COMMENT: Retail on a roll in Central and Eastern Europe

The ‘performance escalator’ appears to be climbing quickly in Central and Eastern Europe (CEE), with
prime traditional shopping centre (TSC) rents in Warsaw for example rising steadily from €90/m2/month in 2013 to €117/m2/ month at the end of Q4 2016.

The pattern has been the same in Prague and Budapest from 2014 onwards. Occupancy in the key shopping centres in these cities is at, or very close to 100%, with waiting lists of prospective tenants reportedly being drawn up. Fresh supply of new developments looks relatively limited. 

CONFIDENT CONSUMERS
Why is the retail sector so strong? Out of all the key real estate sectors, it has the clearest positive link to consumer demand and wage growth. Consumer demand is itself related to GDP but it is also very clear that in this economic cycle in CEE, the consumer is certainly playing a more prominent role than in the last major cycle that ended with the deep regional recession in 2008-09. Consumer sentiment, as measured
by the European Commission’s Economic Sentiment Index (ESI), is stronger in this cycle compared to the last one.

A comparison with the overall sentiment score when looking at the CEE-6 countries taken together illustrates the trend well. The chance of these indicators climbing further is high, because wage growth is buoyant across the region. More money in the pockets of employed consumers, including
many benefiting from significant hikes in the minimum wage in Hungary (30% over 2 years), Romania (16%) and the Czech Republic (11% in 2017), means higher spending on both staples and discretionary
goods. 

Overall wage growth is set to continue in 2017, in a range of between 4%-10% in CEE. In this environment, the chances of further rental growth in the likes of Prague, Warsaw and Budapest, simply resulting from demand pressure, are very high. These trends will also likely reflect nationwide in these countries, as the wealth effect ripples out.

On top of that, benchmarking of tenant rents to Eurozone CPI, which we see as averaging 2.5% in 2017, will also add to the momentum. In the Czech Republic specifically, the probable appreciation of the Czech koruna after the ‘currency cap’ is removed would increase the purchasing power of Czech consumers further. 

YIELD COMPRESSION 
The wage dynamic by itself favours the retail sector above others in the region, as labour costs are an input for office (BPO/ SSC) and industrial (warehousing and manufacturing). Investors are recognising
this change as manifested in significantly lower yields. 

The minimum yield compression seen in the prime TSC arenas in the CEE capital cities between 2010 and 2016 was 125 basis points (bps), ranging up to 200 bps in Bucharest. Bratislava, Prague and Budapest
saw drops of 100 bps between 2014 and 2016. We believe that yields will continue to fall, perhaps significantly so, in Bucharest, Sofia and Budapest in 2017. 

As might be expected, the volumes coming into the retail sector in the CEE space have grown fast when compared to 2014 and prior years. The sector peaked at 42% of the region’s investment volume in 2015, subsiding in relative terms to 30% (flat in absolute terms) of the much bigger pie in 2016. Indications from CMS suggests activity in the sector will be significant in H1 2017. The sector has been a favourite for the flood of money (20% of overall volume) entering CEE from South Africa. 

The main specific risk to this optimistic story, aside from finding sellers of the best assets, is the nascent growth of the disruptive e-commerce and online shopping phenomenon. Penetration levels in the region
are still low, below 50% of the population. Growth rates of 10%-20% for e-commerce were reported in CEE in 2016 and are expected also for 2017 and may stymie high street and TSC demand. Other risks would include political instability from whatever source hitting consumer sentiment and funding rates (a proxy being sovereign bond yields) rising.