NEWS FROM ALL SIDES 2: What does the future hold for Bulgaria’s real estate market?
The real estate market at present
Valeri Vulchev Managing Partner of Forton International JSCo. The Bulgarian commercial property market has experienced dynamic development in all sectors, with trends varying greatly in terms of growth cycle, performance, investor interest, and geographic location. Modern quality supply has registered robust growth, with most of the activity concentrated in the office and retail sectors of the market. However, modern-standing investment stock is still limited in supply, with the retail and industrial sectors of the market offering the greatest investment potential. Office market is most likely going to reach its stage of maturity in 2006, as about 200 000 sq m of office space is in the pipeline, and another 100 000 sq m is at the project design phase. Yet, there are unexploited niches with enormous market potential, where demand for the right product in the right location is huge. Thus investment timing and location will continue to be of major importance. With Bulgaria’s ranking at 15th position among the top outsourcing destinations in A. T. Kearney’s index, the country is expected to attract substantial level of investments in the services sector, which will increase demand for quality office premises. 2005 and 2006 have appeared to be the long awaited turning point in the retail property sector of the market. The first three malls that will provide a combined modern retail space in excess of 100 000 sq m are awaiting completion, and will put under pressure some of the prime high-street locations. These are: Mall of Sofia that will offer 54 000 sq m of retail space; Sofia City Centre Mall with about 31 000 sq m of retail space, and Sky City Mall with 16 000 sq m of retail space. As 34 per cent of monetary household expenditure goes on foods and drinks, the food retail sector is expected to continue to be the major sector, driving retail growth. With hypermarkets/supermarkets facing constantly increasing competition, the first discounters are to enter the Bulgarian market, probably by the end of 2006. Some of the largest retail chains, operating in Bulgaria, are: Metro Cash & Carry, REWE Holding (Billa - 18 stores till the end of 2005 & Penny Market expected in 2006), Ramstore, VP Market, Praktiker, Mr. Bricolage, Praktis, Technopolis, Technomarket, HIT and many others. Some retailers that have shown interest in entering the Bulgarian market in 2006 are: Lidl, Kaufland (already acquiring land in the largest cities) and Mercator. Indisputably, the logistics/warehousing sector is the sector, anticipating its dynamic growth and development phase. The current level of modern stock is obviously insufficient. Due to the lack of such products, prime rents remained at their high last year level of five euro a sq m, with almost no vacancy. Older stock however will continue to retain vacancy rates of about 30-50 per cent. Approaching its EU accession, Bulgaria will have to absorb a constantly increasing level of FDI, which factor will set high requirements for the industrial property sector of the market. In the past few years, demand has concentrated in several industrial zones in key parts of the country like: Sofia, Plovdiv, Rousse, Stara Zagora and others. However, unexploited opportunities for development still exist along the Pan-European Transport corridors (mainly along corridor No 7 - The Danube River), and near the major Black Sea port towns of Varna and Bourgas. One of the largest development schemes under way is Sofia Airport Centre. The proposed business park, with offices and a logistics centre, has a projected built-up area in excess of 115 000 sq m, and will be constructed over the next two years. It is located about 300 m away from the airport’s new terminal, designed to accommodate up to 2.6 million passengers a year. On the investment side of the market, yields have followed their logical trend of compressing, reaching nine to 11 per cent in 2005, and expected to compress further, in line with Bulgaria moving closer to EU accession. However, they still offer significant premium to the yields in the other European countries. Suitable investment grade stock is limited in supply, with alternative investment schemes (sale-leaseback scheme for example) gaining momentum. However, large international developers and investment funds, both public and private, have entered Bulgarian market, a major factor, expected to stir market activity and development. Svetla Kostadinova Senior economist, Institute for Market Economics (www.ime.bg) Development of the real estate market is of great importance to Bulgaria. The construction industry in the country employs a significant number of people, adds value to economy and thus contributes to the steady GDP increase. On the other hand, the banking industry is more than ever involved in the real estate sector by facilitating mortgage credits to individuals and companies by offering more flexible conditions, lower interest rates and longer terms. Last but not least, rapid real estate market development attracted huge foreign investments in the country, both speculative and Greenfield, that accelerated growth of the economy. What are the main reasons for this? 1. The economic environment in the country improved significantly in past five years - we have one of the lowest corporate rates in Europe, inflation is lower, incomes are rising constantly, predictability has improved, economic freedom increased and overall people’s expectations are positive. 2. Legislation has been passed that facilitated secondary mortgage market and real-estate related investments - the law on mortgage bonds in 2000 (banks can find additional money for their credit activities), the law on special purpose vehicles in 2003 (companies that can invest in real estate and thus provide opportunity for small investors to put their money in big investment projects), the improvement of the central credit registry within the national bank and start of operation of the first private credit bureau that would allow for greater transparency. 