Nicholas Watson in Sofia -

Sofia's first modern shopping mall in the affluent Oborishte district that opened in mid-March exemplifies, superficially at least, the state of Bulgaria's real estate market: while the development's retail space was almost totally pre-leased, the offices above lie empty.

Of course, the developers of the Serdika Center, Germany's ECE Projektmanagement and Austria's Sparkassen Immobilien, would point out that it had always been the plan to open the 51,000 square metres (sqm) of shopping space before finishing the 30,000 sqm of class-A office space above some six months later, by the end of the summer of 2010. But even Friedrich Wachernig, member of the board of Sparkassen Immobilien, admits that the short-term outlook for the commercial sector is not as good as that for retail. "The office segment is difficult at the moment and while in the long term the high-end product will consistently win clients, it will take more time than we would've expected some years ago," he says.

The foundering economy, which contracted 5% in 2009 and could well shrink again this year, has had a terrible effect on the demand for office space. By the end of 2009, the net absorption rate for commercial property had fallen to 80,000 sqm, less than half the 2007 level. And with about 166,000 sqm of new office space planned to come on the market this year, following the 188,000 sqm in 2009, the 18% total vacancy rate in Sofia looks sure to rise, especially as the economy isn't expected to start growing again until the second half of the year. "We expect this spring will be toughest for the local economy... Only projects with distinctive concepts, good infrastructural access, sufficient parking, genuine property management and reasonable rental levels will be able to beat the trend," reckons David Davidov of Colliers International.

But that's precisely the type of office space available at Serdika Center, points out Sparkassen Immobilien, which is why both partners intend to stay as long-term investors in the development and not sell on their interest now its virtually complete. "It's a tough time right now, but quality in terms of the location, the partners, the product, will succeed," says Wachernig. "We never intended to open the retail and the office parts at the same time, and we hope there will form some kind of symbiosis between the retail and office parts as people realise there's life developing in this area."

Much hope is being pinned on Bulgaria's still-unfulfilled potential as an outsourcing centre, which over the past two or three years has been one of the main engines of growth in the new office segment. As Maxim Behar, chief executive of M3 Communications Group, notes, Bulgaria still holds a lot of advantages that haven't been lost over the past few years - for example, a well-educated, comparatively cheap labour force - and is about the only place left in the EU where you can create a successful business with an investment of only €50,000.

"Bulgaria is one of the most preferred destinations for outsourcing," says Collier's Davidov, referring to Hewlett-Packard and IBM's decision to take up more than 20,000 sqm and 10,000 sqm of office space in Sofia respectively. "And we will count on this in the following years."

Well stocked

The lack of good retail space means this segment is a more attractive proposition right now in Bulgaria, as evidenced by the attendance of Sofia's glitterati and the mayor at Serdika's opening party, as well as the huge crowds packing the mall's swanky shops the next day.

The general drop in Bulgarian consumer spending in 2009 affected mostly retailers located outside the capital, while in Sofia the average drop in retailers' revenues remained relatively low at about 10-15%. "Outside of Sofia, there are a lot of challenges for retail developers who are finding it difficult to take tenants. The general trend has been the drop of consumer purchasing power decreased turnover and as a result impacted rental levels - but that's not the case in Sofia, income levels here are stable," says Colliers' Davidov.

Clearly, major international retailers are also betting that the Sofia market will remain buoyant. Serdika Center opened with 99% of its retail space pre-leased: one-third is occupied by big international retailers like Peek & Cloppenburg fashion department store; one-third is foreign franchises; and one-third is local brands. "Bulgaria is not always a focus for international players, who tend to look at the bigger markets like Poland and Romania, so certainly this was a challenge to get anchor tenants like Peek & Cloppenburg, their first store in Bulgaria," says Alexander Otto, the head of ECE and son of the company's founder, Werner Otto.

Analysts say other retailers are watching Serdika Center closely to see how successful it is. Nine new shopping malls are slated to open in Sofia and other Bulgarian cities over the course of this year, adding another 600,000 sqm of space to the existing 230,000 sqm. "The three large projects to open in the first half of 2010 - Serdika Centre, The Mall in Sofia and Grand Mall Varna - their performance is key to the development of the shopping mall market in general," says Davidov.

With an average of just 30 sqm of shopping space per 1,000 people, Bulgaria ranks in last place among EU countries and so the market clearly offers a lot of room for growth. But Sparkassen Immobilien is taking a bigger risk with the opening just a few weeks earlier of one of the largest shopping centres in Romania, the €200m, 80,000-sqm Sun Plaza project in Bucharest, which is the 34th mall to open in the country since 2007.

Romania was far more affected by the crisis than Bulgaria (the latter being rather tarred with the same brush in foreign investors' eyes). Romanians in 2009 spent about one-third less on consumer goods than they did in 2008, when the economy grew a healthy 7.1% compared with last year's slump of 7.2%.

Yet for Gijs Klomp, head of asset management at ING Real Estate Investment Management, which on March 22 launched an unlisted closed-end European shopping centre fund, Romania holds out better long-term potential than Bulgaria. "In my view, Romania in the long term has the better outlook simply because it's a bigger country and so has a large domestic market, it's not dominated by one city but has a lot of regional centres, and its people are very brand aware and focused on their image, so its ideal for the retail and leisure investor," says Klomp. "Bulgaria is slightly behind Romania in terms of income and over the longer-term it has quite a poor outlook demographically - it's a small country of just over 7.5m and has almost as bad a birth rate as Russia."