Retail, commercial land sectors booming

  • 2003-05-22
  • Hindrek Leppsalu

Development of retail space in Tallinn is booming again. In 2002, some 80,000 square meters were brought "online", and in 2003 - 2004 a total of 100,000 square meters of new space is expected to reach the market, which will bring total retail space in the Estonian capital to 285,000 square meters.

What's more, with the vacancy rate in Tallinn shopping centers currently at a very low 2 percent, the new space should be snapped up quickly.

The largest development this year is the 50,000-square-meter center next to Tallinn Airport, to be anchored by a Rimi Hypermarket. The site will be developed by the Norwegian developer Linstow and is to be completed by summer 2004.

In addition, Ober-Haus is building a new 22,500-square-meter shopping center in the Lasnamae residential district scheduled for October 2003 completion. The center will be anchored by Kesko, the Finnish supermarket giant.

Importantly, demand is expected to absorb new supply despite the fact that retailers' profits are falling. Competition in the sector is strong, forcing retailers to expand in order to survive.

Also, Tallinn shopping centers suffer from the lack of international tenants, which would attract more clients. New foreign retail developers include Germany's Aldi and Lithuania's Vilniaus Prekyba.

Office space, on the other hand, is expected to see a higher rate of vacancy.

Tallinn currently has 186,900 square meters of modern office space either built or renovated since 1995. Out of that, 92,000 square meters in 14 buildings can be truly called class A.

Rents for CBD class A space bottomed out at 11 euros per square meters in 2000, but with little supply built since then, new leases are being signed as high as 15 euros per square meter.

Vacancy rates in Tallinn city center A-class office buildings fell to 4 percent by the end of last year, but with at least 35,000 square meters of new office space coming online within a year, vacancy is expected to go up to 10 percent.

As is common knowledge, Estonia lacks modern warehouse space, but new legislation is set to increase demand.

Real estate developers have not made serious investments into warehouses since tenants have not been able to offer sufficient warranties or sufficiently long lease agreements (at least 10 years). Both are important factors, since in many cases the spaces are built to the needs of a specific client.

New laws will bring Estonia into conformity with European Union standards for food products by 2003, and namely these regulations will increase demand for modern warehouses.

Yet currently the supply of such spaces remains limited. Most of the warehouses lack heating, water and sewage. As a result, many companies are building their own warehouses.

In Tallinn's commercial land market, strong economic growth and low interest rates have reignited activity. With interest rates at obscene lows, many firms prefer owning to renting.

Hence most of the firms buying land are foreign owned and have even better abilities to borrow at low cost. In most cases land is bought by companies looking to build their headquarters or additional office space.

Preferred plots for development are centered in the Tallinn suburbs adjacent to major highways - e.g., next to the major highway east to St. Petersburg or the highway south to Latvia.

As purchases increase, however, the number of good plots is dropping, pushing prices up.

Demand for plots situated away from major highways is still mediocre and the price rise for these kinds of plots will remain modest.

Lastly, due to the recession in the European real estate market and Estonia joining EU soon, one can feel the appetite of institutional investors for Baltic real estate. Both the representatives of bigger pension funds and smaller private- capital-based Scandinavian funds have become more active in recent months. Mostly they are interested in long-term rental income properties, i.e. retail and office buildings.

If in case of retail the primary interest is for buildings located near main roads with active traffic, then in case of office spaces the definite preference is new buildings in the city center.

In addition to the price of property, investors also look at the tenant mix and background. Buyers prefer buildings established by well-known international tenants with strong lease covenants. In fact, the most common reason for the failure of a building to sell is the existence of poorly written lease contracts.

The yield expected by foreign investors in the Baltics is between 11 percent - 13 percent. This is certainly higher than prime yields in the Scandinavian capitals of 6 percent - 8 percent, or even those in Warsaw, Prague or Budapest, where prime office yields range from 9 percent to 10 percent.

The main reason for higher yield expectation in the Baltics is the small size of the market and the lack of overall liquidity. Buyers purchasing Baltic properties are in for the medium to long term and want to lock in a higher yield for their commitment.