BRIEFING: Intense competition between foreign and domestic investors in CEE

Foreign investors from many countries around the world, from South Korea to Canada and from South Africa to the Philippines, are deploying more capital in CEE and actively competing with domestic rivals for assets.

Foreign investors from many countries around the world, from South Korea to Canada and from South Africa to the Philippines, are deploying more capital in CEE and actively competing with domestic rivals for assets, delegates heard at Investment Briefings’ CEE and Europe Outlook Briefing, which was held in Warsaw recently.

‘We finally have a pool of diversified investors from various regions, from South Africa to Asia, it is no longer just Germany or the UK,’ said Anna Duchnowska, senior director asset management, Invesco Real Estate. ‘A large Japanese bank came to see me in December and they also want to invest in Poland. It is a very good sign.’

Asian investors, who had been looking at the region for a while, are now actually deploying  money and closing deals. They come from China and South Korea but also the Philippines. Americans are net sellers of retail assets, but they are buying logistics. South Africans have become a steady fixture of the market. Canadians and Australians are actively looking. The list goes on.

‘When you look at the make-up of capital now, it is wildly different from what it was five years ago and it has changed for the better,’ said Luke Dawson, Managing Director & Head of Capital Markets CEE, Colliers International. ‘We now have 5 or 6 pools of funds that are active in CEE. As we reach the top of the market, it bodes well that we have a wider and more stable investor base than we used to.’

Foreign investors still dominate the market in Poland and Romania, because there are no structures for locals to deploy capital, while in Hungary and the Czech Republic domestic investors have been increasingly active buyers, often outbidding cross-border rivals to get the best deals.

‘It is a pity that in Poland we have no domestic investors,’ said Duchnowska. ‘It is amazing to look at how quickly things have changed in the Czech Republic, to the point that now almost 50% of acquisitions are done by local investors. I really and truly believe it should happen in Poland, but without a change in the regulations it will be very difficult.’

In Poland over 90% of investments in real estate are done by foreign capital. ‘It is a huge problem for the country, as a lot of money is sitting in bank accounts instead of being deployed,’ said Janusz Dzianachowski, Attorney-at-law and Partner, Linklaters. ‘In the Czech  Republic it is another world.’

Unfortunately there is little prospect of positive change, he said. ‘The problem with Poland is that it has a lot of frozen capital and no structures to invest,’ Dzianachowski said. ‘We have talked about REITs for years and nothing has really changed.’

For the situation to improve ‘there would have to be new legal structures to help people invest in real estate but above all there would need to be a big change in lawmakers’ mentality,’ he said. ‘I am not sure anything will happen anytime soon. I am quite pessimistic.’


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Investor demand will stay high in CEE this year

‘We see demand staying high, at the €12-14 bn mark, but reaching a plateau and staying there,’

Demand for real estate investments will stay high in Central and European Europe, but it has reached a peak and it’s unlikely to climb to greater heights, Mark Robinson, CEE Research Specialist, Colliers International, told Real Estate Day.

‘We see demand staying high, at the €12-14 bn mark, but reaching a plateau and staying there,’ he said. ‘We have reached a high point’.

On the positive side, the market is supported by strong economic fundamentals. ‘The feeling in 2019 is that the economies in CEE in this cycle are very resilient, employment is high and a lot of demand is being led by consumption, which supports investor sentiment and rental growth.’

On the negative side, there is geopolitical uncertainty and economic slowdown close to home. ‘There is the possibility of a technical recession in Germany, which will affect the region. Poland will be less hit, but Czech Republic will be affected,’ Robinson said. China’s slowdown is also a risk, as it will have a negative impact on the world economy.

‘The outlook is mixed, but we will still see high investment volumes,’ he said. ‘Investors are doing their homework, doing due diligence and looking at assets in great depth.  We are at high altitudes in terms of investor sentiment, so we have to be careful.’

The economic underpinning of the market will stay solid this year, but ‘the biggest risk is political rather than economic,’ Robinson said. ‘We believe interest rates will stay at zero this year, and of course the underpin of a zero interest rate is crucial for funding investments in CEE, as funding is in euros.’

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Brexit: occupier markets

Perhaps more than any other variable, the impact of of Brexit on the leasing market has been the subject of most myth-making. Today, we assess the evidence to date.

3. Occupier Markets

Stronger than expected economic performance of the UK since the referendum has fed through to robust leasing activity. Further, the number of companies which have relocated people and activities outside the UK since the referendum on fears related to the UK’s future trading relationship with the EU has been limited to date.

