iGen Capital Limited is an Appointed Representative of SapiaPartners LLP, which is authorised and regulated by the Financial Conduct Authority.This research is for information purposes only and does not constitute investment advice.
Thematic Research
Spring 2018
iGen Capital
Real EstateFocus: South Eastern Europe
2
1
b
2
c
a
Increased Prosperity
Reverse Migration Pull Factors
Reforms and Business Environment
High Tech Outsourcing Destination
Strong Local Macro Environment
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iGen Capital
SEE Property Outlook: Supportive Macro and
Micro Factors
SEE Real Estate: A Total Return Opportunity
d
e
Appendix: Return of Global Growth
CEE/SEE real estate is making a come back
Many investors exited out of CEE/SEE real estate in theaftermath of the Global Financial Crisis, as perceptions ofrisk led many to revert to more traditional asset classes.Today, CEE real estate is showing signs of resurgence, assome investors are returning, with increased investmentvolumes in the past two years. The majority of flows havebeen absorbed by Poland, Czech and Hungary, with yieldsshowing significant compression, while SEE markets stilloffer a significant yield advantage.
Strong Global and Local Macro Backdrop
There is a broad based consensus amongst investors thatglobal growth is on the mend, with asset volatility beingat record lows of recent years.
CEE/SEE economies stand in a significantly strongerposition today than they were when the financial crisishit. These economies have benefited from several yearsof stronger growth than the rest of the EU, with stronggrowth forecast to continue in the medium term, andrecent positive growth surprises. With inflation in check,unemployment rates near historical lows and public debtlevels significantly below EU average of 91%, CEEeconomies are well positioned to continue benefitingfrom political and economic convergence with the EU.
CEE currencies have in the last few years shown verylow volatility relative to past history, as well as majorwestern currencies such as the GBP. Despite recentpolitical problems in some countries such as Hungary,investors continue to regard political uncertainties astransitory and the implied volatility on currency futuresremains low.
Against the backdrop of this improved macroenvironment, and after years of credit contraction postGFC, domestic banks have restarted to increase theirlending to households and businesses, which we expectwill continue to support the local property markets.
South Eastern Europe: Real Estate
3
Micro Factors
A significant increase in prosperity relative to the 1990s,low unemployment and attractive taxation regimes,along with targeted government measures aimed atattracting reverse migration from Western Europeancountries are all expected to help maintain strongdemand for housing and retail facilities.
Commitment to reforms to boost productivity andstrengthen institutions provides a supportive businessenvironment. The long-term goal of convergence withthe EU indicates continued direction of travel to higherlevels of institutional integrity and transparencythroughout the region.
Increasingly a destination of choice for high techoutsourcing, CEE and SEE countries provide a home tomany global blue chip and high tech companies,including amongst others Oracle, Siemens, Bosch,Amazon, HP and Huawei. With their high educationlevels, competitive wages and friendly tax regimes,Romania and Bulgaria top the global outsourcingrankings.
Outlook
Demand for office space is strong, particularly in capitalcities. Yields for some office segments have alreadyshown signs of compression, while others have not yetmoved leaving scope for tactical allocation to certainsegments.
A chronic shortage of affordable housing in some of theSEE markets means that the market is likely to remainbuoyant in the medium term.
Finally, a high unsatisfied demand for low cost retailparks with outlets targeted at mass demand providesopportunities for selective development retaildevelopment.
Our Framework
While institutional investors have taken advantage of thecurrent low interest rate environment to explore yieldand total return opportunities in Western and CentralEuropean real estate, some real estate markets andsegments in SEE remain largely ignored, and may offer asignificant yield advantage to those investors who areprepared to look further afield.
While the global investor community was distracted withthe aftermath of the GFC and developments out of China,economies such as Romania and Bulgaria, have quietlycontinued to grow aided by a strong governmentcommitment to reforms of the judiciary, and an influx ofmultinational companies keen to take advantage of higheducation levels of the local populations, solid broadbandinfrastructure and attractive wage and taxation levels.
We believe that investors should closely look at thesemarkets, and commit to having long-term exposure toreal estate asset in this region.
