Research & Forecast Report Eastern Europe | Investment Q1 ...6 Research & Forecast Report | Q1 2015...

Research & Forecast Report

Eastern Europe | InvestmentQ1 2015

Opportunity Knocks for CEE?

2 Research & Forecast Report | Q1 2015 | Investment | Colliers International

ContentsExecutive Summary 3

Introduction 4

Th e Context 4

European Investment Volumes 5

Why the Disconnect? 6

Relativity 6

Prime Yield Pricing 6

‘Risk-adjusted Pricing’ 6

Scale of Opportunity 7

Th e Evolution of Distress 8

CEE Distressed Sales 9

Value in Values 11

Offi ce Capital Values 11

Retail Capital Values 11

Industrial Capital Values 11

Th e Macro Story 12

Cyclical vs Structural Growth 12Offi ce Demand: Off shoring & Outsourcing Growth 12

Industrial and Logistics Demand 14

Conclusion 15


Executive Summary

RIGHT PRODUCT

Competing with the scale of opportunity which has been made available in western Europe has been a challenge to date. But these opportunities are diminishing and new opportunities are being brought to market in the CEE region. New development activity is also creating new product for sale, without hampering the underlying supply/demand balance. Strong growth trends in occupational demand will continue to justify more product.

RIGHT PRICE

Th e CEE market provides excellent comparable pricing:

• From a m2 perspective, the region trades at 50% of the European average.

• Capital values continue to trade below peak values across all sectors, with offi ces and industrial/logistics particularly attractive on the value curve.

• Yields trade at a discount to other comparably sized EU cities, and stack up on a risk-adjusted basis - both now, and when taking a more conservative view of pricing risk in future.

• Investment fi nancing is also coming back, and margins are diminishing amidst competitive lending scenarios, allowing for a further compression in yields.

THE MISSING PIECE

Outside of Poland and the Czech Republic, the range and depth of investor diversity remains a challenge. Exit strategy is a concern across Europe, but for those willing to take a longer-term view, CEE provides a well priced and signifi cant opportunity. By taking positions in the market now, longer-term institutional investors will help increase the profi le and exit liquidity position of the region, bringing more short-term investors into play alongside the growing number of local investors.

RIGHT TIME

In many respects there couldn’t be a better time, for the CEE market to capture more investment from the increasing global pools of capital. With several years left to run in the global and European investment cycle, and opportunities gradually diminishing elsewhere in Europe (and globally), this is a good time to consider taking a stronger position to invest in CEE.

RIGHT PLACE

Central and eastern Europe (CEE) has a very strong investment story, from a pricing and occupational demand perspective. Offi ce and industrial/ logistics demand trends alike - via outsourcing, off -shoring, best-shoring, e-commerce and distribution - illustrate that signifi cant growth opportunities have yet to be fully realised. Shorter term, GDP prospects are positive - above EU-average - and retail consumption is making a comeback in a number of markets.

RIGHT PRICE


• From a m2 perspective, the region trades at 50% of the European average.

• Capital values continue to trade below peak values across all sectors, with offi ces and industrial/logistics particularly attractive on the value curve.

• Yields trade at a discount to other comparably sized EU cities, and stack up on a risk-adjusted basis - both now, and when taking a more conservative view of pricing risk in future.

• Investment fi nancing is also coming back, and margins are diminishing amidst competitive lending scenarios, allowing for a further compression in yields.


perspective, the region trades at 50% of the European average.

Capital values continue to trade below peak values across all sectors, with offi ces and industrial/logistics

Yields trade at a discount to other comparably sized EU cities, and stack up on a risk-adjusted basis - both now, and when taking a more conservative view of pricing risk in future.

Investment fi nancing is also coming back, and margins are diminishing amidst competitive lending scenarios,


perspective, the region trades at 50% of the European average.

Capital values continue to trade below peak values across all sectors, with offi ces and industrial/logistics

Yields trade at a discount to other comparably sized EU cities, and stack up on a risk-adjusted basis - both now, and when taking a more conservative view of pricing risk in future.

Investment fi nancing is also coming back, and margins are diminishing amidst competitive lending scenarios,

RIGHT TIME

In many respects there couldn’t be a better time, for the CEE market to capture more investment from the increasing global pools of capital. With several years left to run in the global and European investment cycle, and opportunities gradually diminishing elsewhere in Europe (and globally), this is a good time to consider taking a stronger position to invest in CEE.

