Financing alternatives for commercial real estate projects are yet unexplored
Bank financing in the Baltics remains the main driving force behind the development of commercial real estate market. However, further development in this area may also depend on other market players and their proposed financing alternatives.
According to data collected by Swedbank, in Lithuania and Latvia, the total commercial volume of loans granted by for real estate is still lower than the level recorded 8-9 years ago. At the end of the last year, only Estonia was slightly ahead of the historical indicator where the commercial real estate loan portfolio currently stands at around 2.7 billion euros. In Lithuania and Latvia, commercial real estate loans portfolios are similar and amount to more than 2.1 billion euro in each of these countries.
The share of loans to enterprises in the Lithuanian real estate sector compounded to 23.7 percent of the entire banks’ business financing portfolio in 2017. It is lower than the EU average (27.2 percent) and both of the remaining Baltic States - Latvia (27.4 percent) and Estonia (30.6 percent). Nonetheless, the situation cannot be called exclusive as the aforementioned countries greatly fall behind Sweden’s astonishing 60.3 percent share ratio. Thus, the banks still have an ability to fund new projects but the appetite for it might be eroded lately for which there are several reasons.
In the last few years, the capitalization rates for commercial real estate fell sharply. In 2018, for shopping centres and offices segment, it stands below 6 percent. For comparison, the typical investment return on such projects previously fluctuated at around 7.5 percent. At the beginning of this year, the new lowest level was recorded - the "Postija" supermarket’s in Tallinn, which was purchased for 34 million euros, yield should settle at around 5.4 percent. Thus, in the last three to four years, despite the fact that rental income remained at a similar level, the decrease in the capitalization rates resulted in a 20-25% increase of the price of a commercial real estate.
In addition, since the last year, the increased growth of construction prices has been observed in all of the Baltic States. It is likely to continue this year as well and will further result in the higher cost of real estate projects’ development. Considering that the rental prices are somewhat stable, the return on investment from new real estate projects will become even less attractive.
Looking from the perspective of the banks, all of the aforementioned factors - fast-growing capitalization rates, due to the lack of constant supply-side rents, record-low interest rates, and the rapid growth of construction costs due to construction boom – indicates that the real estate market is approaching the peak of its cycle. The commercial real estate markets that are closest to its peaks are Estonia and Lithuania, whereas in Latvia, due to longer stagnation in the entire real estate sector, the transition to a more active growth phase is currently underway.
Lessons from the past crisis indicate that real estate values may vary depending on the cycle stage. Therefore, one of the most important factors evaluated by banks are not due to shrinking capitalization norms increased value of assets, but the cash flows generated by the real estate object and its sustainability. Sustainable projects easily found bank financing at all stages of market cycles.
According to Swedbank, the banks in all Baltic States provided more than 7 billion euro loans for the development of commercial real estate projects amounting to 97 percent of the total funding in this area. About 100 million euro is funded by bonds and a similar amount is invested by other private equity funds. Up to 50 million euro is invested by crowdfunding platforms and other small market players.
The situation in the other European countries differs from the Baltics - banks finance about 85% of all commercial real estate projects, although before the crisis this figure amounted to almost 90%. In addition, if we look at the North American market, bank financing only amounts to about 50% of all commercial real estate projects. Another large part of the projects is funded by debt securities, private equity funds, insurance companies or by other alternative means.
Why is this important? Diversified sources of investment in the US has contributed to a quicker recovery and further development of the economy and real estate market in comparison to the European countries. As a result, we need to see more and more alternative sources of financing that could be a positive change for the whole market and encourage further development. Due to the fact that bank is the cheapest, but at the same time the only source of conservative financing, it focusses only on the needs of a specific segment of the market for certain commercial real estate markets, leaving enough room for other funding market players.
