We’ve been stumbling from one crisis to the next since 2020, straight into an inflation hurricane. People seemed to think inflation was a thing of the past, never connecting it to the value of their own apartments and property funds that for years did nothing but gain in value for years. Now that we’ve been reminded of property’s core, defining purpose in life, I thought it would be a good time to ask readers of ThePrime how they think the asset class is performing. Two respondents took advantage of my offer to answer anonymously. Everyone else spoke refreshingly on the record.
Martin Budina (Contera)
What have the past three and a half years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
There’s no doubt the last 3.5 years were very turbulent and, in some cases, unpredictable. The Covid 19 pandemic followed by Russia’s aggression against Ukraine had a serious impact not only on the real estate market.
During such crises, a diverse client portfolio and well-set up lease agreements are the key to survival. Since we focus on various types of development activities we only had to deal with relatively small issues with only a minor portion of our clients and properties in general.
Obviously, we see the market slow down and we are adapting to it. But despite all the major global topics, the value as well as the volume of our portfolio is constantly increasing.
Which of the major real estate sectors has performed this task the best and/or worst through the recent crises?
E-commerce and city logistics are the best performing RE sectors. Several lockdowns during Covid 19 pandemic caused enormous demand for the e-commerce services and delivery services in general. On the other side there were manufacturing companies which had serious problems especially with dysfunctional supply chains and high energy costs. Luckily, I see that the situation is getting better.
How long do you think high construction costs and interest rates will discourage developers from beginning new projects?
The B2B sector seems to be stabilized now. Real estate developers and landlords found a solution with a majority of their clients and tenants in terms of rents and construction costs. There is still some space for market improvements, but needless to say the situation was far worse a year ago.
However, the B2C sector, mainly residential development, is still losing. Mortgages are unaffordable due to high interest rates. At the same time, persistent high inflation and non-increasing salaries are dramatically slowing down residential development and forcing investors to find new ways to make their projects profitable. Rental housing seems to be the new trend. However, in my opinion, it’s only a short-term solution and most real estate developers will come back to the house selling strategy once the situation calms down.
Is there far more invisible distress behind the scenes that will eventually come out? Or were the predictions of wide-spread defaults exaggerated?
It’s hard to say, but there still seems to be a lot of capital in the economy. Which is a good message obviously, but on the other hand this can feed the inflation further.
Rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
2
Jakub Holec (108 Agency)
What have the past 3.5 years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
During the period of rapid inflation in the last two years, even the yields of traditional inflation hedges such as real estate did not manage to keep up with the growth of the consumer price index. Few assets have managed to provide investors with returns in real terms. Rents for commercial real estate in the Czech Republic are mainly indexed according to the inflation in the Eurozone, as the Euro is the major financing currency. Most tenants were able to keep paying rent, and the price increase was simply absorbed by the increased price of their products and services. The growth of financing costs generally not exceed the growth in rent prices. CRE is still a very safe investment with relatively high yields in my opinion.
Which of the major real estate sectors has performed this task the best and/or worst through the recent crises?
Throughout Europe, logistics and industrial real estate has been the highest-yielding CRE asset in the past 3-4 years, and it still provides the highest yields. During the Covid crisis, CRE yields converted to similar values. Now they are diverging again, and logistics is still the top asset class with the highest yields.
How long do you think high construction costs and interest rates will discourage developers from beginning new projects? Which sector is likely to see the biggest impact or the most restricted pipeline?
We believe that the next meeting of the European Central Bank might conclude the interest rate hike cycle and bring either stabilization or the last hike. After that, interest rates should slowly start coming down. Even though the Euro is not the official currency of the Czech Republic, it’s crucial for commercial real estate financing. Virtually all projects of larger developers are funded using the Euro. A similar scenario is to be expected for the Czech National Bank, which has chosen a strategy of stable interest rates throughout the whole high inflation period. The bank recently formally ended its interventions on the foreign currency markets. This may indicate that the era of high interest rates could slowly be coming to an end.
In July, month-on-month growth of construction prices in the Czech Republic finally started stagnating, another signal that we may finally be getting back to normal. Several factors including high energy prices, supply chain disruptions, and the tense geopolitical situation disrupted the market. We believe that Europe’s ongoing energy transition will keep prices for construction materials relatively high compared to the years before the crisis.
So we expect this discouraging period to last at least until spring of 2024. That’s the earliest point at which we expect major change in interest rates.
In the Czech Republic, offices are currently the asset class with the most restricted pipeline. No new construction has been initiated in the last four quarters in Prague. Developers are now waiting for better times and are avoiding speculative construction.