3. EU accession is anticipated as a reliable measure of an economy that is heading to a more stable and secure business environment for investors. The state’s role should be to guarantee private property rights and contract enforcement. Unfortunately, we are witnessing some negative draft laws and intentions in this field that could have contradictory results. Such examples are the draft law on registering construction companies, the draft act on the sea coast, the idea to tax all agricultural land in the country, among others. If theses are to be implemented we can expect adverse effects on the real estate market. Transparency and security are very important for this market. The government has received financing from the World Bank to create a property register and cadastre. These are in the process of being set up, and delays are causing problems and leading to a less liquid market. An obstacle to a more transparent market is the practice of misreporting the transfer price in real estate deals. There are two incentives to hide the true figures - due transfer tax (two per cent) and the informal economy (all deals above 30 000 leva should be reported to the Financial Intelligence Agency to check the origin of the money and this may be a difficulty if you have misreported your income to avoid high social security contributions, for example). Housing market - after the most successful year (2004), 2005 was characterised by steady housing construction, higher prices, friendly banks and willing customers. Although, price inflation was less aggressive, we witnessed increased prices in several secondary markets in the country (Stara Zagora, Pleven, Blagoevgrad, etc.) as a result of catching up with business development. 2006 will be less profitable for construction entrepreneurs (more time to sell finished apartments, need for more flexible payment schemes in order to be competitive, higher quality demanded by customers). Lower profit is a consequence of increases in the price of materials, lack of qualified and experienced labour (it costs more in salaries to keep it) and higher supply. Vacation (apartment) buildings - the boom in construction of such buildings was dominant in 2004 - 2005 with major destinations summer resorts (Sunny Beach, Golden Sands), as well as winter destinations (Bansko, Pamporovo). Bad infrastructure, lack of commitment and control from local municipalities is on the path to turn these places into overbuilt cities where no decent return from investment can be achieved. That is why, one should be careful when considering investing money in this area. Anyway, other destinations inside the country are gathering momentum and are likely to be very profitable and attractive. Land - one of the major characteristics of land market in Bulgaria is the current ban on foreigners acquiring land in the country. However, this is not considered as an obstacle but a factor that increases the transaction cost, the time to conclude a deal, and involves intermediaries. In any case, this gives the opportunity to many poorer families to sell their land at a higher price. It can hardly be said that there is a dynamic land market in Bulgaria apart from in the big cities and resorts where major construction activity is concentrated. Agricultural land is still less attractive. Despite this, several specialised land investment funds were created so we believe that this market is just starting its real development. Still, land investment will require long-term commitment and is less liquid. Office market - starting to be very dynamic in the capital and expected to be of greater attention for investors. “Specialised” in such investments are special purpose investment companies that accumulate funds from smaller investors, invest them in big projects and manage the property for number of years. Since demand for specialised, high-quality office buildings with additional services is accelerating we can expect that many entrepreneurs will be attracted in this segment. Since more and more companies are willing to build own offices and then sell and lease back we can expect future development. Industrial market - concentrated in several areas in the country (Sofia, Plovdiv, Sevlievo, Bourgas) but more cities are making efforts to attract big companies. Acceleration of the decentralisation process in Bulgaria will give powers to local municipalities to offer competitive business environments and stimulate new investments. The process, however, is slower than desired. Land prices, the urbanisation process and local authorities’ willingness to assist business are seen as incentives for big foreign companies to invest. Trade market - every time an economy grows, trade properties are on the edge of investors’ interest. With rising incomes, consumer confidence and purchasing power increase, and this inevitably boosts spending. In 2005, construction of several big trade centres started, with completion expected in 2006. These malls are attracting huge investor interest and all units are fully pre-sold. The cities of Sofia, Varna, and Stara Zagora attracted such projects. Property as an investment - price inflation of all types of property (except for land) turned real estate investment to be very profitable. Bulgaria was among the few countries in Europe that secured property investment return of above 10 per cent in 2005. The picture is changing slowly in a downward direction but is still attractive for investors. Lower levels of European interest rates and good practice (no major problems with foreign investors in the country so far) attract less speculative investors