October 08, 2014

CEE real estate and low inflation economy favours CE4

CEE real estate and low inflation economy favours CE4

The low inflation environment and positive GDP forecasts are favouring the performance of the more mature Central and Eastern European office markets, according to recent research released by Colliers International.

Damian Harrington, Regional Director of Research for Colliers International, Eastern Europe, said: “We’ve been looking at how this new low inflationary era will affect commercial property and while property returns need not reflect or mimic inflation, other macro-indicators such as GDP are critical drivers of market demand growth.”

In relation to wider inflation and economic growth trends, the central eastern property markets, Poland, Hungary, the Czech Republic and Slovakia, collectively known as CE4, are likely to benefit the most from these shifts as they become a priority for many investors.

In the medium term, it is anticipated that EU inflation will remain muted, while GDP growth will to slowly rise to 2 percent.

In a broader context to Europe, although CE4’s GDP trend is closely correlated with that of Germany, resulting from the integration of CE4 into Germany’s supply chain, GDP in the CE4 region is expected to rise to 3.0 percent on average over the next five years, compared to 1.0 percent in Germany.

This provides CE4 with a better high-growth, low-inflation environment than the EU over the next five years, a factor, which bodes well with supporting higher investment volumes into the region.

Net absorption of office space in the CE4 markets has become much more closely correlated to GDP growth in recent years, albeit with a slight lag. Thus solid GDP growth forecasts should translate to positive office demand over the next 5 years, even though growth will be more muted than historical rates have shown.

However, it’s not just GDP impacting returns with rental indexation and lease length also playing a key role.

“In our analysis, we focused on prime office assets in CE4. By indexing rents to inflation annually for leases with 3 and 5-year terms, we found that when short leases are combined with falling or flat market rents the positive impact of indexation on rental returns diminishes. Of course not all office properties have the same lease length, some are shorter and some longer, up to 7 to 10 year leases,” commented Damian Harrington.

Market rents are at risk of deviating from an inflation-adjusted trend mainly because of the balance of supply and demand in the market in question. In a regime of more stable demand growth, the supply-side of the market becomes a much more critical element of the equation as any over-development is likely to damage occupational stability and rental returns.

Managing this effectively will be critical in order to not only manage positive returns, but to drive an increase in investment turnover through the provision of new modern office product.

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