“The actual count is relatively small in terms of firms and the number of jobs is in the hundreds, not the thousands,” according to Elisabeth Troni, head of EMEA research and insight at Cushman & Wakefield.

To the extent that corporates have decided to relocate, research by KPMG shows that no clear winner has emerged as an alternative to the UK and for the most part London. Luxembourg, Dublin, the Netherlands, Germany and France have each picked up a share of a small pool. Troni said if she was pushed to pick a likely winner from the above, she would suggest Paris, as many of the global firms likely to contemplate moving still often have operations in the French capital which provides some logistical efficiency.

Since the referendum, growth rate in UK office employment has moderated while take-up of UK office space has increased, according to Cushman & Wakefield. However, the expectation for UK office take-up over the coming two years is for take-up rates to decline, synching with the UK office employment rate. “There will reconverge over the next couple of years,” Troni said.

Rental outlook for the City of London – assuming a no deal Brexit is averted – is for a much softer decline in growth rates. Prime rents have held up much better than expected, currently trading at between £65-68 psft, with smaller deals often above £70 psft, says Troni. While the rental decline many anticipated following the referendum has been not emerged, the outlook for lower employment growth suggests softening in City rents over the next couple of years.

BRIEFING: Positive growth ahead for CEE offices

Rental growth in the office sector is attracting record numbers of investors to Central and Eastern Europe.

Rental growth in the office sector is attracting record numbers of investors to Central and Eastern Europe, delegates heard at the Investment Briefings’ CEE and Europe Outlook Briefing, which was held in Warsaw earlier this week.

‘Rental growth is the most important trigger for institutional investors to buy into the story,’ said Anna Duchnowska, senior director asset management, Invesco Real Estate . ‘We cannot count on further yield compression, but rental growth will attract investments.’

Looking ahead prospects are good, she said: ‘I am very positive about offices in general’. There is still a substantial yield spread with Western Europe and the real prospect of rising rents.

For these reasons the office sector ‘will see the most activity and the most positive growth story this year’, said Luke Dawson, managing director & head of capital markets CEE, Colliers International. ‘I am happy with where CEE is, we are in a good place and we have a good couple of years ahead of us.’

CEE and Europe Outlook 2019 panel

The office sector is evolving fast. The co-working trend has reached CEE and in Warsaw, in particular, the sector is growing, with many big deals being signed for 10-15,000 m2 spaces. 

The problem is lack of product, especially in Poland and in the Czech Republic, which is driving prices up. ‘It is very difficult to buy something,’ Duchnowska said. ‘We were bidding for two assets in Prague last week and we lost. There was a massive queue of investors ready to buy, especially domestic investors who understand the market better and are much more aggressive in terms of pricing.’

‘We are very cautious,’ Duchnowska said. ‘It is like retail: it has to be profitable. In the Q22 office tower in Warsaw, for example, 10% of the space is co-working and it’s 100% occupied, because all start-ups want to be in that building. But having 70%, 80% or even 100% of a building devoted to co-working it’s a very different story. It can easily become a problem.’

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‘Investors face tough decisions in 2019’

The year ahead is going to be a difficult one for real estate investors, who are faced with political risk, economic slowdown and the end of the cycle looming

The year ahead is going to be a difficult one for real estate investors, who are faced with political risk, economic slowdown and the end of the cycle looming, Anthony Shayle, head of Real Estate Debt EMEA, UBS Asset Management told Real Estate Day, but investing in debt offers stability and can be a solution.

‘There are many issues facing investors in 2019, many political risks in the environment and growing economic risks too,’ he said. ‘Investors, whether they are fixed income, straightforward real estate investors or asset managers, are bothered about the stability of the asset in the context of where the market is going, in a cycle that has potential interest rate increases as well as political instability.’

The UK is dealing with Brexit, many European countries have their own political issues to deal with and the tensions between the US and China with the increasing risk of a trade war are present in everyone’s mind.

‘The key issue for investors at the moment is that they look at the position of the cycle in real estate markets both in the UK and in Europe and it is very evident that, to varying degrees, the real estate markets are either close to the top of the market or at the very best late stage,’ said Shayle. 

This means that returns in the real estate world could be very volatile, but there is one solution for investors who in many respects want some stability.

‘If investors want more certainty attached to their income, debt offers that,’ Shayle said. ‘It provides stable cashflow deriving from coupons or interest payments. It has stability because the capital side of the equation is dampened by rending at a loan to value rather than taking 100% of the equity risk.’

