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Is Commercial Real Estate cheap in Croatia?

Ivan Laljak in the office

With unprecedently low bond yields and high-priced equities, there has been growing interest for commercial real estate (CRE) asset class in the past period.

In the last couple of years, we have seen increased interest for commercial real estate assets in Croatia. With the engagement of domestic institutional investors (primarily pension funds and large insurers), and the constant interest of foreign investors, market has seen compression of yields. However, as this article will try to explain through comparison with traditional income-generating asset classes, commercial real estate in Croatia – on a yield basis – still presents a very reasonable opportunity.


Interest in Commercial Real Estate

What might sound like a nice problem to have? Having excess capital to allocate comes to mind. However, deploying excess capital can be a difficult thing to do, especially if there is more of that capital than good opportunities on the market. Powerful monetary and fiscal stimulus (with consequent inflationary pressures), coupled with long bull run last decade, left investment managers with lots of dry powder (money ready to be shoot, or invested). While from market perspective this can be a positive thing, which ensures activity and liquidity, managers can have hard time finding opportunities where to put that money to work. 

With unprecedently low bond yields and high-priced equities, there has been growing interest for commercial real estate (CRE) asset class in the past period. CRE offers that current yield (which used to be attractive attribute of fixed-income securities) with potential for capital appreciation (main attribute of many equity investments). Of course, that ratio of current yield vs value appreciation can vary significantly depending on the type of RE investment, from core to opportunistic. 

These attributes contributed to strong growth of alternative assets market in the last decades. Brookfield Asset Management estimates that by 2030, the real assets/alternatives market will pass equity/fixed income. Whether that prediction is too bold or not, the allocation to real assets is certainly expected to grow.

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Game of Risk and Reward: Comparing asset classes

Legendary investor Warren Buffett said that every investment can be looked as a bond, only difference is that coupons that bond will pay are known in advance (and limited by maturity), while in case of equity or RE investment, it is a job of investor to estimate what are the “coupons” that asset will pay over time (in form of dividends or rental income). And, of course, what is probability of that payments, or in other words, risk of the investment.

Investor in a bond, if that bond is bought with intention to be held to maturity, has basically only one risk – will issuer pay stated coupons and principal. If investors believe that issuer is financially strong and will not default on its payments, he will be willing to pay higher price for that investment. In other
words, the yield (and reciprocally price of a bond) depends on the level of trust investor has in the issuer, i.e. issuer’s credit (lat. credo means believe, trust). Thus, bonds are priced based on their credit rating. This means that bonds with higher credit rating will offer lower yields, or to put it more simply,
their cash flows will be more expensive as they are less risky. 

Same principle can be applied for other asset classes as well. Only difference is that analysis can be a bit more complex, as it includes more factors. In case of equities, pricing can be observed through dividend or earnings yield (depending if ratio considers whole earnings, or just portion of earnings which is paid out in form of dividends). Analysis includes financial position of company, competitive advantage, growth potential, industry analysis etc. Although the analysis can be more complicated, the premise is simple – if investor expects stable and sustainable growth of earnings in the future, he will accept lower earnings yield, i.e. he will pay more for that expected cash flows (earnings yield is the inverse of more popular P/E ratio, but it shows the same thing). 

Finally, the same can be said for commercial real estate. If expected cash flows from the asset are predictable and likely to happen, investor is willing to pay higher price. This of course must be determined based on the property’s characteristic such as location, condition, tenant mix and covenant strength of tenants, WAULT (weighted average unexpired lease term), lease conditions (break options, indexation etc.), competing projects, sector outlook and other. Again, the analysis can be more complex compared to bond, but the conclusion is simple – cash flows from quality property on good location, with strong tenants and long WAULT (security that CFs are locked for longer time) will be more expensive. 

Above described can sum up basic idea of investing in income-generating assets, which is paying money now for expected cash flows in the future, while return depends on how expensive these cash flows are. Even though the pricing of every specific issue / company / property will depend on the individual characteristics, the general pricing of every market is primarily based on the strength and stability of the economy, measured by various indicators including GDP growth, unemployment, wages, currency status, but also political stability, investment climate and others (all these attributes
are built into the rate of return or yield).


Comparing cases: Croatia and Austria

Although the topic deserves more detailed analysis, the aim of this text is to point out the potential existence of discrepancies in the pricing of different asset classes in Croatia. The next graph shows yields on 10Y government bodies of Croatia and Austria, dividend yields for stock market indices ATX (Vienna Stock Exchange) and CROBEX (Zagreb Stock Exchange) and yields for prime office properties in Vienna and Zagreb.

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As it can be seen from the graph above, largest spread in yields can be observed for CRE assets: around 4 percentage points for office yields compared to around 20 basis points for equity market and around 90 bps for government bond yields. 

One of the reasons might be perceived liquidity of the market. Due to relatively small size and lack of good opportunities of the market, CRE investment volumes in Croatia can seem low compared to larger markets in CEE. However, investment volumes in Croatia fail to underscore the true investor’s interest, as the demand for good income-generating assets, for several years, outstrips the supply.


What lies ahead?

As described above, CRE market in Croatia is characterized by strong seller’s position, as the supply of investment properties offered on the market currently does not satisfy the demand. Most sought after are opportunities in office and logistics sectors. However, due to strong demand, high activity in previous year was also recorded in retail and HTL sectors, which offered more opportunities. 

In in last two years, market has seen downward pressure on yields influenced by strong competition for deals, inflation panic and low or negative interest rates. Current uncertainties coupled with rising interest rates could stop further compression of yields. With strong existing demand and significant amount of dry powder still available on the market, it is difficult to predict which force will have stronger pull.

Due to strong demand and positive announcements in forthcoming period (Croatia will join Eurozone in 2023 and Schengen in 2024), it is expected that yield spread between Croatia and tier markets will slightly decrease. However, we believe that commercial real estate in Croatia, on a yield basis, will still
look attractive in coming period.

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Colliers Valuation & Advisory and Capital Markets services include: CRE Valuation, Market research,
Feasibility studies, Highest and best use studies and Buy and Sell side investment transactions advisory and


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Ivan Laljak

Senior Consultant, Valuation & Advisory Services


Ivan joined Colliers in June 2018 as a Junior Consultant in the Investment and Valuation Advisory Services department. He is currently Senior Consultant in Valuation and Advisory services where his main tasks include valuation (hotel, office, retail, industrial/logistics, land, residential), financial modeling and analysis, market research, preparation of various types of reports and studies (feasibility studies, highest and best use studies, etc.) as well as NPL portfolio valuation.

Along with VAS, Ivan works in Capital Markets department where he participates in advisory (sell or buy-side) for investment transactions of income-producing properties & land for development. His tasks include market research, preparation of marketing materials (teasers and information memorandums), cash flow and asset analysis and communication with clients and investors.

Prior to joining Colliers and during his studies, Ivan worked, in financial industry and corporate finance. Ivan holds Master degree from the Faculty of Economics and Business, University of Zagreb. He also gained “Financial Modelling and Valuation Analyst” certificate at Corporate Finance Institute. Ivan passed CFA Level I and is Level II candidate.

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