Bettering the West

Nathan North, Eurobuild CEE: The projected investment volumes for this year are lower than for the last two. Does this reflect a slowdown in Poland and the CEE region or a global trend?

Sean Doyle, head of capitals markets, CBRE Poland: One reason for this is that over the last two years, volumes were inflated by large retail portfolio and logistics platform deals. However, in terms of the number of transactions, this year will exceed both 2018 and 2017. Poland is now viewed as a core market by global capital. Ultimately, it is the strong economy and the occupational market fundamentals across sectors that are really encouraging investment in Poland. In recent years logistics has been a consistently strong performer but it is with Warsaw office that we are seeing a real spike in investment volumes. Over the last three years the annual net office absorption for Warsaw office has averaged around 350,000 sqm, while in 2018 it was 375,000 sqm. This places it alongside London and Paris among the highest on the continent. What we are now seeing for the first time is a wider pool of investors studying the local market and making offers.

And who might these investors be?

In the industrial and logistics market, investors from just about every corner of the world are active in the Polish market. With regards to office, there has been strong interest from Asian investors, in particular those from South Korea, Singapore and Malaysia. A number of German investors who had been less active in the Polish market due to vacancy concerns are now comfortable with the improving occupational dynamics – in terms of falling vacancy rates and rising rents. This is one of the reasons for the significant yield compression over the last twelve months into the low to mid 4s.If we rewind back to 2016, there were only a few core office transactions on the Warsaw market, which is very different to the situation today, when we have 15–20 deals a year and multiple bidders. This shows how much deeper the investor pool is now and how Warsaw is viewed as a core market. However, even at these cap rates Warsaw still represents good value compared to certain ‘low growth’ Western European markets where yield levels in the mid 2s to low 3s are common. In the coming months and years, I expect we will see CE capital take an increasing share in office investment volumes.

Are you not worried at all about how all the office towers now being built in Warsaw are going to be filled – and that large levels of vacancy could have an impact on investment?

I’m not concerned about Warsaw occupancy levels at all. 750,000 sqm is due to be delivered over the next three years, but already a large percentage of this has been pre-leased or is in an advanced stage of negotiations. I’m actually more worried about there being a shortage of space given the large requirements in the market that will inevitably fill the few remaining developments that are not already pre-let. Between 2014 and Q4 2016, Warsaw city centre vacancy rates fluctuated at around 15 pct. Since then they have been falling and as of today, centrally located vacancy stands at 5.5 pct and even lower in class ‘A’ buildings. Likewise, Mokotów, where vacancy reached a high of almost 20 pct in 2016, has seen vacancy fall to 13.7 pct. When we have seen these dynamics in markets like Berlin, Amsterdam and the City of London, the subsequent rental growth has soon been followed by sharp yield compression. I anticipate we will see continued yield compression and even larger volumes trading due to large tower deals and the recovery of Mokotów. The yield gap between the city centre and Mokotów, where yields are still 6.5–7 pct and capital values below EUR 3,000 per sqm, has been opening investors’ eyes to the opportunities there.

So how does Warsaw compare to Polish regional cities and other capitals in the CEE region? Are we also seeing the same yield compression there?

Yes, we’ve also witnessed similar yield compression in Prague, Budapest and Bratislava. In particular, Prague has already seen transactions in the high 3s. However, total investment volumes in these markets are smaller on account of the limited opportunities available – which isn’t the case for Warsaw. Polish regional markets are also registering record performances. Yields have compressed to the mid 5s, due in large part to record tenant demand across the country. The strong occupational activity in the capital is being mirrored in cities, such as Kraków, Wrocław, Łódź, Gdańsk, Poznań and Katowice in particular. Across the eight largest regional markets, the net office absorption in 2018 totalled around 520,000 sqm. Kraków, Wrocław and especially the TriCity had office net absorption larger than many European capitals. Long leased logistics yields have compressed to the low 4s while multi-let portfolios are now trading in the 5s. Given the upward pressure on rents we expect further yield compression in this sector.

Isn’t Poland in a sense weird, in that so little investment – about 1 pct – is from domestic sources? Is this set to change any time soon? And if it doesn’t, could it be a real problem if the downturn some are predicting actually happens?

Well, around 4–5 years ago, American investors were playing the leading role in investment volumes in Poland, while 6–7 years ago it was German and Austrian investors. But we anticipate that from 2020 onwards it will be Central European capital that dominates – specifically Czech, Hungarian and Slovakian capital. It’s a standard thing across Europe for about 30–40 pct of the volume to be domestic in source, and so the countries I’ve just mentioned are not weird in that respect, rather they are more the norm. It is unusual that Polish banks, insurance companies and pension funds don’t have larger real estate allocations, given they’re actually on the ground here. The hope is that in the future this will increase and, potentially, the establishment of REITs that can invest in commercial real estate will also give the market some extra liquidity. Yet we are beginning to see private investors increase in numbers and there are funds being set up already, so we expect this will give the market increased depth. Maybe an opportunity was missed 2–3 years ago for Polish capital to make a real statement, when we were at the bottom of the rental cycle and the pricing was at 5–6 pct. However, the strength of the occupational markets in office and logistics and the rental growth in those sectors means there are still massive opportunities in the market here. Likewise we feel retail is being mis-priced at the moment and there are huge opportunities there.

And how scared are you that the ‘retail apocalypse’ will spread here from across the Atlantic and put a severe dent in transaction volumes?

