The Commercial Real Estate Disease Has Reached Europe’s Doorstep, How is Croatia Faring?

Problems in the American commercial real estate market, which have already affected banks in New York and Japan, have this week moved to Europe. The latest ‘victim’ is the German Deutsche Pfandbriefbank AG, whose bonds have fallen due to concerns about its exposure to the sector. The bank responded by issuing an unplanned statement on Wednesday that it has increased reserves due to ‘persistent weakness in the real estate market’.

The German bank describes the current turmoil as ‘the biggest real estate crisis since the financial crisis’, as lenders are taking increasingly larger reserves for debts owed by property owners and builders while loans are falling after rising interest rates have reduced the value of commercial real estate worldwide.

– In 2023, there has been a significant decline in transaction volumes in the commercial real estate sector in Western Europe, as well as in the closer Central and Eastern Europe (CEE region). Throughout the CEE region, investment volumes in 2023 amounted to €4.9 billion, a decrease of 54% compared to the previous year. This relative decline is in line with other European and global real estate markets. In the CEE region last year, the largest shares in transaction volumes were held by the office segment, retail, and the industrial-logistics segment of the commercial real estate market, while Poland had the largest share in volume by countries in the CEE region – explains Karlo Jurić, Colliers’ analyst for Croatia, Slovenia, and Bosnia and Herzegovina.

Banks are seeking higher collateral.

The decline in volume, he added, can be explained by a more cautious approach from investors, rising financing costs, higher yields on government bonds, limited supply, geopolitical tensions, and still-present inflationary pressures. Additionally, it should be noted that in 2023, yields in the CEE region on commercial real estate have increased, which is in line with global trends.

In conversations with colleagues in the German market, a drastic decline in property prices is felt, including in the commercial sector, as the market has slowed due to a weak economy and high interest rates. German citizens have significantly ‘pulled back’, and personal consumption has also fallen, further fueling the crisis, and at this moment, no exit from it is visible. What is positive is that the portfolios of commercial real estate held by banks are limited, but any shock in the financial system is constrained.

Last year, I personally attended the REAL EXPO fair in Munich, where I participated in a market analysis of real estate by one of the leading financial consultants in the world, who established a special department for crisis management, and their main role was to save large projects (mostly commercial real estate) from failure as they saw a black cloud and hard times approaching – commented Filip Brkan, director of Imperium immobiliare, which deals with real estate sales.

This should not be surprising, given that a period of high interest rates still prevails, which certainly increases financing and potential refinancing costs, while banks often seek higher collateral. Countries where a collapse in the real estate market has occurred or is occurring are faced with a buildup of properties in their portfolios.

Brkan emphasized that residential properties are a relatively small problem when considering commercial properties that serve investment purposes, meaning that banks will hold commercial properties for a longer time, and the question is how long it will take for the market to recover so that properties can be re-marketed. The depreciation of properties plays a significant role in this sector, believes the owner of a domestic real estate agency.

However, the commercial real estate sector in Europe, including Croatia, consists of several separate and distinct sub-markets or sub-sectors, each with its own characteristics.

Recently, there has been a pronounced demand in the European real estate market, explains Jurić, for logistics, warehousing, industrial, and distribution spaces due to the trend of nearshoring, which means bringing production and supply chains closer to the countries of end consumers of these goods and services. Experts believe this is a long-term trend that will only accelerate due to current and future geopolitical relations.

The gap in expectations between buyers and sellers.

– Croatia, due to its entry into the Schengen area and the Eurozone, as well as its good geographical position, solid infrastructure, technically skilled workforce, and proximity to the markets of Western European countries, could be one of the winners of this trend, and we see global players such as Accolade Group, RC Europe, and already present regional leaders in the logistics sector like Log Expert entering the Croatian market.

Furthermore, in Croatia, there has not yet been a significant spillover of the decline in the value of the office segment of the commercial real estate market from European and American markets, as this segment in 2023 was one of the most active sectors in Croatia with significant buying and selling transactions such as the purchase of Eurocentar by Atlantic Group, the purchase of Matrix Building A by the Vehicle Center of Croatia, and Matrix Building B by the Slovenian investment fund Alfi – stated Jurić.

These mentioned transactions support the thesis that there is significant demand from domestic and foreign investors for quality office spaces in good locations with high occupancy and top tenants who have long-term lease agreements with indexed rental prices.

– Additionally, it should be noted that there is a significant gap in the market in the expectations of prices and values of commercial real estate between buyers and sellers, which can lead to a decline in realized transactions and a slowdown in activity in the sector itself. Furthermore, in Croatia, there has been a slight increase in yields on commercial real estate, but there is still no significant increase in yields due to solid demand and limited supply.

As the main challenge for the commercial real estate market, we see the increase in interest rates on loans and banks’ aversion to financing development projects and buying and selling transactions. Recently, specialized professional investment funds have emerged in the Croatian and regional market offering alternative financing but under somewhat more expensive and stricter conditions than commercial banks – concluded Jurić.