Tim Gosling in Prague -
Drunk on cheap money, investors threw caution to the wind as they hunted returns in Southeast European real estate in the boom before the 2008 crisis, only to be floored by the global crash. Can they stay sober this time round?
Massive global liquidity, the hunt for yield and high hopes for rising economic growth have been driving investors deeper into Emerging Europe's property markets once more. As returns have dropped in other asset classes, investors are moving money out of bonds and equities and into real estate across Europe. Starting in the mainstream Western European markets, the money has quickly travelled eastwards.
Prime yields in the most developed regional markets have plummeted, with benchmarks for office and retail in Poland and the Czech Republic now sitting at around 5.25%. The likes of Hungary and Romania – which offer a risk premium of up to 250 basis points – are now the focus of strong buying, while the more adventurous are scouring Bulgaria and Serbia, amongst others.
It's those factors that are pulling Polish-based developer and investor GTC into a hunt in Southeast Europe, despite a similar push in the boom years that still has it wobbling under the weight of losses on Romanian and Croatian assets. The developer has spent the last year or so pushing a new share issue past minority shareholders in order to raise capital to power an acquisition spree.
That strategy is driven by a belief there are strong gains to be made via asset management and yield compression. “Property values are at a very low point in the cycle,” GTC CEO Thomas Kurzmann tells bne IntelliNews. “At the same time, the economies in most… Southeast Europe countries are recovering. This will boost cash flow and the respective value of property.”
Martin Tamborsky, an analyst at Erste Bank Group's real estate arm Immorent, notes there are different drivers today compared to 2007. “Then it was based on fundamentals; today the driver is yield.”
On the wagon
Investors are staying sober for the meantime. Many were burned in the same region, particularly Romania, which saw capital flooding in a decade or so ago as investors lusted after a 'new Poland' – a large, new under-developed market in other words. While Romania saw transactions hit a new high of €1.15bn in 2014, at around €200mn activity has been much calmer in the first half of this year.
That is driven by memories of the 2008 crash, and the main risk in Southeast Europe – getting stuck. “In Budapest, Bucharest and [Southeast Europe] we still see limited liquidity,” GTC's Kurzmann admits.
Investors are still not ready to take significant risks by ducking below prime assets or pushing development projects without strong pre-leases in place, notes David Hutchings, head of EMEA investment strategy at Cushman & Wakefield.
Kurzmann bears that out. “GTC will target properties with some upside potential like vacancy and need for upgrade, but still in very good locations,” he states.
However, the chase looks to be hotting up. “There is strong evidence that transaction volumes [in Romania] will bounce back in the second half of the year, as a number of key buildings across all market sectors are in advanced stages of negotiation,” notes a report from Jones Lang LaSalle (JLL).
Erste's Tamborsky points out that office completion in Bucharest is likely to top 250,000 square metres (sqm) in 2016, pushing the vacancy rate as high as 17%. However, he still forecasts yields compressing 75bp to 7% over the next year as US money leads hunters from across the globe. “The selective approach of investors will persist for a while,” predicts Hutchings. “But the very strong global liquidity is a pressure. If schemes like the European Central Bank's quantitative easing continue, it will increasingly push that money to real estate, and we could see a return to the 'more aggressive' investment seen pre-crisis.”
The cheap money tap is unlikely to be turned off any time soon. ECB President Draghi suggested in early September that QE could be extended into 2017 and beyond if necessary. “The global financial system is so fragile, the global economy so lethargic, and asset prices generally so high… that it near forces central banks into a continuation of exceptionally easy monetary conditions,” Deutsche Bank economists noted.
Illustrating the pressure, that wall of money is now pushing investors into even less-developed markets.
Bulgaria was also a victim of the frenzy in the boom years, but has yet to see activity spike to the same degree as its neighbour to the north. However, it did see investment volumes double to €240mn last year, and a similar amount is expected in 2015, predicts Georgi Kirov at Colliers, who reports “massive investment interest”, mostly from the immediate region.
After a brief hiatus, Greek money is also pressing to find a home, he says, with investors from Turkey and Romania also scouring Sofia. The Greek crisis has done little to upset the story, he adds, because the local banking units are strong, and lenders from Western Europe are keen to get in on the action.
However, investments remain opportunistic in this small and somewhat risky market. Less than 30% of deals last year involved revenue-producing assets, Kirov estimates. The bulk saw unfinished projects, land purchases and assets in need of strong management bought. That's despite the fact that the oversupply hangover from the boom years is still wearing off. “The market still needs a couple of years to recover [from that] disaster,” says Andrew Pierson, head of JLL's Southeast Europe operations. Vacancy in the office segment is only now falling from 15%, and rents are starting to rise from a low base.
However, that also means there has been little yield compression to date. Although there are few benchmark deals, prime office assets are priced at around 9%, Kirov says. But he expects that to change, as the pressure rises in other Emerging Europe markets. “The speed at which Central European markets are moving is astonishing,” he remarks.
Stepping across the border and outside the EU, Richard Wilkinson, CEO of Immorent, is looking at a different picture – Serbia. The company's only current development project is Sirius, 30,000 sqm of class A office space in Belgrade. The real estate arm of the Austrian bank hopes to launch construction of the 10,000 sqm first phase this year, with around 60% pre-leased. “We think that level of pre-lease takes away the bulk of the initial risk,” Wilkinson reasons. “The pipeline is pretty small.”
JLL's Pierson is also a huge fan of the Serbian capital. The city of 1.8mn has hardly any modern office space, and just two shopping centres, he says. One of those is now in due diligence, with JLL brokering the deal, and the level of interest in “the first truly institutional sale in Serbia” has been a pleasant surprise to the agent.
Investors from South Africa and the Middle East are scouting the city, he points out. “They won't go to Prague to pay 6%,” Pierson remarks, “they like it in Southeast Europe at 8-9%.” Central European money is also keen. Aside from GTC, Slovakia's HB Reavis and Penta have also been sent south by the heat at home.
They may soon be dashing back up to Vienna to knock at Wilkinson's door. He hopes to have the first phase of Sirius completed and fully leased by the end of next year, at which point Immorent will look to sell.
The CEO says he's confident the enthusiasm in Southeast Europe will last to that point at least. “The risk of over-heating is always there in any market,” he laughs, “but I don't see it in Southeast Europe in the next 12-18 months. The crisis has made the markets a lot more institutional, and I think that will dampen any risk taking, for now.”
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