COMMENT: Time to reassess the investment case for Poland and Spain

Poland and Spain are not the investor darlings portrayed by many property strategists and journalists, argues Nicholas Spiro, partner at London-based investment consultancy Lauressa Advisory. In this commentary, he calls for a reassessment of these markets.

In the commercial property investment markets of central and southern Europe, Poland and Spain hold the greatest appeal.

In the case of Poland, investors are drawn to the size of the country - a population almost as large as that of Romania, Hungary and the Czech Republic combined - the relatively strong performance of the economy since the 2008 financial crisis and a liquid and increasingly mature real estate investment market that accounts for the bulk of transaction volumes in the Central and East Europe (CEE) region.

Spain, meanwhile, is, viewed as the eurozone’s economic turnaround story. Three years ago, the economy was knee-deep in recession, the banks had just been bailed out and unemployment stood at 26%. Now, Spain is enjoying a brisk expansion - GDP growth is likely to be more than 3% this year - the economy has regained competitiveness and much-praised reforms have, in the words of the IMF, ‘reassured [financial] markets and boosted consumer and investor confidence’.

Herd instinct
Yet as is often the case with highly sought-after investment locations, risks tend to be downplayed and underpriced (particularly when interest rates are at rock-bottom levels), a herd instinct develops, causing sentiment to become detached from fundamentals, and hype gets ahead of reality.

We believe the investment case for Poland and Spain needs to be reassessed. While both countries present significant opportunities for property investment and development - and will continue to attract large amounts of foreign capital by dint of their size and relatively strong economic performance - they are not the investor darlings portrayed by many property strategists and journalists.

Indeed, there is increasingly more value and interest in Hungary and Italy, where the more secure fundamentals of the Budapest office market (vis-à-vis those of Warsaw) and the development of a more liquid and actively traded market for banks’ non-performing loans (NPLs) in Italy are already beginning to redraw the real estate investment landscape in central and southern Europe.

Polish elections
A number of catalysts are accentuating this shift. The triumph of the nationalist Law and Justice (PiS) party in Poland’s parliamentary election on 25 October is one of the most significant political developments in a major European country in recent years and will result in a much more eurosceptic, inward-looking and less business-friendly Poland. While PiS’s socially oriented economic policies are likely to be good for growth in the short term, the controversial party’s return to power is likely to force foreign investors to reassess the outlook for Poland’s economy.

This could heighten concern about Warsaw’s office market - where supply this year is set to reach its highest level to date and rise further in 2016, increasing downward pressure on rents and driving up a vacancy rate that has already surged to more than 14% - which, for some time now, has looked and felt like a market that is heading for a potentially sharp correction.

In Budapest, on the other hand, where the vacancy rate has tumbled from more than 20% just three years ago (and is now lower than in Prague and Warsaw) because of a dearth of new supply, take-up in the second quarter of this year was the highest on record. The scope for rents to start rising is considerable.

Disconnect between sentiment and fundamentals in Spain
In Spain, meanwhile, investors have gotten ahead of themselves. The disconnect between sentiment and fundamentals is striking. That prime office yields in Madrid are now just a tad above those in the City of London despite the second-highest youth unemployment rate in Europe after Greece, a public debt level that has doubled since 2009 to nearly 100% of GDP and what the IMF refers to as ‘deep structural problems’ in Spain is cause for serious concern. The fact that a general election on 20 December is likely to result in a fragmented parliament - and possibly a weak minority government - is doubly worrying.

In Italy, however, although the economy is barely growing, recent legal and fiscal amendments have removed some of the key impediments preventing the country’s banks from writing off and disposing of €330 bn of NPLs - many of them backed by real estate - which have been weighing on lenders’ balance sheets and crimping new lending.

A market for distressed debt is beginning to emerge which could, in the words of the IMF, create a ‘virtuous circle’ in which the clean-up of the Italian banking sector improves profitability and helps underpin a nascent recovery.

In Europe’s shifting commercial property investment landscape, Hungary and Italy are two countries to watch.

Nicholas Spiro
Partner Lauressa Advisory