CEE REAL ESTATE SURVEY: Peak here, past nadir there

CEE REAL ESTATE SURVEY: Peak here, past nadir there
By Ben Aris in Berlin March 14, 2017

2016 was a surprisingly good year for real estate in Central and Eastern Europe (CEE). Poland and the Czech Republic remain at the top of the tree for real estate investors and developers, but as these markets are close to maturity, so increasingly investors are looking to new opportunities in Hungary, Romania and even the Balkans, our “CEE Real Estate Survey 2017” found (download the full report here  BNE_SPR_03_17.pdf).

At the same time the Russian market – the largest by value – has passed its nadir. The office market more or less collapsed in 2014 and completions remain a fraction of the last high water market in 2014, prior to the crumpling of oil prices. However, salaries remain high enough to continue to fuel the retail sector: retail completions have continued to grow throughout the crisis years, albeit at a lower pace, and record high warehouse activity in the last quarter of 2016 suggest that Russia’s retail and warehouse sectors will have a strong 2017.

The real estate sector across the region has benefited from two and a half decades of transition; but there is plenty of growth potential left thanks to their still incomplete transition to Western European levels.

“2016 was the busiest year on the
real estate market since the 2008 economic crisis in CE, and I expect further growth of investment volume and yield compression in the coming 12 months. However, markets seem
to be approaching their peaks, but it
is difficult to foresee when they are going to reach it,” Arpad Torok, CEO of Trigranit, one of the biggest developers in the region, told bne IntelliNews.

In all there was €12.56bn worth of transactions in CEE (not including Russia), a 42% increase over 2015 (€8.82bn). That is the third highest CEE regional investment volume since 2007 (€15.8bn) and 2006 (€13.45bn), according to real estate services company Jones Lang LaSalle (JJL).

In almost all of the Central European markets the breakdown of investment was evenly spread across the various subsectors, and it was distributed among the countries much as usual: Poland took 36% of the overall transactional volume, followed by the Czech Republic (29%), Hungary (13%), SEE markets (8%), Romania (7%) and Slovakia (7%). Last year was also a record breaker at a country level with the highest ever volumes recorded in the Czech Republic and Slovakia and second best results recorded in Poland, Hungary and the SEE region.

“In our core countries of Poland, Czech Republic, Hungary, and Romania, also Serbia, the market remains quite buoyant. There are always things with which you can work quite well, for example the lack of quality offices in Serbia is supporting the development and there are lots of companies who are desperate for quality office space. We even topped up one of our properties with an additional floor to cover the requirement of our existing tenants. Whereas in Warsaw, where you have a lot of new projects, it is more about investing in new sub-districts,” says Markus Kuttner, Head of Asset Management CEE/SEE at developers CA Immo.

As recently as 2015 Poland and the Czech Republic made up 80% of all the real estate investment into the region, with Poland accounting for the lion’s share because it is the most populous country in Central Europe and has several large secondary cities. While these two remain the most important markets, the share of investment is slowly shifting to the up and comers.

“If you are looking for the best market to invest into in 2017, it depends on what you mean. If you mean the least risky, then that would probably be the Czech market, the Prague office market. If you're talking of where you could make the most money, and of course that being a higher-risk market, then probably in the Balkans,” Stuart Jordan, law firm Dentons’ head of CEE Capital Markets, told bne IntelliNews. “They are all interesting markets, but it depends what your risk appetite is.”

The growing difficulty in finding good projects or objects in the more mature markets is one of the reasons pushing more investment into new markets. Another has been the appearance of new money from both above and below.

Hungary in particular raced ahead in 2016 thanks to new investors from further afield. China and Malaysian money arrived in Central Europe in 2016, but almost all the real estate professionals interviewed for this article pointed to South African funds’ appearance in 2014 being the real game changer. A change in tax laws at home has led to a flood of investment capital arriving from Africa, looking for higher returns than it can earn at home in the relatively secure and long-term retail sector across the region. South African investors did €1.451bn worth of deals in the retail segment in 2016, or almost 75% of the sector’s entire volume, reports JLL.

