Julia Linde: The commercial real estate market giving out mixed signals

Julia Linde, Real Estate Analyst with Restate

The GDP in the first quarter of the year exceeded relevant rate prior to the crisis in 2019 and the quarter’s 4.5% (4.8% as adjusted seasonally and by number of working days) economic growth on a year-over-year basis surprised even bank analysts that predicted the pre-crisis level to be restored in the second half of the year, rather. The quarterly economic growth foremost resulted from tax compliance and growth in the commerce and ICT sectors. The feeble comparative base of last years’ second and third quarter and significantly relaxed restrictions allow an even faster economic growth to be predicted for upcoming quarters. Eesti Pank’s economic forecast from the month of June predicts that Estonia’s economy will undergo a growth of 5% – 8% this year.

Sense of security to increase

Business operators and consumers assess the state of the economy as more and more stable. Economic trust and the business cycle are making a recovery and exceeding a long-term average. The business sector’s security indicators have significantly improved as compared to last year and remain on high positions, exceeding long-term average indicators. Consumer confidence continues to be low, yet is improving successfully. This is also characterized by improved retail sale numbers that have as of December 2020 exceeded corresponding indicators of the corona year and of relevant months of the pre-crisis year of 2019. Consumption growth is also supported by decreased unemployment – following the height of the 8.8% registered unemployment rate in the month of March, unemployment began to decrease, remaining at 7.7% in June. Consumer confidence is in its turn elevated by an increase of gross monthly salary of as much as 6.8% in a year. As unemployment is reduced, Estonia once again faces a shortage of workforce, on account of which certain pressure for increasing of salaries continues.

Rapid economic growth at the same time causes increased fear of inflation in market participants. Changes in the consumer price index in a year-over-year comparison have increased to 3.8% as of June. In fear of quickening inflation, market participants are looking for opportunities to invest their money safely. In the fall, this will pick up even more speed when as a result of the pension reform money in the form of the corona year’s largest deposits is injected into the market in September. As a result, the market will heat up and prices will rise. In this kind of market situation, poorly marketable real estate can be realized at the best price.

Mixed signals in the commercial real estate market

Although Estonian economy as a whole grew in the first quarter, the construction sector on the other hand indicated a decline of 12.8% in a year-over-year comparison. This year, not as large as usual a volume of premises reaches the commercial real estate market and the year will remain modest, rather.

During the first half year in Harju County (incl. Tallinn) more than 1,500 m2 of office space was taken into use, more than 6,000 m2 of commercial space, and more than 610,000 m2 of warehouse space. This means office spaces were added into use at a mere 1.6% of the past five years’ average volume, commercial spaces at 6.7%, and warehouse spaces at 61%. The decline is drastic for office and commercial premises, constituting a normal outcome of the 2020 crisis year during which many projects were put on hold.

On the other hand, during this year’s first half year in Harju County (incl. Tallinn) a record number of building permits for office buildings was issued for a total of 150,000 m2 which significantly exceeds relevant indicators for previous full years – for instance, the average yearly volume for the past five years is approximately 125,000 m2. In relation to commercial and warehouse spaces, approximately half of the regular yearly volume was issued: approximately 57,000 m2 and 68,000 m2. Most likely, these figures will be realized as completed premises in the coming years when developers’ confidence, future prospects, and the market are even further restored. During the first half year construction of 124,000 m2 of office space, 40,000 m2 of commercial space, and 56,000 m2 of warehouse space has been commenced.

Construction sector confidence restored

In May and June, construction sector confidence already reached the level exhibited in 2017 and 2108. A study conducted by the Estonian Institute of Economic Research indicates that contracts in the construction sector guaranteed work in the second quarter for 5.1 months which exceeds the long-term average (3.6). Considering that in the residential real estate market, premises can be realized before their construction is completed and at historically best prices, this segment of the real estate market draws resources and interest away from the commercial real estate segment.

At the same time, price increases and supply difficulties of construction materials have emerged. Construction material supply difficulties and the increase of prices resulting from raw material crisis are issues that construction and development undertakings have expressed concerns about. According to information of the Estonian Institute of Economic Research, the construction sector’s principal COVID-19 concerns in June relate to increased prices (73%) and procurement of production materials (53%). In the beginning of the year, among more important hindering factors, insufficient demand was mentioned, while in the second quarter this became less important.

Resulting from the situation in the construction and real estate sector, there is strong pressure in the market to increase the rental prices in new developments. Price offers for new development construction have increased by nearly 20% in a short time, while rental prices have remained fairly stable in the market for a long time – yearly growth has been limited to a few percentage points. This situation is preparing the market for an increase of new developments’ rental prices as developers can no longer offer new commercial real estate at former rental rates and significantly higher material prices are being transferred to customers.