as ordinary foreign citizens and companies. The trend however is for steady flattening of Bulgaria’s property returns with European levels in the next three to four years. Sofia - capital property market should be analysed separately from other locations since it differs in many ways. First, housing demand is more dynamic and constant that is due to in-country migration, higher incomes, headquarters’ location of almost all international companies, good investment prospects, etc. That is why housing prices rose permanently with changing of preferred districts in time. Central locations are still of interest but high-quality residential complexes with restricted access in the outskirts of the city are attracting customers. They offer European quality of construction, additional services, property management, security and comfort to its buyers. At the moment, wealthy people are among the major customers but we witness change in customers profile since middle-class buyers are supported by banks in such transactions. Office buildings in Sofia are to become soon the most attractive type of construction. EU accession and positive expectations of business facilitate investment in real estate for their activities. Although rents lagged behind in 2004 and 2005, we see increasing of their levels that should continue in 2006 if no major political downturns happen. Construction of two malls and lack of free trade space are no surprise. As a summary we expect that real estate market will further develop with less intensity in its housing and vacation apartments sectors, and future focus in office and land segments. Atanas Garov Managing Director, Bulgaria, Colliers International The Bulgarian real estate market has seen remarkable growth over the past few years. This segment of “From All Sides” raises the question of whether this growth will continue. To answer that question, one needs to examine the drivers of the development and assess whether or not these drivers are sustainable in the longer term. From a macroeconomic perspective, there is no doubt that the political and economic stability of Bulgaria is of utmost importance to the development of the business environment in general and, as a derivate thereof, the real estate market. Inflation continues to move in the right direction, and the reduction in both unemployment and underemployment is a clear sign of a stable economy. The success of the currency board reduces the exchange uncertainty that has characterised other economies in the region. Perhaps most compelling, though, is GDP growth, which has outperformed not only the Euro Zone but also the eight new Central and East European EU member states over the past six years. The upcoming EU accession might not directly influence the real estate market in Bulgaria, but the psychological effect should not be underestimated. It is a clear indication of the country’s commitment to European standards and values, reducing the perceived risk of doing business in Bulgaria. So, is the macroeconomic growth sustainable? In the absence of clear comparisons, the development in the Central and East European countries is probably the best model for predicting the growth patterns of Bulgaria. In that context, it should be clear that the current economic development is likely to continue in the medium term and eventually plateau in the longer run. The individual commercial real estate sectors on the Bulgarian market, which include office, retail and logistics and industrial, each have separate drivers of demand. Office The office market is the most mature commercial real estate segment. Historically, growth has been driven by international and Bulgarian companies establishing operations in the country. However, Colliers has recently seen two distinct lines of increased demand; the first is driven by established companies looking to expand their businesses in Bulgaria. The demand for class A office space comes primarily from international companies with a long presence on the market. The second comprises offshoring and outsourcing activities. A recent study ranked Bulgaria the world’s 15th most attractive offshoring destination, based on three distinct factors; the financial factor, people skills and availabilities and the business environment. What is interesting in regard to the above mentioned trend is that there are import spin-off effects from the outsourcing and offshoring, thereby further increasing demand. As the factors driving demand in the office sector are persistent in the short as well as the medium term, indications are that the development is completely sustainable. Retail The retail market is still in its early stages of development. The major driver of the retail real estate market is household expenditure, which, in a developing economy is closely linked to disposable income. The (official) average wage has almost doubled in the past eight years, fuelling a strong demand for retail space. The retail market in Sofia is still predominantly formed by high street and big box retail. High street locations are by default in limited supply. In any major European city, demand for high street retail space outweighs demand, and Sofia is no exception. Many international brands are present on the Bulgarian market through franchise arrangement. The contractual obligations of franchisees to meet certain expansion requirements further increase demand. Adding to this that the supply of appropriate shopping center space is currently insufficient has caused growth in recent years that has been largely supply-driven. Mall of Sofia and City Center Sofia - both opening in 2006 - have absorbed some of the demand, but the supply is far from adequate. In the last several years, the shopping habits of Bulgarians have changed. Consumer preferences are gradually shifting in favour of large shopping outlets that offer a wide choice