A game of nerves

Property owners and potential buyers in the region are playing a devilish game. The gulf between their price expectations has remained yawning, accounting – amongst other reasons – for a very gloomy first half of the year. No-one is willing to compromise, but someone will have to. Who is going to blink first?

Mladen Petrov

Remember the year 2006? For football fans that was the year when Italy won the FIFA World Cup in Germany. But that wasn’t really a turn-up for the books, as Italy had already won the championship three times before meeting France in the final. In that year, EUR 4.9 bln was invested on the Polish property market alone, the highest investment volume to date. Now, that’s a real record. In the wake of the global crisis, in 2008 the volume of investment activity in Poland fell by 45 pct to EUR 1.7 bln, while the Czech Republic ranked second in terms of investment volume with EUR 1.17 bln of transacted assets – a 58 pct decrease y-o-y. The biggest slowdown was seen not too far away from these countries, in Hungary, where the investment volume slumped by 74 pct y-o-y, falling to EUR 486 mln. Overall, total investment volumes across the CEE region, excluding Russia, came to only EUR 5.9 bln in 2008, in stark contrast to 2007 when the region saw EUR 11.6 bln in investment, according to Jones Lang LaSalle’s data. It comes as no surprise, therefore, that since the last quarter of 2008 buyers and owners throughout the entire region have found themselves in a stand-off position.

Want to see a horror movie?

In the CEE region things are certainly not looking too bright. In the first half of the year, the value of major real estate transactions in Romania collapsed from EUR 815 mln in H1 2008 to just EUR 62 mln, which represents a 92 pct slump. In the same period, investment transactions were down 97 pct in Bulgaria, while Slovakia saw no transactions at all. The value of transactions on the Czech investment market was down by 96 pct on Q2 2009, with only two transactions – worth EUR 18 mln – taking place over this period. In the first half of the year, the investment volume in the Czech Republic decreased by 87 pct, slipping to the level of EUR 73.1 mln, with there having been only four transactions finalized. In Poland, the value of investment transactions concluded in the first half of the year amounted to EUR 118 mln – something of a success given that this figure represents a 15 pct fall compared to the same period of 2008. All the eight registered transactions, however, took place only on the office and retail markets. The significant outward yield movement in recent quarters and a rebound in commodity prices were the main reasons for the relatively higher investment activity in Russia, which saw EUR 261 mln in investment in H1 2009. Together Russia, Poland and the Czech Republic accounted for 79 pct of the H1 investment volume.

Overall, according to CBRE’s CEE Property Investment report, in the first half of the year the region saw a total of EUR 567 mln in institutional investment. Starting from 2004 up until now, retail and office transactions attracted the majority of investment volume in CEE, which was divided more or less equally between these two sectors. Things are different now. The largest share of investment took place in the office sector (40 pct), while retail properties accounted for 20 pct of the total – compared to 33 pct in H1 2008. The reason for the shift is to be found in the fact that in challenging economic times retail is considered a relatively safe bet. As a result, investors are less willing to sell retail projects. Hotel transactions made up much of the remainder of the invested capital. Meanwhile, the lack of financing left its imprint on the average deal size in the CEE region, which according to CBRE was EUR 15 mln in H1, down from EUR 43 mln in 2008.

Different signals, different players

“Looking at the CEE countries we are seeing different economic signals. Therefore, we are now focusing only on the Czech Republic and Poland as we are interested in conservative markets with a stable economic performance,” claims Thomas Schmengler, managing director of Deka Immobilien, one of the German funds active in the region. “It is still too early to invest, for example, in the Baltic states or Hungary. Russia as well might later become a promising option for investment.”

Despite the worrying rate of transactions, analysts are saying that there are buyers and liquidity on the market. So what seems to be the problem? When it comes to the CEE countries, and especially those who are performing poorly, investors are waiting for some welcome news of an economic recovery, facilitated by the support of the IMF and the EU. On the other hand, those investors looking to expand their real estate portfolios in the region are interested in nothing but the best products, expecting them to come with an affordable price tag.

Tomasz Trzósło, Jones Lang LaSalle’s head of capital markets in the CEE region, divides the investors into several categories. “There are the most aggressive German open-ended funds, which entertain very bold expectations when it comes to prices. Next are the funds that are willing to take some risk and expect significantly lower pricing in return, but they are rather cautious and they still need financing for their acquisitions. Last but not least, there are the opportunistic investors, who are looking for faster and fatter profits. They had been expecting to buy good product in Central Europe, at yields of 9 pct and above, but are now realizing that this is not possible,” comments Tomasz Trzósło.