Some developers still prescribe to the “wait and see” position, especially as regarding office premises, as the productivity of sold premises has continued to decline. Rental prices have remained stable for a long time; in relation to the crisis, tenants were offered concessions or grace periods that will bring about decreased productivity as relating to more vacancies and a significant increase of construction prices. During the second quarter, commercial real estate rental prices in Tallinn and Harju County have stabilized and the 5% decrease as compared to the first quarter of the number of offers of commercial premises in Tallinn indicates a modest restoration of demand and supports preservation of the rental price rate and, if the same trend continues, a growth of the above and a decrease of vacancies.

Commercial real estate to develop in Tallinn’s vicinity

In the first half of the year, a revival could be noticed in Rae rural municipality and partially in Tallinn of the number of transactions involving such registered immovables with the intended purpose of commerce and production which have not been built on. For example, in the first half year in Rae rural municipality were purchased registered immovables not built on, adhering to the following intended use: 14 commercial land, 18 production land, and 46 mixed purpose land; this significantly exceeds relevant indicators for recent full years in terms of both the number of transactions and the total turnover of the transactions.

Factors in favor of developing commercial real estate in Rae rural municipality include in addition to suitable location and transport network also a residential real estate market that is growing at an immense speed and the resulting increasing number of residents in the rural municipality. For example, in a half a year, 324 not-built-on registered immovables of residential land were purchased in Rae rural municipality, while an average of 130 transactions are usually undertaken throughout the whole year.

As relating to commercial real estate, demand is especially high for well-located registered immovables with the intended purpose of commerce and production. The business parks by Tallinn Roundabout and in rural municipalities in Tallinn’s vicinity are likely to undergo growth in the near future which is certainly accelerated even further by the Rail Baltica project that is planned to be completed by 2026.

In the second half of the year, the commercial real estate market can be estimated to continue its recovery. Optimism of the market participants in relevant sectors and growing economic activity are likely to be expected. Vacancies of commercial premises will start to decrease and rental rates are expected to go up for premises more in demand; demand remains high for registered immovables in good location and for high quality premises.

Office premises

  • Compared to the first quarter, rental prices are stabilizing and vacancies remain high.
  • A-class rental rates: 11–20 €/m2, average 14.6 €/m2. A-class new buildings and new developments average rental rate: 15.1 €/m2. Vacancy: mostly 0–10%, average 8%, also higher for new buildings
  • B-class rental rates: 7–15 €/m2, average 11.1 €/m2. B-class vacancy: average 9.7%, varies from premises to premises, generally no more than 20%
  • C-class rental rates: 5–10 €/m2, average 6.8 €/m2, vacancy 5–30%, higher in older office buildings

Commercial and service premises

  • Shopping center rental rates: larger premises 12–20 €/m2, smaller premises 15–32 €/m2
  • Shopping centers of local importance in Tallinn’s city districts: rental rates start at 9 €/m2. Rental rates for new commercial premises in Tallinn’s bedroom communities: 10–13 €/m2
  • Rental rates for commercial and service premises located on the first floor of office buildings and residential buildings vary greatly depending on the location and appeal of the premises and on whether the premises are walk-through. Rental rates start at 7 €/m2 for older premises in a non-central location and are 15–25 €/m2 for premises in a good city center location.
  • Compared to the first quarter, rental rates are stabilizing. New multifunctional commercial premises compete with older less appealing premises.

Logistics

  • Rental rates for small 1–20 m2 warehouse premises for private customers: 11–30 €/m2, average 16 €/m2; rental rates for premises smaller than 100 m2 for small undertakings: 6–11 €/m2, average 9 €/m2
  • Rental rates for Tallinn warehouse premises of up to 300 m2: 5–9 €/m2, average 6 €/m2; rental rates for larger warehouse premises: 3–7 €/m2, average 5 €/m2
  • Rental rates for warehouse premises of up to 300 m2 in rural municipalities close to Tallinn: 5–8 €/m2, average 6 €/m2; rental rates for larger warehouse premises: 3–7 €/m2, average 5 €/m2. Average vacancy: 4.6%
  • Rental rates for older warehouse premises that have not been renovated: 2–4 €/m2

Warehouse/office and loft office

  • Rental rates for Tallinn based warehouse/office and loft office premises that combine different functions: mainly 7–13 €/m2, average 8,3 €/m2
  • Rental rates for premises with extended commercial function in popular commercial areas in Tallinn’s bedroom communities: 9–13 €/m2; rental rates premises with extended warehouse function: 6.5–8.5 €/m2
  • Rental rates for premises with extended warehouse function in business parks located in rural municipalities close to Tallinn: 5–10 €/m2, average 6 €/m2

