Prime yields in Bulgaria have decompressed by 250 - 300 bps since their lowest levels in mid - 2008, according to Elta Consult's report on Bulgarian property investment in 2009. Although this outward movement seems to have halted, capital values in mostsegments are still under pressure due to the continuing decline of rental values. As price corrections accelerated towards the end of the year interest in real estate, on behalf of foreign purchasers as well, increased and transaction volume in H2 more than doubled compared to H1 2009. Despite that for the entire 2009 we have recorded a total investment volume of less than 200 mln euro, which is more than 300% down on 2008.
Although foreign investors' acquisitions increased in the second half of the year they are still below the levels of previous years. Compared to core Central European markets, Bulgaria also seems to be of less interest to traditional investors in real estate, such as institutional funds and collective vehicles (investment or other property funds). For example, no major retail transaction occurred in Bulgaria in 2009. The main reason is that shopping centres represent a relatively large deal lot; the size of shopping centre transactions in the period 2005 - 2008 has been from 90 mln euro to 200 mln euro.
The bulk of transacted properties in 2009 consists of development projects at different stages of planning and construction. The biggest investment deal involving a yielding property, the acquisition of Avtounion Center by Bluehouse in a sale-andleaseback transaction for 27.3 mln euros, took place in October 2009. Another boost to the investment market came from one of the largest corporate property owner, Bulgarian Telecommunication Company (BTC), which sold more than 15 assets in the country (mostly office buildings - headquarters of the company in the capital and regional cities). Some of these deals were also saleand- leaseback as BTC will continue using the office/retail space as a tenant.
We should also note that the second half of 2009 did not see much escalation in the number of distressed sales. Although some property owners threatened with bank foreclosures have been forced to sell below market value, most sellers are not yet willing to conclude deals at prices which opportunistic investors are looking for. There is still a great possibility that this may change in 2010 as the number of properties seized in result of overdue credit payments has increased tremendously over the last year.
As banks have tightened financing restrictions, requiring a larger ratio (over 40%) of pre-leased space and an increased equity contribution on the debtor's part ( over 40%), it has proven extremely difficult to obtain credit for large-scale acquisitions. Though financing institutions have become relatively more flexible in terms of loan restructuring, the number of new loans is still well below previous years. In addition, the limited availability of prime product on the Bulgarian market has suppressed investor's interest further, while existing owners can still renegotiate loan terms in expectation of higher prices or have acquired their assets around the peak of the market and are not willing to accept the losses upon disposal.
The office segment (including development projects) accounted for more than 50% of the entire investment volume in 2009, or 100 mln euros. In terms of volume however it marked a 35% drop compared to 2008 and a 75% drop compared to 2007. As has been the case in the last five years the majority of office properties sold in 2009 (76%) are located in Sofia. Investment in the office segment has been suppressed by heightened purchasers' requirements, such as over 80% occupancy with longer unexpired lease terms and yield of 11% or higher. Currently prime office yield is estimated at 10%.
Over the past year the Sofia office market has been marked by a steady decline in rents (ca. 15% for the whole year) and a steep rise in vacancy (from ca. 8% in 2008 to over 14% at the end of 2009). In addition, there is a huge pipeline expected for 2010 which will put additional strain on take-up levels upon its delivery. As pricing corrections reached more acceptable levels for occupiers and leasing activity accelerated in Q4 2009, we expect that rental decline will slow down in 2010.
One positive trend is that unlike previous years more than 60% of the office pipeline for 2010 is announced as Class A; for comparison purposes only 26% of the total office stock in Sofia at the moment conforms to Class A standards. This will further increase the yield spread between prime and secondary property, as the gap in rental levels between Class A and Class B space expands and the former becomes more appealing to potential purchasers looking for quality assets.
Given the lack of recent transactions of retail properties, it is particularly difficult to pinpoint current retail yields in Bulgaria. Evidence clearly exists that the yield spread between Bulgaria and the core CEE markets has widened which is supported by the lower offer prices from potential purchasers for Bulgarian assets relative to other countries. We have estimated that prime retail / shopping centre yields at the end of 2009 is ca. 9.5% - 10.5%.
Still we believe that the retail sector has a great potential since Bulgaria is on one of the last places by shopping centre provision rate (GLA per 1,000 inhabitants) in Europe. As almost the entire stock consists of traditional-format mall schemes, in the last years many developers started focusing on specialized projects, such as retail parks and factory outlets. Retail warehouses seem least affected by the financial and economic crisis. Hypermarkets have longer lease terms which accounts for the smaller decrease in rents. In addition, the impact of reduced consumer confidence and retail sales has been less pronounced for these retailers, especially for food vendors. Not surprisingly supermarkets chains, including German discount chains, such as Penny, Plus and Lidl, were the most aggressive players on the Bulgarian market - over 90 small- to mid-sized supermarkets were opened in 2009.
Retail assets transacted over the last 5 years are almost equally distributed between the capital and regional markets (in contrast to office and mixed-use properties where the Sofia market accounts for between 75% and 85%). As there is a large shopping centre pipeline under construction at present (ca. 1,000,000 sq m GLA of which over 700,000 sq m in regional cities such as Plovdiv, Varna, Ruse, Stara Zagora, etc.) we expect that the share of regional retail investments will increase even more.
Due to the lack of speculative industrial assets on the market transactions in the sector has been chiefly confined to development projects. For this reason, industrial transactions accounted for a much smaller share of the total investment volume over the last years - 2.5% as opposed to 8% in core CEE and over 10% in Western European markets. Prime industrial yields have risen by 15% - 20% on an annual basis to ca. 11% - 11.5%.
Furthermore with the onset of the economic crisis speculative industrial schemes have almost come to a halt. Most developers are not willing or financially able (considering the tightened financing restrictions) to start large-scale projects meant solely to let; rather they are offering build-to-suit and/or long-term lease solutions. Poor road and rail infrastructure is an additional deterrent to the advance of the industrial sector in general and speculative development in particular.
The investment market in Bulgaria in 2009 exhibited considerable price corrections due to weakened demand and the general lack of liquidity. The average deal size is down more than five times on an annual basis as there were almost no transactions over 10 mln euros.
Office assets and projects accounted for 54% of the entire investment volume. Like in 2008 more than half of all the properties transacted are located the capital region. As most foreign investment funds and developers withdrew from the Bulgarian market at the end of 2008 and the beginning of 2009 embarrassed by the poorly functioning banking system, the share of local purchasers have grown considerably compared to previous years.