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Thematic Research

Spring 2018

iGen Capital

Real EstateFocus: South Eastern Europe

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Increased Prosperity

Reverse Migration Pull Factors

Reforms and Business Environment

High Tech Outsourcing Destination

Strong Local Macro Environment

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iGen Capital

SEE Property Outlook: Supportive Macro and

Micro Factors

SEE Real Estate: A Total Return Opportunity

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Appendix: Return of Global Growth

CEE/SEE real estate is making a come back

Many investors exited out of CEE/SEE real estate in theaftermath of the Global Financial Crisis, as perceptions ofrisk led many to revert to more traditional asset classes.Today, CEE real estate is showing signs of resurgence, assome investors are returning, with increased investmentvolumes in the past two years. The majority of flows havebeen absorbed by Poland, Czech and Hungary, with yieldsshowing significant compression, while SEE markets stilloffer a significant yield advantage.

Strong Global and Local Macro Backdrop

There is a broad based consensus amongst investors thatglobal growth is on the mend, with asset volatility beingat record lows of recent years.

CEE/SEE economies stand in a significantly strongerposition today than they were when the financial crisishit. These economies have benefited from several yearsof stronger growth than the rest of the EU, with stronggrowth forecast to continue in the medium term, andrecent positive growth surprises. With inflation in check,unemployment rates near historical lows and public debtlevels significantly below EU average of 91%, CEEeconomies are well positioned to continue benefitingfrom political and economic convergence with the EU.

CEE currencies have in the last few years shown verylow volatility relative to past history, as well as majorwestern currencies such as the GBP. Despite recentpolitical problems in some countries such as Hungary,investors continue to regard political uncertainties astransitory and the implied volatility on currency futuresremains low.

Against the backdrop of this improved macroenvironment, and after years of credit contraction postGFC, domestic banks have restarted to increase theirlending to households and businesses, which we expectwill continue to support the local property markets.

South Eastern Europe: Real Estate

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Micro Factors

A significant increase in prosperity relative to the 1990s,low unemployment and attractive taxation regimes,along with targeted government measures aimed atattracting reverse migration from Western Europeancountries are all expected to help maintain strongdemand for housing and retail facilities.

Commitment to reforms to boost productivity andstrengthen institutions provides a supportive businessenvironment. The long-term goal of convergence withthe EU indicates continued direction of travel to higherlevels of institutional integrity and transparencythroughout the region.

Increasingly a destination of choice for high techoutsourcing, CEE and SEE countries provide a home tomany global blue chip and high tech companies,including amongst others Oracle, Siemens, Bosch,Amazon, HP and Huawei. With their high educationlevels, competitive wages and friendly tax regimes,Romania and Bulgaria top the global outsourcingrankings.

Outlook

Demand for office space is strong, particularly in capitalcities. Yields for some office segments have alreadyshown signs of compression, while others have not yetmoved leaving scope for tactical allocation to certainsegments.

A chronic shortage of affordable housing in some of theSEE markets means that the market is likely to remainbuoyant in the medium term.

Finally, a high unsatisfied demand for low cost retailparks with outlets targeted at mass demand providesopportunities for selective development retaildevelopment.

Our Framework

While institutional investors have taken advantage of thecurrent low interest rate environment to explore yieldand total return opportunities in Western and CentralEuropean real estate, some real estate markets andsegments in SEE remain largely ignored, and may offer asignificant yield advantage to those investors who areprepared to look further afield.

While the global investor community was distracted withthe aftermath of the GFC and developments out of China,economies such as Romania and Bulgaria, have quietlycontinued to grow aided by a strong governmentcommitment to reforms of the judiciary, and an influx ofmultinational companies keen to take advantage of higheducation levels of the local populations, solid broadbandinfrastructure and attractive wage and taxation levels.

We believe that investors should closely look at thesemarkets, and commit to having long-term exposure toreal estate asset in this region.

Partnering up with an investment advisor with a longtrack record and an in depth understanding of and linksto these markets will help investors take advantage oftactical allocation to certain segments of these marketsat appropriate times.

Thematic: Total return opportunity in CEE/SEE real estate

iGen Capital Limited does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the

firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in

making their investment decision.

SEE Real EstateA total return opportunity

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SEE property markets have been largely ignored by foreign investors in the years since the financial crisis. Recent pick up in

activity suggests investors have noted the higher yield opportunities on offer in these markets.

