Everything would have been fine if it weren’t for Covid.
That’s what a lot of people keep telling themselves, at least. But Mark Robinson (EnCor Wealth Management) says the writing was already on the wall in 2019 for the last cycle. “The recession was due,” he says. “GDP had peaked in 2018 in the Czech Republic, the signals were there, we just didn’t know that the necessary condition for the recession to occur turned out to be a pandemic.” Sticking with the health analogy he says illiquidity in commercial markets is usually one of the first symptoms of any recession. “We saw it drop from Q2 2020 onwards and transaction volumes are running at 30% to 70% of where we were in 2019.” Prior to last year, values were increasing in a highly synchronized manner. “It didn’t really matter in the last cycle which sector you invested in for real estate in Central and Eastern Europe and in the Czech Republic, they all went up in value. There wasn’t very much differentiation going on. But obviously 2020 really changed that.”
What we see now, says Robinson, is a property market where values were rising only in the residential sector, spurred on by a flood of newly printed money and rock-bottom interest rates, and in the industrial sector, thanks to the online sales growth and a surprisingly resilient export market.
When it comes to the office market, however, Robinson says the picture is far less certain. But he insists the huge scrum over the future of work is just a distraction. “There’s a huge amount of debate about the future of the office sector, but I think that’s misplaced,” he explains. “For me it’s much more simple, it’s mathematics. What we’re talking about is a cyclical adjustment of vacancy rates. We had very low rates of vacancy as the economy boomed for the last five to seven years in the Czech Republic, so vacancy compressed for A-class properties in central Prague to 5 or 6%.” That was a great result, says Robinson, but going forward, the only thing that matters for landlords and investors is where vacancy is going. Not just on average, for the market, but which buildings. And even within buildings.
In other words, when you cut out all the theorizing and ignore excuses like Covid-19, vacancy drops during a boom and rises during a recession.
My question for Robinson was a bit wordier, of course. “So this whole debate of how work will be organized and whether people will work from home, that’s essentially window dressing? You’re saying it’s more effective or productive to think about the normal ebb and flow of vacancy within a market?”
“Each individual decision is a bit like what you described,” said Robinson. “But if you add all of those up you’re actually looking at mathematics. Because it’s clear that a lot of people do prefer to work at home but other people prefer to work in the office. They’ve discovered this over the last eight months. There will be substantial demand for offices as meeting places in the future. This is in my opinion undeniable.”
For investors looking to price office assets at this moment, however, “it’s a matter of calculations, again: how much demand for space we’ve lost on a long-term basis due to corporates deciding to downsize, how long that takes to be reabsorbed in the next cycle. It looks like it’s probably two, three or four years for this to all work through…We came into it with the market still going at full pelt in terms of the development pipeline, there was a lot of it going on in 2019. That’s been curtailed somewhat in 2020 but not entirely.”
But when it comes to pricing for prime offices in Prague, didn’t we get the answer from Penta Real Estate’s sale of Churchill? Or are there still questions over whether the deal was repeatable, given the relative inexperience (exuberance?) of the buyer or some anchors thought to be quick on the rent-reduction trigger.
“[The deal] informs about the condition of the market,” he concedes. “But as people will acknowledge, it’s an illiquid market if that’s the only transaction that people could hang their hat hat on in terms of pricing. It’s evidently a high quality asset and there were several bidders for it…But it’s a single transaction. In order to be able to confirm or refute what you just said, we need lots more transactions.”
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