Patrick O’Gorman, director of CBRE’s CEE capital markets section, goes into further detail: “In many national markets the local domestic investor has started to become more active, particularly in the Czech Republic and Poland, having been priced out over the past few years. Generally, a clear separation of CE and EE countries for real estate investments is becoming evident.”

Someone missing

In the profile of 2009 capital investors one important group has all but disappeared: US investors, formerly known as one of the most active group of players on the European property market. At the peak of the market, US investors spent over EUR 20 bln on acquisitions in Europe in the first half of 2007 alone. Two years later, in H1 2009, American companies invested EUR 400 mln on acquisitions in Europe. Western Europe, and especially Germany, the UK and France, have been the most impacted by the absence of the US contingent. The role of the US investors, however, has been taken over by the Germans, which after sitting out the winter months in standby mode, are back in the game. In Q1, Deka Immobilien invested EUR 40.6 mln in the Czech Republic, purchasing from Immoeast the Jungmannova Plaza office building in downtown Prague. Deka Immobilien also added Grzybowska Park – an office building in central Warsaw – to its portfolio after purchasing it from AIG/Lincoln Polska for EUR 70 mln. The fund additionally acquired the newly delivered Deloitte House office building, also in Warsaw, in a EUR 117 mln transaction. And Deka is now on the lookout for more such opportunities.

Free from stress

When it comes to analyzing the recent capital markets reports a positive conclusion might also be drawn. According to Jones Lang LaSalle’s Tomasz Trzósło: “It is true that investment activity in the region has collapsed, but we need to see what is behind this lack of transactions. The lion’s share of deals is taking place on Western European markets, but the reason for that is the significant supply of ‘stressed’ owners, ready to sell their properties at more relaxed prices. Here we are not seeing such transactions and it is unlikely that we will start seeing them.” He goes on to add that: “The interest in Western Europe is natural. Even though Poland and the Czech Republic are stable markets, they still do carry some risk regarding leases, in selected sectors and markets. If one can purchase a fully-let property at a 6 pct yield in London then the choice is obvious, unless an attractive enough yield premium can be offered by the CEE countries.”

According to data provided by King Sturge, over 2008 yields moved out by more than 100 basis points, putting those owners with good debt service cover in no position to sell. At the buyers’ end, in addition to the largely anticipated greater returns on equity, the expected further falls in value are holding up potential property acquisitions. According to analysts there is still a gap between the price expectations of vendors and purchasers, estimated at 50-100 basis points. Who is in a better bargaining position? Analysts believe that it is the sellers who have to rethink their waiting-for-nothing-but-the-best-price strategy.

Yield expectations

Where the yields are in CEE countries today seems to be the 64 million dollar question, mainly due to the limited investment activity. Based on knowledge of closed deals and ongoing negotiations, prime office and retail yields in Warsaw and Prague stand at around 7-7.50 pct, with further yield shifts possibly to take place. But how are yields being determined given the very limited number of transactions on the market? Capital market specialists agree this is a problematic issue. The way agencies currently work out the yields is rather to estimate them, taking into consideration the expectations of the most aggressive investors. Distressed sales, however, cannot constitute a price benchmark. “They are not a good example of real deals, but the transactions that took place in 2007 at the peak of the market should also be disqualified from consideration,” argues Tomasz Trzósło.

On the investors’ preferences, CBRE’s Patrick O’Gorman feels that: “There have been some hints of activity over the past few months, with a couple of smaller deals closing in the Czech Republic and Hungary, and with sale-and-leaseback transactions being the most favoured investment product in Poland. Unfortunately, the other CEE markets are not yet enjoying the same investment interest, but investors are starting to become more investigative of these countries, as has been seen in Romania.”

Capital market experts expect a few more transactions to close in the region before the end of the year for properties that are under offer and going through due diligence right now. Deka Immobilien’s Thomas Schmengler adds that: “Over the next six months prices in the region are expected to remain stable. Properties that combine a good price, quality and location are not likely to go for less than now. Regarding the activity of the German funds, I think they are all back on track, with increasing competition being observed in Europe. We are in a good position to buy and I believe that we will see some promising signs of investors coming back during Expo Real. More deals are to be expected in the next 6-8 months.”