Investment Opportunity Landscape

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Eurozone property yields and interest rates, 2007-2017Real estate investment volumes in European countries Q4 2016-Q3 2017 (€bn)

Source: PWC/Urban Land Institute, Emerging Trends in Real Estate, 2018

In their search for income, investors have focused on property markets in the UK,

Germany and France, where transaction volumes have been the highest. PwC

survey shows that investors are starting to look further afield to find appropriate

income levels.

Thematic Research | Real Estate | 2018

Eurozone Prime Office Yields

Prime Yields in Eurozone reflect the highly priced RE markets and are expected to remain flat at current levels

Eurozone prime yield outlook to 2025

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Source: CBRE , 2018 Europe Real Estate Market Outlook, January 2018

Investors expect prime yields in Eurozone to remain at bid up levels for many

years to come, as they begin searching for more attractive yield levels further afield.


Attractive Regional Property Yields

Prime yields have been gradually compressing since 2015, as property investors return to the region.

Prime yields Q4 2017 and Colliers International 12-month forecast

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Source: Colliers International, The CEE Investment scene – H1 2018 CEE flows and drivers, 2018

CEE/SEE property yields across the board are reflecting gradual increase in investor

interest. Yields are expected to continue compressing as some markets (notably

Romania) still offer attractive yield levels.


Investment Volumes in CEE RE Growing

Investment into commercial real estate in CEE has shown signs of pick up

Investment volume per country 2007 – H1 2017

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Source: CBRE , CEE Property Investment, H1 2017, July 2017

After many years of depressed investment levels, volumes have picked up and are

showing momentum. Flows have been favoring Hungary, Poland and Czech, with

Romanian RE market still largely ignored by investors.


Fund flows which returned to CEE in the last couple of years have largely ignored Romania and Bulgaria

Fund Flows into CEE Property Market

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Historical CEE Investment Volumes (€ bn, Annual/Quarterly) Flows by country (2017, € million)Flows by sector (€ million)

Source: Colliers International, The CEE Investment scene – H1 2018 CEE flows and drivers, 2018

In the first half of

2017, Romania only

attracted circa

€399m of real

estate investment,

and the overall

number of 2017

stands at just

under €1bn only.


SEE Property OutlookSupportive Macro and Micro Factors

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Consecutive Years of GDP Growth…

The systemic contagion of the Global Financial Crisis propagated to the CEE countries with some delay,

but resulted in a sharper downturn relative to Western Europe

A recent pick up in real GDP growth can be seen with most CEE economies outperforming Eurozone in the last few years

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Source: CBRE, Central Eastern Europe Real Estate Market Outlook 2016

The sluggish GDP growth in

Eastern Europe of post

financial crisis has been

followed by a rebound in

most CEE markets from 2013

onwards, which has

outpaced the Eurozone

growth.

Local Macro Increasing Prosperity Reverse Migration Commitment to Reforms Outsourcing Destination


…followed by Solid Core Growth Forecasts for CEE Region…

The headwinds faced by Central and Eastern European Economies in the recent years have been

replaced by recent steady real GDP growth

Strong GDP growth is expected to continue into 2018, supported by accommodative monetary policy

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Source: EBRD, Regional Economic Prospects in EBRD Countries of Operations, November 2017

Real GDP growth forecasts

for the CEE region are

significantly ahead of the

forecasts for the advanced

economies of the OECD

with the US, Eurozone and

Japan expected to grow at

2.5%, 2.1% and 1.2%

respectively.



…and a Positive Growth Surprise in H2 2017

Strong labour markets and rising domestic consumption have delivered a positive GDP growth surprise

in the CEE region.

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Source: Erste, What’s up in CEE?, December 2017

2017 and 2018 growth forecasts in the CEE region have been revised to 4.6% and

3.6% respectively in late 2017, due to strong domestic demand, higher growth in

public sector wages and higher PMI readings in manufacturing.

Real GDP Growth Forecasts Unemployment Rates



Moderate Inflation and Interest Rate Rises

Mild inflation pressures may result in base rates to rise in some instances

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Source: Erste, What’s up in the CEE, December 2017

Interest rate rises are expected to increase in Romania, where the growth surprise

was due mostly to a jump in domestic consumption. However, wage pressures are

viewed as a one-off structural adjustment, mostly in the public sector, and are not

expected to persist in the long term.

Inflation Forecasts Base Rate Forecasts



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Croatia Czech Hungary Poland Romania Serbia Slovakia Slovenia

2016 2017f 2018f 2019f

Robust Local Fundamentals

Fiscal discipline and low public debt levels accompanied with managed floating exchange rates in some

instances have resulted in currency stability over the last few years

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Source: Erste, What’s up in the CEE, December 2017; iGen Chart

Public Debt Forecast

CEE public debt levels are

substantially below the

Eurozone average of 91.5%

of GDP (Source: World Bank,

2015), suggesting that CEE

public finances are in

significantly better shape

than their Western European

counterparts.

