With German property funds having recently frozen shareholder redemption, it seems like it could be a while before property markets bounce back. Romania is not protected against these market movements, despite the existing demand and still strong fundamentals, pundits say. Yield decompression is one of the main problems, but specialists expect real estate trading to pick up in the first half of 2009. Meanwhile, property owners are holding their breath for news from their banks.

It is amazing, and unfortunate, how many developers, land owners and vendors continue to suggest that Romania is different and that what happens in the UK and Western Europe should not be used to peg Romania, says Troy Javaher, director of business development for CEE Capital Markets at Jones Lang LaSalle Romania. It is never wise to try and catch a falling knife, says Javaher, when talking about what investment funds and property owners can do amidst the property downturn.

Investment in the real estate market has stalled in Romania and nobody knows exactly when transactions could restart. There are no usable benchmarks and everybody expects the re-pricing of properties, some hopeful they will buy cheap, others fearing of how much they will lose by selling cheap. Unfortunately, the situation is exacerbated by many of the vendors and developers in Romania who are refusing to accept that Romania is not isolated or immune to a substantial yield shift, believes the JLL specialist.

German funds freeze shareholder redemption

While most of the investment funds that have invested in Romanian properties are not feeling good and are each trying to come with safeguard plans for survival, the investment market has one fewer reason to look ahead with hope. Several open-ended German funds, sought to support the investment market and be active buyers, have recently suspended the redemption of shares by their shareholders, following increasing demand from shareholders in need of liquidity.

Late last week, Aviva Investors suspended trading on its European Property fund after a rapid increase in redemptions led to concerns over its liquidity position. The EUR 350 million fund had a cash level of 26 percent at the beginning of the year but this had dropped to less than 9 percent by September causing concerns over a lack of immediate liquidity. Aviva Investors tried to sell some of its assets to secure liquidity, but has failed to do so. Aviva Encore Plus open-ended balanced property fund has decided to defer redemption requests for up to twelve months as the group works to improve liquidity.

Fund managers have recently frozen nearly EUR 30 billion of German property funds, and pundits fear this move could foreshadow a commercial real estate collapse on several markets. A series of open-ended property funds have been temporarily shut down, including those run in Germany by AXA, UBS and Morgan Stanley. Most funds said they would not allow redemptions for three to six months, which is the minimum time they have thus put markets on hold. The funds have suffered from a string of major investors pulling out their cash to raise liquidity. UBS, one of the funds which has frozen redemptions, said the temporary suspension of redemptions for both funds had been implemented solely because of the current increase in redemptions and not because of any fundamental issues relating to the funds.

In order to redeem the money, the funds have to sell assets in their property portfolios, which is costly and hard to do considering the frozen investment market and the lack of benchmarks for evaluating assets.

“Even those disciplined investors who during the boom times obeyed the fundamentals of property investing, such as prime locations, sustainable income levels, high-quality construction and technical specifications, solid covenants, even these investors are being hit hard,” Javaher tells Business Review.

Romania, not far from the madding crowd

For some, it may seem like Romania is far from the noise. But it is not and the noise is getting louder, as many of these investors own Romanian properties. Take DEGI, which has made two investments in Romania, in an office building portfolio and in Iris shopping center, the latter bought earlier this year, and was also looking to buy more. DEGI has suspended the redemption of shares for DEGI Europa and Degi International Funds, both investors on the Romanian market. “In order to ensure the necessary liquidity for maintaining an uninterrupted business operation in the best interest of its investors, the fund has to suspend the redemption of shares,” said DEGI. The redemption was limited to a three-month period, and payments into the fund, through saving schemes and in the form of one-time deposits, continue to be possible. The fund stated its business continued to be sound, with high letting percentages, and with one-year performance amounting to some 4.4 percent for DEGI Europa fund and to 4.8 percent for DEGI International, as of October 30 this year.

