cite aq · cite aq allocator quarterly q1 2019. trends in central and south east european real...

CITE AQA L L O C A T O R Q U A R T E R L Y Q 1 2 0 1 9

TRENDS IN CENTRAL AND SOUTH EAST EUROPEAN REAL ESTATEMillennials and their preferences are among the main driving forces behind some of the trends we observe in property markets across the world, eg trends to favour flexible office space with a community feel, as well as trends for communal living. Central and South East-ern Europe are no exception to the emergence of these phenomena and real estate investors need to be aware of these when considering the region as a potential target for investment.

CO-WORKING SPACE IS CATCHING ON IN CEE AND SEE

Despite recently negative headlines, co-working has ex-perienced strong growth in the last few years, and its geo-graphical reach now includes countries, such as Poland, Czech Republic and Romania, outside the traditional fo-cus of real estate investors.

EMERGENCE OF THE “NEW PRIVATE RENTED SECTOR” IN CEE AND SEE

Institutional investors have not traditionally considered PRS in the region to be an investable market segment, only focusing on commercial, industrial and logistics. Shifts in the market suggest that a new version of the PRS concept has emerged in CEE and SEE.

2 | CITE Allocator Quarterly

This AQ focuses on developments in the office and residential segments of the real estate markets in Central and South Eastern Europe. We invite our readers to

consider new investment options available in these markets, driven partly by the emergence of the millennial generation in the region.

CONTENTOF THE QUARTER

NOTE FROM THE CIO 03CO-WORKING OFFICE SPACE TRENDS

IN CENTRAL AND SOUTH EASTERN EUROPE04

DISCLAIMER 24

NOTE FROM THE CIO

Cover: Modern residential building in Poland / Shutterstock by sashk0

DEVELOPMENT OF THE “NEW PRIVATE RENTED SECTOR” IN CENTRAL AND SOUTH EASTERN EUROPE

16

Real estate has long been considered an estab-lished investment asset class, part of alternative investments alongside hedge funds and commod-ities, and often an important element of institu-tional investors’ portfolios. While investing in real estate in the US and Western European markets has been very popular, especially in the extremely low interest rate environment of the last decade, real estate in the Emerging and Frontier Markets has been considered a more marginal investment proposition. Indeed, as far as Emerging Markets

are concerned, investors tend not to venture fur-ther than equities and EM debt, which together typically make up the bulk of the EM allocation in an institutional portfolio.

However, real estate can often be a viable alterna-tive to gain exposure to high-growth economies and use of the leverage element inherent to real estate investing, even at conservative levels, can make a significant contribution to total returns potentially available from this type of investment.

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The significant fund flows that have been ab-sorbed by Western European real estate since the Global Financial Crisis, compressing yields to record low levels, seem to have only selectively benefited a handful of Central European property markets. Some of the high-growth South East Eu-ropean markets have gone largely unnoticed by real estate investors, despite strong fundamentals and booming economies. In our Allocator Quar-terly from Q3 2018, we discuss in more detail the fundamentals of economies such as Romania and Bulgaria in some detail1, and venture to suggest that investing in real estate in the South East Euro-pean region may be a viable alternative to gaining exposure to these vibrant economies.

It is also worth noting that in 2018 Romania came close to being upgraded from a Frontier Market to an Emerging Market by index providers2, sug-gesting that its markets in general may begin to benefit from a higher level of investor interest go-ing forward.

One of the main reasons why investors may not look at Central and South Eastern Europe closely as a viable source of real estate exposure is lack of knowledge of the regional real estate markets and understanding where opportunities may actually lie. Those investors who attempted to participate in these markets in the past may have entered at the peak of the global boom in 2007-2008, prior to the GFC, and have obviously suffered dispro-portionately as hot money vacated the region en-tirely in the years that followed. Also, strategies involving chasing prime assets, or focusing on very large luxury residential developments did not fare well in the extreme cycle, as such assets may have been out of sync with the needs of the local population.

ANJELIKA KLAMPManaging Director

For an investor, willing to take a second look at the Central and South East European region to-day, there is a case in selectively examining cer-tain real estate segments in the region, as some institutional investors have already begun to do in the last few years. These include a number of specialist companies who raised their funds via capital markets3, and have been among the first institutional investors to return to these markets post GFC.