RIGHT PRODUCT

Competing with the scale of opportunity which has been made available in western Europe has been a challenge to date. But these opportunities are diminishing and new opportunities are being brought to market in the CEE region. New development activity is also creating new product for sale, without hampering the underlying supply/demand balance. Strong growth trends in occupational demand will continue to justify more product.

RIGHT PLACE

Central and eastern Europe (CEE) has a very strong investment story, from a pricing and occupational demand perspective. Offi ce and industrial/ logistics demand trends alike - via outsourcing, off -shoring, best-shoring, e-commerce and distribution - illustrate that signifi cant growth opportunities have yet to be fully realised. Shorter term, GDP prospects are positive - above EU-average - and retail consumption is making a comeback in a number of markets.


Introduction

Market forces in the sphere of global investment point toward an ongoing recovery in investment activity within the European commercial real estate market. In fact, from a yield perspective, it appears that some core, European markets have gone beyond recovery into full-pricing mode as of Q1 2015.

Within the CEE region, the likes of Poland

and the Czech Republic continue to be very strong performers in terms of investment turnover, without showing signs of overheating. Outside of these markets there had been a limited recovery until a significant rebound in activity in 2014 saw Hungary, Bulgaria, the Baltics and especially Romania improving as expected. Russia, unfortunately, has moved in the opposite direction.

It is apparent that the current investment cycle has some way to go on a European (and global) level. This raises a few important questions:

› Will the investment recovery/growth story continue in CEE, and at what pace?

› What factors are likely to shape the investment destiny of the CEE markets in the near future?

› Could market conditions finally translate into a significant step-change in investment activity for the wider CEE region, this time around?

With this in mind, this report will review the key investment trends to date, positioning CEE markets against a wider European and global backdrop. Does CEE warrant further investment? We believe the answer is yes. Let’s see what you think.

The ContextAs our recent EMEA Paper ‘How Long will the Cycle Last’ points out, there is an increasing likelihood that the significant waves of global capital pounding the European commercial real estate (CRE) market will continue to flow ashore. Global funds under management amount to $32 trillion. Institutional, private equity and sovereign wealth funds are growing and increasing allocations to property. This weight of capital, alongside increasing debt availability and a new real estate development phase are helping elongate the current investment cycle.

Extraordinarily low interest rate regimes also support the very strong likelihood that this global property bull cycle will continue for another few years at least. In Europe, forward yield curves suggest no UK rate hike until 2017, with no rise evident in the eurozone before 2020.

Quantitative easing (QE) and low interest rates are driving an international search for yield, with property offering relatively high returns, but its pricing benchmark (long term government bond yields) is distorted, so risk is more difficult to assess. In turn, this has led to yields in certain global and European markets surpassing their previous 2007 peak.

In brief, more money is chasing product, which in turn is becoming more expensive. In some cases, certain markets may no longer fit the return requirements of many an investor, where yields provide limited income and the potential for further capital growth appears less sustainable.

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Fig. 1: Investment Volumes Europe vs CEE

Source: Colliers International

PopulationEst. Offi ce SpaceGDPInvestment

Volumes

100%

/E

uro

pe

CEE 50%

CEE 35%

CEE 20%

CEE 7%

€ Billion

European Investment VolumesEuropean investment volumes continued to recover in 2014 reaching €220 billion, up from €180 billion in 2013. Th e main recipients of these volumes continue to be the UK, Germany, France, Nordic and Benelux markets.

More peripheral markets have also made a comeback, with Spain and Ireland clearly back on the investment agenda. Th e CEE region, on the other hand, has seen investment volumes decline as a proportion of total European investment – from around 10% post-crisis, to just 7% in 2014, despite maintaining volumes at over €10.5 billion last year.

Th e swift change in circumstances in Russia is the primary reason for this decline, with deal volumes dropping by 50% in 2014 to €2 billion. So overall, despite a signifi cant rebound in volume growth in other CEE markets, the region as a whole has failed to keep pace with the wider European market.


Fig. 2: Investment Volumes Growth [Eastern Europe Region; 2013 vs 2014]

Romania

Bulgaria

Czech Republic

Slovakia

Hungary

Latvia

Lithuania

270%

77%

68%

-52%

-69%

71%

160%

61%

31%

0%

2% Estonia

Poland

Russia

Croatia

Ukraine-100%

2007 2008 2009 2010 2011 2012 2013 2014

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Europe CEE

Fig. 3: GDP Eastern Europe Region[2014 vs f2015; %]


Romania Czech Republic Hungary Russia Croatia Ukraine SlovakiaBulgaria Latvia Lithuania PolandEstonia

4

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-2

-4

-6

-8

f20152014


Why the Disconnect?At the outset, we can see that the region produces 20% of Europe’s GDP, represents around 35% of modern offi ce stock and 50% of its population. However, even accounting for the 50% diff erence in m2 values between CEE and western Europe in general (the discount is much higher compared to the UK, Germany and France), the disconnect between the size of the opportunity and current turnover is apparent.