Julia Linde, Real Estate Analyst with Restate

The GDP in the first quarter of the year exceeded relevant rate prior to the crisis in 2019 and the quarter’s 4.5% (4.8% as adjusted seasonally and by number of working days) economic growth on a year-over-year basis surprised even bank analysts that predicted the pre-crisis level to be restored in the second half of the year, rather. The quarterly economic growth foremost resulted from tax compliance and growth in the commerce and ICT sectors. The feeble comparative base of last years’ second and third quarter and significantly relaxed restrictions allow an even faster economic growth to be predicted for upcoming quarters. Eesti Pank’s economic forecast from the month of June predicts that Estonia’s economy will undergo a growth of 5% - 8% this year.

Sense of security to increase

Business operators and consumers assess the state of the economy as more and more stable. Economic trust and the business cycle are making a recovery and exceeding a long-term average. The business sector’s security indicators have significantly improved as compared to last year and remain on high positions, exceeding long-term average indicators. Consumer confidence continues to be low, yet is improving successfully. This is also characterized by improved retail sale numbers that have as of December 2020 exceeded corresponding indicators of the corona year and of relevant months of the pre-crisis year of 2019. Consumption growth is also supported by decreased unemployment - following the height of the 8.8% registered unemployment rate in the month of March, unemployment began to decrease, remaining at 7.7% in June. Consumer confidence is in its turn elevated by an increase of gross monthly salary of as much as 6.8% in a year. As unemployment is reduced, Estonia once again faces a shortage of workforce, on account of which certain pressure for increasing of salaries continues.

Rapid economic growth at the same time causes increased fear of inflation in market participants. Changes in the consumer price index in a year-over-year comparison have increased to 3.8% as of June. In fear of quickening inflation, market participants are looking for opportunities to invest their money safely. In the fall, this will pick up even more speed when as a result of the pension reform money in the form of the corona year’s largest deposits is injected into the market in September. As a result, the market will heat up and prices will rise. In this kind of market situation, poorly marketable real estate can be realized at the best price.

Mixed signals in the commercial real estate market

Although Estonian economy as a whole grew in the first quarter, the construction sector on the other hand indicated a decline of 12.8% in a year-over-year comparison. This year, not as large as usual a volume of premises reaches the commercial real estate market and the year will remain modest, rather.

During the first half year in Harju County (incl. Tallinn) more than 1,500 m2 of office space was taken into use, more than 6,000 m2 of commercial space, and more than 610,000 m2 of warehouse space. This means office spaces were added into use at a mere 1.6% of the past five years’ average volume, commercial spaces at 6.7%, and warehouse spaces at 61%. The decline is drastic for office and commercial premises, constituting a normal outcome of the 2020 crisis year during which many projects were put on hold.

On the other hand, during this year’s first half year in Harju County (incl. Tallinn) a record number of building permits for office buildings was issued for a total of 150,000 m2 which significantly exceeds relevant indicators for previous full years - for instance, the average yearly volume for the past five years is approximately 125,000 m2. In relation to commercial and warehouse spaces, approximately half of the regular yearly volume was issued: approximately 57,000 m2 and 68,000 m2. Most likely, these figures will be realized as completed premises in the coming years when developers’ confidence, future prospects, and the market are even further restored. During the first half year construction of 124,000 m2 of office space, 40,000 m2 of commercial space, and 56,000 m2 of warehouse space has been commenced.

Construction sector confidence restored

In May and June, construction sector confidence already reached the level exhibited in 2017 and 2108. A study conducted by the Estonian Institute of Economic Research indicates that contracts in the construction sector guaranteed work in the second quarter for 5.1 months which exceeds the long-term average (3.6). Considering that in the residential real estate market, premises can be realized before their construction is completed and at historically best prices, this segment of the real estate market draws resources and interest away from the commercial real estate segment.

At the same time, price increases and supply difficulties of construction materials have emerged. Construction material supply difficulties and the increase of prices resulting from raw material crisis are issues that construction and development undertakings have expressed concerns about. According to information of the Estonian Institute of Economic Research, the construction sector’s principal COVID-19 concerns in June relate to increased prices (73%) and procurement of production materials (53%). In the beginning of the year, among more important hindering factors, insufficient demand was mentioned, while in the second quarter this became less important.

Resulting from the situation in the construction and real estate sector, there is strong pressure in the market to increase the rental prices in new developments. Price offers for new development construction have increased by nearly 20% in a short time, while rental prices have remained fairly stable in the market for a long time – yearly growth has been limited to a few percentage points. This situation is preparing the market for an increase of new developments’ rental prices as developers can no longer offer new commercial real estate at former rental rates and significantly higher material prices are being transferred to customers.

