Nicholas Watson in Prague -

For those investors who want to gain exposure to Central Europe's property markets but don't want to splash out on a house, there are a growing number of open-ended real estate funds now on offer.

The latest country in the region to give small investors the chance to invest in such funds is the Czech Republic, where the government last year passed a law enabling the creation of open-ended real estate funds and in February the Czech National Bank finally approved the application of Reico Investicni Spolecnost, a daughter company of Ceska Sporitelna bank, to open the first Czech real estate fund for small investors.

According to Martin Skalicky, investment director of Reico's real estate fund, the fund is now worth CZK600m (€22m) and made its first acquisition in August in the Czech town of Brno, where it purchased an office building called Platinum.

The Reico fund, like other such real estate funds, makes its money from the rents from the buildings its buys, the capital gains made on those properties, as well as the financial engineering used to buy those properties. "When we invest into any property, obviously we are not spending the whole 100%, but leverage up to 70% from third parties," says Skalicky.

In this way, the fund is targeting an annual return of 5-7%, which is a yield above those expected for funds that invest in bonds.

Reico may have been the first, though the central bank expects to see as many as five new real estate funds opened by the end of this year. Funds are expected from CSOB Investment Company, a subsidiary of CSOB Bank owned by Belgian banking and insurance group KBC, as well as from the investment arm of Komercni Banka, which is part of the Societe Generale Group.

In next-door Slovakia, the real estate fund market is also relatively new, though more advanced than in the Czech Republic, with four local asset management companies having set up real estate funds. One of the latest to launch was Slovenska Sporitena's SPORO Realitny Fond on May 2 this year with initial start-up capital of SKK300m (€8.9m).

Unlike its Czech cousin, this fund can also be invested indirectly into securities related to the property market, for example bonds of developers, real estate companies, equities of developers, mutual funds, real estate investment trusts (REITs - a different structure to these open-ended funds), and mortgage bonds, as well as into properties directly or the special purpose vehicles that are often set up by developers of large projects.

"We are very selective when considering the investment into properties. Our investment strategy is conservative and we are focused mainly on the finished and rented projects with good localities," says Vladimir Bolek, investment manager at Asset Management Slovenskej Sporitelne, which manages the fund.

Hungary has the region's most well-developed real estate fund market, having had such funds for more than a decade. However, Attila Fekete, CEO of Erste Fund Management Hungary, which runs the Erste Open-Ended Real Estate Fund, says it's only really since 2000 that the market has taken off as interest rates decreased. "As interest rates have fallen in the traditional bond markets, it has opened up space for an additional asset class like this," says Fekete.

Four big players dominate the currently €1.6bn core real estate fund market, with Erste's fund currently the market leader in terms of volume with a 25% market share. The performance of these four funds illustrate well the advantage of being a long-term investor in these funds, which managers say is essential to get the most potential from the fund. In the three years to August 31, Raiffeisen's fund earned an annual yield of 9.30%, Erste's fund earned 8.57%, OTP's returned 8.50% and Pioneer's returned 8.20%.

Office space

A common thread running though these funds is their focus on the commercial, industrial and retail segments of the real estate market, and away from the residential, meaning small investors can gain good exposure to the currently best performing parts of the market that are not normally open to them.

"The Hungarian residential market has reached saturation phase - there's so many unsold developments and prices are stagnating," says Fekete. "We expect demand to continue shrinking, but there may be some niche developments which could still be successful."

On the other hand, the Czech commercial property market, while perhaps not exactly booming, is certainly performing well above that of its Western peers. According to Michael Atwell of Cushman & Wakefield's capital markets group, Central Europe saw investment in real estate of nearly €6.5bn in 2006, which was up 45% up from the year before. Annual yields from Czech commercial real estate were 5.5-7%, compared with yields of just 4-6% in Western Europe.

The best investments in commercial property are increasingly found in the regional cities and outlying regions, where places such as Reico's Platinum building in Brno offers 100 basis points more in yield than in the well-developed market of Prague, says Atwell.

Reico's Skalicky likes the industrial, logistics and distribution segments, amongst others, particularly with regards to the mushrooming automotive sector in the Czech Republic and Slovakia. "This investment also generates flowing businesses related to the main automotive production facilities, and generates demand for residential for the workers as well as training facilities for those workers," says Skalicky.

For this reason, Skalicky says his fund is now looking for attractive properties in Slovakia, "the first foreign country we are stepping into." This move outside its own borders is another familiar theme that runs through these real estate funds and is illustrative of one of the main problems with them also: there are simply not enough good projects to satisfy the growing demand.

"Supply just can't keep pace with investor demand for product, it's a common problem for these funds," says Fekete, whose fund's core area of investment was at first banking real estate, such as its flagship Europe Tower in Budapest, but which has since broadened to commercial office and retail space.

The Erste Open-Ended Real Estate Fund is targeting a minimum level of real estate exposure in the fund of 80% of its net asset value, meaning it needs to find projects worth another €240m. However, Fekete says currently only 36% of the fund is actually invested in real estate, the rest in the money markets.

Bolek says his SPORO Realitny Fond is prepared to look even further afield. "We will focus on direct investment in property in Slovakia and other countries of Western Europe, the CEE region, and partially Asia," says Bolek. "The current trend is to 'shift to the East' where the investors see the possibility to get better results because of the growing economies in these regions - we are also participating in this trend."

Send comments to The Editor