Meanwhile, Immoeast, the biggest property owner in Romania, with some EUR 3.4 billion of assets in the country, is also facing difficult times. After posting its first ever loss, some EUR 261 million before interest and tax, due to currency effects and falling property prices, and after seeing some of its management team resign, the fund announced it would start a sales program to generate liquidity. Immoeast has said it was in negotiations to sell EUR 500 million worth of property. Although no actual property was named, considering the fund holds almost 40 percent in its CEE portfolio, it is likely it will sell some of its assets here as well. The investment fund, which has been the biggest property buyer in Romania in the last two years, is now stopping some of its development projects which have not reached construction and leasing. More recently, the fund announced it was investigating a EUR 520 million missing payment.

“I don’t think investment funds will draft special crisis strategies for Romania. If a regional fund needs liquidities it may try to sell some of its portfolio and the choice of properties up for sale is mainly triggered by the criterion of generated liquidity for each property, rather than its location,” says Bogdan Georgescu, managing partner at Colliers International Romania.

Yield decompression, particularly problematic in Romania

When the German open-ended funds and other equity-rich funds, including special opportunity funds, will target distressed assets return is not clear, although it seems highly unlikely that there will be any notable activity until early 2009, predicts Jahaver of JLL.

Georgescu also sees deals restarting in the first half of next year, when he expects more information to help determine the new prices of properties on the Romanian market. “While there is no relevant information coming from the market, establishing yields is more of an art than a science, which means it is done from the valuator’s subjective interpretation, less from an objective analysis of the market,” Georgescu tells BR.

Yields reflect the risk perception or the pricing of risk. “It is inconceivable that the risks of Romania, the structural risk, the systemic risk, have increased as much as 150-200 basis points over the course of a few months. What has actually happened is that money has become more expensive, funds and other various buyers want more return for the same money. They are paying more for their financing and expect more in return,” believes Muler Onofrei, general manager of real estate group Goodman in Romania.

So basically we are seeing a reverse phenomenon which will affect the value of the buildings put up for sale for a while, he goes on. “What is rather unfortunate, due to market valuation and accounting policies, is that people will see the value of their hold portfolio being reduced as well, in a rather artificial and arbitrary manner,” says Onofrei.

The level of yields for property valuation in Romania is impossible to pinpoint, and any property investment professional knows this, says Troy Javaher of JLL. The current common aspect of all opinions on yield decompression is that nobody gives any figure. “While yield decompression is affecting the entire CEE and Russia region, it is particularly problematic here in Romania,” he continues. According to him, the last major certified transactions occurred in 2007 and at levels which are far from their current state.

Before the freezing of funds, many of the key German buyers continued to express the view that Romania was overpriced relative to the other CE countries. “True or not, that is the perception, and this perception is driven in part by yield levels that were reported last year,” says the JLL representative.

Property owners are massively affected by the increase in yields and the drop in value of their portfolio, and although many strive to improve the fair value of their properties, it is “very, very hard” to do so, as Javaher puts it. “The key macro factors are outside the funds’ control. On the micro level, there are some asset management activities which can help mitigate the losses, but ultimately the value of these changes will take a while to be captured in financial terms,” he says.

It was the group behavior of buyers that drove yields down aggressively, with not much to do with fundamentals, and it is still them who are reversing the tide now and moving yields up, Onofrei says. “Both movements have more to do with behavioral board decisions and the price of funds on the financing market. This has nothing to do with the strong fundamentals of the Romanian economy, or any economy for that matter,” he explains. “Basically, we are taking the hit with no fault of our own whatsoever.”

Most funds with capital to deploy will openly admit that they will do essentially nothing until the beginning of 2009. There is certainly a general sense that things may get worse before they get better in terms of pricing, and that it makes sense to see what the banking and financing situation is after the New Year, says Troy Javaher.

