Looking at what is going on in world politics, TriGranit’s CEO finds it difficult to comprehend why many still stress the political risk factor when talking about the Central European real estate market. He’s optimistic about the future and expects further diminishing returns on investment, along with new investors appearing in Budapest. Árpád Török talked to us about plans for developing TriGranit and the future of the real estate market.
When TPG bought TriGranit last year, the plans at that time were heavy on acquisitions, but 2016 has been about development and sales. How come?
It’s true – our plans focus heavily on acquisitions, but let’s not forget that TriGranit is an integrated real estate platform, that is, an investor, developer and operator all at once. Since there is no ownership pressure on us regarding acquisitions, we have the opportunity to purchase only those properties that we truly believe in. And should the market lean more towards development or sales, we’ll shift our focus accordingly. But let’s look at the year 2016, which, by the way, is one of the most successful ones in the company’s 20-year history! We have worked on preparing acquisitions during the past 10 months, and screened a great number of potential assets, aiming to acquire them. Additionally, we prepared three office market investments that offer a total of 60,000 square metres, and finished 20,000 square metres of offices to let. And, by selling the Millennium Towers office complex in Budapest and the Krakow BCC at a record value, we realised the largest transactions in both the Hungarian and the Polish real estate markets.
What does that mean in details regarding acquisitions?
During the past few months, we screened a very serious real estate portfolio of offices and shopping malls in the region worth €16 billion in total and covering 10 million sqm, with the intent of acquisition. We bid on about 15-20 percent of them, and there are assets negotiations are still going on about. There were projects where the tender was withdrawn, there were instances where TriGranit was outbid, and there were projects we did not purchase because they did not reach the required levels of economies of scale. From this latter point of view, we would rather focus on larger transactions, and monitor portfolios that span countries or asset classes. But let’s not forget that completing an acquisition takes at least 6-8 months counting from the initial offer. Thus, the only way we could have realised an acquisition by now is if we had bid on a portfolio already by the time we were acquired by TPG in December 2015. Let’s be real, it isn’t even physically possible. We have, however, concluded the sale of the Bonarka City Center in Krakow, which ranks as the Polish real estate market’s greatest single asset transaction this year, and the third greatest volume sale of all time in the Polish retail market. We did not plan on selling the Bonarka City Center this year, but we received an offer which made it possible to capitalise on the project’s investments over the past 10 years. We sold the shopping mall at a record price. Parallel to this, we also said good-bye to the Millennium Towers office complex, where we used to be developers and operators, and had 26 percent ownership at the time of the transaction. This was the largest transaction on the Hungarian office market ever, both in value and size.
Based on information published by the buyer, one can calculate that the Krakow BCC shopping mall and Millennium Towers sold at 5% and 6.85% yield levels, respectively, thus both properties were sold at a record low yield. What do you expect, how far can yields diminish in Budapest?
Much like the Millennium Towers, the Park Atrium office building also sold at a record low yield indicates that yields are between 6.75-6.85 percent in the premium segment of the Budapest office market, which is a rather good yield. This, however, is outstanding only as far as the last six years or so goes, but falls short of the pre-crisis level. I don’t know if we can expect the sale of office buildings to be at an even lower level this year, but I’m certain that Budapest is going to get more expensive over the coming 12 months and that there will be transactions at 6.5 percent. I wouldn’t, however, bet on yields reaching 6 percent. If we look at Prague and Warsaw, yields there are now around 5 percent, at a pre-crisis level. Budapest has been above its competitors by 170-175 basis points for a long time, and it’s a big question whether this can be reduced owing to changes in perception regarding political risk, the market size, liquidity, or anything else.
Do you see any changes coming in perceived political risk?
Decreasing yields and transactions concluding at higher prices are a sign of trust. What generates this is another question. Is it because Poland and the Czech Republic have become too expensive or because investors view the Budapest market as safe? Hungary has high quality assets and good tenants with good guarantees, these certainly build trust. Commercial consumption as well as economic performance is increasing. I think that, lately, investors have been more positive regarding political risk. For the long run, however, it is important for the market to remain predictable – market-based regulations and decisions are required. Without those, international investors are going to turn their backs on Hungary.
What changes do you see in the composition of investors?
This year, established investor groups that used to be the major pre-crisis players have returned to buy in Budapest, but what’s a much more interesting change is that some have appeared who were not present before the crisis. South African capital is present throughout the region, including the Czech Republic, Poland and Romania, and keeps the market under very heavy pressure. They have yet to buy in Hungary – it is worth pondering if they will at all.
As a whole, are you optimistic about the future of the regional investment market?
Absolutely, there are very exciting things going on in the industry now, markets seem to be approaching their peaks, but it is difficult to foresee when they are going to reach it. I expect price increases and further growth of investment volume in the coming 12 months. Budapest will likely have a year just as positive as this one, and every quality asset can change hands in the 12-24 months to come. Even though the market is small on a regional scale and existing products can thus run out quickly, if current developments – planned for 2018 – conclude successfully, those can also be sold by the developers.