Well, in 2018 the Polish retail investment volume, EUR 2.5 bln, was more than double that of the UK – however, four transactions accounted for a big chunk of that. Also, we are not seeing the same level of bankruptcies in retail as we are in the US or Western Europe, although the absence of high street retail and the generally lower saturation levels here is one reason for this. In Poland there is about 0.7 sqm per person compared to 4.5 sqm in the US. Across Europe the average is about 1.3–1.5 sqm. The US simply built too much retail. Here first generation shopping centres are still doing well, places where people were first able to do such shopping and continue to do so. Second and third generation malls in city centres and retail parks on the main arteries are still performing incredibly well. So we are simply not going through the crisis that is taking place in the US. It has, however, generated a certain negative sentiment towards retail, dampening the demand for such products – and that’s why we’ve been seeing fewer transactions. Added to this, the Sunday trade ban and even the proposed ‘congestion tax’ on large retail properties has caused nervousness. However, certain policies, such as the 500+ family allowance, have in fact boosted retail consumption in smaller towns. But the growth of e-commerce and online shopping is naturally having an additional impact

So if there has been less investment in retail, how about in alternative asset classes? Are these more niche markets now maturing in Poland and how much potential do they have?

There has been a growth in volumes in alternative asset classes – in hotels, PRS, student and senior housing – which is another indicator of how Poland is maturing as an investment market. With the exception of Germany and the Netherlands, most Western European countries had very small PRS markets, accounting for around 5–10 pct of the investment volume, but this has now grown to 25–30 pct. As the Polish economy continues to boom, the GDP growth and rising salaries will inevitably lead to an increase in rents and rental value. Almost 900,000 sqm of office space was taken up in the big Polish cities last year – and this translates into 100,000 new jobs. So people are heading into the cities to take up these jobs, leading to a very healthy residential market. The multifamily, private rental sector, in particular, has huge potential. Last year we saw record investment volumes in hotels and we expect 2020 will eclipse all previous years. The student and senior housing markets are also growing rapidly from a very low base.

In the past people said that PRS could never take off here because no one could afford it. What’s changed? Is it just the amount of money they have to spend?

There has been a generational shift in attitudes to renting. Generation Z and even younger millennials are more averse to burdening themselves with mortgages and are less likely to put down roots at a young age. Also, as mentioned previously, salaries are rising and employees are becoming more open to relocating and an increasing number of jobs, and this is encouraging and facilitating remote working – meaning that people can move around. All of this is underpinning the rental market growth across Poland. However, large amounts of private Polish money was invested in rental apartments, which will represent limited competition for PRS as these owners rent them out. However, they are unlikely to be able to compete with large, well-managed PRS facilities and we are already witnessing the private investor trend slow. The sharp rise in resi prices has meant that it makes more sense for developers to sell individual flats rather than do block deals for whole buildings – thus we anticipate huge growth in this market.

So how likely is this downturn that many people have been predicting? Is Poland going to be somewhat insulated from it, as it was the last time?

In the last downturn what we saw happening first was that logistics and industrial funds moved from the West to Poland as part of their cost-cutting measures, capitalising on Poland and the CEE region’s strategic position, low costs and skilled workforce. Later we saw BPOs being set up in regional cities as IT and financial companies grew their footprint here. But there are certain factors that we can’t ignore. Our economy is very much linked to that of our closest neighbour to the west. So a downturn in Germany will certainly not help us. Industrial output is already down in Poland. The automotive sector, for example, has recently experienced an 11 pct y-o-y drop in production. The global economy is heading for a downturn, so there will be a slowdown in Poland – but not to the same extent as in previous recessions. We still have a booming economy – and Warsaw in particular has the potential to be the Singapore of Europe with the large influx of new occupiers and booming IT and tech sectors, assuming that the occupational activity will remain strong. In 2007/8, Poland was still regarded as Eastern European and there was genuine concern in Poland over the amount of office towers that were then planned – but now Poland is regarded as a developed economy and even now we still probably don’t have enough pipeline office supply to meet the requirements of the market.

Then should we, paradoxically, be praying for a downturn?

Any downturn would have a negative impact on investment volumes – but we are clearly benefiting from the uncertainty surrounding Brexit: financial institutions have been moving certain operations from London to such places as Frankfurt. Dublin and Warsaw. Similarly, certain investors who were buying in the UK are now turning their attentions to Poland due to the nervousness around Brexit. Many investors are being priced out of France and Germany or finding it hard to justify investment in other ‘low growth’ markets. Poland showed amazing resilience in the last downturn, so irrespective of what happens I’m fairly certain we will weather the storm well once more.

Are there no clouds at all on the horizon for the investment market, then?

Thankfully, not too many. The low unemployment and labour shortages could be an issue, but Poland is benefiting from immigration, so people from an ever expanding geography are making Poland their home, which can only be a good thing. As the economy continues to boom, it also becomes more attractive to Poles living abroad and they are returning home with new energy and ideas. The lack of clarity around tax structuring did slow the market a couple of years ago, but this appears to have settled. I’ll refrain from commenting on politics, but stability and maintaining good relationships with our EU friends will always be good for business. Finally, environmental issues and sustainability should dictate the plans of city authorities, developers, investors and, crucially, governments across Europe to ensure the long term health of the markets, the economy and their citizens.

From Frisco to first place

Sean is the head of capital markets at CBRE Poland, covering office, retail, industrial, residential, hotels and alternative sectors. He started his career in San Francisco before moving to London and eventually Poland, where he has been for 14 years. He has led CBRE to its current number one position on the Polish market in recent years, transacting over EUR 12 bln.