Investment turnover has closely correlated with positive GDP growth over 2014, and GDP forecasts for 2015 are equally positive so it doesn’t appear to be a GDP issue short-term (outside of Russia and Ukraine, which will be in reverse in 2015). Additionally, the medium-long term growth prospects for the region are robust, arguably more so than in the other more established European markets, which we’ll point out later in the report.

So where is the disconnect?

RelativityTh e CEE region is sometimes perceived – often unfairly – as being riskier than other more established European markets. In addition, the scale, quality and pricing of the opportunities available in CEE markets may not have always whetted the appetite of many a global investor, relative to those available in the more established European markets. But markets and risk-adjusted opportunities are evolving during this current cycle.

Prime Yield Pricing: an advantage for CEE?

A brief review of yields, relative to their previous 2007 peak, shows that a number of locations have already surpassed their prior best. Th e core markets of London, Paris, Munich and

Stockholm, alongside global cities such as Hong Kong and New York, have reached a premium of up to 1.5% (lower) than their previous peak.

A number of other markets aren’t too far off , including Frankfurt, Brussels and Milan, in addition to the core CEE markets of Warsaw and Prague. Further afi eld, we have the more peripheral CEE markets including Bucharest, Sofi a and Dublin, which are at least 100 basis points off their previous peak.

So in terms of yield at this point in the cycle, investment in CEE markets makes more sense than investing in the core markets. Or does it? For some markets, the previous peak probably didn’t make much sense either. Yet for CEE, the peak rates used here reached no lower than 6% outside of Warsaw – which fell to 5.9%. So in this respect, current pricing levels are favourable.

Let’s look at yields from a slightly diff erent perspective i.e. risk-adjusted pricing.

Prime Yield ‘Risk-adjusted Pricing’: An advantage for CEE?

Figure 6 looks at current yield pricing from a risk-adjusted perspective by examining the spread of yields over 10-year national government bonds.

Th e current spread on off er (i.e. year-end 2014 prime yields vs year-end bond rates, although we appreciate that certain government bond rates have changed recently in response to QE), gives us an idea as to which markets off er a solid risk-premium. As we can see, all CEE markets remain above the healthy 3% margin – except for Moscow, which is an exception to the rule under current circumstances.

Fig. 5: Prime Offi ce Yields [2014 vs Previous Peak; %]


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Fig. 4: Offi ce m² Pricing Evolution [2007-2014; €/m²]


2007 2008 2009 2010 2011 2012 2013 2014

Europe CEE

At/below prior peak

At least 100bps above prior peakWithin 100bps of prior peak


But what about ‘exit spreads’? Exit liquidity is something of a concern for the majority of investors, particularly those with a shorter investment horizon of up to fi ve years. Th e right hand part of Fig. 6 illustrates a conservative view of what the yield spread could be in future, based on current yields over a 5-year average bond price. By pricing in an increase in long-term (and therefore short-term) interest rates, it paints a view of how many markets would remain ‘attractive’ buying propositions if government bond yields bounced off their current fl oor. Anything around a 2% spread is relatively positive, anything below is ‘not so good’. In this respect, CEE looks good with Sofi a, Prague, Bucharest and Warsaw featuring in the better positioned markets.

While Czech bond rates are very low, the current ‘exit spread’ over bonds provides capacity for an upward movement in bond pricing, without creating additional pressure on property yields. Conversely, there is the possibility that government bond yields could compress further in Romania, Bulgaria and Poland, giving these markets some extra comfort in terms of their longer-term pricing position.

Th e macro story for the CEE region creates a very positive picture for occupational growth. Th is is an all-important factor for maintaining sustainable bond prices and for driving and sustaining new product (development) and rental levels.

But before we look forwards, let’s review the availability of real estate investment opportunities across Europe, which has had a part to play in why CEE investment volumes have yet to reach their ‘strategic position’ to date.

Scale of Opportunity Th e opportunities which diff erent investors seek are based on a myriad of factors, roughly defi ning investors as core/ core plus, value add or opportunistic. In simplistic terms this boils down to the extent to which each grouping is prepared to move up the risk curve in anticipation of higher returns. While certain markets are deemed core (less risky) and others more opportunistic, this parallel often glosses over the fact that a range of product exists in every market to satisfy these investment risk/return styles.