Is there far more invisible distress behind the scenes that will eventually come out? Or were the predictions of wide-spread defaults exaggerated?
We are already receiving information about developers of commercial real estate defaulting on their payments to Czech banks. However, we believe these are rather occasional and unconnected events, which do not represent the whole market. We often hear about the situation in the United States, with its problematic offices or shopping center assets. But this is not the case in the Czech Republic, where employees are returning to offices in large numbers. Office vacancies have been slowly going down since Q2 2022. Premium offices record even lower vacancies and are very much sought after. Premium retail parks and office centers in the Czech Republic are generally much younger compared to their counterparts in Western Europe or the US and their stock is still not sufficient.
On a scale of 1-5, rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
2 – overall
1 – logistics and industrial
3 – office
3 – retail
Josef Stanko
Colliers
What have the past 3.5 years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
That really depends on who you choose as a partner. When the market was ruuning well and almost everything was successful, it was tough to sink a project or predict what could go wrong. But you have to be careful in times like these when choosing an investment instrument. Residential could be tricky now due to financing and demand. Office needs to be precisely executed and industrial needs the economy to thrive, not stagnate. But in general, my belief in property is still firm and strong. As a long-term hedge it still represents one of the best conservative investments.
Which of the major real estate sectors has performed this task the best and/or worst through the recent crises?
I can comment mainly on the Czech market, which is still something of a Pandora’s box. But we see offices are here to stay and there’s almost no drama at all on the leasing market. Industrial evolved into a sector worthy of investment even in the Czech Republic. Retail is on its way back to normal and and retail parks beyond question they have a purpose. I think the market performed very well as a whole and that recent years have simply are just cutting out the weak.
How long do you think high construction costs and interest rates will discourage developers from beginning new projects?
Many projects (especially offices and residential ones) were halted correctly in my view, as the concerns about sufficient demand were justified. The economics of these projects (or the market) just didn’t work any more. On the other hand, industrial developers seem unconcerned about this, considering the record volume under construction. The office sector has quite a strong pipeline after the upcoming supply gap. It looks like a stronger period for the real estate market. But this won’t be lightning quick and the strongest players on the market will have to lead by example.
Is there far more invisible distress behind the scenes that will eventually come out? Or were the predictions of wide-spread defaults exaggerated?
I believe there will be some issues that come up, but in our market, they’ll be mostly isolated pockets, such as bad scenarios with bonds, unlucky individual decisions or politicized topics like affordable housing.
On a scale of 1-5, rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
Depends on the type and other variables – but I would go for a 2+.
Michal Sotak (Cushman & Wakefield)
What have the past 3.5 years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
Property performs as an inflation hedge if there is a good balance of supply and demand. That’s generally been the case in the Czech Republic. So my belief has been strengthened.
Which of the major real estate sectors has performed this task the best through the recent crises?
Residential, industrial and shopping centres. Due to the limited supply and sustainable demand.
How long do you think high construction costs and interest rates will discourage developers from beginning new projects? Which sector is likely to see the biggest impact, or the most restricted pipeline?
Czech construction costs are not coming down, particularly in sectors with a large share of labour (residential, refurbishments). So this will hit new supply for a long time. Interest rates will come down in H2 next year. Structurally, the balance of uncertainties will limit supply for a long time to come. Industrial will see a healthy supply. Resi will see some supply. Other sectors will generally see no supply.
Rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
2
Hamish White (REM Group)
What have the past 3.5 years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
Rents have increased faster than normal thanks to inflation but values have decreased considerably so in many cases owners are now worse off.
Which of the major real estate sectors has performed this task the best and/or worst through the recent crises?
The winner must have been industrial and logistics. The old rule of thumb that industrial/logistics yields are 1.5% over prime office has been turned upside down. Residential values have skyrocketed, but if for example you owned an apartment in Budapest and wanted to sell and convert funds to euro, then the FX loss has wiped a chunk from your capital gains.
How long do you think high construction costs and interest rates will discourage developers from beginning new projects?
This will take a few years to work through for sure. But it depends on supply and demand. If a tenant really needs a BTS, then they will have to pay the price. The office sector is still in a state of flux with this home office factor aspect and vacancy is increasing in many markets. But I’ve seen this happen twice in my 30 year career and both times the vacancy decreased.
Watch the office sector. My pick is that offices don’t die and there will be increased demand but there is a lag time to have project permitted and built. In Hungary, retail is very restricted but it’s hard to see new shopping centers popping up anytime soon. But the inverse is that people love to shop and there will always be a need for retail/social.
Is there far more invisible distress behind the scenes that will eventually come out?