Partnering up with an investment advisor with a longtrack record and an in depth understanding of and linksto these markets will help investors take advantage oftactical allocation to certain segments of these marketsat appropriate times.
Thematic: Total return opportunity in CEE/SEE real estate
iGen Capital Limited does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the
firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in
making their investment decision.
SEE Real EstateA total return opportunity
1
SEE property markets have been largely ignored by foreign investors in the years since the financial crisis. Recent pick up in
activity suggests investors have noted the higher yield opportunities on offer in these markets.
Investment Opportunity Landscape
5
Eurozone property yields and interest rates, 2007-2017Real estate investment volumes in European countries Q4 2016-Q3 2017 (€bn)
Source: PWC/Urban Land Institute, Emerging Trends in Real Estate, 2018
In their search for income, investors have focused on property markets in the UK,
Germany and France, where transaction volumes have been the highest. PwC
survey shows that investors are starting to look further afield to find appropriate
income levels.
Thematic Research | Real Estate | 2018
Eurozone Prime Office Yields
Prime Yields in Eurozone reflect the highly priced RE markets and are expected to remain flat at current levels
Eurozone prime yield outlook to 2025
6
Source: CBRE , 2018 Europe Real Estate Market Outlook, January 2018
Investors expect prime yields in Eurozone to remain at bid up levels for many
years to come, as they begin searching for more attractive yield levels further afield.
Thematic Research | Real Estate | 2018
Attractive Regional Property Yields
Prime yields have been gradually compressing since 2015, as property investors return to the region.
Prime yields Q4 2017 and Colliers International 12-month forecast
7
Source: Colliers International, The CEE Investment scene – H1 2018 CEE flows and drivers, 2018
CEE/SEE property yields across the board are reflecting gradual increase in investor
interest. Yields are expected to continue compressing as some markets (notably
Romania) still offer attractive yield levels.
Thematic Research | Real Estate | 2018
Investment Volumes in CEE RE Growing
Investment into commercial real estate in CEE has shown signs of pick up
Investment volume per country 2007 – H1 2017
8
Source: CBRE , CEE Property Investment, H1 2017, July 2017
After many years of depressed investment levels, volumes have picked up and are
showing momentum. Flows have been favoring Hungary, Poland and Czech, with
Romanian RE market still largely ignored by investors.
Thematic Research | Real Estate | 2018
Fund flows which returned to CEE in the last couple of years have largely ignored Romania and Bulgaria
Fund Flows into CEE Property Market
9
Historical CEE Investment Volumes (€ bn, Annual/Quarterly) Flows by country (2017, € million)Flows by sector (€ million)
Source: Colliers International, The CEE Investment scene – H1 2018 CEE flows and drivers, 2018
In the first half of
2017, Romania only
attracted circa
€399m of real
estate investment,
and the overall
number of 2017
stands at just
under €1bn only.
Thematic Research | Real Estate | 2018
SEE Property OutlookSupportive Macro and Micro Factors
2
Consecutive Years of GDP Growth…
The systemic contagion of the Global Financial Crisis propagated to the CEE countries with some delay,
but resulted in a sharper downturn relative to Western Europe
A recent pick up in real GDP growth can be seen with most CEE economies outperforming Eurozone in the last few years
11
Source: CBRE, Central Eastern Europe Real Estate Market Outlook 2016
The sluggish GDP growth in
Eastern Europe of post
financial crisis has been
followed by a rebound in
most CEE markets from 2013
onwards, which has
outpaced the Eurozone
growth.
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
…followed by Solid Core Growth Forecasts for CEE Region…
The headwinds faced by Central and Eastern European Economies in the recent years have been
replaced by recent steady real GDP growth
Strong GDP growth is expected to continue into 2018, supported by accommodative monetary policy
12
Source: EBRD, Regional Economic Prospects in EBRD Countries of Operations, November 2017
Real GDP growth forecasts
for the CEE region are
significantly ahead of the
forecasts for the advanced
economies of the OECD
with the US, Eurozone and
Japan expected to grow at
2.5%, 2.1% and 1.2%
respectively.
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
…and a Positive Growth Surprise in H2 2017
Strong labour markets and rising domestic consumption have delivered a positive GDP growth surprise
in the CEE region.