“South African funds started to be very active in 2015 and the trend continued during 2016. NEPI, Rockcastle, Redefine are good examples,” says Pawel Debowski, chairman of Denton’s European Real Estate Group. “There are others too coming to Central and Southern Europe and [they] are mostly interested in retail but not only. For them the attractiveness of Central Europe is quite simple: it is safe enough that it is comparable to Western Europe in terms of legal safety and stability, with much more attractive yields.”

At the same time, local investment funds have grown to a size that they are starting to make an impact. These local funds can now afford an investment ticket size of around €50mn or so which puts investment grade real estate assets within their reach. Local investment firms pushed down the average transaction size in the process, say developers, but this has also broadened the market.

It’s early days for these smaller local funds and demand for €60mn-100mn properties remains lower, while demand for properties over €100mn, which appeal to the big institutional investors, are in short supply. Still, in 2016 the local funds accounted for a third (35%) of the total investment volume, with international investors making up the rest (65%), according to real estate advisers CBRE. Most importantly, the local investors are providing a new exit for bigger institutional investors to cash out of investments in the smaller, less fashionable markets.

“Obviously you will have big investors and developers in Slovakia and Czech Republic and also in Poland, but we see this second tier starting to play an important role in real estate... It is possible to find a national investor for the assets which are not appealing for the large institutional investors,” says Robert Snincak of CBRE.

Poland

Poland’s real estate market remains by far the most important in Central Europe and was once again the stand-out performer in CEE in 2016. Poland had more than €4.5bn transactions in 2016 vs €4.1bn of deals a year earlier – the best result since 2009 and the second best ever, according to JLL.

Trigranit’s Torok believes Warsaw remains the most promising real estate market for 2017. “It’s definitely Poland that offers the most opportunities for investment and for development, not least due to its size and strong and stable economy; GDP is 26% higher today than in 2008. As for offices, the shared services-driven Warsaw and the secondary cities in Poland and Budapest are exceptionally strong in CE. When speaking about retail development opportunities, I would definitely say Warsaw is among the top three strongest cities in CE.”

The market was dominated by a number of very large transactions, and the sector split was made up of €1.958bn in retail, €1.798mn in offices and €769mn in warehousing. The transaction pipeline indicates that the total investment volume in 2017 should be at the same or higher level, but the pace of growth has clearly slowed in Warsaw, which is maturing rapidly.

Warsaw remains the jewel in the crown and 2016 saw a record number of office developments under construction, with the total supply at the end of last year exceeding 5mn sqm. Despite the high saturation, construction activity remains at a very high level: there are more than 60 projects under construction that will provide the market with 850,000 sqm of new space in 2017, according to CBRE. But the market has also become very competitive, which has begun to drive investors and developers out to secondary cities.

The turbulent politics of the last two years has also unsettled investors, but not really stymied business yet. “Unfortunately, recent political events have had an impact on the real estate market, especially in Poland where new banking and retail taxes were introduced by the government... The Polish government needs to clarify the situation on VAT transactions and Sunday trading laws. Unfortunately, this has not happened,” says Karol Pilniewicz, head of CEE operations for Valad Europe, part of the Cromwell Property group, an Australian listed REIT with €6.9bn of assets under management.

And after a stellar 2016 there are already signs that Poland will have a good 2017. “Usually what we have experienced in the past for Poland was a very high activity towards the year end, and this December was indeed a very busy month for closings in Poland. In the past years, however, a busy December was usually followed by a quiet January and February. This year the market activity picked up already in early days of January,” says Denton’s Debowski.

Czech Republic

The Czech Republic is the other doyen of real estate investment in Central Europe and had a stonking year in 2016, with transactions accelerating in the last two quarters to a full-year volume of more than €3.6bn of deals – the highest ever level of annual trading on record and more than a third (36%) higher than the year before.

This activity was split mainly between office (18 deals) and retail (11 deals) out of a total of 36 deals. The office sector dominated in the second half of 2016, accounting for 51% of total investments, followed by industrial (31%) and retail (10%). The hotel and residential sectors accounted for the remaining 8% of the total commercial second half volumes, according to JLL. The market also saw its first ever purchase of an office building by a Chinese investor: the central Prague Florentinum office complex was purchased by CEFC, an energy and financial services company, for more than €280mn from Penta Investments, a closely-held Slovak financial group.