EU Average



Low Historical Volatility for Currencies

CEE and SEE currencies have exhibited low volatility against the EUR for the last few years

Currency returns in the last five years – CEESEE exchange rates versus GBP and USD

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Source: Bloomberg, February 2018

GBP and USD exchange rates to the EUR have been significantly more volatile in

the last five years, compared to CEE and SEE currencies exchange rates. With some

of the regional currencies following some form of management against the EUR,

investors have come to expect reasonably predictable exchange rates.



Currencies Price in Low Volatility

Implied volatility on currency forwards at significant lows relative to recent history

Implied volatility on CEE currency forwards against EUR

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Source: Bloomberg, January 2018

Investors seem to view political risks in the region as transitory and are pricing in

low volatility despite recent political strife. Convergence with the wider EU is

accepted as the general direction of travel, and provides support to CEE and SEE

currencies.



Local Banks in Better Health

After years of contraction post GFC, domestic credit finally showed increases in 2016 (and in 2014 in some cases)

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Source: IMF, Effective Government for Stronger Growth, November 2016; RBI/Raiffeisen RESEARCH, Banking Sector Convergence 5.0, June 2017

Domestic banks have reduced their NPL ratios since the highs of post financial crisis,

and domestic credit to households and corporations has started to expand in some

markets.

Credit to Households and Corporations (yoy % change, July 2016) Markets with NPLs below 10% (as of 2016, % of total loans)



“Prosperity” in the Region

“Prosperity” is a composite measure that includes aspects such as governance, income inequality, health and ease of doing

business. Measures of prosperity within the CEE have increased over the last 20 years with Austria being the benchmark.

PPP GDP per capita has significantly converged to that of Germany since 1995, with 9 countries at levels of above 40% of German PPP GDP per capita in 2015 versus only 2 in 1995*

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Source: Legatum, Central and Eastern Europe Prosperity Report, 2016; * World Bank Development Indicators



Increasing Regional Prosperity

Prosperity in the CEE region has been steadily increasing since the 90s, and is now at a not too

dissimilar level as prosperity in Western Europe.

Business environment measures have improved, with continued efforts to fight corruption and strengthen institutions

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Source: OECD Economic Outlook, Volume 2017 Issue 2, Chapter 1

Recent pick up in credit accessibility is likely to further boost the business

environment measure. Increase regional prosperity helps improve local political

stability and confidence necessary to boost investment.



Demographic Trends

CEE countries have been suffering from a falling educated working age population through emigration, and rising

dependency ratios. Improving PPP incomes and vibrant local job market should help reverse this trend.

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Source: Colliers International, CEE Real Estate: Labour Force Boomerang, July 2017

Size and breakdown of CEE populations in Western Europe (2016) % of population of country residing in Western Europe (2016)



Pull Factors for Returnees

CEE countries offer attractive tax rates relative to Western European economies and some governments have

introduced specific measure to attract emigres back to domestic jobs or to start local businesses.

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Source: Colliers International, CEE Real Estate: Labour Force Boomerang, July 2017

Tax rates in CEE-6 and selected major EU countries (2017) CEE direct and indirect government action



Business Environment Continues to Improve…

Corruption Perceptions Index readings show that many of the CEE markets are perceived on par or

ahead of some major Western European economies, eg Italy ranked 60th.

Regional governments continue programs of institutional reforms requested by the EU in the context of accession programs

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Source: Transparency International Corruption Perceptions Index, 2016

The EU has put emphasis of improving the efficiency of tax collection administration

and the reform of the judiciary systems to increase confidence and impartiality.



Romania – High Commitment to Eradicating Corruption

Recent judicial reforms and a zero-tolerance attitude to corruption with high enforcement rates have resulted in

1,270 prosecutions in 2016 alone, including Prime Minister who stepped down in November 2016

WJP Rule of Law Index places Romania 32/113 globally (ahead of Italy) on corruption perceptions, with improving government transparency

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Source: World Justice Project, Rule of Law Index 2016



… and Further Reforms Expected to Boost TFP

Continued commitment to institutional reforms is required by the European Commission in order to

facilitate convergence

CESEE: Estimated Efficiency Gains from Institutional Reforms (% potential improvement in Total Factor Productivity)

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Source: IMF May 2016, Regional Economic Issues: Central, Eastern and Southeastern Europe

Improved institutional

strength is expected to

increase social capital of the

local population and lead to

higher TFP readings and

higher GDP growth, which

should continue to provide

support to future GDP

growth.



