A tale of two Euros

As Jos Tromp, the director and head of CEE research and consulting at CBRE, points out: "The market has changed quite a bit over the last couple of quarters. We saw it picking up quite considerably in Q2 and Q3, but the trend at the moment is quite ambivalent. For 2011 the CEE investment volume is likely to be the third biggest in history, but after a quarterly average of EUR 2.5 bln in the first three quarters, only about EUR 500 bln was transacted during October and November, which is an indication that the market is now slowing. And this trend looks set to continue into this year." It was in Q3, of course, that a number of eurozone countries were hit by the sovereign debt crises.
When it comes to the make-up of investors, the purchase of Europolis' portfolio by CA Immo at the beginning of last year signalled the return of Austrian investors to the CEE region after a slow 2009-2010. Another more active purchaser nation was the US, in the form of US private equity. Blackstone, for example, has been buying actively in Poland. Additional opportunistic investors have come from the UK. There have been a smaller number who are picking up the available products at lower prices. There are some local players active, such as CPI, who have bought retail portfolios in the Czech Republic and Slovakia for example. However, other nationalities have been less active, so there has been some consolidation of investor interest - or of those who can invest. German investors have in particular been less active in the region. In 2007-2008 they accounted for 20 pct of the investment in the CE region, but have now fallen to 5 pct. This trend comes mainly on the back of troubles in the German open-ended fund sector. However, closed-end funds and special funds have remained active.
The investor interest was mainly in prime office assets in capital cities and prime retail in large and regional cities. A total of EUR 8.7 bln had been traded in the CEE region (including Russia) by the end of November - and around 90 pct of this was in Poland, the Czech Republic and Russia, offering a strong indication that most of the other markets in the region are still mostly illiquid. Most of the focus has been on prime offices (EUR 3.3 bln) and prime retail (EUR 3.8 bln), making up 85 pct of the turnover. The performance of the Czech Republic in 2011 was particularly striking, accounting for 23 pct of the total investment turnover in the region, not far behind Poland (29 pct) and Russia (36 pct).
Demand for retail traditionally rises during crises. Despite the lower deal flow in the industrial segment, high quality logistics based on long leases to good quality tenants remains an interesting asset class. "These trends are likely to continue next year (2012)," predicts Jos Tromp, "with tenancy to remain important across all sectors. However, financing is becoming less available again. European banks are the main players in the markets still, and currently they need to increase their capital buffers and address issues affecting their loan books. As a consequence some banks have announced an end to property financing. The increased eurozone uncertainty has led the banks to focus more on Western European and established CEE markets at the expense of countries such as Romania and Bulgaria." Property financing, according to Mr Tromp, remains a crucial element in the equation, and so he feels that there is unlikely to be a recovery in such countries until the financing becomes more easily available again. "The good mood of H1 2011 is now slipping away again - and with it the chances of a quick continued recovery in these countries this year. One thing we've learned from the whole rollercoaster ride of the last two or three years is that nothing is certain. The Franco-German discussions could help to remedy the situation, but it is unlikely to be solved very quickly. But the fundamentals of such countries as Romania remain very good. So despite the current outlook not being so positive, confidence in such markets could change," concludes Jos Tromp of CBRE.

Offices: more for less
In the office development market it has been a rather different story. According to CBRE, the development curve reached its bottom in the first half of the year, when new office stock in the ten regional capitals only came to around 460,000 sqm - 60 pct of which came to the market in Moscow. Vacancy in the region is generally trending downwards at the moment, with Warsaw and Prague currently seeing the highest take-up. According to one of the main players on the CEE office development market, Nicklas Lindberg, president of Skanska Commercial Development Europe: "The two markets that I find most interesting right now are Warsaw and Prague. This is where the demand for new office buildings will be the highest, and at the same time where most investors with capital to invest will be active. In the current market situation, investment funds are looking for security, and this can be found in capital cities such as Warsaw and Prague. We are planning to develop new office buildings in the markets where we already have a presence and I believe that the same trend will continue in the next few years. Our aim is to expand our activity in Hungary and the Czech Republic, as I see the biggest growth potential for commercial real estate in those markets."
Mr Lindberg believes that a clear trend has emerged on the market characterised by an increased demand for "more things for less money", and this is especially true when it comes to environmentally-friendly buildings. In his view: "A pressure for high-quality products in all markets is also visible. As far as green buildings are concerned, I would not call it a trend - this is becoming a basic thing in an increasing number of markets. We will keep developing in this area and our goal is to continue being the leading green developer on the market. Now we intend to go one step further and show tenants the benefits which green buildings have to offer, both in terms of quality and in terms of finances. Modern office space needs to feature green solutions, be functional and offer good value for money - this is what tenants are looking for. Some products and features which so far have been considered innovative, justifying a premium in price, will soon become standard solutions for all new developments, resulting in lower costs for higher quality."
However, Nicklas Lindberg also remains cautious about the situation in terms of financing this year. "It is likely to get worse in 2012 before it gets better. This can be a challenge for developers with a business model based on external financing. Fortunately, Skanska is a self-funded company, thus we can start new projects now and benefit when the market picks up."

