Property investors look beyond central and eastern Europe's capital cities

Judging by the number of cranes and construction sites dotting the sides of Warsaw's main commercial street, it is easy to see how the city was the fourth most active office development market in Europe last year after London, Paris and Moscow.

One of the unfinished buildings is already celebrating having signed a blue-chip tenant: Deloitte.

The catch?

The financial services advisory firm is moving from the other side of the road.

There has been a rash of sparkling new buildings stealing tenants from slightly older versions that three years earlier were the toast of the city. But analysts agree the cannibalisation cannot last for ever.

Central and eastern Europe's property market has been hit by a wall of capital that has surged out of the US, Asia and western Europe, thanks to a heady blend of quantitative easing by central banks, a hunt for decent yields and a widespread shift to property investments by global pension funds.

Investment in central and eastern European property surged 25 per cent last year to €7.8bn, according to JLL, a property services company, flooding leading markets such as Warsaw, the prime location in the region.

"There is loads and loads of money coming in," says Hadley Dean, managing partner for eastern Europe at Colliers International, a property advisory company.

"And it is all desperate to find a home," he adds.

How that money is changing investment cycles and spending patterns in the region is the key question for the industry's developers, investors, tenants and analysts.

And it is not only the prime locations that are benefiting.

Surging inflows have disproportionately boosted smaller markets in the region, with a 52 per cent jump in Czech Republic investments last year. Romanian investment more than trebled, while Hungary's market had its best year since 2007, according to JLL.

That trend is likely to continue.

Warsaw, for a few years the market of choice for both established local players and international investors looking to dip their toes into the wider regional market, is beginning to show signs of overheating.

The vacancy rate for office space in the Polish capital was 13.5 per cent in 2014, up from 9 per cent in 2012, and is expected to touch 17 per cent by the end of this year, according to research by Erste Group Immorent, the property arm of Austria's Erste Group.

Deloitte's move across the city's Jana Pawla II Avenue is one of many big tenancy deals this year that have merely moved rental income from one building to another.

And as the money flow shows no sign of slowing, developers are betting that as appetite for Warsaw cools, capital will spread further around the region.

"There will be a halt, or a slowdown in current projects," says Tomasz Trzoslo, managing director at JLL Poland.

"Investors might be more willing to do the business elsewhere. We already see that some investors are more keen to look at not only Polish regional cities, but also other capital cities in the region."

Quantitative easing policies by US, European, Japanese and British central banks spooked by the threat of stagnant growth have slashed funding costs and dumped huge amounts of capital on to investment balance sheets.

That has widened the audience for non-traditional assets such as central and eastern European property, bringing a more diverse group of buyers to the region.

And the fundamentals are strong. As the eurozone flirts with recession, leading central and eastern economies, excluding Ukraine, are expected to grow by between 2 and 3.5 per cent a year for the next two years, according to the International Monetary Fund.

Last year, Starwood Capital, a private equity group, snapped up two main properties in Warsaw; Lone Star spent €160m on a 28 per cent stake in regional player Globe Trade Centre; and Blackstone bought a Polish logistics portfolio from Standard Life for €118m.

The trend of non-traditional investors entering the region should continue. Robert Martin, principal at Europa Capital, a London-based property fund manager, notes that pension funds and Asian and Middle Eastern investors are taking far more interest in the market.

Arpad Torok, chief executive of TriGranit Development, a Hungarian developer, expects "another three to five years [of significant inflows] in this region. There is more money in the global funds, the US funds, than ever before."

He adds: "They need to spend; they want to spend. What else are they going to do with the money? I am not saying this is a smart strategy, but it does provide a certain push to these markets."

Many global investors or developers have used Warsaw as a regional starting point over the past five years, and the surge in capital availability comes at the same time as a rising level of confidence among them to look further across the region.

"A lot of what investors in this space look for is scale. And Poland is the only place in the region that gives you that," says Collier's Mr Dean. "People are hoping that there are another three years of the cycle [left in Warsaw], but I think the smart money is spreading out elsewhere."

An anti-corruption push in Romania bears hallmarks of one enacted in Poland a decade ago that helped spur growth in the sector, while rising transparency in countries such as Serbia and Bulgaria is bringing southeastern Europe closer to the standards expected in more mature markets.

Meanwhile a $4bn deal for an Abu Dhabi investor to regenerate Belgrade's eastern Sava riverbank is expected to spark further interest in the Serbian capital.

Further, the continuing skirmishes between Russia and Ukraine mean that, for many, those markets are on hold - or forgotten.

"The traditional funds are quite obviously looking further afield for increased returns," says Mr Dean. "The question is how far south this wave of money coming over the ocean is going to go after Poland. It is definitely not going to go east."

Many developers, investors and market analysts agree that 2015 could be the year when Romania steps up as a serious market in the region.

Like Poland, it hopes that a handful of second-tier cities outside its capital can attract significant investor interest, and it can continue to expand its business process outsourcing (BPO) industry.

The growth in Poland's BPO industry, which shows no signs of slowing, has been a huge boon for both office developers and regional city mayors. Thanks mainly to the BPO industry, Wroclaw and Krakow had more office space under construction at the end of 2014 than the whole of Hungary, according to JLL data.

"The markets that have been treated unfairly, let's say, for the past two or three years, will benefit from the overflow of global capital," says TriGranit's Mr Torok. "And if you look at the quality of assets in Budapest and Warsaw, frankly there is no difference.

"All the other countries will benefit because they provide more attractive yields."

. . .

Look abroad: Local groups expand beyond the region

When Marcel Sedlak arrived in London three years ago looking for potential projects for HB Reavis, the Slovakian property developer, the agents and advisers he met raised their eyebrows and looked quizzical. "They were like: 'Are you serious?' 'Do you know what you are doing?'" recalls Mr Sedlak, now a director at HB Reavis.

Today, that scepticism looks misplaced. HB Reavis, which has two projects under way in the city, will officially open the doors on its first completion, on the north end of London Bridge, next year.

That opening will mark a new chapter for the company, which is part of a growing cohort of central and eastern European property developers that are leveraging domestic dominance to expand outside the region, turning the previously accepted investment story of cash flow from west to east on its head.

"There is an element of prestige about the decision [to develop in London], but it makes business sense," says Mr Sedlak. "We are becoming more and more respected in the London market. But we know that we need to prove ourselves and deliver."

The boom in central and eastern Europe's property market over the past decade has attracted finance from across the globe, resulting in a surge of business for local companies. Now, as domestic markets become more crowded, they are looking further afield.

Alongside HB Reavis, developers such as Hungary's TriGranit, CPI in the Czech Republic, Echo Investment and Capital Park in Poland and Ukraine's Dragon Capital have outgrown their home markets.

"TriGranit very quickly realised that it needed to go regional," says Arpad Torok, chief executive. "We went through the learning curve a bit faster than our western European peers. So, in the past 15-20-year period, we have realised more projects and in more countries, getting accustomed to different legislations, different requirements, different markets. We have been forced to work in 10, 15 countries in parallel.

"So we are more flexible and quicker learners, but deliver what has been delivered in western Europe for the past 50-60 years."

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