Wojciech Kosc in Warsaw -

When the Latvian bank Citadele’s fund managing arm CBL Asset Management said in early June it would launch a real estate investment fund with a conservative mandate, the announcement quickly disappeared amongst countless others generated in connection to the European real estate industry.

But it should not have, because the fund has the makings of one of the first investment vehicles in the region to adapt to the realities of the recovering Baltic economies. After the credit-fuelled growth ended in a crash in 2008, the environment is now more suitable for cautious investors. Accordingly, the new fund plans to derive returns from investment in stable income-producing property assets over a longer period of time.

Such strategies were not always the case with investors in Baltic real estate. Until the crisis, says Deniss Kairans, managing partner at the Riga office of Colliers International, a real estate services company, the Baltic region’s real estate investment market had been a popular arena for investors thriving on speculation. “Most investors before the crisis were speculating on fast yield compression,” confirms Andris Rengitis, head of real estate at CBL Asset Management, who is managing the new fund. “When the crisis struck and yields went from sixes to 10-12%, the market froze.”

The Baltic real estate sector became one of the hardest hit by the crisis, contributing to steep declines in economic growth. Estonia’s GDP contracted 14.7% in 2009, Latvia’s 14.2% and Lithuania’s 14.8%, according to Eurostat.

Now that the Baltic economies appear to have embarked on a more sustainable path of growth, Rengitis says funds with more conservative strategies should be able to find their place on the Baltic real estate market.

Rengitis points out the macroeconomic environment is favourable, especially given the low interest rates that should have institutional investors such as pension funds seek alternative ways of putting capital to work. Real estate is one such way, Rengitis says.

According to Prequin, an assets analysis and intelligence company, the top 25 Europe-based public pension funds had an average allocation of 14% of total assets invested in real estate in 2014. According to CBL Asset Management research, this amount in the Baltics is only 2%, with the majority of investments located in Estonia.

The strategy of Citadele’s fund is thus to attract pension funds and other institutional investors to buy into Baltic real estate. “[The fund’s strategy is] to generate steady cash flows with less emphasis on potential capital gains from market shifts,” reads the announcement on the fund’s establishment.

The fund is going to target office and retail segments, while the “main criteria for property selection are high liquidity properties in different market conditions and property competitiveness to ensure their successful operation in the long term,” according to the announcement.

Rengitis says that the current yields on commercial real estate come in at 7.25-7.75% and offer investor advantage over Western Europe’s yields of around 5%. “There is capital looking to invest and there are the low interest rates. If you are conservative in leveraging your buys, you can obtain an [internal rate of return] of 10-15%,” Rengitis claims.

Even the most conservative leveraging might not necessarily be many investors’ first choice, however. “After the crisis, banks have grown more conservative in lending. This is translating into investors being more wary about what assets to put their money in,” says Madis Raidma, CEO of East Capital, a Swedish-based fund manager in the region.

“Yields will compress, of course, but it is going to happen very gradually. On top of that, the rental levels have not quite recovered yet from the bottom of the crisis and are at 30% of what they were around 2006-2007,” CBL Asset Management’s Rengitis says. “So there is a nice upside if rental growth happens, which I think it will – again, in a step-by-step fashion.”

Office rents in the Baltic states were about €20-25 per square metre before the crisis hit, while they are hovering at around €14-€16 in Riga today, and around €13 in Tallinn and Vilnius, according to Colliers.

Enough to go around?

But if the market froze during the crisis and is only recovering now, is there enough real estate on the market? It is some issue, says Colliers’ Kairans. “The money is there, but there is little product,” he says, although adds that is changing too.

Kairans points to Lithuania as a country with potential for office development because the country is popular with companies locating their offshore services centres there. Estonia, in turn, is attractive to Finnish companies, which translates into development of industrial real estate. Retail is seen as a prospective segment in both Estonia and Lithuania.

Only Latvia appears to be more of a no-man’s land, because local developers have tended to bet on residential projects because of demand from Russian nationals. “New supply is indeed coming to Estonia and Lithuania, with Latvia a bit behind, although I think it will catch up in the next year or two,” believes Raidma of East Capital.

The demand for office space in the Baltic states is driven by expansions and relocations of local firms concurrent with the entry of foreign companies, especially in Lithuania, according to Colliers’ report on the Baltic real estate in the first quarter of 2015.

Retail has been developing well across the region, as rising wages are getting an extra boost from low inflation and domestic consumption is seeing as the main economic growth driver. The sector’s attractiveness to investors was proven in early 2015, after international investors Partners Group bought a portfolio of seven retail projects for €163mn – the biggest transaction in the Baltic states since 2008.