Across the CEE region, Warsaw and Prague are deemed the core markets, increasingly akin to the likes of Madrid, Berlin, Copenhagen, Amsterdam and Manchester in size and scale. Bucharest, Bratislava, Budapest and Sofi a are one step removed on the risk scale, as are the likes of Belgrade, Zagreb, Riga and Vilnius, as the view becomes more opportunistic.

While Warsaw and Prague have continued to trade solid investment volumes over the last few years, and will continue to do so, the relative position of the other cities has been more challenging, particularly in light of the size and scale of opportunities available elsewhere across Europe. Th is is highlighted by the signifi cant volume of distressed debt and distressed assets which have been made available to, and snapped up by, a range of investors, primarily comprising US private equity.


Fig. 7: 10-Yr Government Bond Yields [%, End 2014]14121086420

Russia

Switzerland

Romania

Hungary

Bulgaria

Poland

USA

Italy

Hong Kong

UK

Spain

Ireland

Austria

Netherlands

Sweden

Denmark

France

Belgium

Germany

Czech Republic

Fig. 6: Yield Spreads vs Bonds [%]: Current Pricing vs Exit Pricing

6 5 4 3 2 1 0 0 1 2 3 4 5 6

Moscow

Hong Kong

London WE

New York C.

Paris

Manchester

Madrid

Munich

Warsaw

Stockholm

Vienna

Budapest

Dublin

Milan

Bucharest

Geneva

Frankfurt

Copenhagen

Brussels

Amsterdam

Prague

Sofi a


-5.1


Th e Evolution of DistressIn the immediate aftermath of the post-Lehman meltdown, it was anticipated that markets would be fl ooded with distressed commercial real estate assets. However, the market has panned- out diff erently from what many expected, as ‘extend and pretend’ became the modus operandi.

Rather than seeing a range of assets fl ooding the market, distressed sales have been carefully managed back into the system as values have recovered. Another key aspect of European distressed sale management is the form of the opportunity. Although the immediate volume of sales post- crisis appeared as single assets, since 2011, sales of debt portfolios by the European banks have been made increasingly available and increasingly dominate the distress scene.

Th is has provided well-capitalised investors with signifi cant, large, lot-size opportunities at discounted prices. An estimated €200 billion of CRE-secured NPLs have been sold to date. Over 50% of of these sales have been at prices at - or less than - 40% of face value. A further 45% of sales have been achieved at discounts of 40-80% of face value.

It is also worth noting that the vast majority of NPL sales to date have been within the UK, German, Irish and Spanish markets. Th ere has been very limited activity in CEE, although this is expected to change going into 2015.

Fig. 9: Domicile of Bank NPL Sales [100%]

UK Ireland Spain Germany

OtherItaly

BelgiumFrance

Portugal


Fig. 10: NPL Discount to Face Value [100%]

80-100% discount

<40% discount 40-80% discount


Fig. 8: European Distressed Sales:Assets and Debt [€ Billions]120

100

80

60

40

20

0

Debt Assests

Fig. 11: CRE Non-Performing Loan ‘Iceberg’


200

100

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-200

-100

-300

-400f2017 f2018 f2019 f20202011 2012 2013 2014 f2015 f2016

2009 2010 2011 2012 2013 2014 f2015

CRE-Secured NPLs: To Be DeleveragedCRE-Secured NPL Sales

9 Research & Forecast Report | Quarter 2013 | Sector | Colliers International

CEE Distressed Sales By comparison, if we look at the size and scope of CEE asset sales over the same period, we get some idea of the diff erence in the scale and scope of the distress opportunity.

Less than €5 billion of distressed assets are known to have been traded since 2009, accounting for less than 7% of all sales over the same period. Th is compares with almost €50 billion across Europe (5% of all sales) and ca. €120 billion in the US (9% of all sales).

In light of this, and the €200 billion of European NPL sales which have been closed, it is unsurprising that investor attention has been elsewhere than CEE, working on the sizeable, low-hanging fruit on off er.

Looking forward, however, PwC research points out that upcoming NPL sales in 2015 will increasingly feature CEE markets as sales derived from Italian and Austrian banks are targeted. Equally, the US opportunity has been on the decline since 2010 – fi rst to react, fi rst to change and adapt - a strategy which brought US investors into Europe in search of the opportunities on off er. So as the market opportunity for distressed sales continues to diminish across Europe, this could see investors shift their intention generally to the CEE region in search of opportunities, particularly those in search of yield.