Retail: crisis-proof (for now)
As the retail sector was the one least affected by the eurozone crisis, it is perhaps unsurprising that Rachel Lavine, the CEO of retail investor Atrium European Real Estate, is claiming it to have been a successful year: "We completed three major transactions in 2011, having acquired shopping centres in Szczecin, Warsaw and Prague. We also bought plots adjacent to our malls in Warsaw and Toruń each of app. 20,000 sqm. And we delivered growth in occupancy up to 97 pct, with margins of 91 pct and increased dividends by over 40 pct since 2010. Would I be happier if we'd bought two more shopping centres - well I can't say that I wouldn't be."
She currently divides the region into two: those countries where investment opportunities still abound, and those in which there is little reason to invest. "We should differentiate between Slovakia, Poland, the Czech Republic and the rest. We're talking about more mature markets and a lot of competition. These markets are more mature than the rest of the CEE region, but provide better yields when compared to western markets."
In her view, although Poland is a large market, there is simply not enough space left for retailers, so investors are left fighting for the bigger cities, such as Warsaw, Łódź, Kraków and Poznań. According to CBRE's data, last year Poland also dropped down the European rankings from second to tenth position in terms of the desirability of expanding there for retailers, partly due to the lack of suitable stock in the major cities. "The Czech Republic is a smaller country," remarks Rachel Lavine. "Again we see GDP growth, educated people, with the law working well. It is not comparable to Romania, for example. However, apart from Prague, there are very few big cities, by which I mean cities of over 200,000 people. Slovakia is nice, but it's a tiny little country by comparison to Poland. Still, it's quite a desirable market and you can still get financing. In countries such as Bulgaria, Latvia and Romania, on the other hand, it's very hard to find financing. You can find the big international retailers but they are mainly franchising, which is not as good," she says.
As for the future, Rachel Lavine of Atrium refuses to make any firm predictions: "We are very cautious about 2012. A big recession in the eurozone will directly affect the CEE region. Most of the banks are going to be slower, which has an obvious impact as most things are dependent on the financing. If growth is limited or even negative, it will affect Poland. Given its level of exports to Western Europe, the fact that its economies are equally as dependent on financing, which mainly comes from Western European banks, and the existing levels of unemployment there, I don't agree that Eaastern Europe is insulated." Despite the dangers, Rachel Lavine remains relatively calm about the future of Atrium. "Our specific situation is strong as we are not leveraged compared to the competition. We're leveraged at the level of 10 pct, which is close to nothing," she claims.

Construction: after the football, shopping
Another sector that has benefited from the mini-boom in retail is construction. "Such is the case with Erbud - Over the last four years we have built 25 shopping centres, which gives us a combined retail portfolio valued at EUR 1.6 bln," reveals Dariusz Grzeszczak, a member of the board of Polish constructor Erbud. "In the case of public tenders, we expect fewer tenders after the Euro 2012. That is why our strategy is to focus mainly on acquiring contracts from the private sector. After all, we do not see any slowdown there. At the present moment our order portfolio for shopping centres is worth around PLN 300 mln. At the end of December we received a project to build an Auchan shopping centre near Kraków, a contract worth PLN 180 mln. In the next few months we should gain a number of large contracts, even contracts worth PLN 200-300 mln. In our opinion, this sector has good prospects for the coming three to five years," believes Mr Grzeszczak. However, the company is also looking to win contracts to build offices. "Similarly, as with shopping centres, we intend to specialise in this segment. We are counting on good contracts in the TriCity as well as in Poznań. In this market too, we have unique knowledge, which brings benefits to investors," says Mr Grzeszczak.

Industrial: also retail driven
Some solid growth was also seen on the warehouse market in the first half of the year, with the GDPs of many countries in the region beating expectations. However, economic activity also began to slacken in this sector towards the end of the year due to the jitters caused by the EU sovereign debt crisis. Still, Ben Bannatyne, Prologis' managing director and regional head for the CEE region, claims to be pleased with his firm's performance: "We completed three projects over the last year and have just started a fourth one. But there was not the upside in rental levels which we had been hoping for," he says. Over the year rents remained stable. Prime warehouse annual rents in September stood at EUR 69.6 per sqm in Warsaw and EUR 45 per sqm in Prague. As the year drew to a close, Mr Bannatyne's optimism remained intact despite the poorer market conditions: "There's been a slowdown in leasing demand, but we are in a lucky position. We own and manage the largest portfolio of industrial facilities in the region. When the market is buoyant, we focus on development and when it is challenging we lease within our own portfolio."
However, not all countries in the CEE region have performed equally well, so developers have begun to concentrate their activities on the most promising markets, which include Poland, the Czech Republic and Slovakia. Before the beginning of 2011, the lack of financing on the market had resulted in few speculative developments taking place and led many developers instead to concentrate their efforts on BTS schemes. According to Ben Bannatyne, this has largely been due to the fact that "the absolute trend is the lack of funding. Banks are still extremely choosy. In any normal world that should limit development severely. Again, this will bring the focus back to location and Prologis will benefit from it," he claims.
The current importance of location has concentrated warehouse investment in cities such as Prague, Brno, Bratislava, Warsaw, Wrocław, Katowice and Poznań. Prologis' managing director believes the growth this year in BTS development will not only be driven by retailers but mainly by light manufacturers. "Growth in development will be principally driven by light production and I expect further growth in the third party logistics sector as well as the further development of the big retailers." In Poland much of this activity has been generated by strong consumer demand and the strength of the market is to remain largely dependent on it. "The biggest driver" says Ben Bannatyne, "has been retail spending. If retail continues to grow there should not be much of a dip." Nonetheless, just as with the other sectors a lot depends on the problems in the eurozone. He concedes that "all of this development is caveated by the possibility of the euro coming apart," before adding "but I don't foresee a doomsday scenario occurring, certainly not in the CEE region."