Annus horriblis

Empty desks, no news, a complete freeze – a day in the life of an investment team employee. 2008 certainly was a very special year for the global investment market. 
And, as it turns out, for all the CEE countries too

Mladen Petrov

The financial crisis has clearly affected property investment across the world in 2008. In the first six months of 2008, it looked like the CEE region would be able to withstand these forces to a certain extent. In the second half of the year, however, it has become clear that this region too is driven by the highly international financial system. The proof is to be seen in the 2008 investment volumes. Since the beginning of 2008, EUR 9.5 bln had been invested in institutional property in the CEE market (Bulgaria, Croatia, the Czech Republic, Hungary, Poland, Romania, Russia, Serbia, Slovakia and Ukraine), whereas in 2007 the investment volume stood at EUR 14.2 bln. So far, Southeastern European countries, such as Romania and Bulgaria, and the Eastern European markets of Russia and Ukraine, have felt the most significant impact of the slowdown in investment, even though in some countries the volumes remained at relatively high levels in 2008. According to CBRE’s CEE research team, the situation is likely to persist in the short to medium term.

2008 scrapbook

Property investment in the first half of 2008 in the CEE region remained relatively strong, with the CEE’s total share of all European investment turnover increasing from 6 pct to 9 pct.

The EUR 9.5 bln that was invested in institutional property in the CEE market as of the middle of December 2008 was respectively 36 pct and 26 pct down from the 2007 and 2006 levels. This, however, is still 58 pct up on the overall results for 2005. The last quarter of 2008 was extremely slow, with a transaction volume of around EUR 370 mln by mid-December. The main reason for the lean quarter is to be found in the closure of a number of German open-ended funds that were active earlier in 2008, combined with the limited lending that is taking place. In October alone around EUR 46 bln (in bonds, equity funds and money market funds) was withdrawn from the German Publikumsfonds. According to an October 2008 report by CBRE, the total sum under management by these funds was EUR 585 bln in October 2008 – 13 pct lower than at the end of September.

Poland remains the largest CEE investment market, with over EUR 14 bln invested between 2003 and 2008. During 2008, 13 office transactions were registered on the Warsaw market, worth over EUR 870 mln. A year ago, in 2007, the total investment volume amounted to EUR 837 mln. The two most significant transactions were the purchase and leaseback of Telekomunikacja Polska’s property portfolio by the Baltic Property Trust for EUR 168 mln and the purchase of Marynarska Business Park for EUR 167 mln by DEGI.

Changing places

In 2008 an important change took place: Russia took second position from the Czech Republic. Property investment volume in Russia, at least in the first half of the year, accounted for exactly a third of all CEE investment volume, with almost EUR 2 bln being invested. The ‘Top-10’ investors listed by volume in 2008 for the CEE region is headed by KanAm Grund, with EUR 950 mln. Last year the fund acquired four ‘A’ class office buildings in Moscow’s Paveletskaya district. In second place came another German open-ended fund, DEGI (around EUR 570 mln), which in 2008 failed to make its first acquisition in Bulgaria: due to the unfavourable market conditions the purchase of Mall of Sofia was cancelled. The third largest investors in 2008 were Orco and RREEF Alternative Investments, each having a 4 pct share in the overall investment volume.

The Czech Republic came in third out of the CEE countries, with over EUR 500 mln of investment in the first half of the year. The volume was driven by several large transactions, amongst which was Bohemia Real Estate Investment’s purchase of the Telefonica portfolio for EUR 162 mln and Pradera’s purchase of a retail portfolio for EUR 123.5 mln. Despite the slow investment activity in the second half of 2008, for Romania this was another year in which the country continued to close the gap on Hungary, one of the countries that saw a significant outflow of investment. The H1 2008 investment volumes of EUR 153 mln in Hungary came to only 8 pct of the total for 2007. In May 2008 on the other hand, RREEF Real Estate, a subsidiary of Deutsche Bank, acquired a real estate project in Bucharest for EUR 340 mln, which includes the Upground residential estate and two office buildings. The forward-purchase deal (the projects are to be acquired at the completion of the construction work) was the biggest real estate transaction in Romanian history. Meanwhile, DEGI bought the Iris shopping centre in Bucharest for EUR 147 mln.

In 2008, or at least during its first half, stronger activity from local purchasers was observed. In Bulgaria, for example, around 52 pct of the acquisitions were made by local companies. Among the most significant transactions involving local investors was Alfa Developments’ acquisition of a 75 pct stake in the portfolio of Landmark. In Russia, local buyers accounted for 18 pct of the transactions in H1 2008.

Under pressure

Western Europe and especially the United Kingdom began to see changing market conditions in Q3 2007, but changes could be observed everywhere. Since the beginning of 2008, yields in the CEE region have also been coming under upward pressure. This trend is particularly visible when it comes to office yields. Prime office yields in Warsaw in Q4 stood at around 6.25 pct, representing a correction of 85 basis points (bps) compared to a year ago. In Budapest, prime office yields currently stand at 6.75 pct, after a 100 bps outward movement since Q4 2007. In Prague, prime office yields moved out in the same period by 125 bps to the level of 6.50 pct. In general, CBRE expects further outward movement due to the time lag and deteriorating economic conditions in some CEE countries.

In Q3 2008, year-on-year capital value growth rates in Central Europe had declined by close to 2.3 pct for prime office property. In fact, this decline would have been even more significant were it not for the occupier markets’ relatively strong performance last year, especially in the first half of 2008. In the CBD of Warsaw, for example, the vacancy rate for office buildings stands at around 1 pct.  South Eastern Europe’s capital values, however, declined by a more significant 10.5 pct in Q3 2008, with the most significant shifts taking place in Romania and Bulgaria, especially in the secondary segment.

Back to 2005?

“To understand what could possibly happen to investment volumes in 2009, it is important to understand the drivers of CEE volumes in the recent past: yield compression, the easy availability of cheap money and an increasing property stock. Now that property investment volumes are falling, it is becoming apparent that the record volumes achieved in 2006 and 2007 were not a result of structural long-term growth, but rather a market inflated by the effect of the first two factors,” observes Jos Tromp, Head of CEE research and consulting at CBRE.

In the current market, yields are moving out and loans have become difficult to secure. As a result, investment volumes face pressure from two directions. Based on preliminary Q4 2008 results, quarterly declines have not yet come to a halt in the CEE region. Banks will remain risk adverse in H1 2009, which will make the trading of anything but the best properties much more difficult, if not impossible. Equity is increasing in importance in the conclusion of deals, while loan to value ratios have fallen from 80/20 towards 60/40. There is, however, light at the end of the tunnel. As banks need to issue loa