Yes! There is stress but it’s nothing compared to my experience of the great financial crisis. Ask any of the big owners if they could cover their debts if they had to sell today. I bet quite a few are close to technical default, but they won’t dare admit it.
Rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
In my personal experience I’ve done ok from the effects of inflation but I’m glad not to be leveraged. I’m a 2.
Peter Szamely (Hypo NOE)
What have the past 3.5 years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
I believe there is no straight forward answer. It depends if you are an investor or a developer, as well as when the building was purchased or completed. The sector is also not irrelevant. In an ideal situation, you completed and fully-let your building at the beginning of the pandemic. Building costs were stable at that time, so there should be no relevant cost overruns. Tenants made their decision earlier so they committed for, say, a 5-year period. And there were still some buyers around. Leveraged buyers could still enjoy the benefits of cheap borrowing rates. Then it got worse.
If you were unlucky enough to open your hotel at that time, then your investment became a disaster due to closing restrictions. If you had a logistics shed or a logistics project to develop, you were much better off. What’s certain is that if you have a recently-built building with green facilites and healthy tenants, than you were hedged well against inflation. You can’t build today for the same money as it cost three years ago. But healthy tenants can afford to pay indexed rent.
Which of the major real estate sectors has performed this task the best and/or worst through the recent crises?
Best – Logistics, due to increased ecommerce, huge occupational demand, and strong investment demand
Worst – Hotels and full-scale downtown shopping centres due to restrictions, tenants who may have gone bust, vacancy and high fixed-costs
Middle – Offices due to home office, redundant space has been given up, and tenant may have gone bust
Good – power centers and strip malls with tenants that offer day-to-day consumption goods because they were less impacted by Covid restrictions
How long do you think high construction costs and interest rates will discourage developers from beginning new projects?
I think investment demand plays a more crucial role than construction costs. In general, construction costs have stabilized, though they’re a bit higher than before the war. They shouldn’t be an insurmountable obstacle. Liquid investors, meaning those who have money, are waiting for those who came under pressure start selling. There still seems to be a certain level of occupational demand. However, unleveraged buyers are better off than tenants while leveraged buyers are the worst off. The question is when banks will be ready to increase deposit rates.
Is there far more invisible distress behind the scenes that will eventually come out? Or were the predictions of wide-spread defaults exaggerated?
It’s probably building up. We have not seen much yet, but we’ll probably see more towards the end of the year or the beginning of next year.
Rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
Property is a long-term asset. In the long run, it’s still a good heding tool against inflation. Unlucky investors who got the timing wrong have suffered though. However these should still be considered as a minority. That means, my score would be a “2”
Zdenka Klapalova (Knight Frank)
What have the past 3.5 years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
Real estate investments are of a long-term character. The question is in which part of the phase you buy and sell. In most cases they produce a return that’s indexed either fully or partially to inflation. In the long-term, real estate is a good protection against inflation. It’s certainly a more stable allocation that other assets. Short-term speculation naturally brings with it risks of a fall in price. But if the owner isn’t under pressure, it’s possible to time the sale of the property for the right moment.
Which of the major real estate sectors has performed this task best through the recent crises?
Logistics are spoken about a lot. But I’d say that the best locations and the best-in-class product work the best.
Which sectors do you have the greatest concern about going forward?
The impact on retail, though it’s not absolute. Investments by a number of local investors have proven this.
Which sectors will be hit hardest by high construction costs and interest rates?
Offices and residential. The low level of supply and growing demand will be seen in rents and sale prices and will lead to equilibrium. We need more commercial and residential projects.
Is there more invisible distress behind the scenes that will eventually come out? Or were the predictions of wide-spread defaults exaggerated?
The expectations for more distressed sales didn’t pan out. The situation isn’t nearly that dramatic and there aren’t many forced sales.
Rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
2
Tomas Fabian (Skanska)
What have the past 3.5 years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
It basically confirmed for me that in the long-run, CRE is a vital instrument for preserving investment value. Extracting just a specific period in such a cyclical business environment tends to be misleading. The whole cycle should be taken into consideration.
Which of the major real estate sectors has performed this task best through the recent crises?
I wouldn’t pick any specific sector, as there are still subtle nuances causing major impacts on specific performances. But overall, the CRE asset class confirmed its resilience. On the flip side, we should never forget that we are in a cyclical business with slightly different dynamics in each CRE sector.
Which sectors have suffered the most, or do you have the greatest concern about going forward?
Offices are mentioned in all the headlines lately. It reminds me somewhat of the buzz around the retail sector a few years back. It’s all about repositioning and redefining the product. I am not at all concerned about offices in good locations that are accessible via public transport and have strong ESG credentials. There will always be demand for such product from occupiers as well as investors.