In summary, distressed sales in CEE have been conspicuous by their absence. In terms of the number/size of deals which have been closed post-crisis, this has reduced the role of CEE in the overall European sphere. On a more positive note, the lack of distressed activity points to CEE being a very robust market in terms of weathering the post-crisis storm. While transparency is still an issue (as it is across many continental European markets), and certain deals may have not been captured, or have been subsumed by the larger NPL pan-European portfolio sales, the robustness of the market is visible.

Th ere is a further positive fl ipside to the process of deleveraging. While debt fi nance is widely available in Poland, the Czech Republic and Slovakia, it is only just making a genuine comeback elsewhere. Th e predicted increase in NPL sales by Austrian and Italian banks will positively impact bank balance sheets, ultimately improving the lending position of banks active in the wider CEE region, albeit not in a uniform manner. Positive change is likely to follow in the order of Romania, Bulgaria, Serbia and Hungary.

Obviously, more debt fi nance at achievable rates, will help realise a wider increase in investor appetite, encouraging investment into the wider CEE region, especially when taking into account the position of markets on the value curve, and the positive macro/ occupational growth story.


Fig. 12: Distressed Asset Sales[2009-2014; € Billion]

Europeex. CEE48,877

USA118,799

CEE4,709

Europe USA CEE


Fig. 13: Distressed Sales Over Time[% of Sales]20

15

10

5

02009 2010 2011 2012 2013 2014


CEE Distressed Sales - In Detail • Th e €1.5 billion sale of the Europolis portfolio to CA

Immo in 2011 constitutes the biggest single distress deal to happen in the CEE market. Th is classifi ed as a multi-country deal given the widespread geography of assets involved in the transaction. Th e remainder of the multi-country deals comprises the more recent Arcapita sale of shares in the P3 logistics platform, acquired by TPG Capital and Ivanhoe in Q4 2013. Arcapita, based in Bahrain, had previously fi led for Chapter 11 bankruptcy protection in New York in 2012.

• Th e Czech Republic, Poland and Romania make up the lion’s share of the single-country deals, accounting for a further 37% of transactions. Th ere have been very few transactions in all the other markets.

• In terms of the source of deals, it would appear that complications with the holding company and/or vehicle holding assets has been the major driver of the need to sell, as opposed to asset specifi c concerns.

• In particular, the liquidation of German open-ended funds (GOEFs) has been a major source of ‘distressed transactions’, accounting for ca. €660 million (15%) of transactions to date, in addition to the Europolis deal. Th e often confl icting needs of retail and institutional investor groups, combined with declining market conditions in the aftermath of the fi nancial crisis, destabilised the GOEF structure. Th is resulted in the loss of 15 funds to liquidation in little over two years.

• Th e majority of these GOEF sales have been transacted in the Czech Republic and Poland – the most active and liquid markets to sell into post-crisis. Based on our analysis of liquidated GOEF funds, a further €1 billion of assets are yet to be sold, although the liquidation dates of these funds stretches out to end-2017.

• Further company-specifi c asset liquidations, including a number of sales by Orco, Dawnay Day Carpathian and Equest Balkan Capital, have amounted to ca. €400 million (10%).

• Banks have been responsible for €110 million of sales transactions, with the likes of Barclays, Sberbank, CIB, Bayer Landesbank and Alpha Bank behind the deals.

• Another bank associated name in the distressed deal schedules is Ektornet, a wholly owned, but independently managed subsidiary of Swedbank. Ektornet established companies in each of the Baltic countries to acquire, manage and sell Swedbank’s distressed assets. It is the most transparent and structured work-out system of the banks in the region, and has resulted in the closing of 10 income-producing investment deals worth around €100 million.

• Collectively, however, bank-derived activity accounts for only 5% of the regional distressed asset sales market. A fi gure far below the one anticipated in 2009, but one which is consistent with the limited number of distressed loan sales witnessed in the region to date.

Our analysis highlights that company/holding structure-specifi c issues have resulted in around 75% of the distressed asset sales that have taken place. Property/asset specifi c issues have only contributed to 25% of such sales to date.


Fig. 14: CEE Sales by Country


Fig. 15: CEE Sales by Source

CompanySpecifi c

Asset Specifi c

Multi Country

RussiaRomania

Poland

CzechRepublic

Estonia

Lithuania

Latvia

Bulgaria

Croatia

Slovakia

Hungary


Value in Values A quick review of capital value movement illustrates the extent to which capital values have changed post-crisis by ‘sub-region’. These are categorised as follows:

• Tier 1 indices include Warsaw, Prague and Bratislava;

• Tier 2 & 3 indices include Budapest, Zagreb, Belgrade, Sofia, Bucharest and Kyiv;

• Russia indices include Moscow and St Petersburg;

• Baltic indices include Tallinn, Riga and Vilnius (this is a much shorter time series, from 2009).