13
Source: Erste, What’s up in CEE?, December 2017
2017 and 2018 growth forecasts in the CEE region have been revised to 4.6% and
3.6% respectively in late 2017, due to strong domestic demand, higher growth in
public sector wages and higher PMI readings in manufacturing.
Real GDP Growth Forecasts Unemployment Rates
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Moderate Inflation and Interest Rate Rises
Mild inflation pressures may result in base rates to rise in some instances
14
Source: Erste, What’s up in the CEE, December 2017
Interest rate rises are expected to increase in Romania, where the growth surprise
was due mostly to a jump in domestic consumption. However, wage pressures are
viewed as a one-off structural adjustment, mostly in the public sector, and are not
expected to persist in the long term.
Inflation Forecasts Base Rate Forecasts
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
0
10
20
30
40
50
60
70
80
90
100
Croatia Czech Hungary Poland Romania Serbia Slovakia Slovenia
2016 2017f 2018f 2019f
Robust Local Fundamentals
Fiscal discipline and low public debt levels accompanied with managed floating exchange rates in some
instances have resulted in currency stability over the last few years
15
Source: Erste, What’s up in the CEE, December 2017; iGen Chart
Public Debt Forecast
CEE public debt levels are
substantially below the
Eurozone average of 91.5%
of GDP (Source: World Bank,
2015), suggesting that CEE
public finances are in
significantly better shape
than their Western European
counterparts.
EU Average
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Low Historical Volatility for Currencies
CEE and SEE currencies have exhibited low volatility against the EUR for the last few years
Currency returns in the last five years – CEESEE exchange rates versus GBP and USD
16
Source: Bloomberg, February 2018
GBP and USD exchange rates to the EUR have been significantly more volatile in
the last five years, compared to CEE and SEE currencies exchange rates. With some
of the regional currencies following some form of management against the EUR,
investors have come to expect reasonably predictable exchange rates.
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Currencies Price in Low Volatility
Implied volatility on currency forwards at significant lows relative to recent history
Implied volatility on CEE currency forwards against EUR
17
Source: Bloomberg, January 2018
Investors seem to view political risks in the region as transitory and are pricing in
low volatility despite recent political strife. Convergence with the wider EU is
accepted as the general direction of travel, and provides support to CEE and SEE
currencies.
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Local Banks in Better Health
After years of contraction post GFC, domestic credit finally showed increases in 2016 (and in 2014 in some cases)
18
Source: IMF, Effective Government for Stronger Growth, November 2016; RBI/Raiffeisen RESEARCH, Banking Sector Convergence 5.0, June 2017
Domestic banks have reduced their NPL ratios since the highs of post financial crisis,
and domestic credit to households and corporations has started to expand in some
markets.
Credit to Households and Corporations (yoy % change, July 2016) Markets with NPLs below 10% (as of 2016, % of total loans)
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
“Prosperity” in the Region
“Prosperity” is a composite measure that includes aspects such as governance, income inequality, health and ease of doing
business. Measures of prosperity within the CEE have increased over the last 20 years with Austria being the benchmark.
PPP GDP per capita has significantly converged to that of Germany since 1995, with 9 countries at levels of above 40% of German PPP GDP per capita in 2015 versus only 2 in 1995*
19
Source: Legatum, Central and Eastern Europe Prosperity Report, 2016; * World Bank Development Indicators
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Increasing Regional Prosperity
Prosperity in the CEE region has been steadily increasing since the 90s, and is now at a not too
dissimilar level as prosperity in Western Europe.
Business environment measures have improved, with continued efforts to fight corruption and strengthen institutions
20
Source: OECD Economic Outlook, Volume 2017 Issue 2, Chapter 1
Recent pick up in credit accessibility is likely to further boost the business
environment measure. Increase regional prosperity helps improve local political
stability and confidence necessary to boost investment.
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Demographic Trends
CEE countries have been suffering from a falling educated working age population through emigration, and rising
dependency ratios. Improving PPP incomes and vibrant local job market should help reverse this trend.
