Serbias fourth-largest city, Kragujevac, does not have a happy history. The scene of an infamous massacre in the Second World War, by the early 1980s it was harbouring lofty ambitions of becoming the Detroit of Europe. For a while, its prospects looked encouraging, with exports of the ultra-cheap Yugo car exceeding industry analysts forecasts. The disintegration of Yugoslavia brought that phase of industrial success to a shuddering halt, with annual production falling from 200,000 units at the start of the 1990s to 14,000 by 1999, when the Zastava plant was bombed by Nato forces.
Today, Kragujevac is enjoying something of a renaissance. In September, Fiat signed a joint-venture agreement worth close to 1 billion aimed at restoring output to 200,000 cars by 2010, creating 5,000 new local jobs in the process. The potential for an economic revival in the city has not been lost on real estate developers, with Israels Plaza Centers investing 60 million in a new shopping mall. Construction of the mall, which will house well over 100 shops, began in September, suggesting that there is plenty of dynamism in the market beyond the Serbian capital of Belgrade.
"Although Belgrade accounts for about 34% of Serbias GDP, in the last 12 months we have seen several important retail developments in a number of other regional centres," says Jovan Jovanovic, head of investment at Belgrade full-service real estate firm YU Kapital. "The Fiat deal has really put Kragujevac back on the economic map."
Jovanovic is bullish about the prospects for the broader retail sector of the Serbian real estate market, pointing to the example of a project such as Shopping City in the Belgrade municipality of Čukarica, a 100-hectare site that is being developed into the first retail park in Serbia. Others are equally excited about the potential for retail developments in Serbia, with MPC Properties, in which Merrill Lynch has a holding, due to open the flagship Usce shopping mall, with a gross lettable area of 43,500 square metres, in the first half of 2009.
At Shopping City, negotiations are progressing well with international retailers, who to date have been slow to explore the opportunities in the Serbian market, says Jovanovic. Germanys Metro has had a presence in Serbia for a number of years, and Swedens Ikea is due to open its first factory in the country in 2009. However, the majority of multinational retailers remain conspicuous by their absence.
Local developers say there is no shortage of reasons why international retailers and other investors should be scrutinizing Serbias potential. In 2007, according to Colliers Internationals latest bulletin, Serbia recorded GDP growth of 7.5%, the highest in the countrys history, with inward flows of foreign direct investment reaching 1.1 billion at the end of last year, underpinned largely by the privatization process. It is highly improbable that that rate of growth will be sustained, and a recent IMF report suggests that tough times are ahead for the economy as Serbia looks to deliver continued robust growth combined with low inflation and a manageable current account deficit. Nevertheless, the IMF expects real GDP to expand at between 6% and 7% in 2008/09.
Looking to the longer term, however, the prospect of EU membership appears to be the biggest draw for existing or prospective investors in the Serbian real estate market.
"The likelihood is that Serbia will be fast-tracked into EU accession," says Stuart Place, a director at Argyll Investment Services in Guernsey, which last year launched the Belgrade Pioneer Fund, one of the first vehicles dedicated exclusively to investment in the Serbian real estate market.
Place describes Serbias accession to the EU as being in everybodys interest, not least because of the countrys importance as a transportation hub. In particular, some 800 kilometres of the 2,360 kilometre Corridor X between Salzburg and Thessaloniki runs through Serbia. As the EIB noted last year when it announced that it was providing 66 million of funding to support the rehabilitation of Serbian bridges and roads, "a well-developed transport infrastructure... particularly along the priority pan-European Corridor X, is of crucial importance for ensuring deeper integration with the European Union".
Serbias prospects for EU accession were enhanced in July with the arrest of war criminal suspect Radovan Karadzic, which immediately prompted a positive comment from Standard & Poors. Although the agency did not go so far as to revise the negative outlook on its BB rating, it advised that the detention of Karadzic signified "a notable reduction in political risk, particularly if it were followed up with the successful arrest of Ratko Mladic, the remaining high-profile war criminal still at large".
Continued robust economic indicators twinned with an acceleration of EU convergence will support expansion in a number of areas of the real estate market beyond retail. Rising demand in the office market, for example, has driven yields for high-quality premises from 12.5% in 2003 to an estimated 8.2% in 2008, according to data published by Greeces Eurobank Properties, which notes that in Belgrade the vacancy rate for class-A stock has decreased to below 7%. A similar trend has unfolded in the logistics/industrial sector, where yields have fallen from 11.5% to 10% since 2003.