And as far as understanding the real estate op-portunity in the region, unsurprisingly it is not too dissimilar to what investors are used to expect in more established markets. To illustrate the point, in this edition of CITE Allocator Quarterly, we dis-cuss two trends observed in Central and South East European real estate markets:

• the increasing use of co-working spaces in capital cities in Central and South East Euro-pean region, and the related need for inves-tors to consider this trend when evaluating office space investment opportunities;

• the emergence of the new version of the “Pri-vate Rented Sector” in the region, and the new opportunities it may create for investors wishing to gain exposure to the region’s eco-nomic growth.

We hope to hear from any of our readers with whom these topics resonate and who would like more information on any of these trends and re-lated research.

Greetings from the team,

1. https://citeinvestments.com/wp-content/uploads/CITE-AQ-Q3-2018.pdf

2. http://emergingmarkets.blog.franklintempleton.com/2018/08/02/frontier-market-romania/

3. https://www.globalworth.com/about-us/company-overview


CO-WORKING OFFICE SPACE TRENDS IN CENTRAL AND SOUTH EASTERN EUROPE

In the last decade the use of flexible office space has expe-rienced fast-paced growth globally, and the modern version of the concept, i.e. co-working, has revolutionized the tradi-tional serviced office market since the entry of WeWork in 2010 (recently rebranded as The We Company1).

Within the space of a few years, WeWork has grown to oper-ate in excess of 500 office locations across 97 cities globally2, and as of November 2018 was valued by its investors at US$ 42 billion3.

A plethora of other new entrants have also joined the market, spurred on by the momentum generated by WeWork with its revamped flexible office space concept. Cushman and Wakefield estimate “that there are over 200 co-working com-panies [in the US alone], operating at least one location4”.

A number of larger participants operate multiple locations, among which are Premier Business Centres, Carr, Knotel and Davinci in the US, and The Office Group and i2 Office in the UK. Even traditional participants such as the International Workplace Group (IWG, former Regus), who have operated in the flexible office space market since 1989, are embrac-ing the co-working trend with the launch of its Spaces brand.

Despite the buzz around some of the larger companies of-fering co-working space, the percentage of total office inven-tory occupied by such spaces remains modest. According to C&W, as of August 2018 co-working space accounted for only around 1% of total office inventory in the US, although it tends to be higher at around 3%-5% in some larger US cities4.

In central London, which is considered to have one of the

1. https://www.theguardian.com/business/2019/jan/08/loss-making-wework-rebrands-to-the-we-company2. https://www.wework.com/locations3. https://www.bloomberg.com/news/articles/2018-11-13/softbank-commits-another-3-billion-to-wework4. Cushman&Wakefield,“Co-workingandFlexibleOfficeSpace–AdditiveorDisruptivetotheOfficeMarket?”,August

2018,http://www.cushmanwakefield.us/en/research-and-insight/2018/co-working-report

Above:CoworkingOfficeGroup/ShutterstockbyProStockStudioOpposite:ModernofficebuildinginBucharest,Romania/ShutterstockbyRaduBercan

TEN LARGEST TAKERS OF NEW OFFICE SPACE,LONDON, 2012-2017


more established flexible office space markets, flexible office space was estimated to account for around 4% of total office inventory5. This sets the benchmark for other places of how large the market share of flexible office space could become over time.

In fact, C&W numbers show that in London between 2012 and 2017 four out of 10 largest takers of new space were flexible office space providers, accounting for just over 50% of surface taken up by the top 10 new lessees5. WeWork fig-ured as by far the largest taker of new space during the pe-riod, on its own taking up 2,577,864 square feet of space, with The Office Group in fifth place only behind the likes of Google, Amazon and Deutsche Bank.

Further, C&W estimate that in some markets, such as Lon-don, the share of flexible office space could grow to as high as 10% of total office stock by 2030, given long-term socio-economic trends and the evolution of how office space is increasingly viewed by larger companies as part of their em-ployee retention strategy. Indeed, co-working space provid-ers increasingly target their marketing at larger companies, encouraging them to use flexible working space as a supple-ment to their main office space, in order to allow their em-ployees flexibility in where and how they work.

In fact, C&W argue that the recent growth experienced by flexible office space in many markets, such as London, has been rather constrained by capacity, and the real estate sec-tor’s ability to offer space to the segment5. Going forward,

Source:datafromCushman&WakefieldResearch&Insight5,chartpreparedbyCITEInvestments

PROFESSIONAL STATUS OF COWORKING MEMBERS

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more developments are needed so that flexible office space operators are able to pre-let space ahead of completion to ensure they get access to the amount of floorspace required.