The Czech Republic together with Poland have been clearly ahead of all the other markets in the Central Europe real estate business but players say they are reaching saturation. The supply of new developments is limited, which makes it harder for investors to find the right asset.

“Czech Republic is a fully matured market with the lowest yields in the region,” says Dentons’ Debowski. “I think the Czech Republic will be the first place where yields will get very close to yields in Western Europe.”

And the market has had a fillip thanks to Poland’s political woes. “Because of what is happening in Poland, probably the darling of the region at the moment is the Czech Republic, whereas historically it’s been Poland,” says Cushman & Wakefields’ Hallet.

The strength of the Czech market has also spilled over the border into neighbouring Slovakia where the property investment volume in 2016 was an estimated €846mn – the highest level in the history of the Slovak market and 25% higher than the previous peak in 2005.

“The Slovak market is blooming thanks to attractive opportunities, reasonable buyers, high liquidity levels comparable with matured CEE markets, and the lack of products in other countries,” JLL said in a recent report, adding that 85% of the deals were cross-border transactions with at least one non-Slovak party.

Hungary

Hungary is rising fast in attractiveness in Central Europe’s real estate market as the traditional leaders run out of room. The size of the Hungarian investment market doubled in 2016, according

to CBRE, and it has become the third most important market in the region after investors put in more than €1bn in 2016 into a total of 72 transactions.

Again, most of this money came in the second half of the year: €830mn was committed in new deals in the last six months of the year, a two-thirds (66%) increase over the same period of 2016 – the highest second-half year volume in Hungarian investment since 2007 (when it reached €1.3bn).

And Hungary had a substantial boost from the new money arriving in the region, with its offering of plentiful opportunities at a reasonable, if slightly elevated, risk level. “Poland has still the strongest economy among the countries where TriGranit operates, but I should highlight Hungary as a busy market for us in 2016. Budapest has some of the best macroeconomic indicators in the region and the country received its long-awaited credit rating upgrade from Fitch and S&P in 2016. Investor confidence has returned, and there is a remarkable demand for new class A office stock both from investors and from tenants. The investment volume is similarly overwhelming – a record €1.7bn in 2016, triple its 2014 level,” says TriGranit's Torok.

Investors spent €1.54bn in 2016, surpassing the 2015 result by 107%, according to CBRE, which is expecting the same or better result for this year. All in all, investment sales in Hungary have quadrupled since 2013 in Hungary and the market grew by an annual 20% in the last three years alone, according to Lóránt Kibédi-Varga, Managing Director of CBRE Hungary.

Romania

Romania’s real estate sector hit several home runs in 2016 in Bucharest. The capital accounted for more than 70% of the total investment volume, less than in 2015, showing that the secondary cities are becoming increasingly attractive. Office transactions already dominate, making up close to half of all the deals (45%), while retail and industrial accounted for close to 26% each, according to JLL. All in all, the 2016 property investment volume for Romania was up by

a third (35%) over 2015 to €890mn, even if the number of transactions was slightly smaller than the year before.

The largest transaction registered in 2016 was the acquisition of 26.88% of Globalworth’s shares by South African group Growthpoint for approximately €186mn; Globalworth is now the largest owner of office space in Romania. The most notable retail transaction was the acquisition of Sibiu Shopping City by NEPI from ARGO for a total of €100mn, which represents the largest single asset deal outside of Bucharest since the economic crisis. In industrial, the largest deal was the acquisition of P3 Logistic Parks by GIC, the Singapore sovereign wealth fund, through the pan-European acquisition of P3.

“Occupier demand is at record high levels in all market segments. Availability of quality product is increasing and there is significant yield spread between Romania and Poland or the Czech Republic,” JLL said in its CEE Investment Pulse report at the end of last year.

SEE region

Following the increased investment activity in the first half of 2016, the SEE region also registered some significant transactions in the second half of the year, bringing volume to almost €1bn. Also, as was the case in the first half of 2016, investments were driven mainly by retail opportunities acquired by South African investors. There were no office deals in the period at all.