Author: Martynas Trimonis, Swedbank Lithuania Real Estate Client Manager
Posted: https://ziniuterasa.swedbank.lt
Financing alternatives for commercial real estate projects are yet unexplored
Bank financing in the Baltics remains the main driving force behind the development of commercial real estate market. However, further development in this area may also depend on other market players and their proposed financing alternatives.
According to data collected by Swedbank, in Lithuania and Latvia, the total commercial volume of loans granted by for real estate is still lower than the level recorded 8-9 years ago. At the end of the last year, only Estonia was slightly ahead of the historical indicator where the commercial real estate loan portfolio currently stands at around 2.7 billion euros. In Lithuania and Latvia, commercial real estate loans portfolios are similar and amount to more than 2.1 billion euro in each of these countries.
The share of loans to enterprises in the Lithuanian real estate sector compounded to 23.7 percent of the entire banks’ business financing portfolio in 2017. It is lower than the EU average (27.2 percent) and both of the remaining Baltic States - Latvia (27.4 percent) and Estonia (30.6 percent). Nonetheless, the situation cannot be called exclusive as the aforementioned countries greatly fall behind Sweden’s astonishing 60.3 percent share ratio. Thus, the banks still have an ability to fund new projects but the appetite for it might be eroded lately for which there are several reasons.
In the last few years, the capitalization rates for commercial real estate fell sharply. In 2018, for shopping centres and offices segment, it stands below 6 percent. For comparison, the typical investment return on such projects previously fluctuated at around 7.5 percent. At the beginning of this year, the new lowest level was recorded - the "Postija" supermarket’s in Tallinn, which was purchased for 34 million euros, yield should settle at around 5.4 percent. Thus, in the last three to four years, despite the fact that rental income remained at a similar level, the decrease in the capitalization rates resulted in a 20-25% increase of the price of a commercial real estate.
In addition, since the last year, the increased growth of construction prices has been observed in all of the Baltic States. It is likely to continue this year as well and will further result in the higher cost of real estate projects’ development. Considering that the rental prices are somewhat stable, the return on investment from new real estate projects will become even less attractive.
Looking from the perspective of the banks, all of the aforementioned factors - fast-growing capitalization rates, due to the lack of constant supply-side rents, record-low interest rates, and the rapid growth of construction costs due to construction boom – indicates that the real estate market is approaching the peak of its cycle. The commercial real estate markets that are closest to its peaks are Estonia and Lithuania, whereas in Latvia, due to longer stagnation in the entire real estate sector, the transition to a more active growth phase is currently underway.
Lessons from the past crisis indicate that real estate values may vary depending on the cycle stage. Therefore, one of the most important factors evaluated by banks are not due to shrinking capitalization norms increased value of assets, but the cash flows generated by the real estate object and its sustainability. Sustainable projects easily found bank financing at all stages of market cycles.
According to Swedbank, the banks in all Baltic States provided more than 7 billion euro loans for the development of commercial real estate projects amounting to 97 percent of the total funding in this area. About 100 million euro is funded by bonds and a similar amount is invested by other private equity funds. Up to 50 million euro is invested by crowdfunding platforms and other small market players.
The situation in the other European countries differs from the Baltics - banks finance about 85% of all commercial real estate projects, although before the crisis this figure amounted to almost 90%. In addition, if we look at the North American market, bank financing only amounts to about 50% of all commercial real estate projects. Another large part of the projects is funded by debt securities, private equity funds, insurance companies or by other alternative means.
Why is this important? Diversified sources of investment in the US has contributed to a quicker recovery and further development of the economy and real estate market in comparison to the European countries. As a result, we need to see more and more alternative sources of financing that could be a positive change for the whole market and encourage further development. Due to the fact that bank is the cheapest, but at the same time the only source of conservative financing, it focusses only on the needs of a specific segment of the market for certain commercial real estate markets, leaving enough room for other funding market players.
Author: Martynas Trimonis, Swedbank Lithuania Real Estate Client Manager
Posted: https://ziniuterasa.swedbank.lt
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