Confirming C&W’s assessment, Knight Frank also recognize the conditions in the London office market in 2018 and beyond as “ripe for the next off-plan pre-let cycle”6, supporting the idea that capacity constraints are currently likely to bite in the office market more generally, and act as a lid on the strong growth in the flex-ible office space.

Office space comes in many shapes and forms with the spectrum of characteris-tics and services to suit all budgets and requirements. The traditional office mar-ket end offers lower rents, and lower density (i.e. larger space per desk), but in exchange requires tenants’ long-term commitment, and potentially higher set-up

Contrary to com-mon perception, users co-working

office spaces are not limited to freelanc-

ers and start-ups, but include larger

companies too

5. Cushman&Wakefield,“Co-working2018–TheFlexibleworkplaceevolves”,2018,http://www.cush-manwakefield.co.uk/en-gb/research-and-insight/2018/co-working-2018

6. Knight Frank, The London Report 2018, https://www.knightfrank.co.uk/research/the-london-re-port-2018-5244.aspx

Source:deskmag2017GlobalCo-workingSurvey4

TYPICAL SERVICES OFFERED BY FLEXIBLE WORKPLACE OPERATORS AND EXPECTED BY USERS


costs. At the other extreme, the new version of flexible office space, i.e. co-working, offers the most flexibility with short leases, but requires higher rent psf with potentially higher desk den-sity.

Increasingly co-working spaces are op-erated not only out of office buildings, but other types of spaces are also used as co-working locations, e.g. pubs, ho-tels, cafes and libraries, where co-work-ing sessions are held at certain times where the location would otherwise be vacant5.

In general, co-working puts emphasis on the idea of office space as a ser-vice, instead of the more traditional approach that sees office space in the real estate product realm. Certainly, millennial trends to increasingly favour convenience, flexibility and immediacy, all facilitated by use of technology have supported the emergence of co-work-ing as a phenomenon with longevity.

Further, co-working blurs the line be-tween working and living, as it pro-vides a greater integration between the two, which were previously completely separate under the old paradigm of traditional office space. Among the fac-tors which make co-working style office spaces attractive to users are elements such as onsite showers, bar, events, as well as a community feel, in addition to break out space and even possibly an onsite gym.

Beyond the traditional approach of fo-cusing on providing an efficient space to get work done, co-working strives to offer users an improved lifestyle, with easily accessible services and a qual-

ity of environment that is designed to make being at work more pleasurable.

While the emergence of and strong growth in co-working spaces has been accompanied with a buzz, its profit-ability has often been questioned, with speculation around the financial health of the largest global provider, WeWork1.

Further, investors are aware that build-ing valuations may be adversely im-pacted when too large a proportion of a building is dedicated to co-working space. Indeed, C&W estimate that valu-ations remain unaffected if between 15% and 30% of a building is used for

co-working space purposes4, beyond which the impact on building valuation may become more problematic.

Investors also recognize that not all of-fice spaces are amenable to being used in a flexible manner, and co-working operators require a certain scale to en-sure they can offer the bolt-on services to their users in an efficient manner. Indeed, C&W’s research shows that there is certainly a positive correlation between location size and profitability5, which also implies the requirement for a minimum surface in order to accom-modate communal areas.

Source:Cushman&WakefieldResearch&Insight5

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Youngcreativepeopleinmodernoffice/Shutterstockby4PMproduction

PROFITABILITY OF CO-WORKING SPACES GLOBALLY,AS A FUNCTION OF MEMBER BASE


On balance, however, despite headwinds experienced by the largest company in the sector recently, the fact that SoftBank advanced a further loan of US$ 3 billion to WeWork in late 2018 (albeit scaled down to US$ 2 billion in January 20191) still supports the notion that co-working is not simply a fad, but a trend that is with us to stay.

While the buzz around co-working has been at the forefront of investment news in Western markets (e.g. US and UK), we hear relatively little about its penetration into office space markets elsewhere. It is undeniable, however, that co-work-ing and flexible office space more generally, is beginning to catch on elsewhere, including in Asia and the rest of Europe.