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Brexit: the macro context

Economic variables are the dominant factors which influence environment for real estate markets. Today, we take a closer look the outlook for UK growth over the near and medium term under different Brexit scenarios.

2. Marco

The range of economic outcomes for the UK over the next 12 months is wide. Cushman & Wakefield research, supported by data from Moody’s, suggests annual GDP performance spread is 6%: with remaining in the EU forecast to drive annual GDP growth of 3.8%, which most forecasters while a disorderly no deal would deliver a contraction of -2.2%. A Brexit in name only solution implies growth above 3%.

The wide variety of outcomes in growth projections in the near-term makes devising appropriate strategies for real estate more difficult. “The advice we are giving to clients is to go back to first principles, think about fundamentals and focus on long-term ‘knowns’,” said Elisabeth Troni, head of EMEA research and insight at Cushman & Wakefield in a Brexit webinar.

By 2020, the spread in GDP growth forecasts between the different scenarios evaporates and each converge to baseline trend growth of around 2% per annum. The potential lower outlook for longer term economic growth looks weak by historical standards but could become the ‘new normal’ for the UK, Troni suggests, adding:

“Our peers, the US and the eurozone, are actually doing quite well, one lesson we have learned through the referendum period to today is that Brexit has virtually no impact on the rest of the world. The collateral damage that was expected by forecasters from Brexit has done very little to dent Europe. Europe is holding up quite well which has helped support the baseline growth rate. [The UK] has had a much stronger environment sine the referendum than expected largely because Europe has been less affected by Brexit than we thought.”

Troni added that Cushman & Wakefield is attaching greater probability to a more subdued growth projection of below 2%, which will feel low relative to performance of international peers but avoids a no deal exit. Capital Economics forecast an extension to Article 50 would moderate UK GDP growth in 2019 down 30 basis points to 1.5%, which contrasts sharply with negative growth of -0.2% in a disorderly scenario.

Markets’ rising confidence that a no deal will be avoided prompted the pound to rally 2% last week against the dollar closing Friday at $1.32, its highest since last October.

We are optimistic about Europe in 2019

The economy has slowed down and there are political challenges, but ‘there are a lot of investors around, the occupier markets are doing well.

There are plenty of reasons to be optimistic about the year ahead and not worry about a downturn which may not happen until 2021, according to CBRE.

‘We are quite optimistic about Europe in 2019, there is nothing to inspire pessimism or fear,’ Neil Blake, EMEA chief economist and global head of forecasting, CBRE, told Real Estate Day. ‘The concerns are overdone because the fundamentals are good and the markets are still flying.’

The economy has slowed down and there are political challenges, but ‘there are a lot of investors around, the occupier markets are doing well, employment is still growing and rents are picking up. No one ever mentions lack of investment demand and there is plenty of money looking for a place to go. We are optimistic that the cycle will not end soon and we will not see a slowdown next year. The downturn may happen in 2020 or 2021’.

Considering the levels of concern over Brexit, ‘UK offices have done better than most people predicted,’ said Blake. ‘In Central London there has been a massive amount of new supply, most of which has been taken up. Rents have held up and there is no shortage of tenants. Regional offices have done better than London.’

Looking ahead, in 2019 vacancies may increase due to more supply coming to the market and rents are likely to go sideways, he said.

Logistics also had ‘a cracking year’ in 2018 and it looks set to continue on an upward trend this year. On the negative side, the retail sector is experiencing difficulties, Blake said, as it is ‘caught in the perfect storm of e-commerce growth, reduced spending power and changing consumer habits’. 

But difficulties throw up opportunities: ‘There are some worthwhile investments out there in the retail sector,’ he said. ‘More transparency on the sector in 2019 would help us identify them.’

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BRIEFING: Student Housing

There is a huge imbalance between supply and demand in CEE cities, which are increasingly popular.

Student housing has huge growth potential in Central and Eastern European countries, as demand is growing but there is very little supply, experts agreed at Investment Briefings’ CEE and Europe panel discussion, which took place in Warsaw this week.

‘There is a huge imbalance between supply and demand in CEE cities, which are increasingly popular,’ said Rainer Nonnengässer, CEO, International Campus. ‘Students have a hard time finding accommodation. This is what makes investments into student accommodation in the region so attractive.’

The sector is very small but it is destined to grow. ‘Student housing would be my investment choice in 2019,’ said Luke Dawson, Managing Director & Head of Capital Markets CEE, Colliers International. ‘It is a long-term, sustainable asset class that has got a lot of runway ahead.’

