Although property valuations and rental prospects remain supportive, the higher risk premium associated with CEE markets means that property yields are likely to increase more in the near term and to unwind more slowly than in Western European markets.
- Although property valuations and rental prospects remain supportive, the higher risk premium associated with CEE markets means that property yields are likely to increase more in the near term and to unwind more slowly than in Western European markets.
- In our latest Non-Euro European Commercial Property Outlook, we noted that rising risk aversion in response to the impact of COVID-19 was likely to have a larger effect on sentiment towards property in CEE markets (Czech Republic, Hungary, Poland and Romania) than in Western Europe.
- That said, at first glance, CEE markets do not necessarily appear more vulnerable. For one, our latest Valuation Monitor suggested that most CEE markets are not overvalued. Indeed, only Budapest offices and Prague industrials posted scores in overvalued territory. (See Chart 1.) And property valuations are expected to remain supportive given recent sharp cuts to interest rates and unprecedented moves to purchase bonds by central banks. What’s more, monetary policy is expected to be loosened further in many CEE countries, keeping bond yields near, or below, their current levels for the next couple of years.
- In addition, the hit to economic activity from containment measures in CEE is expected to be less sharp than in some large euro-area markets, reflecting that the direct impact of the virus has been smaller and that lockdown measures have been less restrictive so far. Indeed, the Oxford COVID-19 Government Response Stringency Index shows that, aside from the Czech Republic, CEE government responses so far have been less strict compared to countries such as Spain, Italy and France. In turn, the rental prospects for CEE markets appear better than many Western European markets.
- However, we think that shifts in investor sentiment will be greater than in Western Europe given the higher risk premium generally associated with CEE property. Admittedly, CEE markets are bigger, more transparent and more liquid than in the past. But even though the risk associated with wider CEE investment has reduced (as proxied by relative government bond yields), property yields remain elevated compared to the euro-zone. (See Chart 2.) What’s more, CEE investment markets remain dominated by cross-border investors which tend to be more susceptible to shifts in sentiment, albeit the recent weakening of CEE currencies may provide some support at the margin. As such, we expect the gap between CEE and euro-zone property yields to widen during the COVID-19 disruption.
- Even so, there is also likely to be differentiation within CEE markets. Indeed, the yield shifts in more-developed CEE markets such as Prague and Warsaw are expected to be more like those in Western European markets. Meanwhile, yield rises in Bucharest and Budapest are forecast to be quite a bit higher and to take longer to unwind.
Chart 1: Overvalued Property Market Scores (%-pts)
Chart 2: Relative Office & Government Bond Yields (bps)
Source: Capital Economics
Sources: Refinitiv, Capital Economics
Amy Wood, Property Economist, firstname.lastname@example.org