As the strength of the retail property market in the United States loses momentum, real estate developers are dispatching personnel to seek new opportunities abroad. Many of these firms are looking to China and India as the hope of the future. But, while no country can match the appeal of the two Asian giants, American developers have been overlooking attractive opportunities in another part of the world — Eastern and Central Europe.

A first wave of development hit the region in the mid-and late 1990s. But interest has waned, aside from a handful of mostly private institutional investors and fund managers. Now several factors are aligning that make it attractive for a new wave of investment. The first couple of U.S. REITs are now venturing into the region. But there is room for much more.

The former members of the Eastern bloc have some of the fastest growing GDPs in the world — as of December 2006, GDP growth in Central and Eastern Europe was expected to reach 4.9 percent, according to RREEF, compared to 2.6 percent for the 15 original members of the European Union and about 3 percent for the United States. Some of the strongest gains were expected in Russia, with 7 percent, and Turkey, with 5.5 percent. And this pace is expected to continue in 2007.

The increasing scope of the European Union also makes investment more attractive. As of January, Romania and Bulgaria entered the European Union. That's on top of the 10 states that joined in 2004. Moreover, Croatia has applied and is expected to enter by 2010. Turkey is also up for membership in the EU, but that may not happen until 2015, according to some projections.

And while the first wave of development brought hypermarkets and a lot of “necessity” retail projects, the region remains grossly under-retailed.

Despite progress in the past decade, Slovenia, for example, only has 0.8 square feet of shopping center space per capita, according to research from brokerage firm Cushman & Wakefield Healey & Baker, while the amount of retail space per person in Bulgaria and Serbia is near 0 when rounded. By contrast, the average for the 25 current members of the EU is 1.7 square feet of shopping center space per person, with Norway and Sweden offering as much as 8.4 square feet and 3.6 square feet; respectively. In the United States the figure is 20.3 square feet per capita.

At the same time, the projects coming online are becoming increasingly sophisticated. Hypermarket-anchored properties still dominate. But more ambitious projects, including multilevel fashion malls and mixed-use centers, are already happening.

“We are still on the frontier in that arena, but it's happening,” says Gordon Black, managing director of private equity for Europe at Heitman, a Chicago-based private real estate investor and fund manager. “In Kiev, Moscow and St. Petersburg, they can support very large mixed-use projects. If done right, they could be hugely successful.”

For example, Dutch investor ING Real Estate (in a joint venture with another Dutch firm, Rodamco Europe) is working on a mixed-use project in Poland, called Zlote Tarasy. The 2.4-million-square-foot center, located next to Warsaw Central Station, will feature an eight-screen movie theater, 484,400 square feet of office space, parking for 1,621 cars and 220 stores including Marks & Spencer, Zara, H&M, MAC and the Body Shop. Hard Rock Café will also have an 8,611-square-foot venue at the property. Zlote Tarasy is set to open in February of 2007 and expects to bring in 1 million visitors a month.

And in Moscow, local developer Stolny Grad will break ground this year on a 5.2-million-square-foot mixed-use project next to one of the city's major train stations. The center, called Slava (or Glory in English) and valued at approximately $1 billion, will contain at least 820,000 square feet of retail space. Slava is scheduled for completion in 2010.

“Generally, the outlook is very positive for development and investment in Central and Eastern Europe — Western firms are queuing up to buy into new retail projects here,” says Nigel Young, managing director and owner of Prague-based real estate leasing and advisory firm NAI MIPA. “I've had at least 10 or 15 funds come through my office looking to invest in these properties. The reasoning behind this is that investors see the region as an area where yields are more attractive than in Western Europe and there is also real potential for rental growth.”

Today, retail properties in Central and Eastern Europe offer net yields of approximately 6.5 percent, according to Cushman & Wakefield, while yields in Western and Northern Europe are closer to 5.4 percent. At the same time, rental growth for the region reached 13.9 percent from June 2005 to June 2006, compared to 10.7 percent for the U.S. and 5.4 percent for Western Europe.

It is also becoming safer for U.S. companies to do business in former Eastern Bloc nations, as countries that have entered or are hoping to enter the European Union work on their economic performance and legislative issues. Central and Eastern European governments are putting more emphasis on enforcing business contracts than they have in the past and are making it easier to register property and pay taxes, according to the World Bank Group. The Czech Republic, Hungary and Poland all earned scores lower than 3 on Jones Lang LaSalle's Real Estate Transparency Index 2006, which uses a scale of 1 to 5, with 1 indicating the highest level of transparency. Turkey and Romania also made significant improvements, going from a score of 4.69 in 2004 to 4.08 this year and from 4.75 to 4.08, respectively.

