Does the fact that it’s only Czech funds buying Czech real estate assets matter?
It’s a question I keep asking, because the bifurcation of the investment market has become so profound. Q2 results only strengthened this trend as 90% of all real estate transactions were completed by local capital.
Do local funds know something the foreign funds don’t? What’s holding the foreign funds back?
For months, Michal Sotak (Cushman & Wakefield) has been telling anyone who will listen that yields are falling, driven by strong occupational fundamentals and the glut of available capital. My primary question for him was whether it’s still a good time to buy.
But before we got to the issue of pricing, Sotak said it’s important to understand how Czech funds choose their investment targets. And how Czech investors choose their funds.
“The important thing to understand is that retail investors decide based on emotions,” he says. “People need to feel that they’ve done the right thing by putting their money into a specific fund.” A few funds have managed to do this by building strong brands that manage to connect with investors.
“To be honest, I think that’s a difficult way to do it,” says Sotak. “Another way to do it is to buy buildings that are sexy, but these are almost without exception the well-known shopping centers.”
In the end, he says, “the financial advisor himself or herself needs to create emotions when they’re talking to the investor. That’s why the distribution network is so important, because they’re where these emotions of trust and confidence are created.”
In order to understand what drives funds to buy which buildings, Sotak has spent the last year meeting not just the acquisition managers, but their sales teams. It’s easy to forget that most of them sell a variety of funds and investment vehicles. Part of his mission in speaking to the distribution teams is to give them the information they need to convince their customers that property is a good bet. But he’s learning from them at the same time.
And one of the key insights he’s taken from this is that unlike SICAV real estate funds, deep analysis of ROI and WALT indicators is not what drives the consumer market. “When it comes to retail, emotions rule. If you were to do a plot of inflows into funds versus returns, you would see that the funds with the highest inflows have the lowest returns. If a fund was losing money, that would create negative emotions. But in a way, it doesn’t really matter whether they’re returning 3% or 4%.
“If you look at what investment products are available for Czechs, they can buy US shares, but they don’t do this on a large scale. And what else can they do? Beyond property, there aren’t so many financial instruments that are easy to understand where it’s easy to send money every month.”
Is it a good time to be buying commercial real estate in the Czech Republic now?
Michal Sotak: Absolutely.
Why?
Sotak: Because the balance of demand and supply on the capital market is massively in favor of demand for product rather than supply. I’m no macroeconomist, so I won’t make any predictions about the next five years, but in the next 18 months, my prediction is that yields will still go down. The only limit on that will be borrowing costs, which are currently at, let’s say, 4.25. That puts something of a floor on pricing, but the yield will be sharper 12 months from now. Therefore, unless there is a sudden dramatic change in the external environment, if you buy in the next few months, you’re likely to make money in this kind of tactical, short-term sense. I wouldn’t want to make longer-term predictions.
Obviously, this isn’t investment advice, but which sectors do you guess that applies to?
This applies to offices and to shopping centres. It applies to industrial, but keep in mind that the industrial occupational market has weakened in the last year. For various reasons, demand for space is lower than it was, say, in 2022.
Automotive was still strong then, eshops were still booming from COVID and there was still traditional 3PL retail demand…
Exactly. These days, the eshop sector is consolidating and the automotive sector is undergoing a transformation which will ultimately mean they’ll need less space. So, when you are buying industrial, you have to be very mindful of the rents you underwrite. The sector you need to be careful about now is retail parks, where there’s a lot of supply. There’s something like 30 retail parks being built every year and that simply has a negative impact on rental levels. Otherwise, with offices, shopping centers and hotels, there is no reason for me to believe that they will not increase in price in the next 12 months.
What you want to do as a buyer in this environment is go early and buy from people who want to exit strategically, not opportunistically. These are usually western investors that are simply leaving the market.
Speaking of which, can we talk about the unwillingness, or inability of foreign investors to pay as much as Czech real estate investors? When foreigners accuse Czech funds of overpaying, what do they mean? Are they right? Or are they just saying what investors always say after losing a tender?
Intellectually, the key reason why western investors can’t compete with local money is because they don’t underwrite value growth. So, when they buy a building, they underwrite the rental income, but they don’t underwrite the appreciation in value.
They won’t do it on principle?
Exactly. Whilst Czech funds will do it, because their performance measure, the KPI, the NAV growth actually does reflect cash-plus-revaluation. Revaluation is very often 50% of their returns. Local funds are incentivized to underwrite value growth and to manage it honestly — because the valuation process isn’t 100% rigid. Western investors don’t do this very often because they aren’t evergreen, open-ended structures. Their investors aren’t interested in it.
There’s no clear-cut way, then, to say who’s over-paying, who’s under-valuing and whether pricing has adjusted appropriately?
First of all, there has been a price adjustment. We went from sub 4% yields to in general five-plus yields. In the west the shift was let’s say 250 basis points, whilst here it was probably less…but there was price adjustment. As for whether the Czech funds are overpaying… overpaying relative to what? They need to get their returns, which in the end are, let’s say 3% to 5%. It’s not so easy to judge what it means and they’re getting those returns from the buildings that they’re buying. In that sense they’re not overpaying.
I think a bigger question is, is this pattern of buying sustainable? And my answer is no, it is not sustainable because if you look at the balance between capital versus the product on the Czech market, it simply can’t continue forever. What will happen is that that money will go elsewhere. We will export capital and Czech funds will buy abroad. Otherwise, they’ll get stuck with cash on their accounts with no buildings to buy.
Czech investors are already having an impact on the Polish market. If they’re paying 6.5% for Polish industrial, are they going to be happy paying 5% at home?
If you pay 6.5% for industrial in Poland, that 6.5% has 30% incentives built into it, so it’s actually 6.5 x 0.7. It’s actually not necessarily a better deal than what you’re getting in Czechia. But in general, if you’re asking whether Czech funds will become more sophisticated by investing abroad, I think the answer is yes, they will. The biggest ones have inflows of €30 million, €40 million per month. They can’t do small deals in Czechia because they won’t be spending money fast enough to deploy the capital they’re raising. They have to do big deals, so they probably have to do them abroad. And then they’ll have to manage those big buildings. The top Czech funds will grow into essentially into the DEKAs of the world, and it will be a professionalization process for them.
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