According to C&W research5, around 0.5% of the total office stock across the main Western European cities (e.g. Frank-furt, Berlin, Munich, Brussels, Paris, Hamburg and Stockholm) is currently dedicated to flexible working spaces. Amsterdam is a standout case in continental Europe with close to 6% of its office space stock being occupied by flexible working pro-

viders. But while the proportion of flexible working space in continental European cities remains modest at the moment, growth has been strong and is expected to continue in the next few years.

Central Europe is no exception to the co-working trend. For example, Warsaw is already ahead of Hamburg, Stockholm and Barcelona in terms of total flexible office space stock, while other locations such as Prague and Budapest are on par with places like Lisbon and Rome.

Further afield, the Romanian economy, which has experi-enced significant economic growth in the last few years, has seen an explosion of office construction in the capital, Bucharest, supported by an influx of multinationals. A large number of international companies, such as Amazon, Micro-soft, HP, IBM and others are attracted by Romania friendly tax regime, a highly educated workforce and salaries still sig-nificantly below European averages7.

7. CITEInvestments,AllocatorQuarterly,Q32018,https://citeinvestments.com/alloca-tor-quarterly-q3-2018/

8. https://seenews.com/news/romanian-software-it-sector-revenue-to-reach-45-bln-euro-in-2018-industry-626501

9. https://www.romania-insider.com/spaces-third-location-bucharest/10. https://www.romania-insider.com/co-working-spaces-bucharest/

Location size is pivotal in

determining profitability, with a minimum scale

requirement


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A strong presence of the IT and outsourcing sectors is supported by Romania’s world-class IT infrastructure, with broadband speeds among the highest in the world. In fact, the IT sector has taken a strong foothold in the country with rev-enues estimated to exceed EUR 4 billion in 2018 and projected to grow at rates of between 14% and 16% per annum, to reach a level of close to EUR 7 billion in 20218.

Availability of co-working spaces in Bucharest has followed economic growth, with Spaces opening a third location in Bucharest in October 20189. There are also a multitude of independent flexible workspace operators in the Bucharest market, providing users with many co-working location options10.

The demographic and social trends have certainly been conducive to supporting growth of the co-working sector in Romania. For example, entrepreneurship is be-ing encouraged by government policies, which offer returning emigres financing of up to EUR 40,000 to start local businesses11. Romania is also known to be among the top ten countries globally for percentage of female entrepreneurs12.

Popularity of flexible office space is related

to vibrancy of entrepre-neurship and millennial generation preferences

Top:Activeemployeeinflexibleoffice/ShutterstockbyProstock-studioBottom:Teamatwork/Shutterstockbyg-stockstudio

ESTIMATED TOTAL FLEXIBLE WORKPLACESTOCK ACROSS EUROPE


According to a study by IWG, 60% of Romanian employees work remotely at least once a week, and 20% of those who fall into this category prefer to work in a shared workspace rather than from home13. Meanwhile the same study shows that managers believe that remote work-ing can bring savings for firms, and opportunistic use of flexible working space can help reduce total rental and associated costs. They also believe that employees who use flexible workspace are more productive and efficient, partly because use of flexible workspaces may reduce employee commuting time, often a problem given that Bucharest suffers from high congestion levels.

In the Romanian current economic climate, where labour shortages have not been uncommon in the last few years due to strong economic growth, employers compete not

only on hard aspects such as pay and benefits, but also more intangible aspects around the quality of the work environment. These intangible aspects are all the more important differentiating factors in attracting the young-er workforce who offer the right skillset for Romania’s vibrant IT and outsourcing industries.

A 2018 survey by CBRE14 of factors that employees value in their workplace, and whether they are satisfied with their current arrangements, showed interesting trends that are broadly in line with common wisdom regarding generational shifts in preferences and workplace out-look. The survey included a significant number of partici-pants from the IT and high-tech outsourcing industries and showed that the younger generations of employees (i.e. generations “Y” and “Z”) seem to attribute more value

11. ColliersInternational,CEERealEstate:LabourForceBoomerang,July201712. https://www.romania-insider.com/romania-women-entrepreneurs/13. https://www.romania-insider.com/study-romanian-employees-work-remotely/14. CBRE,RomaniaSpecialReport–Howwework,November2018,https://www.cbre.com/research-and-reports/Romania-Special-Report---How-we-work

While stocks of flexible working

space in CEE and SEE are currently

low, growth has been strong


Businesspeopleinmodernoffice/ShutterstockbyMonkeyBusinessImages


to aspects such as having a “Welcoming place to eat your own meal”, access to “Relaxation Areas” and “Quiet Rooms & Phone Booths” relative to older generations of employees (generations X and the Baby Boomers). More generally, generations Y and Z seemed to put a greater emphasis on the work/life balance and the softer aspects of their work environment.