The harmonisation of standards and mutual recognition of courses is driving student mobility in Europe, while programmes like Erasmus have boosted student exchanges in Europe. ‘Warsaw, Prague and Budapest have gained much more traction recently,’ Nonnengässer said. ‘They are attractive cities, they are young and lively and the cost of living is lower than in other EU cities.’

Because construction costs are lower in the CEE region, International Campus ‘has the opportunity  to keep prices lower than in Germany, our main market, so we can attract domestic students and not just more affluent international students.’

The asset class is fast expanding beyond student housing to include co-living and micro-living for young professionals. ‘We are starting to look at co-living schemes as well as student accommodation,’ Nonnengässer said. ‘I believe that in the next few years the dividing line between residential, hospitality and concept-based living products will disappear.’

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Brexit: the politics

The historic defeat of prime minister Theresa May’s Brexit plan earlier this month informs the political and economic trajectory, which in turn have implications for UK property occupier markets and investment activity. This week, we will consider each in turn.

1. Politics

The probability of an extension to Article 50, which requires unanimous consent from the other 27 member states, has increased. While Downing Street has not conceded this, chancellor Philip Hammond and Andrea Leadsom, leader of the Commons, have both intimated the possibility. However, this will require the UK offering a good reason for the extension from Europe’s perspective. One scenario which may find support in Europe is time to hold a People’s Vote.

An Article 50 extension scenario – dubbed by some ‘fudge and delay’ –could lead to a softer Brexit and even a second referendum. While protracted uncertainty will weigh down the UK economy and investor sentiment, including the outlook for rental growth, the prevention of a disorderly ‘cliff edge’ exit from the European Union would stave off a materially lower growth and a potential liquidity crisis.

UK Parliament will vote on Mrs May’s “Plan B” on Tuesday, which is essentially Plan A with the promise of yet further attempts to renegotiate the contentious Northern Ireland backstop. In addition, as many as 14 amendments to her deal have now emerged – running a spectrum of scenarios and with differing degrees of MP support – which will also be debated tomorrow.

Whichever proposals emerge successful after Tuesday’s parliamentary debate, the rising influence of parliament in the final Brexit deal reduces the probability of a no deal which is good news for property markets. However, this is in contrast to the most popular opinion among Tory grassroots members. A survey by Conservative Home found 48% want no deal, while 24% want a Canada-style solution and just 10% back Mrs May’s current plan. The political gap between Tory grassroots and the prime minster’s current trajectory underscores the need for a cross-party consensus.

In a scenario envisaged by the Bank of England, a worst-case disorderly exit – where the UK leaves the EU with no agreement and no transition period – could lead to a peak-to-trough collapse in UK commercial property pricesby 48%, more precipitous than the 42% slump during the global financial crisis a decade ago. Residential property prices would slump by 30%. However, this is a theoretical stress-tested worst-case scenario, not a forecast.

BRIEFING: Brexit is going to benefit CEE

Some investors are taking a wait-and-see attitude to the UK and will deploy at least part of their capital in the CEE region.

It is still not clear what impact Brexit will have on the UK, but it is clear that it will benefit Central and Eastern Europe, delegates heard at Investment Briefings’ CEE and Europe Outlook panel, which was held in Warsaw lastweek.

‘Is Brexit going to benefit CEE? The answer is yes,’ said Luke Dawson, Managing Director & Head of Capital Markets CEE, Colliers International. It will probably not increase investment volumes by €1 bn, but we will see a few investors come and look that wouldn’t otherwise have come here.’

Some investors are taking a wait-and-see attitude to the UK and will deploy at least part of their capital in the CEE region, where markets have matured and are now more liquid and more attractive.

‘A place like Poland is filling that gap,’ Dawson said. ‘It is something between Western Europe and an emerging market. The returns are pretty attractive but, as our markets continue to mature, investors are also more comfortable with the levels of risk.’

The risks associated with Brexit are also putting political issues in Poland and Hungary in perspective. ‘The political situation in Poland has become less of an issue,’ said Janusz Dzianachowski, Attorney-at-law and Partner, Linklaters. ‘Big investors in our country, like the South Africans, are not very concerned, as they have a very different idea of political risk from ours. Now it is all about Brexit and how we can benefit from it.’ 

There is another, less positive side to Brexit that some investors worry about, said Rainer Nonnengässer, CEO, International Campus: ‘They focus less on the benefits and more on the uncertainty that it will bring and the negative impact on the European economy that could affect the real estate sector as well.’ This worry is particularly acute in Germany, where the economy is already slowing down.

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