There are some clear differences by sub-region and sector, which we can summarise in the following observations:

Office Values

None of the sub-regions are back to peak capital values. It is unlikely that Russia – notably Moscow – will get back to peak anytime soon, in that it peaked very strongly in 2007 and the market has now taken a turn in the opposite direction.

The Tier 1 and Baltic markets have recovered from their 2009 dip, but remain short of their previous peak level. This is a good, not a bad, thing - as it provides capacity for value growth. In the Tier 2 and 3 markets, the scope for value improvement is even stronger.

Retail Values

As reported in our ‘If I were a Rich Man’ report from 2014, retail values have seen the biggest recovery since 2009. Russia (Moscow) values had already surpassed their previous peak in 2013 before flattening out in 2014. Given the depreciation of the rouble and the sharp increase in interest and internal financing rates, it is impossible to put a figure on where retail values could be, but they are clearly down.

The Baltic markets, albeit running off a shorter time series, are above Tier 1 market values, which have grown steadily post-crisis, but not alarmingly. Prices are close to their previous peak, but some capacity for growth remains, particularly in the prime shopping centres with defensive positions.

Retail consumption and spending in the region is starting to creep back up, which should help sustain the rental side of the equation. This should also be the case in Tier 2/3 markets, which should have hit their value floor in 2014, providing a good opportunity for investors to get involved on the upside.

Industrial Values

Interestingly, all market regions, bar the Baltics, have been very flat post-crisis. None of these markets are close to their previous peak, despite industrial investor activity really picking up in the last couple of years and large deals being closed in Tier 1 locations especially. Aggressive developer strategies have deflated rents, but vacancy in Warsaw and Prague in particular has fallen to much lower levels, which should maintain sustainable rents and drive demand for new product and development. This could also put downward pressure on yields.

In summary, there are no major concerns of the market overheating, with scope for sustainable value growth across the Tier 1, 2 and 3 markets.

This growth story is backed by positive macro fundamentals for the region as a whole, with growth opportunities in modern office and industrial/logistics in particular.

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Figure 16: Weighted Capital-Value Indices


2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

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Tier 2&3Tier 1 Russia Baltics







Th e Macro StoryPoland, the UK, Switzerland and Austria are arguably the strongest growing economies across Europe. Outside of Ukraine and Russia, the remainder of CEE is also fi rmly back on track, with positive GDP growth forecast for 2015, ahead of GDP growth witnessed in 2014.

Cyclical vs Structural GrowthAcross Europe, a patchy economic recovery is underway, but it continues to be undermined by being a relatively ‘jobless’ recovery. Th e CEE region, however, will continue to benefi t from a number of other structural growth drivers, which will continue to increase occupational demand in the offi ce and industrial/logistics sectors in particular.

Offi ce Demand: Off shoring & Outsourcing (O&O) GrowthOur analysis of offi ce demand across major cities in the region highlights that there has been very strong demand for offi ce space from the O&O sector since 2010. Following the early phase of growth up to ‘pre-crisis’ times, the sector has grown by 80% in terms of the volume of offi ce space occupied over a four- year period. Not only has there been strong demand from new companies wishing to enter the regional O&O market – at least 200 new companies have set up operations since 2010 - there is also evidence of a maturation of the sector, with a large number of established operators having expanded their footprint across a wider geographical area.

Th is is a refl ection of the strong depth of skills and experience available in these markets which is allowing existing companies to evolve their service off ering to provide higher value-added functions. In turn, this is attracting more new companies to the region.

When compared with the donor markets of western Europe and OECD countries, the CEE region exhibits much lower labour costs – McKinsey research highlights that the average hourly wage in core-CEE markets is 75% less than in the EU-15; in Bulgaria and Romania it is 90% lower (and lower than China). While this is a major part of the initial attraction for new companies viewing the region as a base for operations, once a business is established, further expansion is based on the quality and depth of the talent pool: the most active locations are also the most expensive.

In total, an estimated 400,000 jobs have been brought to the region via the O&O sector. Th is is not a short-term, cost-saving venture and prospects for future growth look very healthy.

Across Europe, a patchy economic recovery is underway, but it continues to be undermined by being a relatively ‘jobless’ recovery. Th e CEE region, however, will continue to benefi t from a number of other structural growth drivers, which will continue to increase occupational demand in the offi ce and industrial/logistics sectors in particular.