21
Source: Colliers International, CEE Real Estate: Labour Force Boomerang, July 2017
Size and breakdown of CEE populations in Western Europe (2016) % of population of country residing in Western Europe (2016)
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Pull Factors for Returnees
CEE countries offer attractive tax rates relative to Western European economies and some governments have
introduced specific measure to attract emigres back to domestic jobs or to start local businesses.
22
Source: Colliers International, CEE Real Estate: Labour Force Boomerang, July 2017
Tax rates in CEE-6 and selected major EU countries (2017) CEE direct and indirect government action
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Business Environment Continues to Improve…
Corruption Perceptions Index readings show that many of the CEE markets are perceived on par or
ahead of some major Western European economies, eg Italy ranked 60th.
Regional governments continue programs of institutional reforms requested by the EU in the context of accession programs
23
Source: Transparency International Corruption Perceptions Index, 2016
The EU has put emphasis of improving the efficiency of tax collection administration
and the reform of the judiciary systems to increase confidence and impartiality.
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Romania – High Commitment to Eradicating Corruption
Recent judicial reforms and a zero-tolerance attitude to corruption with high enforcement rates have resulted in
1,270 prosecutions in 2016 alone, including Prime Minister who stepped down in November 2016
WJP Rule of Law Index places Romania 32/113 globally (ahead of Italy) on corruption perceptions, with improving government transparency
24
Source: World Justice Project, Rule of Law Index 2016
Thematic Research | Real Estate | 2018
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
… and Further Reforms Expected to Boost TFP
Continued commitment to institutional reforms is required by the European Commission in order to
facilitate convergence
CESEE: Estimated Efficiency Gains from Institutional Reforms (% potential improvement in Total Factor Productivity)
25
Source: IMF May 2016, Regional Economic Issues: Central, Eastern and Southeastern Europe
Improved institutional
strength is expected to
increase social capital of the
local population and lead to
higher TFP readings and
higher GDP growth, which
should continue to provide
support to future GDP
growth.
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Romania – A Favoured Outsourcing Destination
A large number of high tech companies make Romania their outsourcing destination of choice, due to
Romania’s capacity to handle process of highest complexity, and attractive local wage levels
BPO, ITO, software development and research programs are all delivered in various shared service centres
26
Source: Colliers International, Romania Market Overview, 2017
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Business Process Outsourcing Destination
High education levels, high internet speed and competitive wage levels make many CEE countries a
destination of choice for business process outsourcing (Bulgaria, Romania, Lithuania, Czech, Hungary, Poland)
Business Process Outsourcing index map
27
Source: Cushman & Wakefield, Where in the World? Business Process Outsourcing and Share Service Location Index, 2015
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Local wages in the region are still at very competitive levels relative to Western Europe
BSS Pull Factors
28
Average national gross salary (€ per month, 2016) Number of students (2016)
Source: Central Statistical Offices, 2016
A large number of students with high technical and professional skills as well as
competitive wage levels continue to attract business services and process
outsourcing, with focus on the capital and large university cities (eg Timisoara, Cluj)
Source: Central Statistical Offices / CBR Research, 2016
Source: CBRE, Business Services: Destinations in Central Europe, 2017
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
High Operational Complexity for BPO
High operational complexity of IT services, and attractive local wages relative to Western European
benchmarks act as pull factors for many IT and industrial companies
Additional pull factors include quality of life/infrastructure, business environment and attractive office rents
29
Source: Colliers International, A Thoroughbred Racer, November 2017 (ABSL, BOA, SARIO, Hays Recruitment, Randstad)
A large number of
multinational high tech
companies from a variety of
sectors choose to have a
presence in the CEE. This
includes amongst others
Oracle, Microsoft, Xerox, HP,
IBM and Adobe.
Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination
Thematic Research | Real Estate | 2018
Return of Global GrowhA supportive global macro environment
Appendix
Modest Growth Forecasts for Major Economies
A broad-based cyclical recovery is finally underway in the US, Western Europe and Japan, with
synchronized increases in output across different economies.
Real GDP of the major economies is expected to continue to expand in the next two years, although at a decreasing rate
31
Source: OECD Economic Outlook, Volume 2017 Issue 2, Chapter 1
The recovery in the major economies is moderate relative to past episodes,
because of past shortfalls in investment and resulting productivity lags, but it is
broad based with advanced economies showing declining unemployment.