But American investors have been slow to take advantage of the favorable conditions and should hurry to enter the market before all the best opportunities are gone, says Young. Major metropolitan centers in Poland, Hungary and the Czech Republic are already beginning to overflow with shopping center projects, while the British, Dutch, French and Germans are descending en masse on the remaining holdouts of Bulgaria, Romania, the former Yugoslav republics, Russia, Turkey and Ukraine. This year Bulgaria and Romania will double their shopping center totals, while retail space in Ukraine will jump 163.4 percent, according to estimates by Cushman & Wakefield. In 2007, the continent as a whole will see the influx of 77.5 million square feet of new retail space, an increase of approximately 17 percent over existing inventory.

So far, Simon Property Group has been among the first U.S. REITs to venture into Central Europe, with 50 percent stakes in six Polish supermarket-anchored shopping centers, in addition to 41 property holdings in Italy, four in France and one in Portugal. General Growth Properties has a project under development in Eskisehir, Turkey and holds interests in six additional Turkish shopping centers through its partnership with Hamburg-based ECE Projektmanagement. But it's a slew of institutional real estate investors, including GE Real Estate, Apollo Real Estate Advisors, Heitman and AIG/Lincoln, that makes up some of the most active retail real estate players in Central and Eastern Europe.

Heitman was one of the first U.S. firms to enter Central Europe in the mid 1990s with investments in the office, industrial and retail sectors in Hungary, the Czech Republic and Poland. It is now working on its third investment fund valued at approximately $440 million. With this new discretionary vehicle, Heitman will target most of the European Union's new members, including Bulgaria and Romania, which became members on Jan. 1.

“We are trying to find the right locations — that may involve a large center in a primary market or something in a secondary market where there is not as much attention, but where we can still find 100,000 or 200,000 people who have purchasing power,” says Gordon Black.

After developing a good sense of the region — the firm now has four offices and 50 employees in Europe, of which 70 percent are locals — Heitman is also getting bolder. While it previously concentrated on traditional shopping centers, it is now assembling a portfolio of single-unit downtown retail locations throughout Poland, something Black believes has not been attempted by other investors. Part of the reason for the move is that many Europeans are accustomed to shopping in downtown city centers.

“It's very intensive from a management perspective, but the yields are quite attractive,” Black says.

Overall retail property yields in Warsaw are currently at 6.5 percent, according to GVA Worldwide, but single-unit locations in the city's downtown can bring yields of up to 10 percent, according to Black. Meanwhile, rents at shopping centers in the Polish capital range from $4.30 to $5.50 per square foot a month, while the unit shops go for more than $6 per square foot a month.

Heitman is also looking into opportunities to invest in Russia, Turkey and Ukraine, which have the largest populations on the continent and the most rapidly developing economies. There are currently 143 million people living in Russia, 70.4 million in Turkey and 47 million in Ukraine. This year, Russia ranked second and Ukraine fourth on A.T. Kearney's Global Retail Development Index, while Turkey got the number 10 spot. Russia's $180 billion retail market increased by 19 percent in 2005 and Turkey's grew by 12 percent.

GE Real Estate is also expanding its foothold in the east, according to Karim Habra, managing director for Central Europe with the company. Like Heitman, GE has been on the retail scene in Central Europe since the 1990s, but still sees tremendous opportunity for investment in smaller urban centers in Poland, Hungary and the Czech Republic, as well as in Bulgaria, Romania and Russia.

“I think these markets are still under-developed, especially in secondary cities,” Habra says. “In Poland, you still have about 60 cities that have more than 100,000 people and they haven't seen modern shopping centers yet.”

The Mall of Sofia, one of only three Western-style shopping centers in the Bulgarian capital, according to brokerage firm Colliers International, features 236,000 square feet of space and offers rents of $3.50 to $7.00 per square foot a month. GE Capital paid approximately $47 million for a 50 percent stake in the center. The two other Sofia projects include the 215,300-square-foot City Center Sofia, developed by the UK-based Balkan Properties, and the 172,200-square-foot Sky City.

Demand for retail investment in Bulgaria remains very high, Colliers found, although yield statistics are impossible to track — in 2005, there was only one investment transaction in the retail sector, the GE deal. Colliers estimates the number is just under 10 percent.

GE is also scouring the ground in Romania, where it has no prior holdings. The country GDP's growth is projected to reach 5.8 percent in 2007, according to Colliers. But, outside the capital city of Bucharest shopping center space amounts to 2.045 million square feet, a number that is low even compared to Romania's neighbors.

