42 months – minus 70% / Property Watch 2006/3

On the domestic market of investment-purpose properties, yields were falling permanently and at an increasingly dynamic rate in recent years. According to Eston calculations, investors can realise a return that might be almost 70% lower in terms of own capital invested than it was 3 years ago.

It is well-known that on the market of investment- purpose properties, the offer is limited, but demand is important. Quality products change hands within short after having entered the market, where, as a result of the buyers’ direct competition, typical returns are falling spectacularly in each market segment. According to a survey by Eston, this stable fall in returns has actually halved in the last three years the returns achieved by investors on their own funds invested and, in case if the trend persists, the reduction in the yield of own funds could reach 70% by the end of the year.

A meghatározó ingatlanpiaci hozamok és az EKB alapkamat alakulása

In each segment of the market of investment-purpose properties, we recorded declining yields in recent years. Such trend can be justified by an enhanced interest from investors, with a slow expansion in quality offer, and its dynamics are affected also by the quantities and quality mix of properties offered for sale in the different portions of the market. Changes in returns on invested capital, however, subject to the occurrence of certain conditions, could be far more significant than the average fall in returns experienced on the marketplace. On the market, it can be considered typical that properties are purchased applying low-level (about 20-30%) own contribution, with the use of bank financing. As long as there is no change in the financing costs, the return on invested capital, i.e. the assessment of properties in their quality as investment assets, is influenced basically by the changes in market yields, moving roughly in accordance with the dynamics of changes in prevailing yields. When a dynamic fall is observed in typical market yields, a fast appreciation can be expected, therefore, a sale of the property within short might also ensure high profit levels. That said, if the same, increasingly expensive product can be acquired using a more costly financing only, return on invested capital might show a dramatic drop.

In the framework of investment transactions in the country, typically financing schemes with interest rates linked to the European Central Bank’s prime rate are used. For a modelling of the changes having occurred in recent years in the returns on invested capital in the case of a Category „Aâ€? office building, we used an overall ECB prime rate of +1.5% for borrowing, and assumed own contribution to be equal to 20%. (To simplify matters, transaction costs, mostly covered also by own funds, were not taken into consideration.) According to our calculations, in the stagnation period of the ECB prime rates, prospective returns fell from 30% to 17% between mid-2003 and mid-2006, where the dynamics in yields achievable in terms of own funds became critical with the ECB rate hike (i.e. with a more expensive financing). If a fall in typical yields continues and ECB also goes on with rate hikes, the realisable yield of own funds might drop to even 10.8% by the end of the year, representing, in a comparison with the returns in June 2003 (30%), a very significant (64%) drop.

About the reasons thereof
The trend of declining yields observed in respect of investment-purpose properties is not incidental, of course, and it is far from being unforeseeable. It is true that a prediction of some factors is more difficult, but an eventual change in the trend shall not be considered an unexpected event. In high-quality properties, attractive for the international property funds and other institutional investors – and their local peers, having strengthened in recent years – for a long series of years, actual offer has been actually missing. With the completion of buildings that meet state-of-the-art standards, with their occupancy by lessees and their coming to the market, investors’ activities began to catch up since about three years ago, and this was supported also by an accumulation of investable funds on the international markets and the long-term stability of the ECB prime rate.

Jellemző, saját erőre vetített megtérülés
Due to the active developers’ activities and the coming to the market of successfully leased properties, the expansion of investment opportunities generated aggregate transaction values that kept boosting from one year to the other. This process was supported by the fact that interest from international investors towards the region increased also because of the accession to the European Union – our country typically holds a share of 20-35% in property investment volumes spent in Central and Eastern Europe.

Since 2000, in most cases, office buildings were transferred to new owners on the Budapest market and, in accordance with that, this was the market segment where yields first dropped to below 10%. An assumption about a continuing fall in yields can be also observed in a series of second sales of some properties (such as Alkotás Point and Science Park). In the case of retail trade properties, typically portfolios consisting of several shopping malls were sold (such as 14 entities of Plaza Centers, or six completed and six not-yet-built units of the Stop.Shop chain) – this is why this type of property became, within a short period, a dominant element in the annual invested volumes. Even more delimited is the offer of modern logistic parks, against a background of the above-mentioned market segments. On this fast-responding market, the number of major ongoing projects is even now less than twenty in number. This also means fewer deals (that is, expected returns are declining at above-average rates), but it also means, occasionally, substantial invested amounts (e.g. the sale of Harbor Park in 2005, sale of Rozália Park this year).

On the basis of the calculations disclosed, the latitude of operations became narrower for property market investors and, yields maybe falling below 10% in terms of own capital invested also justify a search for alternative investment opportunities. In our opinion, the time for issuing an alert did not come yet, but from now on, investors will give preference more and more to properties with quality parameters and long-term value growth prospects. The drop in property market returns is expected to slow down by the end of the year, but we shall not expect to see a recovery of falling returns, for the time being.

The analysis has been published in the freshest issue of Property Watch.