Source: Moody’s Analytics / Colliers International

Fig. 17: Economic Growth Position 2015

Expansion

Recovery

Stagnant

Recessionary


Firstly, our analysis of O&O companies located in CEE shows that only 30% of the top 100 global outsourcing companies are already here. Th is suggests a strong growth opportunity to capture some of the remaining 70%.

Secondly, the CEE region now stands ahead of other globally competitive O&O regions in terms of the World Bank ‘Ease of Doing Business’ rankings. In addition to providing a strong cultural fi t with established OECD countries, there is increasing impetus for O&O companies to build true partnerships with customers that sustain their culture and brand. We are likely to see existing operations evolve to provide much more advanced combinations of ‘software and service’, using web/cloud platform-based solutions for services that depend on judgement and analysis, rather than simply process or transactional-based activities.

With an estimated 1.4 million jobs yet to be outsourced from Europe and US headquartered locations, according to research by Hackett Group, the CEE region could continue to absorb a sizeable proportion of these jobs. Based on the volume of jobs outsourced to date, attracting 20% of this fi gure is not unreasonable, which could translate into 280,000 new jobs by 2025. At 10 m² per person, that’s an additional 2,800,000 m² offi ce requirement.

Public-sector-oriented O&O services is another untapped market. We have also seen signs of O&O growth in the retail and logistics sectors - a direct result of growth in e-retailing and e-commerce. Given the vast scope for the evolution of this business regionally, not to mention globally, this is a defi nitive growth area for the regional industry to service – not just in terms of demand for offi ce space.

Source: World Bank/ Colliers International

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h o

f Leg

al In

stit

uti

ons

OECD high income

30.

Latin America&Caribbean

100.East Asia&Pacifi c89.

Sub-Saharan Africa

142.

South Asia120.

Eastern Europe& CIS

71.

No. of Economies

Av. Rank “Ease of Doing Business”

Middle East&North Africa

106.

Fig. 18: Doing Business Regimes‘Simple & Cost Eff ective’ vs ‘Complex & Expensive’

Fig. 19: Outsourcing & Off shoring Job Growth


8.5

6.5

4.5

2.5

02009 2010 2011 2012 2013 2014 f2015 f2016 f20172002 2003 2004 2005 2006 2007 2008

Technology

Outsourced in CEE

Outsourced

To be Outsourced

Not Outsourceable


Fig. 20: Industrial & Logistics Growth Drivers


Pan -EuropeanDistribution

Retail &E-commerce

Best-shoringManufacturing

Inter/ Multi-modalFreight Networks

More Industrial & Logistic

Space Required

Industrial and Logistics Demand: There are four areas of significant growth for the CEE region, bringing with it an increase in occupier demand for industrial and logistics space. The European industrial and logistics market is diversifying and becoming more complex in response to changing demand, improved transportation networks and dynamic technologies.

The movement of freight still centres itself within the hubs of the ‘Golden Triangle’ in the UK, and the continental ‘blue banana’ of Benelux, western Germany, France and the northern part of Italy, but the concentration of activity is also increasing across the top of northern and central Europe into Poland, the Czech Republic and Slovakia. We are also seeing distribution volumes grow in Russia, with activity shifting further east from Moscow.

While the extent of this growth is underpinned by expanding trade, improved infrastructure, time sensitivity and cost, the increase in the number of logistics operators specialising in intermodal/ multimodal transport in CEE suggests an ongoing structural shift in freight distribution is taking place.

Intermodal freight and logistics operators have become a significant driver of demand in CEE, with pan- European operators seeking economies of scale in the main logistics hubs of the Czech Republic and Poland. Western Slovakia will be one market to watch moving forward. Russia, still chiefly an internal market, is quickly developing its own large-scale intermodal/ multimodal network driven by retail and domestic e-commerce fulfilment demand.

It is not only in Russia where the rise of online retailing is beginning to filter through to the logistics sector. In the core CEE logistics markets, take-up from e-commerce occupiers has increased fourfold in the last three years, especially in Poland and the Czech Republic.

As well as expanding locations, there is increasing evidence of ‘hub and spoke’ distribution models taking shape. Hubs are getting bigger, with e-commerce occupiers dominating take-up of larger facilities (40,000 m²), particularly in the Czech and Polish markets. Yet the spoke components are still developing, a likely outcome of which is the growth of ‘last mile’ facilities - i.e. the demand for smaller, urban e-fulfilment operations.