Coffice15, a first-mover in the Bucharest co-working scene was established in 2013 as part of the SWAN office development, winner of multiple sustain-ability awards and certifications including BREEAM. David Allen of Chayton Capital, the firm behind the SWAN development, is among the first real es-tate investment managers in the region to have introduced the co-working space element as part of the overall office offering at SWAN.

“Back in 2013, we were testing the market with this idea of co-working space organized in and around a café. We wanted to see if there would be any appetite for a 250-300 sqm space with 8 individual offices around the main café area, and meeting rooms at the back. The main café area is also sometimes used to run events.” says David. “Since we allocated this part of the building to co-working space, it has been run by the same operator and has been kept busy by tech and service provider type users, staying between six and eight months on average.”

“Co-working office space has proven to be a popular model

with companies and freelancers [in SEE], and we see [it] as a

phenomenon which will continue to grow”

says David Allen of Chayton Capital

15. http://www.coffice-swan.ro/home

Businessmeetingincafé/ShutterstockbyMonkeyBusinessImages

15CITE AQ Q1 2019 |

David continues, “Also, a number of other operators have entered the co-working office market in South Eastern Europe, including some of the more established players such as IWG, with its Spaces brand. Unlike some of the smaller operators, they have had the strength of their balance sheet to be able to open more than one location within a short space of time. Co-working office space has proven to be a popular model with companies and freelancers here, and we see co-working as a phenomenon which will continue to grow in the medium term in the Central and South East European markets. We will be looking to participate in this growth.”

David cites critical size/scale, proximity to transport, and convenience of location as some of the key determinants of success of a particular co-working space.

From its tentative beginnings less than a decade ago, co-working space has revo-lutionized how we see serviced office space, and has established a new normal of offering office space as service, emphasizing immediacy and convenience. It has enjoyed global penetration, including in markets such as South Eastern Europe, which traditionally have been considered late adopters of such trends. However, it seems that demographic and social trends and preferences of the millennial generation in these markets are very similar to those observed in Western mar-kets, and therefore co-working spaces are likely to continue to grow their footprint across Central and South Eastern Europe in the medium-to-long term.

Co-working concept / Shutterstock by Montae

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DEVELOPMENT OF THE “NEW PRIVATE RENTED

SECTOR” IN CENTRAL AND SOUTH EASTERN EUROPE

The latter can take different forms, depending on the amount of development risk an investor is prepared to take on, with on the riskier side investors getting involved in development projects, and on the other end of the scale investors purchasing freshly developed or existing assets already rented to produce income, i.e. investment in the Private Rented Sector (PRS).

Investment in PRS is a well-established concept in West-ern Europe, investment opportunities abound and de-mand for such accommodation is well recognized. Indeed, in many Western European countries high percentages of households live in private rented accommodation with market level rents. Examples of European countries with the highest proportions of households in such accommo-dation include Switzerland, Germany, Denmark, Sweden, Austria and The Netherlands (with proportions of popula-tion in market level rentals estimated close to respective-ly 50%, 40%, 37.7%, 34% and the latter two around 30%1).

There is indeed a high level of demand in these markets for private rentals, driven by a combination of factors such as affordability of buying one’s own home, itself a

Institutional investors in real estate recognize a number of real estate investment seg-ments, which tend to be more or less popular depending on the stage of the market cycle. Among these segments feature retail, industrial, office, logistics and residential.

function of mortgage rates and incomes, as well as pref-erences of households in certain circumstances to opt for more flexible accommodation instead of being tied to a mortgage. Some also argue that in some markets, such as Germany, there is a cultural affinity to renting, which may vary over time along with broader economic and cul-tural trends.

There has also been in Western Europe a steady supply of private rentals, with a combination of private and in-stitutional investors investing in buy-to-let properties on a smaller or larger scale. In fact, lettings investments and build-to-let developments are a recognized low-risk seg-ment of the real estate asset class for institutional inves-tors in Western European real estate.

