What’s HOT and what’s NOT on CEE’s investment markets?

Avison Young has compiled a report analysing investment activity for the first half of the year in the CEE region together with AY offices in Czechia, Hungary and Romania.

The industrial and logistic sectors, the darling sector of 2021, sought-after by almost every institutional investor stay atop the shopping list of most in 2022, albeit recording lower investment volumes due to a lack of available products. Demand is propelled by almost zero vacancies across the region which is driving rental growth in all geographies. Yields compressed in Czechia (CZ) & Slovakia (SK); remained stable in Poland (PL) & Romania (RO), and moved out in Hungary (HU). Liquidity remains very strong and RO and HU look particularly attractive today in terms of both yield and rental rate.

The residential sector is still heating up despite rising interest rates. A growing number of institutional investors view this segment as a safe bet as we enter a macroeconomic slowdown. Increased mortgage rates force a portion of the demographic to rent, driving demand for rental properties and in turn, rental rates. Many residential developers have created a second pillar of their business by keeping some projects on their books, creating special residential funds or forward selling to institutional investors.

The office sector has traditionally taken the lead in most countries, and it remains the largest volume maker (36 percent of total volume across CEE) in H1 2022. However, we have seen outward movement in office yields in CZ & SK, with only RO reporting yield compression y-o-y. Major institutional investors have narrowed their investment criteria as a direct result of the current cost of debt and the focus on ESG, leaving space for shrewd buyers to pick up an existing office asset at very attractive pricing. The growth in construction costs over the past years means many existing buildings are trading at or below the cost of replacement, and rental growth is forecast over the coming 12 months in most CEE office markets. These two factors offer landlords’ of existing assets a huge competitive advantage and improved returns over a new-build project when setting rental rates and leasing strategies.

The retail sector has been blossoming alongside the office in terms of total volume (32 percent of total volume across CEE). Convenience schemes still dominate the retail investment market in Poland and investors have confidence in small retail parks. In HU, there was robust activity, and on the back of a large portfolio transaction, the retail sector represented 35 percent of total investment volume. Investors should look towards discounters for strong performance today; when we all feel the inflation pinch the general demographic will curb unnecessary purchases and be more prudent on those that are necessary. Therefore, discounters and all those in their supply chain will typically benefit during high inflation. This means supermarkets, selected e-commerce platforms, and their supply chains. HU, RO and PL all offer very generous yields in this recession-resilient sector.

War in Ukraine and inflation replaced COVID-19 as the main drivers of uncertainty in 2022

The transactions that proceeded from the end of 2021, moved into H1 2022, so even though the war in Ukraine and the record-breaking inflation impacted all the CEE markets, it didn’t reflect in the total investment volumes in H1 2022 to a great extent.

The industry now finds itself in a difficult macroeconomic environment with record inflation levels and a looming potential energy crisis. There are huge pressures on governments to tackle rising energy costs. This presents challenges for investors and occupiers and reinforces the rationale behind the need to have an ESG strategy for real estate. ESG and energy efficiency are distinct but interrelated clearly. Energy efficiency is a must today; it is measurable and therefore it is the first port of call in the application of an ESG strategy.

Inflation isn’t all bad news; the real estate sector has always been a great hedge against higher inflation as rental levels are adjusted accordingly. Next year investors will benefit from increased running yields as 2022 indexation is applied to passing income. Nevertheless, the combination of rising rents and increasing utility costs may be challenging for tenants, especially in low-margin businesses across all sectors.

Again, this demonstrates there’s great value in older stock. Existing income-producing assets with a reasonable capital value per sqm and strong tenants will be a winner for many investors in the upcoming period. They will benefit from indexed income but also flexibility to adjust their ERV if needs be.

Increased interest rates are causing financing to be more expensive

High inflation has forced central banks across the globe to raise interest rates; High-interest rates in the CEE, especially in local currencies, mean significant increases in the cost of financing development projects. Combined with the inflationary environment pushing costs of materials and labour upwards, this is a particularly challenging time for developers. According to Avison Young, the market is witnessing increased prudence from developers when assessing new projects or land plot acquisitions. Also, assets with local currency-denominated leases will be difficult to finance in the current environment without dramatically impacting the net returns and cash flow to investors.

The higher cost of debt (in EUR as well) is pushing yields up slightly, nevertheless, liquidity on the market still looks very strong and investors who can acquire 100 percent equity have a significant advantage. Looking at the investment volumes, Avison Young has not seen any significant shifts so far, as there have been large transactions and portfolio sales that bolstered the H1 numbers, but AY expects lower volumes and fewer assets on the market throughout H2 2022.

All investment volumes up 30 percent Y-O-Y in H1 2022

H1 investment volumes are up by 30 percent reaching €5.4 billion, however, it is still a 12 percent drop from the €6.1 billion recorded in 2020, where Q1 2020 hadn’t yet been affected by the COVID-19 pandemic.

All the CEE countries are reporting increased volumes in the first six months of 2022. PL remains number one in attracting the largest amount of investment with €2.9 billion in 55 deals, making H1 2022 its third best H1 period since 2016 in terms of transaction volume, followed by CZ reaching €1.2 billion, which is 30 percent up y-o-y. SK climbed to ca. €620 million, this record-breaking number is the result of a large transfer of ownership in part of Penta’s office portfolio ‑ to the newly established developer Alto Real Estate (owned by Jozef Oravkin, ex‑Partner of Penta). HU transaction volume recorded a small increase from 2021 transaction levels of €590 million, reaching €619 million in H1 2022. RO came close to €320 million, taking it up a notch up from last year’s €316 million.

Office (36 percent) and retail (32 percent) have become new champions in terms of investment volume across the CEE market, while a lack of available property in Industrial & Logistics remains the single most limiting factor for transactions across the CEE region.

The most attractive yield spreads can be found in the retail park segment where prime yields in CZ compressed to 5.25 percent versus yields of 6.50 percent‑7.25 percent in all other CEE countries. The RO industrial segment also offers excellent value and we forecast yield compression in this market over the coming 12 months.

Czech investors again lead as the number one investor group by volume claiming 25 percent of investment activity, allocating their funds locally, as well as in SK and PL. They are followed by Hungarian investors (16 percent). Of particular note is the spectrum of investor origin in 2022, a truly diversified pool of capital is seeking CEE Real Estate adding to the liquidity of the region.