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Ekonomiskā vide - 2021 03 12
nekustāmais īpašums | koronavīruss

Property market during pandemic –winners and losers of the year

Property market during pandemic –winners and losers of the year Foto: Benjamin Child, Unsplash

Contrary to the forecasts of a possible decline in property prices and the number of transactions, the year 2020 passed without dramatic changes. The number of investments in the real estate segment in the Baltic countries has exceeded the EUR 1 billion mark, which has already become the benchmark in recent years, and each real estate segment was affected differently by the Covid 19 pandemic.

Tourists have disappeared

The hotel industry has been hit the hardest. In the Baltic States, over 80% of hotel customers come from other countries. Due to travel restrictions, the flow of visitors has almost completely dried up, as can be seen from the number of closed hotels. It is too early to assess the recovery of this segment. Much will depend on the speed of vaccinations and overall success in containing the virus, but it is safe to say that 2021 will be a very difficult year for this segment as no significant improvements are expected during the tourist season.

Retail trade and crumbling bricks

Shopping malls are the second hardest hit segment. Nationwide retail restrictions, social distancing, lack of incentive programmes, and the breakthrough of e-commerce have significantly impacted mall performance. Many tenants have demanded rent reductions, and some malls have seen an increase in vacantspaces.

While restrictions and their impact on mall performance vary from country to country, according to European Real Estate Investors Association (INREV), property valuations in this segment across Europe began to decline in the second quarter of 2020, when investment funds focused on retail assets experienced the largest decline in value since 2009.

However, there is a significant difference between shopping malls, where the majority of space is occupied by staple retailers (groceries, pharmacies, pet shops), and large shopping malls, where there are fewer staple retailers.

In shopping malls where the main objective of customers is to buy staples, the decline in customer flow was less dramatic and consequently their performance was less affected.

Competition of shopping malls

In the last decade, new and expanded shopping malls have opened in Riga, increasing retail space by 55%, which means that the number of ways for customers to spend their money has increased significantly as malls compete not only with each other, but also with all the e-commerce players.

This may lead to stratification in the market as tenants also rethink how much retail space they need and where they need it overall. Preference will be given to malls with the largest flow of people.

A good location that matches daily travel habits and offers an attractive tenant mix can attract customers who are willing to go to a particular shopping mall.

We will also see changes in lease agreements, such as more clearly defined "force majeure" circumstances, turnover-based rents, and more relaxed termination terms if the anchor tenant leaves.

But there are also positive trends. According to ECB, household account balances in Latvia increased by 3.9% between the first and third quarters of 2020, amounting to EUR 340 million in absolute terms. It is clear that with the lifting of trade barriers and renewed consumer confidence in the future forecasts, much of this money will be spent on consumer goods.

Where is my workplace?

There is also a lot of uncertainty in the office sector, as most office workers have had to work remotely. Many still work from home every day, so the need for offices in the future has become a relevant issue in the real estate industry. According to Google Mobility, the number of people at work and on public transport in Riga has decreased by 37% and 47%, respectively, in the first 6 weeks of 2021 compared to last year, which means that offices are currently much less busy than before the pandemic.

How each of us perceives working remotely depends on our individual circumstances at home as well as in the office. In the past year, we have experienced “pandemic work” rather than “work from home” because many workers have school children studying from home to care for in addition to their jobs. With schools opening up, working from home might become even more attractive, but a lot will depend on how well commuting to the office fits into the daily logistics.

It is likely that some employees will continue to work from home after the pandemic, but the model where employees work from home a few days a week is likely to prevail, reducing the need for office space.

For example, if a company currently rents 1,000 m2 in a Grade B office for EUR 9/m2, in the future it will be able to rent 500 m2 in a BREEAM or LEED certified Grade A office for EUR 15/m2. This not only saves costs for the company but is also a great benefit for the employees. The certification of the building means a certain standard of quality with a focus on air quality, employee well-being and resource consumption, which reduces operating costs.

However, this is not so simple and requires significant planning on the part of both the company and the employees. If all employees work remotely on Mondays and Fridays, but are in the office on the other days, such a model provides no basis for reducing existing office space.

Tenant pressure on lease terms in this segment is expected to increase sharply, both in terms of flexibility of leased space and lease terms, and tenant demands for office quality and sustainability will also increase.

Where is my parcel?

The warehousing segment has weathered the pandemic best, as the volume of goods shipped has increased significantly due to the breakthrough of e-commerce. At the same time, high customer demands for speed of delivery of goods pose a major challenge to companies' logistics chains, creating additional demand for warehouse space.

This has been noticed by investors, and the demand for logistics real estate has led to rising prices in this segment, which is reflected in falling profitability (investor returns). For the first time in history, the yields of the best logistics properties in Europe fell below the retail segment in 2020. Historically, the office segment accounted for around 40% of European real estate investors' portfolios, while logistics properties accounted for only 10-15%. However, given current trends, a redistribution of capital flows in favour of the logistics segment is likely.

The situation is similar throughout the Baltic region. The return on logistics real estate is even significantly higher than in other European markets, which makes the Baltics an attractive investment destination. At the same time, it must be considered that the Baltics is a small market and there will be no large logistics centres like in Germany or Poland.

In our country, logistics centres located at the end of the entire supply chain are more prevalent, so real estate prices will continue to depend on the location of the property and the composition of tenants in the respective property.

What will the future bring?

Investors have access to the financial resources to invest, and although returns in the real estate segment are higher in the Baltics than in Scandinavia and Central Europe, investors will seek to take advantage of these opportunities.

The biggest problem of the real estate market in Latvia at the moment is the lack of new and high-quality properties, which is also confirmed by the largest investment transactions in 2020, which already feature very well-known names.

The development of new projects is riskier, but this can make the Latvian and Baltic market even more attractive for new foreign investors in the future. Moreover, with the emergence of new assets, the pressure on rents of older properties will increase, forcing them to invest in order to maintain their competitiveness.

Real estate in the EU is responsible for about 36% of total CO2 emissions, so investors, as well as banks and tenants, will pay special attention to the energy efficiency of buildings and the certification of real estate. A lot of draft legislation at European level is still in the pipeline, but the direction we are taking isclear.

According to the World Bank, the real estate sector needs to reduce its CO2 emissions by 36% by 2030 to meet climate targets. We are already seeing changes in Latvian legislation and increasing energy efficiency requirements. A better product also means higher construction costs, so it also affects the price of the end product. At the same time, savings are achieved through reduced utility costs.

Jānis Ozoliņš
Head of Large Corporates Department and Real Estate Financing Department at SEB

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