In addition, GE has recently acquired 16 hypermarket-anchored shopping centers in Poland from the French operator Groupe Casino for $699.6 million, the second largest real estate deal in the history of Central Europe, according to Habra. The acquisition marks the first time the company will retain 100 percent of a hypermarket-anchored property (it previously bought only gallerias attached to hypermarkets).

GE's regional portfolio is worth $2 billion. The firm has 40 employees on the continent spread between two offices — one in Warsaw and one in Prague.

In addition, in November, GE signed an agreement to acquire a 50.98 percent stake in Garanti Gayrimenkul Yatirim Ortakligi, a REIT listed on the Istanbul Stock Exchange, for $50 million. Garanti has a market cap of $94 million and invests in development projects in the retail and residential sectors. It currently owns six investment assets in Turkey and Romania, including Dogus Power Center, a 678,000-square-foot retail property in Istanbul.

In addition, Urban Retail Properties, a privately held real estate manager and developer, is close to signing a deal in Serbia. Ross Glickman, Urban's chairman and CEO, has been looking at several sites for a mixed-use development along the Danube. Serbia has 9.4 million people, but just 108,000 square feet of retail space — the equivalent of two strip malls — to serve its young and growing population. “There is no place to shop,” Glickman explains. “Most of the consuming public here is under 30 with increasing income potential, and they are looking for places to socialize as well as to shop. [Serbia has] not made much use of their infrastructure and the Danube is ripe for utilization in terms of marinas and restaurants and residential.”

A few words of caution

There are plenty of development opportunities in Central Europe, but U.S. retail developers who want to enter the market must be mindful of the region's nuances.

Although car ownership is rising, many locals use buses, trolleys and subways as their primary mode of transportation. They are accustomed to doing their grocery shopping every other day as opposed to shopping sprees meant to cover one or two weeks. And in Russia and Turkey more than three-fourths of the population live in cities, making urban retail projects more desirable. The same holds true for Serbia.

“We are looking at the urban areas of Belgrade — that's where the opportunities are and where people are congregating,” Glickman says.

In addition, while membership in the EU offers a lot of benefits for investors — free movement of capital, no customs, a unified currency and a common system of taxation — it takes time for new Union members to adapt to a different way of life. In many instances, they are still working out their business regulations and that can be frustrating.

Government corruption is also a problem, with Lithuania posting the highest bribe frequency of the new EU members in 2005, according to the World Bank Group. Bulgaria, Estonia, Czech Republic and Hungary all have murky records as well.

Taking that into account, doing business in Central and Eastern Europe is still easier than in Asia, where American developers have been heading for years, says Young. Proponents of doing business in Eastern Europe say the political situation is relatively stable and government regulations don't change as often as they do in some Asian countries. The locals are eager for foreign investment and with the exception of Russia and Ukraine, where bureaucracy is difficult to overcome without help from local contacts, municipalities try to accommodate foreign developers by issuing permit approvals within a reasonable period of time.

“The languages are much simpler than in Asia, a lot of professionals speak English and it's not difficult to get professional help on the ground,” says Young. “I wouldn't say it's without tricks, but horror stories about people acquiring land and not being able to build anything are fairly rare.”

Net Lease Gains Ground in Europe

The popularity of net lease deals continues to grow in Europe. In December, New York-based net lease REIT Capital Lease Funding, Inc., announced that one of the first real estate investment funds to be offered to European investors through its new management company, Matapeake Partners, will focus on net lease properties. “We believe our investment in Matapeake will help drive higher returns on properties we joint venture and provide us with an additional source of capital not dependent on the U.S.,” said Paul McDowell, CEO of Capital Lease. The fund is expected to close in mid-2007.

But the firm is not the first to enter the net-lease arena in Europe. Last July, W. P. Carey & Co., a global real estate investment firm, completed a transaction with the German Do-It-Yourself chain operator Hellweg Die Profi-Baumarkte GmbH & Co. KG involving 1.3 million square feet of space in 16 German cities. At the time, the $154-million deal represented the firm's largest single investment in the region.

European net lease deals offer a number of advantages to U.S. investors, including better pricing and the opportunity to capitalize on the strength of the euro, says Richard H. Ader, chairman of U.S. Realty Advisors, LLC, which specializes in net lease investment and advisory services. Ader is most optimistic about generic properties in Eastern Europe, with office buildings, distribution facilities and retail stores that can be converted to another use topping his target list.
EM