On the opposite side of the tenure scale, we find some Central and South East European countries, such as Ro-mania, Croatia Lithuania, Bulgaria and Poland, where the majority of the population are owner occupiers, and where the Private Rented market is very small or virtually non-existent. Specifically, 2017 Eurostat updates show that in Romania only 1% of the population resides in PRS

1. https://ec.europa.eu/eurostat/statistics-explained/index.php/Housing_statisticsLeft:ModernresidentialdistrictinRomania/Shutterstockbystruvictory

National average

Capital region

National average

Capital region

National average

Capital region

National average

Capital region

EU-28 - 22.3 - 44.1 - 22.1 - 9.8 -Belgium Arr. de Bruxelles-Capitale / Arr. van Brussel-Hoofdstad 37.1 51.7 38.2 37.0 16.5 7.1 8.2 4.1Bulgaria Sofia (stolitsa) 10.5 5.6 55.4 45.8 25.5 33.2 8.6 15.4Czech Republic Hlavní město Praha 19.0 29.4 37.1 30.4 20.5 20.7 7.7 7.4Denmark Byen København 34.1 68.1 44.6 21.8 14.0 5.7 7.2 4.4Germany Berlin 24.3 42.3 46.5 36.3 23.1 19.2 6.1 2.1Estonia (¹) Põhja-Eesti 17.0 12.0 47.1 47.3 22.8 23.2 9.4 15.2Ireland Dublin 13.3 13.9 22.9 30.8 20.7 20.2 22.0 18.0Greece Attiki 7.6 2.4 47.8 55.1 29.1 27.1 15.5 15.3Spain Madrid 11.1 8.0 43.0 50.3 24.7 24.2 18.5 14.9France Paris 28.7 59.7 37.0 26.0 23.9 11.7 10.4 2.5Croatia Grad Zagreb 13.6 13.7 42.5 43.3 23.6 22.3 11.0 17.0Italy Roma 20.7 12.3 51.4 60.1 19.8 20.4 7.9 7.1Cyprus Kýpros 3.0 - 24.6 - 36.1 - 34.1 -Latvia Rīga 22.7 23.5 46.6 48.4 24.3 21.7 5.1 6.1Lithuania Vilniaus apskritis 13.5 12.7 49.6 43.3 28.9 30.2 6.2 12.6Luxembourg Luxembourg 21.8 - 31.5 - 21.6 - 14.0 -Hungary Budapest 20.3 33.2 48.3 38.0 21.7 17.3 9.7 11.6Malta Malta 13.0 13.5 23.2 24.3 23.4 24.1 8.7 9.1Netherlands Groot-Amsterdam 18.9 32.7 41.9 29.7 26.4 25.0 9.5 10.1Austria (²) Wien 25.5 42.4 40.1 35.4 22.7 14.6 11.7 7.6Poland Miasto Warszawa 19.1 10.3 43.0 49.1 22.7 16.1 11.4 17.8Portugal Grande Lisboa 10.7 9.8 37.1 46.0 36.0 31.4 16.3 12.8Romania Bucureşti 11.2 7.7 59.1 60.3 19.0 23.3 8.0 5.5Slovenia Osrednjeslovenska 21.3 16.6 45.0 47.9 25.0 23.7 8.7 11.8Slovakia Bratislavský kraj 8.2 8.7 52.6 48.0 21.5 23.5 5.8 11.3Finland Helsinki-Uusimaa 9.6 12.1 48.7 44.3 29.7 29.8 10.7 12.8Sweden Stockholms län 24.3 23.8 47.7 44.1 12.3 12.4 4.6 6.8United Kingdom (³) Inner London (⁴) 37.8 57.7 39.7 26.6 15.6 10.4 6.9 5.3Iceland Höfuðborgarsvæði 11.5 10.3 44.5 42.9 25.1 27.1 18.9 19.6Liechtenstein Liechtenstein 9.7 - 38.0 - 33.1 - 16.0 -Norway Oslo 16.8 31.0 41.3 38.7 23.2 20.0 12.7 10.0Switzerland Bern 26.6 32.3 41.1 41.2 21.5 18.3 10.8 8.2

Note: data for capital regions is based on NUTS level 3 regions.(¹) Also comprises dwellings in uncompleted buildings, in cases where a residential building is under construction.(²) Before 1945 instead of before 1946. 1945-1980 instead of 1946-1980.(³) Low reliability.(⁴) Average of Inner London - West (NUTS UKI11) and of Inner London - East (UKI12).Source: Eurostat (Census hub HC53)

Capital region Before 1946 1946-1980 1981-2000 2001 onwardsPeriod of construction

DWELLINGS BY PERIOD OF CONSTRUCTION - 2018


type accommodation, closely followed by Croatia and Lithu-ania (both at 1.5%), with Bulgaria at 3% and Poland at 4.3%1.