How long do you think high construction costs and interest rates will discourage developers from beginning new projects?
At the moment, uncertainty around the cost of financing seems to be having the biggest impact. At the same time, rapid interest rates growth recently made us all realize that proceeds are not for free. When it comes to the cost of financing, I am convinced that past decade is nothing like what we should expect in the next cycle.
Is there far more invisible distress behind the scenes that will eventually come out? Or were the predictions of wide-spread defaults exaggerated?
Across the region we‘re seeing high activity in M&A as well as in opportunistic investments. Each case should be assessed separately, though. In my opinion it’s not so visible yet, but we‘re likely to see more of it in the near future.
Rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
2
Anonymous
What have the past 3.5 years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
I’ve probably been more skeptical than many people over the past three years, and I was surprised to see the extent to which tenants were willing and / or able to accept significant inflationary hikes during the past 12 months. Frankly, I don’t think many of us in the pre-Covid days ever expected inflation to reach the heights it has over the last couple of years. As such, it never seemed like it could be an existential issue for some tenants. I believe that, given the levels of inflation we’ve seen, property has performed a lot better than we could have reasonably expected. What’s been notable is the creativity of some landlords under the circumstances. For example, moving Czech Crown leases into Euro leases, in exchange for a lower inflationary hike.
Which of the major real estate sectors has performed this task best through the recent crises?
I’m not sure if it is a sector-by-sector trend. From my (purely anecdotal) experience, the nature of the relationship between the tenant and their space has been the key driver. Some firms are pretty much tied to their premises, so less they’re likely to push back hard against an inflationary hike. There’s also been good discipline from a lot of retail landlords, in refusing to “blink first” and sticking to their guns in triggering inflationary clauses, which makes it less attractive for tenants to up sticks and move to alternative premises.
Which sectors have suffered the most, or do you have the greatest concern about going forward (and why?)
I don’t have much personal experience of this, but I would have thought that it is consistent with the wider economy, i.e. smaller companies operating in local currency are likely to have suffered the biggest impacts on their trading results, so these will be the tenants that have suddenly become much riskier for landlords than they were previously. It would be interesting to see some sort of affordability indices, to see if this really is the case.
How long do you think high construction costs and interest rates will discourage developers from beginning new projects?
Resi developers face a two-pronged assault on their business. Until interest rates fall, mortgages are still going to be hard to come by. At the same time, the carrying cost of their land banks is likely to be higher than they are comfortable with, and interest rates can’t come down too soon. That’s probably why we are seeing so many land banks coming to market over the last few months.
Is there far more invisible distress behind the scenes that will eventually come out? Or were the predictions of wide-spread defaults exaggerated?
I have no idea. The banks are pretty close to their clients, or at least to their biggest clients, so the players who probably need to tread with most caution right now are those who have significant leverage in their own eyes, but who the bank may view as too small to worry about.
Rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
2
Anonymous
What have the past 3.5 years done for your belief in property as an inflation hedge? How has it performed compared to expectations?
Property is an inflation hedge to some extent, so it depends on nature of inflation. Although property is not a perfect inflation hedge, it can offer protection. Property works better in a modest inflation environment as an inflation hedge.
Which of the major real estate sectors has performed this task best through the recent crises?
Globally multifamily, though not in rent-controlled markets.
Which sectors have suffered the most, or do you have the greatest concern about going forward?
The office sector could be a source of concern in the future as it depends how much tenants can afford to pay if inflation remains very high for many years.
How long do you think high construction costs and interest rates will discourage developers from beginning new projects?
Interest rates will be staying higher for longer, which could mean 2-3 years. They won’t stay at their peak (which may still be coming) but at significantly high levels. The low interest rate environment of the past 10 years is not going to return. And it’s unlikely that we’ll see a dramatic drop in construction costs in the near future, although some decrease will take place. In Prague, the impact appears to have been heaviest on the office sector since no new construction has begun on office projects in the last 12 months. Office rents would have to move up significantly if high interest rates and construction costs don’t fall, otherwise the numbers for the projects are not going to work.
Is there far more invisible distress behind the scenes that will eventually come out? Or were the predictions of wide-spread defaults exaggerated?
There will be distress (non-performing loans etc.) coming to the market and the worse is yet to come in CEE. CEE is lagging behind the USA, the UK, and mainland Europe in terms of the speed of price adjustment. Things will get worse before they will get better in CEE. There’s already been reporting that a few of the big developers in Germany have collapsed following defaults.
Rate property’s performance as an inflation hedging investment in view of the past few years? (1 is best, 5 is worst)
3