of brands and often lower prices. This development is to some degree at the expense of neighbourhood convenience shops but also on the backdrop of a general increase in purchasing power. The increasing purchasing power of Bulgarians and the growing number of tourists visiting the country is expected to continue to fuel the growth in the retail real estate sector - not only in Sofia but certainly also in Bourgas, Varna, Plovdiv and Veliko Turnovo in the years to come. Logistics and Industrial The logistics and industrial real estate market took off in 2005. After years of underdevelopment, the sector saw some dynamic changes last year. The demand from International logistics operators and local production companies remains unmet, but there are a number of contemporary speculative industrial and warehouse facilities in the pipeline. This is indicative that developers anticipate a significant increase in demand. The strategic geographic location of Bulgaria, with five out of 10 Trans-European corridors passing through the country, and its upcoming status as the southeastern EU frontier provide expectations for growth within the logistics sector. But one of the major drivers of the logistic and industrial real estate sector in Bulgaria is the development in the retail segment; this creates brand new demands on transportation and warehousing, thus driving the changes in the sector. Supply of contemporary production facilities is almost non-existent. This has intensified the construction of build-to-suit facilities, i.e. space that is constructed to meet the requirements of the specific company. An alternative to build-to-suit is the so-called industrial park. These are clearly defined strategically located areas with established infrastructure. Inside the industrial zones, a number of companies establish warehouses and light manufacturing facilities, providing synergies and mutual benefits. Industrial Zone Rakovski, the largest privately held industrial zone, has been the most successful project so far. Developed on more than 800 000 sq m, the project has been 75 per cent absorbed in less than two years - with the Kaufland distribution facility as the anchor. So, if the question is “will the growth of the real estate sector continue”, then the answer is clearly a yes. The industry will continue to progress and mature. As supply catches up with demand the projects will be increasingly sophisticated, contributing to the perpetual development of Bulgaria. Stefan Dimitrov NORMAN Real Estate Corporate Investments In the long term prognosis, the newly emerging real estate markets in South East Europe will be a hit in the next 20 years. The main factors in Bulgaria’s economy will have a greater influence on the real estate market than they have now. Foreign investors that have already invested in Bulgaria’s real estate market will not withdraw if Bulgaria’s European Union membership is postponed by a year. Negative consequences on the market could be expected if Bulgaria remains outside the EU, but this is a highly unlikely scenario. In the next two years, there will be a considerable increase in non-public investment funds interested in buying property in Bulgaria. Such funds will invest mainly in building malls and tourist complexes. Investment revenue is expected to be 30 per cent a year. An increase will be registered in public funds investing in shares of companies dealing with real estate. Land suitable for logistics and distribution centres will maintain high prices in 2006-2007. The same applies to industrial and trade land. Municipalities will develop the practice of exchanging or selling attractive municipal terrains “in one package”. Such packages will be offered to big investors or people close to the municipality without tenders. Agrarian land already in regulation, close to the road network near Sofia and used for industrial purposes will increase its volume. The increased interest in such land will continue to keep the prices high in 2006-2007. It is expected that in 2006, the small and medium companies will rent or invest in cheap office buildings current in the stage of planning or construction. In the next two years, this tendency will increase enormously because more and more companies will leave the apartments in residential buildings that they are currently using as offices. In 2006 the demand for buying first class land for office buildings will maintain its level. There will be an increase in foreign companies’ interest in the construction of spa centres in Bulgaria. Bulgaria will continue to be an attractive place for people seeking fast profit in real estate. Private Investments A possible delay of Bulgaria’s EU membership by one year will have no negative effect on the interest among small foreign investors, who usually invest in one or several apartments in Sofia or in the country’s resorts. For the majority of small foreign investors, such a delay will not be a problem, given that Bulgaria’s eventual EU membership is certain. A factor that could stop these investors could be the high price of real estates. However, current real estate prices in Bulgaria are several times lower than those in other Central European countries and countries such as Spain, Croatia, and Greece, among others. The level of real estate prices in Bulgaria are close to the level in Turkey, but at the moment there is no serious competitiveness between the two countries in their struggle to attract more small-scale investors. In 2006, there will be an increasing differentiation between the various sectors of the real estate market in Bulgaria. The same will apply to the level of real estate prices in the various sectors of the market. The level of prices in first class real estate (Bansko, Borovets, Pamporovo, the Black Sea coast) will remain high. Prices of buildings in prestige areas, yet to be built, will increase