Key to interpreting these numbers is to understand the his-tory behind the housing market in the former countries of the Socialist block. Most of the owner occupier housing stock predates the collapse of communism. It was privatised after the collapse of communism, with the state giving residents ownership of their apartments, either for free or for a to-ken sum. The preponderance of the owner-occupier model in these markets is therefore not only and necessarily driven by cultural preferences for owning, but also is determined by a legacy framework which will take several generations to evolve.

Of course, what this means is that the housing stock in these countries is of significant age2. In many cases it is not well maintained and is therefore in a state of significant dilapi-dation. It is also plagued with poor energy efficiency and building practices. For example, 59.1% of Romanian housing stock was constructed in the period between 1946 and 1980. In fact, Romania is the European country with the highest percentage of residential buildings from that period, closely followed by Bulgaria (55.4%) and Slovakia (52.6%), which cer-tainly supports the case for renewal of housing stock and the need for a wave of new housing development in the region. A CITE Investments article in the Financial Investigator maga-zine focuses on the sustainability issues in the South East European real estate, and how a wave of new housing invest-ment can alleviate energy efficiency problems in the region3.

Source: Eurostat

HOUSING TENURE IN EUROPE

19CITE AQ Q1 2019 |

Given high overcrowding levels, demand for modern ac-commodation is certainly present in these markets, both for purchasing and for renting. In fact, it has become increasingly popular for local private investors to invest in buy-to-let units on a small scale. According to REAS5, in some cities in Poland up to 40% of primary residen-tial transactions were taken up by private buy-to-let in-vestors. Also, the Polish rental market has been rather fragmented with two thirds of private landlords owning a single unit, according to a 2017 survey by the same re-search organization. Most existing assets were owned by several landlords („Swiss Cheese”), making it difficult for new institutional players to make their move.

In the last few years, however, we have finally seen the beginnings of the institutionally funded Private Rented

2. https://ec.europa.eu/eurostat/statistics-explained/index.php/People_in_the_EU_-_statistics_on_housing_conditions3. CITEInvestmentsintheFinancialInvestigatormagazine:“InvestmentforSustainableRealEstateinSouthEasternEurope”,October2018 https://fi.intms.nl/fi_43a1c02c/files/downloads/jaargang-10-nummer-6-financial-investigator-6-2018_1_bkjy3W.pdf4. https://ec.europa.eu/eurostat/web/products-eurostat-news/-/DDN-20181212-1?inheritRedirect=true&redirect=%2Feurostat%2F5. REAS“Long-termrentalonlyforayear?”,November20186. TPA/REAS“InstitutionalinvestmentsinthePolishprivaterentedsector”,2017

It is also worth noting that overcrowding is a significant issue in some Central and South East European countries, with Romania at the bottom of the European ranking by average dwelling size. Indeed, the average size of a Romanian dwelling is 43.9 sqm, well below the European Union average of 96 sqm. Taken together with the number of occupants per dwelling, it is clear that overcrowding is a serious concern for Romania and a number of other Central and South East European countries, such as Poland, Latvia, Bulgaria and Croatia1.

According to Eurostat4, in Romania and Bulgaria specifically, where overcrowding is particularly acute, over 60% of young people between the ages of 15 and 29 lived in overcrowded conditions in 2017, a level well over double the EU-wide average of 27%. This overcrowding is often not a lifestyle choice, but is borne out of necessity given lack of affordable modern housing.

Source: Eurostat

DWELLINGS BY SIZE (IN SQM, 2018)


Sector in Poland. A market report from TPA and REAS6 shows that the Polish market has seen a number of large institutional investors, both domestic and foreign, move into the PRS space in the capital and some larger cities, a move partly facilitated through collaborations with de-velopers where investors would forward-buy a develop-ment to a certain specification.

Thus, between 2014 and 2017, three institutions entered the Polish PRS market: the Rental Housing Fund of the Polish state bank BGK, the German real estate invest-ment manager Catella Real Estate AG, and the Dutch Bouwfonds Investment Management. Between them they have invested over PLN 1 billion into the Polish PRS sector so far, and the total committed volume is signifi-cantly higher, with the Rental Housing Fund and Bouw-fonds planning additional investments close to EUR 1 billion still5.With these first institutional movers, the Polish institu-

tional PRS market has been firmly established spurring with it the creation of local support infrastructure to ser-vice it, e.g. locally based asset managers, rental compa-nies etc.