The immediate effect is that any further acquisition plans of such funds, which are normally the end-users in the development scheme, are currently suspended. To a certain extent, this means there is no appetite for acquisition of real estate assets in general,” says Francisc Peli, partner with Peli Filip law firm. “On the contrary, once disposal programs start being implemented, we will be in a situation in which various funds are offering assets for sale and there will be limited demand to buy them. Hence yields will go up accordingly,” he adds.

Banks, not expected to declare defaults on property owners

The repricing of properties and temporary drop in portfolio values would be manageable if the owners didn’t need to pay their banks, as most of the funding for their projects was provided by lenders. This was actually how the crisis started, through an unsafe combination of debt and property.

“As the drop in market values is related to the external conditions linked to the global crisis, I think banks will wait for at least a few months for the market to cool off before asking clients for a new evaluation followed by a possible increase in their own equity,” said Bogdan Georgescu.

“Banks will be realistic and will not declare defaults on loan-to-value grounds because they know as well as anybody else that they will have nothing to do with the assets, some of which are under development, in such a market. Some will declare defaults, but most will help struggling developers to get tenants and get the cash flow moving. I think that the banks will be smart and will wait for things to come around, which they will, soon,” says Muler Onofrei.

As long as the owner makes its monthly repayments to the bank, everything is fine. Things get more complicated however if the owner has contracted a banking loan for a new development and has put other projects in its portfolio as collateral for the loan, and the financial crisis has made the developer halt construction works, says Valentin Cudric, investment director with NBGI Private Equity. “Because of the crisis, the project might have been halted mid-way through construction works. Some of the granted loan, which was guaranteed with a property that has a decreasing value, might have been already used, and it is obvious the owner can’t respect the reimbursement terms. I am afraid that in this case, if the credit contract doesn’t state any facility for delaying the use of the loan, the bank could ask for its money back and it might want to execute the collateral, the property which has a lower value,” Cudric theorizes.

If the owners have assets under development they should be flexible over the rents in order to get the tenants in and get the cash flowing. “I am sure that the banks will be more concerned about the cash flow and getting their money back than about loan-to-value covenants,” says Onofrei.

At times like this, markets usually get flooded with distressed sales, but at the moment pundits believe this will be limited. “There will be distressed developers or distressed individuals, maybe even some distressed projects, but some other developers will take over and take the development further, because there is a simple truth: there is demand. I do not think that we will see more than four or five big distressed projects in the following six months – which is a normal healthy level,” says Goodman’s GM for Romania. If assets are not priced accordingly, on a relative basis, significant transaction activity will simply not happen. “Or, at least not until the distress is so severe that outside parties step in and force the sales,” says Javaher of JLL.

The upside of the downturn

Reluctance to realize that assets no longer command the sums they once could is not a Romanian phenomenon, as many multinational vendors and developers are similarly unwilling or unable to accept the drastic repricing of their assets or development projects, Javaher explains.

Despite all the worries, there might be a silver lining for Romania. “The crisis has equally affected all real estate markets in the region, and not only the Romanian market. But compared to other markets, Romania has more chances to recover faster because the local demand and the need for quality space is yet to be met on almost all market segments,” Georgescu believes.

“I agree that Romania has many very attractive, compelling fundamentals which are not present in the Western markets. Nonetheless, capital is global, and with cash being so rare and so key at the moment, investors will search across borders for the best relative value,” says Javaher in his turn. He points out that market demand and good market fundamentals are not enough to attract the little remaining money in.

Javaher, as well as other market commentators and players, believes it is important to note the healthy, positive aspects of this crisis. “For those investors holding solid assets in prime locations, there is a potential upside. This is due to the constraints on supply which, until recently, was a major concern for investors, particularly those unfamiliar with the Romanian market. Many foreign investors in 2007 and even early 2008 were citing the fear of oversupply as a major factor for not investing. This massive pipeline is simply not going to happen, and this could benefit those investors with the better Romanian assets in their portfolios,” says Javaher.

By Corina Saceanu.