Investment profile of commercial property in Latvia

  • 2006-02-22
  • By Kristine Kolosovska [ Bridge Capital ]
Financial investors in Latvia have begun to show an interest in commercial property now that the overall economy and real estate have reached a certain stage of development. Contrary to strategic developers, who take an active part in property development and risk taking, financial developers are more likely to invest in existing properties that have stable cash flows and reliable tenants. Indeed, the role of financial and institutional investors increases with general market maturity, when the possibility of astronomical returns is almost eliminated.

Latvia's real estate market is considered to be very dynamic, offering attractive risk-return investment opportunities, while stability of the financial system allows for long-term financial planning in all market segments. Together these form the basis for more activity from institutional investors, such as local and international real estate funds, pension funds and other asset management companies.

Retail is considered to be one of the most lucrative sectors in Latvia thanks to the increasing purchasing power of the population and popularity of consumer financing. The share of retail chains in total retail turnover is gradually increasing each year. The market is basically divided between the two-three largest players who still look for opportunities to commission more and more hyper- and supermarkets each year.

Retail property rent rates have grown steadily 10 's 15 percent each year, which is rather typical for a fast growing segment. In such an environment investors are more inclined to go after property investments rather than development. Basically, there is only one large shopping center developer, Linstow, whose portfolio might be of greatest interest to any serious investor. However, there is no sign that Linstow will sell its portfolio in the short term.

In comparison with other European capitals, the supply of retail property per person in Riga is comparable with the average European level. The number of new large format shopping centers will diminish each year since the market is currently close to saturation. However, significant development potential is seen in super- and hypermarket development in residential districts due to the boom in living space construction.

Meanwhile, the office real estate sector is very fragmented. There is no apparent market leader, and existing developers are inclined to develop medium scale office centers of 1,800 's 5,500 square meters. For institutional investors this creates difficulty to find appropriate investment grade properties and to allocate above 15-25 million euros in a single object. Despite low vacancy rates in existing office centers, the demand for high quality Class A offices is rather limited. Although the demand for high quality premises mainly comes from international companies, banks, utilities and municipalities, the companies are more inclined to develop their own premises than to rent them. As a result, the market does not realize its full potential: the current supply of Class A and B is just about one-third of office supply per capita than 's e.g. in Prague or Warsaw. Still some investors continue to look at sale and leaseback transactions here.

The most surprisingly undeveloped segment appears to be warehouses and logistics facilities. This market is only developer-led, meaning that retailers, local producers, even international transportation companies tend to develop their own logistical hubs. The situation seems to be strange for such country as Latvia, which is the "transit bridge between East and West." The segment of "third-party logistics" is completely undeveloped; the majority of companies continue to carry out their own logistics and do not believe in the power of outsourcing. Low supply and low rent rates in comparison to other European countries is a natural consequence of poor demand.

But third-party logistics is gradually beginning to take off in Latvia. With the current lack of supply, investors are interested in beginning a project from the development phase while obliging the seller to fill the center with tenants.

To summarize, the market is rather attractive since the yields are higher than in old European countries by almost 20 's 30 percent. However, the scale problems do not allow allocating serious capital into the available properties. Despite the growth and attractive yields, the Latvian investment property segment lacks competitiveness, for example, in comparison to Russia, where investors enjoy high yields, grand projects, but somewhat higher risk as well.

Kristine Kolosovska is an analyst at Bridge Capital
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