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Commercial Real Estate as an Asset Class

Real estate, in terms of asset classes, was often categorized within the sphere of alternative assets. However, today commercial real estate (CRE) is usually ranked with traditional asset classes such as bonds and equities. While the Global Financial Crisis was a reminder of risks related to investing in real estate, it is broadly considered an attractive asset class. The last decade has seen a large inflow of investments in commercial real estate.

Commercial real estate attracts investors because it can produce returns that are uncorrelated with public markets (bonds and equities). This feature makes commercial real estate a great tool for diversification of a portfolio while at the same time providing security of a physical asset.

Commercial real estate investment strategies

Even within one asset category, the level of risk (and potential return) may differ. For example, investing in triple-A government bonds will present low levels of risk and potential return when compared to high-yield, often called junk bonds. The same goes for commercial real estate. CRE investment strategies are often categorized into four groups, which all come with different risk and reward profiles:

- Core,
- Core Plus,
- Value Add and
- Opportunistic.

Core investments are stable with low risk. These investments typically imply Class A fully occupied properties with long-term leases in place (high WAULT) and strong tenants. These are Class A buildings in prime locations that do not need any renovations or major capital expenditures. With Core investments, income represents majority of expected long-term return (e.g. expected return = 70% income + 30% appreciation in value).

Core Plus investments have some potential for growth with low to moderate risk. These properties have the ability to increase cash flows with some minor improvements. Core Plus properties are sometimes mixed with Value Add. However, they offer lower risk, but with lower upside potential. Income still represents the majority of expected long-term returns.

Value-add investments typically target properties with in-place cash flow but seek to increase that cash flow over time by making larger improvements or repositioning the property. Investors can add value to the property through physical improvement (refurbishment, renovation etc.) or with an improvement of asset management (leasing vacant spaces, lowering operation expenses, etc.). Investors often pursue these types of investments to reposition the property and then exiting the investment to capture the resulting appreciation in value (e.g. expected return = 30% income + 70% value appreciation).

Opportunistic real estate investments follow the Value Add approach offering higher returns with greater risks. Opportunistic properties have zero, or close to zero cash flows in place, these are often mostly of fully vacant buildings that require significant capital expenditures. Developments are, in terms of risk and return, often categorized together with opportunistic properties. In this type of investment, nearly all of investor’s return will come in appreciation.

A general comparison of mentioned commercial real estate investment strategies with other traditional asset classes related to risk and potential return is shown on the next graph.

European government bonds vs commercial real estate yields

With bond yields at unprecedentedly low levels in recent years, institutional investors have been looking beyond government bond markets for sources of income to meet their liabilities. This quest for yield has been leading to a widespread increase in allocation to commercial property. The spread between bonds and CRE yields has been attractive enough to compensate for the risk premium. The next graph shows the prime central business district (CBD) office yields for selected European cities and yields of long term government bonds.

Croatian government bonds vs commercial real estate yields

As shown on the graph above, Zagreb / Croatia has the largest spread, after Ljubljana / Slovenia, between prime CBD offices and long-term government bonds, while historical data for period 2009 – 2020 is shown on the graph below.

As it can be seen, the lowest spread was in 2009 amidst Global Financial Crisis, when yields on government bonds peaked. Economic recovery, fiscal consolidation, low yield environment in EU and improved credit rating (in 2019 Croatia got an investment-grade rating from 2 out of 3 major credit rating agencies) created downward pressure on Croatian government bond yields, causing an increase in the spread between Zagreb office properties and Croatian 10Y government bonds and in the same time increasing the attraction of investing in CRE.

As the key interest rates across Europe stand at historically low levels (ECB’s main refinancing rate and deposit facility rate are below zero), it is expected that long term government bond yields will remain low or even in negative territory. On the other hand, yields for prime CRE properties are expected to remain stable or even increase for the sectors most affected by the current crises (like HTL or retail). Thus, we anticipate that the spread between prime CRE yields and government bonds will remain stable in the next few years and investors will continue to see CRE properties as an attractive income-generating opportunities. The same is expected for markets of Croatia and Slovenia.

Colliers Valuation, Investment and Advisory services include: Valuation services, Financial Feasibility Studies and Buy and Sell side Investment transactions advisory and brokerage.

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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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