Looking at the current economic figures, Hungary, which spearheaded the way for investment opportunities into Eastern Europe, is showing a lacklustre growth performance. Compared with other neighbouring countries, Hungary seems to be pausing for breath, while Poland and the Czech Republic catch up.
The Hungarian economy has had its historical frustrations, ranging from a lack of government transparency and red tape to tough competition from neighbouring countries. Over recent years, however, these impediments to investment have dispersed, with European property funds making significant progress in establishing themselves as solid viable investment opportunities.
A big signal, in terms of investment trends, that Hungary’s market has stabilised is the recent announcement by The European Bank for Reconstruction and Development (EBRD) that its job is finished in Hungary. It is pulling out to expand in Russia, Ukraine, Romania, Bulgaria and Serbia.
Following suit, the first opportunistic banks are heading eastward, while the more conservative banks are entering Hungary in the second wave of long-term investment activity. This is a clear indication that Hungary’s market has reached a stage of maturity.
The weak performance of the Hungarian economy since 2002 has been due to poor macroeconomic management, turmoil in the currency markets (in early 1993) and rapid wage growth.
Over the next few years, the economy should grow more strongly, partly on the back of foreign investment made in privatised industry. More than 70% of the country’s manufactured exports now come from foreign-owned plants set up by companies such as IBM, Philips, Matsushita, Texas Instruments, Ford, General Motors, Audi and Suzuki. The service economy should also continue to grow quickly.
According to Oxford Economic Forecasting, Hungary is predicted to grow slightly slower than other Eastern European countries, but still faster than the first-wave European Union countries (EU15), and is expected to regain some momentum in 2006.

Budapest commercial property market
Office market summary
n Vacancy at the end of 2004 was around 17%. We forecast that this will drop to around 12-13% by the end of 2005;
n Demand is strengthening. In 2004, take-up was at highest recorded levels since 2001;
n Very few development opportunities remain in the city centre: road congestion is becoming a more significant factor influencing office locations;
n There is a substantial amount of office production scheduled for completion in 2005 and 2006. However, it is expected that tenant demand will absorb a great deal of this production (see right);
n Rents continue to fall. Prime headline rents are €13-17/m2 per month (e156-204 /m2 per annum), although effective rents are 15% lower.

Warehouse market summary
n Total modern warehouse stock in Budapest and surrounding areas was 528,000m2 in Q4 2004;
n Vacancy for modern warehousing in Budapest has fallen to 5%;
n Most new developments are in established warehouse locations to the south-east and west of the city. There has been an increase in speculative development during the last year;
n Take-up rose sharply in 2004;
n Development activity is mainly focused around Budapest, in western, south-west and south-east access points to the city;
n Areas near the Austrian and Slovakian border are important logistics hubs and we expect more activity in the south and east, where Hungary borders the emerging light manufacturing locations in Romania:
Prevailing user types
n Logistic companies;
n Consumer product distributors;
n Retail distribution.
The key growth sectors are:
n Electronics;
n Motor industry;
n Retail;
n Fast moving consumer goods (FMCG);
n Prime rents: 4,7-5,2 e/m2/month;
n Service charge: 0.7-1 e/m2/month;
n Average lease term: three to five years.

Retail market summary
n A fifth of retail sales are now concentrated in shopping centres/hypermarkets in Hungary – Tesco now has 53 stores and Auchan has seven stores in the country. This competition is forcing many of the older pre-1991 shops to close;
n As purchasing power catches up with the EU average retail brands have been encouraged to enter the market;
n Construction of new shopping centres in Budapest has almost halted after years at very high levels;
n Hungary has the second highest per capita income among the recent 10 EU accession countries.

Investment activity
EU accession has changed the nature of the investment market from an emerging market to a more established market where income-driven funds are most active. Investors are from Germany, Austria, US, France, UK and Ireland. These investors are
generally looking for prime assets with long-term sustainable income (and possibly some reversion).

Investment yields
Limited availability of investment opportunities has resulted in net investment yields moving in by 50 basis points in the last six months (see right).
As the larger international funds target the major A class office buildings smaller international and domestic funds are beginning to target the more attractive B class buildings. Investors in this class of property are looking for gross equivalent yields in the region of 10-11%. However, it may be possible to achieve less than 10% in the case of well-located, downtown properties.

Investment transactions
The investment market has picked up significantly in the past 16 months, with a number of transactions taking place. Investment deals, mostly in offices, totalled e720m in Hungary last year, up more than 50% on the e470m transacted in 2003, and bringing the total investment volume since 1999 to e1.9bn. Mid-2004 gross equivalent yields were around 8.5%, whereas now investors are generally looking for buildings producing 7.25 - 8%. All buildings are on Euro indexed leases. There is a huge volume of money currently chasing too few opportunities, which is driving yields ever lower. However, those transactions that have occurred include those listed on the right.
Cross-border European property investment is attracting increasing interest. Historically hindered by structural differences between national markets, such as varying lease lengths, transactions costs and differing degrees of transparency, not to mention a lack of infrastructure within which to purchase properties, investors have in the past been deterred from venturing far a field.
There is always a balance of risk between potentially higher returns and the risk of investing in a less mature market. Hungary may fall between two sides in that it is perhaps regarded as more risky that Poland or Czech Republic, but not as opportunistic as Romania or Bulgaria.
Over recent years, however, these impediments have dispersed with viable European property funds made possible through the partnership of investment management companies’ capital and investment expertise, with the local knowledge of global property service firms.
Indirect investment, via funds, is enabling investors to unlock property expertise in jurisdictions where the investor does not have the knowledge or capability to invest directly. In particular cross-border investment funds are becoming increasingly popular with investors who are keen to diversify their portfolios as Europe, and eastern Europe in particular, become more accessible.
As well as increasing exposure to geographical markets within property as an asset class, the lacklustre performance of gilts and equities has prompted asset managers raise their property allocation from an average of 5% up to 10%, pouring money into the property market. Investors are looking to European property for a secure income stream, with 6-8 % more realistic than in other asset classes.
This inundation of capital shows no signs of slowing, with European all property investment volumes reported to have reached around €90bn over 2004. Further, it is estimated that the amount of capital sloshing around European property markets could well increase over 2005.
Yet while investor demand across Europe has increased, the less-than-sparkling outlook for the European economy has cooled occupier markets, dampening new development and consequently limiting the supply of investment product.
In response, investors have found themselves in strong competition for investment grade properties, pushing prices up, and compressing yields.
Pan-European funds have become more popular, and increasingly international by the nature of their structure.
The need for tax efficiency is critical to the choice and structure of a fund. The most commonly used structure for pan-European property funds is the Luxembourg Fonds Commun de Placement (FCP), which is tax transparent. However, the vehicle could, depending on investor requirements, be a company, which is tax exempt and resident in a tax haven.
What remains important to investors into the Budapest market is the growing choice of funds in which to invest in. After the first flutter of activity, Budapest is simply catching its breath before the next round begins.
Jake Lodge,is divisional director, commercial agency manager at Bradmore King Sturge, Budapest