due to the high prices of land, construction materials, design costs, and labour. The rates of increase, however, will not reach more than 15 to 20 per cent a year. In the next two years, the buyer will set the conditions of real estate deals. The lower prices of second class buildings and buildings located in central areas but built 20 years ago or even more, will force investors to sell. Such investors had relied on quick profit and revenue. Others will be more careful when buying but will not leave the sector. The terms for completing the construction of apartments in old residential buildings, located in central areas with old infrastructure and a without lifts will be delayed due to the low demand and higher requirements of potential buyers. The demand for country houses will increase, as well as demand for real estate in attractive holiday complexes in the resorts. In addition to trying to attract British investors, Bulgaria must work to attract investors from the Spanish, Russian, German and Israeli markets. Some of the most important media in those countries are currently reporting that prices on the Bulgarian real estate market will increase the same way as they did in Spain and Portugal.’ Remarkable growth over the past few years. This segment of “From All Sides” raises the question of whether this growth will continue. To answer that question, one needs to examine the drivers of the development and assess whether or not these drivers are sustainable in the longer term. From a macroeconomic perspective, there is no doubt that the political and economic stability of Bulgaria is of utmost importance to the development of the business environment in general and, as a derivate thereof, the real estate market. Inflation continues to move in the right direction, and the reduction in both unemployment and underemployment is a clear sign of a stable economy. The success of the currency board reduces the exchange uncertainty that has characterised other economies in the region. Perhaps most compelling, though, is GDP growth, which has outperformed not only the Euro Zone but also the eight new Central and East European EU member states over the past six years. The upcoming EU accession might not directly influence the real estate market in Bulgaria, but the psychological effect should not be underestimated. It is a clear indication of the country’s commitment to European standards and values, reducing the perceived risk of doing business in Bulgaria. So, is the macroeconomic growth sustainable? In the absence of clear comparisons, the development in the Central and East European countries is probably the best model for predicting the growth patterns of Bulgaria. In that context, it should be clear that the current economic development is likely to continue in the medium term and eventually plateau in the longer run. The individual commercial real estate sectors on the Bulgarian market, which include office, retail and logistics and industrial, each have separate drivers of demand. Office The office market is the most mature commercial real estate segment. Historically, growth has been driven by international and Bulgarian companies establishing operations in the country. However, Colliers has recently seen two distinct lines of increased demand; the first is driven by established companies looking to expand their businesses in Bulgaria. The demand for class A office space comes primarily from international companies with a long presence on the market. The second comprises offshoring and outsourcing activities. A recent study ranked Bulgaria the world’s 15th most attractive offshoring destination, based on three distinct factors; the financial factor, people skills and availabilities and the business environment. What is interesting in regard to the above mentioned trend is that there are import spin-off effects from the outsourcing and offshoring, thereby further increasing demand. As the factors driving demand in the office sector are persistent in the short as well as the medium term, indications are that the development is completely sustainable. The retail market is still in its early stages of development. The major driver of the retail real estate market is household expenditure, which, in a developing economy is closely linked to disposable income. The (official) average wage has almost doubled in the past eight years, fuelling a strong demand for retail space. Retail The retail market in Sofia is still predominantly formed by high street and big box retail. High street locations are by default in limited supply. In any major European city, demand for high street retail space outweighs demand, and Sofia is no exception. Many international brands are present on the Bulgarian market through franchise arrangement. The contractual obligations of franchisees to meet certain expansion requirements further increase demand. Adding to this that the supply of appropriate shopping center space is currently insufficient has caused growth in recent years that has been largely supply-driven. Mall of Sofia and City Center Sofia - both opening in 2006 - have absorbed some of the demand, but the supply is far from adequate. In the last several years, the shopping habits of Bulgarians have changed. Consumer preferences are gradually shifting in favour of large shopping outlets that offer a wide choice of brands and often lower prices. This development is to some degree at the expense of neighbourhood convenience shops but also on the backdrop of a general increase in purchasing power. The increasing purchasing power of Bulgarians and the growing number of tourists visiting the country is expected to continue to fuel the growth in the retail real estate sector - not only in Sofia but certainly also in Bourgas, Varna, Plovdiv and Veliko Turnovo in the years to come. 20.03.2006 http://www.sofiaecho.com/(13.06.2006)