In June, South African REIT Hystead, which is a joint venture between Hyprop Investments and Homestead Limited, made their second transaction in the region by acquiring Skopje City Mall, the dominant shopping centre in the Macedonian capital of Skopje, for €92mn.

In addition, South African REIT NEPI, which is already well known in the region, entered a new market by buying Arena Centarin Zagreb, considered the most dominant shopping centre in Croatia, in the largest single asset transaction in the SEE region.

Russia

Russia remains the biggest real estate market by far in the region. Just the value of the residential housing stock in Moscow was estimated to be worth a cool RUB52.3 trillion ($870bn) at the start of this year by real estate services company Savills – more than the value of the entire combined gross domestic products of Poland, Hungary and the Czech Republic.

With an official population of 11.92mn, the retail market in Moscow alone is larger than most CEE countries. However, the 2008 crisis, and then a lower profile second slump in 2015, wrong-footed many developers. Vacancy rates were a low 1-3% until 2014, and then they soared to 10.2% in 2016.

The retail segment hit its nadir last year as the delivery volume of new space slightly exceeded 2015’s volume. Nine new shopping centres with a total leasable area of 473,000 sqm were delivered in Moscow in 2016. Only two new shopping centres announced for 2017 were suspended in 2016, while the rest of the projects initially announced remain on track for completion this year – a total of 183,000 sqm, which is still less than half (2.5 times lower)

than the 2016 delivery volume, according to CBRE. Not much will change in retail until real disposable incomes start to grow again – something that is not expected to happen in 2017.

Russia’s nascent recovery is partly being driven by new investors looking to get in on the ground floor while prices are dirt-cheap. Last year a total of 39 new international brands entered the Russian market, with 34 opening their first ever store (all but eight of which were in cooperation with a Russian partner).

Even more encouraging for the retail sector's prospects is warehousing,

which saw its most dramatic decline in vacancy rates in six years, from 13.6% as of the end of the third quarter of 2016 to 12.2% as of the end of the year. The new supply of warehouses in the fourth quarter of 2016 hit 570,000 sqm, the highest quarterly level in the market’s history, although the annual level of completions (1.2mn sqm) was slightly behind the previous record set in 2015 (1.3mn sqm). The fact that retailers are investing into new warehousing space suggests they believe the retail market is about to grow strongly.

“Stabilisation of the economy, absence of significant currency fluctuations and global political stability encouraged some companies to be more proactive in their plans. We expect tenants to remain active this year as well,” says Viacheslav Kholopov, Regional Director, Head of Warehouse and Industrial Department, JLL, Russia & CIS.

There is little good news for office development, which took an even bigger hit than retail. Office completions tumbled to less than a fifth of the 2014 high water mark last year.

Things got so bad that there were reports of leasees renting out their expensive office space in the prestigious Moscow City business district as hotel beds to make ends meet.

However, the big change in the office market is the conversion from dollar-denominated pricing to ruble-based bills, which has freed the business from its painful FX exposure and laid the groundwork for a recovery. Vacancy rates are still high in the mid-teens but began to fall in the last two years to finish 2016 at 15.9%, according to CBRE.

As supply is still way ahead of demand, many developers are still delaying completing until they can find a willing tenant and completions were at a record low in 2016. Only 317,300 sqm of new space was finished in 2016 – 2.3-fold less than the year before and the lowest level in a decade. Still, market professionals believe the nadir was in 2014 and that the market will slowly recover from here as the excess supply works its way through the system.

Turkey

Turkey’s real estate sector suffered in 2016 because of political uncertainty, a coup attempt in July being the most obvious event. FDI inflow between January and November 2016 tumbled 42% compared to the same period in 2015, which took the wind out of the sector, according to JLL.

“Right after the coup attempt, the investment market was suspended as investors had become very cautious. The solidarity and unity messages issued by the government and opposition parties cooled the tension following the failed attempt. Investment activity resumed but remained very limited due to the state of emergency declared by the government,” JLL said in its 2017 Turkey report.

Financing costs have risen after the Turkish lira plummeted in value against the dollar. The upshot is there have been no transactions in the office sector, and the prime yield is estimated to be in the range of 7.75%, JLL said in its report.

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