7 juni 2011

"EURO says ‘Yes!’ for Estonia?" or "Real Estate Investment Market in the Baltics"

Baltics as a Single Investment Market

The key characteristics of investments are usually defined as the relationship between the risk of the investment and the expected return. The lower risk is thus associated with lower returns and vice versa. This idea, if brought to the Baltic real estate investment market, would mean that the expected returns for real estate investments among Lithuania, Latvia and Estonia should be equal if country risk profiles are similar enough, all other things held equal. The yield levels thus shall also be similar for similar types of income producing properties. But are the countries that similar?

The three Baltic states were often considered as a single geographic unit by many international institutional and private investors – a convenient approach for the territory with a total population of around 7 million inhabitants. The risk profiles consequently were perceived as more or less homogenous and thus there were no significant differences in the yield levels among the countries. However, a post-crisis period differentiated the market in several ways.

Estonia Leads

The largest transactions in the Baltics in 2010-1H 2011 were in Estonia, with the sale of Kristiine shopping centre (EUR 105 million, acquired by Finnish company Citycon) leading the way. Furthermore, the introduction of euro has opened the access for Estonian real estate owners to the international, yet mainly Nordic, funds, targeting properties in the euro area, where the currency risk management via hedging is unnecessary, thus also smaller markets operating in Euro can be considered. This has left Latvia and Lithuania in an inferior position, if compared with Estonia.

From a Broader Perspective

However, the above is only one side of the story. By comparison, in 2010, the real estate investment transaction volume in Central and Eastern Europe reached 10.8 billion US$, whereas in Western Europe the volume was around 14 times higher with 144.9 billion US$, according to Cushman & Wakefield. Newsec calculates that the total for the Baltics in 2010 was around 35 million EUR (~51 million US$), only a 0.4% of the total for CEE. The interest to invest in any of the Baltic countries from the largest institutional investors is still very limited, even for Estonia. There are only a handful of attractive properties in each of the three countries, and most of them were not on sale during the crisis.

Due to low number of transactions, the market liquidity is an issue as well, which makes investments into Baltics mostly suitable for local and nearby foreign investors, such as Scandinavian, some German investment, pension funds – those who already know the market relatively well. For example, the main source of investors in the Baltics over the past year was from Finland, Sweden, and Norway.  Therefore, the yield levels are expected to stay above the ones observed in the Nordics for similar class of properties, though the difference, which currently is around 200-250 bps or even higher, is expected to diminish down to 100-150 bps over the coming few years, especially in Estonia.

What comes next?

The increased attractiveness of Estonia for Finnish investors is a short-term phenomenon caused by the combination of the optimism after the crisis, the introduction of euro as well as the close relationship that Estonia and Finland had for years. Due to lack of market depth in Estonia, or Latvia, or Lithuania, the three countries will remain niche markets for any kind of international real estate investors, mostly serving for diversification purposes.

A strong boost for the market would be the adoption of the Polish model of investing the capital accumulated in local pension funds into local properties. This would form a local capital basis as well as increase the liquidity in the market, with a strong player present in the market. However, this has also additional issues to consider, such as the political willingness in each of the Baltic countries, the pension reforms and the situation with private pension fund regulation.