However, we should keep in mind the cyclic nature of economics, and thus the real estate market. Previously, the market would experience 7-9-year-long cycles, years of prosperity followed by a kind of recession, crisis, or market correction. Seven years have now passed since the last crisis. The percentage of US people unable to pay their debts is on the rise, several branches overproduce. Car purchase and student loans are climbing to very high levels. All this has not yet been critical, but should this trend continue it will have a negative effect on the economy. Analysts predict a kind of market correction in the US already by 2018-2019, which then can spiral out into the entire world. This will not necessarily come in the form of a crisis, but rather as a type of restoration, a deceleration of the current big boom, and a decrease in development volume. The interest rate is still low, however, and there is a lot of capital out on the market waiting to invest in real estate, and as long as it remains that way there isn’t any serious problem.
Can you imagine that because of product shortage, forward contracts will become popular again?
It could happen, but I don’t think the market is there yet, and this is of course also a question of pricing.
Before the crisis they existed because there was nothing else left for investors to buy.
Correct, and I hope many have learned their lesson from the crisis. But compared to its level 7-8 years ago, the office market and retail assets one can acquire have grown significantly. Thus, all it can influence are new developments.
What do you believe to be those risks that can have the greatest influence on the real estate market in today’s Europe? Can Brexit have an effect on the regional markets?
I don’t think Brexit will greatly influence this region, but if it does at all, it should have a positive effect. Although most people agree that Western Europe is going to benefit the most from Brexit, and companies leaving London are going to relocate to financial centres there, a few SSC’s might look for this region. From a Central and Eastern European perspective, world economy risks are far more significant. If the FED raises the interest rate, that is going to affect banks all around the world. This will result in raised margins in Europe as well, which will clash with yields. And all this worsens the profitability of real estate investments. We cannot yet foresee if this is going to happen, and to what extent.
Are you more optimistic or pessimistic about global economy?
They always ask: is there political risk in Central Europe? Isn’t Brexit a political risk? You can no longer single out Central Europe as a politically risky region, because previously unthinkable events have taken place in the developed West, too. There are still major differences between Central and Western Europe from an investor’s perspective. Among others, lack of local capital plays an important role in this. Any place with serious local capital – typical in Western countries – means greater stability. Local capital does not leave in the event of an economic or other crisis, as opposed to opportunist global investors, who can leave easily.
Still, local purchases have begun to take place in the region.
The Czech investment market gains great strength from local capital that other investors find difficult to compete with. It is very interesting that there is no such phenomenon in Poland, but if REIT structures become more widespread, that can give the region’s largest market a chance. It is proof of development in Hungary that players like Erste or Diófa became large buyers. They became active in a period where no one else was willing to buy, and with good reason.
From an investor’s perspective what are the most attractive among TriGranit’s markets?
Poland offers the most opportunities for investment and for development – we currently have two office markets and one retail development plan in preparation. We are also looking at investment opportunities in Budapest, but currently we could not buy at a price we could sell at – unless it were a value-added case. Furthermore, since we can, we are rather developing than buying in Budapest, as in today’s market environment that offers greater and safer returns.
Speaking of development, what are TriGranit’s current projects?
We are working on three other developments – the Millennium Gardens office building in Budapest at 35,000 square metres, a 15,000 square metre large office building in Bratislava, and if all goes according to plan, in the first half of 2017 we are going to launch the next building at Bonarka for Business, building H, to let at 10,000 square metres.
This is going to be your first post-crisis development in Budapest. What else can you tell us about it?
As part of the Millennium City Centre, Millennium Gardens shall be constructed next to MÜPA, the National Theatre and the prospective Congress Centre on the banks of the Danube. The office building will feature 35,000 square metres to let and over 600 parking places. This is a well-known, strong submarket and we already have prospective lessees, so we plan on starting construction late in the first quarter of 2017. This development consists of two buildings that we would like to realise at the same time, but we are flexible enough to carry out construction in two goes if necessary. We are financing Millennium Gardens partly from our own funds and partly from bank loans.
Are you optimistic about the Budapest office market’s future?
Basically yes, but I have bad news: with the exception of the Central Business District and the absolute premium segment, we do not expect significant increases in rent. Rents increase when demand is much greater than supply and lessees come under pressure. Looking at the coming week or two, the opposite is going to happen – about 100,000 square metres of new office space is being constructed within a few hundred metres distance on Váci Road, which lessees will have access to from 2018 on. Location is still a primary concern for a lessee, so for buildings next to each other the price is going to be the decisive factor. I do not expect rents to decline – like in Warsaw – but I don’t think a rise will come. There is no inflation any more to exert pressure on rent prices, either. Since financial margins are also improving, it is not necessarily vital to work with much higher rent in order to make an investment profitable.
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