According to Colliers International’s latest report, Opportunity Knocks for Central Eastern Europe (CEE), there are signs that the current European investment cycle will be extended, creating an opportunity for CEE to absorb greater volumes of capital.
Damian Harrington, Regional Director of Research for Colliers International, Eastern Europe, said: “Institutional, private equity and sovereign wealth funds are growing and increasing allocations to property. The weight of this capital, alongside increasing debt availability and a new real estate development phase are helping extend the current investment cycle.”
Quantitative easing and low interest rates are driving also driving this international search for property, which offers relatively high returns. Risk has been difficult to gauge because bond market pricing is distorted, especially in the case of long-term government bond yields which are often used as a benchmark for property yields and the cost of borrowing. In some global and European markets this pattern has led property yields to surpass their previous 2007 peak, meaning that these markets are less attractive to investors from a pricing perspective.
In the CEE region, Poland and the Czech Republic continue to be very strong performers in terms of investment turnover but do not appear to be showing any signs of overheating from a yield pricing perspective. Neither do the markets of Hungary, Bulgaria, Romania and the Baltics where there was a significant rebound in investment activity during 2014. Russia, unfortunately, has moved in the opposite direction.
In the report we look at the spread of yields over 10-year national government bonds and even though some of government bond rates have changed in response to quantitative easing, the analysis provides insight into which markets offer a risk-premium.
All CEE markets, except Moscow, have a healthy 3.0 percent spread above the rate of government bonds. This indicates a positive spread between the potential cost of debt and the return on the asset. Even a conservative view, which looks at the 5-year bond rate, shows that the CEE region looks good from a risk-adjusted yield perspective with Sofia, Prague, Bucharest and Warsaw featuring in the better positioned markets.
Conversely, however, investment volumes in the CEE region, as a proportion of total European volumes, have declined from around 10 percent in 2010 (post-crisis) to 7.0 percent in 2014.
Although the change in conditions in Russia has driven the majority of this decline, the markets in the CEE region just haven’t kept up the same pace with the broader European market.
A significant factor which has played down CEE investment volumes post-crisis is a lack of obvious distressed portfolio sales. CEE sales have been carefully managed back into the system as values have recovered, but total sales to date comprise less than €5 billion, less than 7 percent of total sales post-2009. Elsewhere across Europe, almost €50 billion of distressed assets have been sold over the same period, thereby reducing the role of CEE region in overall European investment volumes.
This figure pales in comparison to the €200 billion of commercial real estate (CRE) non-performing loans (NPLs) which have been reported sold, primarily to well-capitalised investors seeking significant large lot size opportunities at discounted prices. The bulk of these NPLs have been sold by banks focussed on the UK, Ireland, Germany and Spain with limited exposure to CEE.
As the volume of distressed debt and asset sales diminishes across Europe, much as it has in the US market, investors will need to consider other opportunities. Additionally, Italian and Austrian banks, comprising a strong element of CEE loans, are being targeted for sales in 2015.
“While the CEE region may be perceived as being riskier and the scale and quantum of opportunities available may not have always whetted the appetite of some global investors, we could see investors shift their intention to the CEE region as the market opportunity for both distressed sales and well-priced assets diminish across Western Europe. To some extent, you could say that prime yield pricing is an advantage for the CEE region, and the fundamentals supporting growth in occupational demand for both offices and industrial and logistics growth are stronger. It is a region with room for more capital,” said Mr Harrington.