However, while it looks like the concept of PRS is catch-ing on in Central and South East European countries, it seems that the traditional version of PRS that investors are used to seeing in Western Europe, has been adapted to fit local conditions and needs. Indeed, what we should be talking about in the case of Central and South Eastern Europe is the “new PRS” or the concept of “communal liv-ing”.

The concept of “communal living” has traditionally been curtailed in Western Europe by government restrictions on the minimum apartment size (in some cases 40 sqm). Such restrictions do not exist in Central and South East-ern Europe, making it possible for developers to build

Source: Eurostat

OVERCROWDING RATES, 2016

21CITE AQ Q1 2019 |

…traditional version of PRS that investors are

used to seeing in West-ern Europe, has been

adapted to fit local conditions and needs… with “communal living”

emerging as the “New PRS”

NewblockofapartmentsinBucharest,Romania/ShutterstockbyFlorinRO

Source: Eurostat

PERCENTAGE OF 15 TO 29 YEAR-OLDS LIVING IN OVERCROWDED HOUSEHOLDS


smaller units to satisfy demand from small households.In Romania, smaller size units are accepted by the market as the norm, with the average dwelling size, whether old or new, being only 43.9 sqm often with multiple occupants, as reported by Eurostat. Demand for modern small-size and centrally located accommodation, is therefore, significant.

If we are, indeed, to be guided by the experience of PRS in Poland as the test case for the rest of Central and Eastern Europe, it seems that the “new PRS” trend does tend to fo-cus on smaller size units. Specifically, according to REAS in Poland, “over 50% of the rented units are not larger than 40” sqm, and “70% of all premises owned by rental property investors are studios and 1-bedroom flats”. Also, the use of renewable one-year contracts is widespread, protecting the landlord from rogue tenants in case of rent delinquencies.Also, the “new PRS” or “communal living” often involves fully-furnished units with on-site facilities such as a gym, a laun-dry room, a cinema room and security in the lobby. They also

include full provision of utilities and communication services, i.e. internet, without the tenant having to procure it them-selves. Finally, such developments often come with a signifi-cant parking provision to accommodate those tenants with vehicles.

Such accommodation is not only popular with students, but also with young professionals, keen to move away from their parents, breaking the tradition borne out of necessity due to lack of housing. This millennial generation also tends to prioritise flexibility to move when necessary, instead of be-ing tied to a mortgage, and the ease of the moving in process which is rather akin to moving into a hotel.

A version of this “new PRS” concept with communal services on site exists in parts of Western European markets, such as the United Kingdom, but tends to provide larger units and stops short of providing utilities and furniture.Looking at the Romanian market in more detail, we find

Source: Eurostat

23CITE AQ Q1 2019 |

Institutionalization of the PRS segment in SEE will happen in the near to medium term, as conditions for real estate investment are currently favourable

that there are some test case projects already in existence, funded by developers themselves. Indeed, we have come across examples of large-scale developments of between 150 and 300 units that fit the “communal living” or “new PRS” category. Such projects tend to be in high demand from tenants, who value dealing with a professional counterparty, and the ease of using such accommodation.

There is a clear lack of modern and affordable housing for rentals in these Central and South East European markets. Also, Poland’s example shows us that it is pos-sible to progress within the space of two or three years from a “grass-roots” PRS market to a market where institutional investors play a significant role. Finally, there are some prototype projects in South Eastern Europe, funded by developers, that have served as a successful proof of the “new PRS” concept locally, showing that the concept is rooted in the idiosyncrasies of local demand for smaller units.

We believe that the process of institutionalization of the PRS segment in South Eastern Europe will happen in the near to medium term, as conditions for real es-tate investment are currently favourable with local economies performing strong-ly. After all, other segments of the SEE real estate market are already popular with institutional foreign investors, e.g. the prime office market has seen significant foreign investment flow in the last two or three years.

It is only a matter of time before institutional investors recognize the full invest-ment potential of supporting the renewal of the increasingly obsolete housing stock in the region.

ResidentialbuildinginPoland/ShutterstockbyRomanBabakin

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