"There is no economic logic in land prices being twice as high in Belgrade as they are in Sofia or Bucharest"
Siniŝa Braŝanac, Citibel Invest
The Serbian housing market, however, has the most eye-catching growth potential over the short to medium term. Braŝanac explains that annual construction of residential units in Belgrade nosedived during the Yugoslav war from an annual level of perhaps 10,000 in the 1980s to a little over 1,000 in the 1990s. With the population of Belgrade rising during the same period, the inevitable consequence today is a severe housing shortage in the Serbian capital. As Argyll explains in its report on the Belgrade Pioneer Fund: "The level of residential new build is well below the needs for replacing existing housing stock. It is estimated that 90,000 to 100,000 apartments are still missing in Belgrade. With 8,000 to 10,000 units currently being built per year, the supply-demand gap will take at least 10 years to equalize."
The expanding availability of mortgage finance in the Serbian market is certainly supporting a rise in home ownership, but from a minuscule base. According to Colliers International, in 2007 housing lending in Serbia increased by almost 100%, to 1.2 billion. "The main demand driver has been the government incentives aimed at solving the housing problems and facilitating the first apartment purchase for citizens in Serbia," notes Colliers.
Nevertheless, the European Bank for Reconstruction and Development reported in 2006 that the Serbian mortgage market was equivalent to just 2% of GDP, compared with an EU average of 34.5% in 2005. Indeed, Place says that one of the attractions of the Serbian market when Argyll started researching its potential two years ago was the under-geared structure of the economy relative to a number of other developed and emerging European markets.
Against this backdrop, some market participants are disappointed that foreign investment in the Serbian real estate market has been limited in recent months. Disappointment but not, perhaps, much surprise, for a number of reasons. The first is that supply-demand dynamics, especially in Belgrade, have meant that the market is anything but cheap. "We have seen price rises in the last year or so that arent realistic," says Braŝanac. "There is no economic logic in land prices being twice as high in Belgrade as they are in Sofia or Bucharest."
The second is that bureaucracy in Serbia means that negotiating, documenting and concluding transactions can still be tortuously slow. A third is that in common with all other markets, financing is much scarcer and much more expensive than it was six to 12 months ago.
A fourth explanation for the apparently subdued appetite among foreign investors for exposure to Serbia is that after a surge in demand in recent years, the most active players in the region now appear to be renewing their focus on domestic opportunities. That is especially true of a number of the Greek investors that have so conspicuously underpinned investment flows into such countries as Bulgaria, which in 2007 attracted a record 2.15 billion of foreign investment in its real estate market. In the first quarter of 2008, that dropped to a little over 333 million the lowest quarterly total for two years.
For Greeces real estate investment companies (Reics), in particular, unearthing opportunities in the domestic market appears to be the main priority. That is in part because the amendments to the law governing the sector have significantly enhanced the relative attractiveness of investing locally, making Reics exempt from Greek corporate income tax, additional taxes on rental income (usually levied at 3%), and taxes on dividends and capital gains. The amended law also allows Greek Reics to buy assets through the acquisition of SPVs, and to borrow up to 50% of their total assets.
"Greek Reics now probably enjoy more advantageous tax treatment than those in any other EU country," says Kenny Evangelou, general manager of Emporiki Real Estate in Athens. Emporiki, which is a subsidiary of Crédit Agricole, is one of a number of Greek banks planning to launch a Reic in 2009. It will focus chiefly on local assets. "Emporiki has a presence in Romania, Bulgaria, Albania and Cyprus," says Evangelou. "But in the first instance a big chunk of our Reic will be accounted for by owner-occupied property in Greece where Emporiki Bank will remain the tenant. We may also add overseas property as well."
Of the two existing Greek Reics, comfortably the largest is Eurobank Properties Reic, which was listed on the Athens Stock Exchange in April 2006. "Today we have a real estate portfolio of approximately 600 million, cash of about 200 million and debt of just 75 million," says George Chryssikos, executive director and general manager at Eurobank Properties Athens headquarters. "That means that we have an unusually strong balance sheet for a European real estate company."
For the time being, however, Chryssikos says that Eurobank Properties is in no hurry to spend its cash, or to greatly alter the geographical balance of its exposure, with 71% of its portfolio now in Athens and Greater Athens and 15% in the rest of Greece, with just 8% in Romania, 5% in Serbia and 1% in Ukraine.
The benefits of patience
"We anticipate an increase in yields in Greece in the 25 to 50 basis point range over the coming months, so we are adopting a wait-and-see attitude at the moment," says Chryssikos. "We believe that by waiting for a few more months we will start to see increasingly attractive opportunities in areas like distressed portfolios, in Greece as well as overseas. We dont enjoy the same tax advantages outside Greece as we do in the local market, but the strength of our balance sheet gives us the negotiating power to strike some very good deals in overseas markets. Although we dont foresee a big change in the geographical weight of our portfolio, the balance will be determined by the quality of the opportunities that arise."So with Greek investors turning their focus back inwards, Serbia will have to strive that much harder to attract foreign investment to help unleash its full potential. Kragujevac and the other cities in the country will hope EU membership comes swiftly to bring a boost to their development.