Thematic Research | Real Estate | 2018
A More Robust Global Financial System
While US Fed has started to hike rates at what is likely to be a modest pace, the interest rate outlook in
the Eurozone is expected to remain benign in the near term.
32
Source: OECD Economic Outlook, Volume 2017 Issue 2, Chapter 1
Short-term deposit rates are expected for a mild increase from a low/negative base,
while higher central bank reserves indicate a much more solid liquidity approach to
the banking system. QE tapering in Eurozone is expected to gradually begin in
2018.
Expected O/N Interest Rates for end-2018Size and composition of central banks’ balance sheets have changed massively over
past decade
Thematic Research | Real Estate | 2018
Benign Inflation Environment
Sluggish growth of recent years, low wage pressures and technological drive to achieve cheaper goods
have meant that inflation remains at moderate levels.
33
Source: OECD Economic Outlook, Volume 2017 Issue 2, Chapter 1
Inflation in advanced OECD economies is forecast to remain at a median of 2%,
which means that pressure for central banks to raise interest rates is likely to
remain low.
Headline Inflation Core Inflation
Thematic Research | Real Estate | 2018
Long-term Interest Rates Stable
Current outlook for long-term rates suggests that interest rates will remain low for the foreseeable
future.
Government 10-year Bond Yield forecast to remain relatively low in the advanced OECD economies
34
Source: OECE Data
With inflation continuing to
be at benign levels in most
advanced economies, there
is little pressure for fast
interest rate increases.Long-
term yields on government
debt are likely to remain
compressed, and investors
will continue to look at
alternative asset classes in
their search for yield.
Thematic Research | Real Estate | 2018
Low Global Asset Price Volatility
Equity markets in the major economies exhibit low volatility suggesting that they are pricing in low
levels of uncertainty regarding global economies conditions.
Equity markets’ volatility is near pre Global Financial Crisis levels, with business confidence indicators on the up
35
Source: OECD Economic Outlook, Volume 2017 Issue 2, Chapter 1
Bond spreads between high-yield corporate debt and government bonds have also
seen further downward pressure and are close to lows of 2014, both in the US and
Europe,
as investors’ hunt for yield continues.
Thematic Research | Real Estate | 2018
Business Confidence High
The BCI, one of OECD leading indicators for GDP growth, is showing solid signs of recovery since the
lows of the financial crisis.
Businesses expect strong GDP growth to continue into 2018, supported by accommodative monetary policy
36
Source: OECD Data, iGen Capital
Business confidence in the
world’s major economies is
back to pre-crisis levels and
reflect an increased investor
risk appetite.
95
96
97
98
99
100
101
102
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08
-01
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08
-06
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08
-11
20
09
-04
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09
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-02
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-07
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12
-03
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-06
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-04
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-02
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-07
20
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-12
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-05
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-10
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-03
20
17
-08
OECD Business Confidence IndexG-7 and Total
G-7 OECD
Thematic Research | Real Estate | 2018
-15
-10
-5
0
5
10
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
OECD Investment Growth ForecastG7 Countries (in % terms)
CAN DEU FRA GBR ITA JPN USA OECD
Investment Expected to Grow
Low investment levels in recent years have led to lagging productivity gains, and are due for an upgrade
OECD forecasts that investment will grow at a solid rate of around 3.2% for OECD countries
37
Source: OECE Data, iGen Capital
Renewed investment should
provide support to the
global economy and result in
productivity gains to support
continued GDP growth.
Thematic Research | Real Estate | 2018
Global Fiscal Easing
OECD forecasts that the fiscal stance “to ease in many OECD countries” between 2016 and 2019.
Fiscal easing measured as the change in underlying primary balance as percentage of potential GDP is in negative territory for most economies
38
Source: OECD Economic Outlook, Volume 2017 Issue 2, Chapter 1
Government interest payments have fallen despite rising debt levels in many OECD
countries. Governments are taking advantage of low interest rate environment to
borrow and ease fiscal policy. This provides further support in maintaining investor
risk appetite.
Thematic Research | Real Estate | 2018
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