. Yes, real estate is now more attractive as an asset class, but Poland's attractiveness is more to do with macro and debt reasons," he claims.
It remains the case, however, even if it is market fundamentals that are driving the current investment in CEE real estate, that the widening yield gap can only be a bonus for the region. On the other hand, any beneficial effects could be offset by other consequences of the euro crisis. One is that the recurring problem of restricted credit availability could well worsen. Another is the threat of a second recession as austerity measures kick in. And the other main fear is the nightmare scenario of a euro zone break-up. According to CBRE's EMEA ViewPoint survey of investor intentions published in March, financing is their main worry at the moment, followed by the prospect of a double-dip recession, with the possible euro zone collapse being the third biggest concern.

More of a squeeze on finance
In the view of Erste Group Immorent's CEO: "The main concerns are the availability of bank finance and the overall macro-economic situation. As banks are required to hold more capital than before, there is of course a process of balance sheet adjustment that is taking place across the industry. That affects the availability of financing for commercial real estate," explains Richard Wilkinson. Karol Bartos of MGPA believes that this year is going to be a particularly difficult one for the debt market, "and this will last as long as there is an inflation risk from quantitative easing and the pressure to print money. The next 18-24 months will be crucial. But overall I'm quite positive because real estate is in a relatively good position. And no-one now is seriously treating a collapse of the euro zone as a possible scenario.