Some developers still prescribe to the “wait and see” position, especially as regarding office premises, as the productivity of sold premises has continued to decline. Rental prices have remained stable for a long time; in relation to the crisis, tenants were offered concessions or grace periods that will bring about decreased productivity as relating to more vacancies and a significant increase of construction prices. During the second quarter, commercial real estate rental prices in Tallinn and Harju County have stabilized and the 5% decrease as compared to the first quarter of the number of offers of commercial premises in Tallinn indicates a modest restoration of demand and supports preservation of the rental price rate and, if the same trend continues, a growth of the above and a decrease of vacancies.

Commercial real estate to develop in Tallinn’s vicinity

In the first half of the year, a revival could be noticed in Rae rural municipality and partially in Tallinn of the number of transactions involving such registered immovables with the intended purpose of commerce and production which have not been built on. For example, in the first half year in Rae rural municipality were purchased registered immovables not built on, adhering to the following intended use: 14 commercial land, 18 production land, and 46 mixed purpose land; this significantly exceeds relevant indicators for recent full years in terms of both the number of transactions and the total turnover of the transactions.

Factors in favor of developing commercial real estate in Rae rural municipality include in addition to suitable location and transport network also a residential real estate market that is growing at an immense speed and the resulting increasing number of residents in the rural municipality. For example, in a half a year, 324 not-built-on registered immovables of residential land were purchased in Rae rural municipality, while an average of 130 transactions are usually undertaken throughout the whole year.

As relating to commercial real estate, demand is especially high for well-located registered immovables with the intended purpose of commerce and production. The business parks by Tallinn Roundabout and in rural municipalities in Tallinn’s vicinity are likely to undergo growth in the near future which is certainly accelerated even further by the Rail Baltica project that is planned to be completed by 2026.

In the second half of the year, the commercial real estate market can be estimated to continue its recovery. Optimism of the market participants in relevant sectors and growing economic activity are likely to be expected. Vacancies of commercial premises will start to decrease and rental rates are expected to go up for premises more in demand; demand remains high for registered immovables in good location and for high quality premises.

Office premises

  • Compared to the first quarter, rental prices are stabilizing and vacancies remain high.
  • A-class rental rates: 11–20 €/m2, average 14.6 €/m2. A-class new buildings and new developments average rental rate: 15.1 €/m2. Vacancy: mostly 0–10%, average 8%, also higher for new buildings
  • B-class rental rates: 7–15 €/m2, average 11.1 €/m2. B-class vacancy: average 9.7%, varies from premises to premises, generally no more than 20%
  • C-class rental rates: 5–10 €/m2, average 6.8 €/m2, vacancy 5–30%, higher in older office buildings

Commercial and service premises

  • Shopping center rental rates: larger premises 12–20 €/m2, smaller premises 15–32 €/m2
  • Shopping centers of local importance in Tallinn’s city districts: rental rates start at 9 €/m2. Rental rates for new commercial premises in Tallinn’s bedroom communities: 10–13 €/m2
  • Rental rates for commercial and service premises located on the first floor of office buildings and residential buildings vary greatly depending on the location and appeal of the premises and on whether the premises are walk-through. Rental rates start at 7 €/m2 for older premises in a non-central location and are 15–25 €/m2 for premises in a good city center location.
  • Compared to the first quarter, rental rates are stabilizing. New multifunctional commercial premises compete with older less appealing premises.

Logistics

  • Rental rates for small 1–20 m2 warehouse premises for private customers: 11–30 €/m2, average 16 €/m2; rental rates for premises smaller than 100 m2 for small undertakings: 6–11 €/m2, average 9 €/m2
  • Rental rates for Tallinn warehouse premises of up to 300 m2: 5–9 €/m2, average 6 €/m2; rental rates for larger warehouse premises: 3–7 €/m2, average 5 €/m2
  • Rental rates for warehouse premises of up to 300 m2 in rural municipalities close to Tallinn: 5–8 €/m2, average 6 €/m2; rental rates for larger warehouse premises: 3–7 €/m2, average 5 €/m2. Average vacancy: 4.6%
  • Rental rates for older warehouse premises that have not been renovated: 2–4 €/m2

Warehouse/office and loft office

  • Rental rates for Tallinn based warehouse/office and loft office premises that combine different functions: mainly 7–13 €/m2, average 8,3 €/m2
  • Rental rates for premises with extended commercial function in popular commercial areas in Tallinn’s bedroom communities: 9–13 €/m2; rental rates premises with extended warehouse function: 6.5–8.5 €/m2
  • Rental rates for premises with extended warehouse function in business parks located in rural municipalities close to Tallinn: 5–10 €/m2, average 6 €/m2