Manufacturing is also undergoing a renaissance across the entire CEE region. This is driving demand not only in the traditional markets of Poland and the Czech Republic, but also for new facilities in Hungary and Serbia. Russia is working on localising its manufacturing and production and creating a base for domestic and foreign companies alike.

In summary, the industrial and logistics market is developing rapidly and we are just beginning to see the impact on the demand for ‘hub and spoke’ facilities, and new forms of freight and transportation modes. The positive effects on the market through further growth in logistics, manufacturing and retailing demand will continue to revolutionise the CEE markets in the short and long-term, providing investment opportunities for an increasingly popular global market sector.





Fig. 21: CEE Number of Investors: Foreign vs Local


250

200

150

100

50

02009 2010 2011 2012 2013 20142002 2003 2004 2005 2006 2007 20082000 2001

ForeignLocal

Conclusion: Th e Exit StrategyInvestor demand has reached unprecedented levels on a global and European scale. As quantitative easing and low interest rates continue to drive this boom, investors are being faced with a dilemma.

Distressed opportunities are diminishing across Europe, and prime core product pricing has fallen in a number of markets to below the previous 2007 peak. Th is is making many an investor shift their attentions up the risk curve in terms of both product type and geography. However, uncertainty over economic growth, political discontent, the recent Russia/Ukraine crisis and the threat of terrorism are putting extra emphasis on investors’ needs for a clear ‘exit strategy’.

One interesting observation from our analysis of CEE investment activity in recent years is that European (and global) institutions are returning to CEE markets, having got their houses in order as a result of the new EU banking and fi nancial regulations. Austria may no longer be the driving force in EE investment, though it is picking up. Germany and the UK have been consistent players and 2014 saw their highest level of investment yet. US players have also seen a recovery, though how much of this is down to fundamentals and how much to currency is not yet clear. In addition to these overseas players, the likes of NEPI and CPI – essentially locally based and/or controlled investors - have become far more dominant, just as a more diverse range of local investors have become increasingly involved in the markets of the region.

It is also worth noting that debt is becoming increasingly available, even though its supply is patchy across the region. As bank deleveraging continues in the years ahead, it will bring greater capacity to markets outside of Poland, the Czech Republic and Slovakia. Equally, although alternative lending sources are yet to signifi cantly impact lending across Europe, they are becoming increasingly exposed to Germany. Th is will have a positive indirect knock-on impact on CEE markets in due course.

New development, driven by demand for new industrial/ logistics and e-fulfi lment space, alongside the demand for offi ces to satisfy outsourcing growth, will help drive the volume of standing institutional grade assets. Alternatively, the redevelopment and refurbishment of existing, ‘obsolete’ assets for residential, healthcare and leisure use will also drive new investable product. Further down the line, new infrastructure development – such as the development of multi-modal industrial parks and facilities - off ers a key way forward. Some cities still lack modern infrastructure, be it eff ective modern public transport and mass transit systems, or improvements to road networks and motorways. As this infrastructure is planned, there is scope for investors to become involved in the delivery of such important new infrastructure. As it is built and delivered, the overall attractiveness of CEE towns and cities to occupiers and investors will also improve. Exit is relative. For those with a long-term view, buying into well-priced product with a strong macro-story in CEE markets is a strong argument. Whether it is strong enough to tempt investors away from relatively expensive, safe-haven investments remains to be seen, but the CEE option could create a more attractive exit option in time, as more investors continue to engage the market.

About Colliers International

Colliers International is a global leader in commercial real estate services, with over 15,800 professionals operating out of more than 485 offices in 63 countries. A subsidiary of FirstService Corporation, Colliers International delivers a full range of services to real estate users, owners and investors worldwide, including global corporate solutions, brokerage, property and asset management, hotel investment sales and consulting, valuation, consulting and appraisal services, mortgage banking and insightful research. The latest annual survey by the Lipsey Company ranked Colliers International as the second-most recognized commercial real estate firm in the world.

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Copyright © 2015 Colliers International.

The information contained herein has been obtained from sources deemed reliable. While every reasonable effort has been made to ensure its accuracy, we cannot guarantee it. No responsibility is assumed for any inaccuracies. Readers are encouraged to consult their professional advisors prior to acting on any of the material contained in this report.

Damian HarringtonRegional Director Research | EE +358 400 907 972 [email protected]

Neil CrookResearch Consultant | EE+48 666 819 [email protected]

Katy DeanSenior Regional Research Analyst | EE+420 226 537 [email protected]

Juliane PriesemeisterRegional Research Analyst | EE+420 226 537 [email protected]

Colliers International | Eastern Europe




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