Romania – A Favoured Outsourcing Destination

A large number of high tech companies make Romania their outsourcing destination of choice, due to

Romania’s capacity to handle process of highest complexity, and attractive local wage levels

BPO, ITO, software development and research programs are all delivered in various shared service centres

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Source: Colliers International, Romania Market Overview, 2017



Business Process Outsourcing Destination

High education levels, high internet speed and competitive wage levels make many CEE countries a

destination of choice for business process outsourcing (Bulgaria, Romania, Lithuania, Czech, Hungary, Poland)

Business Process Outsourcing index map

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Source: Cushman & Wakefield, Where in the World? Business Process Outsourcing and Share Service Location Index, 2015



Local wages in the region are still at very competitive levels relative to Western Europe

BSS Pull Factors

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Average national gross salary (€ per month, 2016) Number of students (2016)

Source: Central Statistical Offices, 2016

A large number of students with high technical and professional skills as well as

competitive wage levels continue to attract business services and process

outsourcing, with focus on the capital and large university cities (eg Timisoara, Cluj)

Source: Central Statistical Offices / CBR Research, 2016

Source: CBRE, Business Services: Destinations in Central Europe, 2017



High Operational Complexity for BPO

High operational complexity of IT services, and attractive local wages relative to Western European

benchmarks act as pull factors for many IT and industrial companies

Additional pull factors include quality of life/infrastructure, business environment and attractive office rents

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Source: Colliers International, A Thoroughbred Racer, November 2017 (ABSL, BOA, SARIO, Hays Recruitment, Randstad)

A large number of

multinational high tech

companies from a variety of

sectors choose to have a

presence in the CEE. This

includes amongst others

Oracle, Microsoft, Xerox, HP,

IBM and Adobe.



Return of Global GrowhA supportive global macro environment

Appendix

Modest Growth Forecasts for Major Economies

A broad-based cyclical recovery is finally underway in the US, Western Europe and Japan, with

synchronized increases in output across different economies.

Real GDP of the major economies is expected to continue to expand in the next two years, although at a decreasing rate

31


The recovery in the major economies is moderate relative to past episodes,

because of past shortfalls in investment and resulting productivity lags, but it is

broad based with advanced economies showing declining unemployment.


A More Robust Global Financial System

While US Fed has started to hike rates at what is likely to be a modest pace, the interest rate outlook in

the Eurozone is expected to remain benign in the near term.

32


Short-term deposit rates are expected for a mild increase from a low/negative base,

while higher central bank reserves indicate a much more solid liquidity approach to

the banking system. QE tapering in Eurozone is expected to gradually begin in

2018.

Expected O/N Interest Rates for end-2018Size and composition of central banks’ balance sheets have changed massively over

past decade


Benign Inflation Environment

Sluggish growth of recent years, low wage pressures and technological drive to achieve cheaper goods

have meant that inflation remains at moderate levels.

33


Inflation in advanced OECD economies is forecast to remain at a median of 2%,

which means that pressure for central banks to raise interest rates is likely to

remain low.

Headline Inflation Core Inflation


Long-term Interest Rates Stable

Current outlook for long-term rates suggests that interest rates will remain low for the foreseeable

future.

Government 10-year Bond Yield forecast to remain relatively low in the advanced OECD economies

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Source: OECE Data

With inflation continuing to

be at benign levels in most

advanced economies, there

is little pressure for fast

interest rate increases.Long-

term yields on government

debt are likely to remain

compressed, and investors

will continue to look at

alternative asset classes in

their search for yield.


Low Global Asset Price Volatility

Equity markets in the major economies exhibit low volatility suggesting that they are pricing in low

levels of uncertainty regarding global economies conditions.

Equity markets’ volatility is near pre Global Financial Crisis levels, with business confidence indicators on the up

35


Bond spreads between high-yield corporate debt and government bonds have also

seen further downward pressure and are close to lows of 2014, both in the US and

Europe,

as investors’ hunt for yield continues.


Business Confidence High

The BCI, one of OECD leading indicators for GDP growth, is showing solid signs of recovery since the

lows of the financial crisis.

Businesses expect strong GDP growth to continue into 2018, supported by accommodative monetary policy

36

Source: OECD Data, iGen Capital

Business confidence in the

world’s major economies is

back to pre-crisis levels and

reflect an increased investor

risk appetite.

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OECD Business Confidence IndexG-7 and Total

G-7 OECD


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-5

0

5

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

OECD Investment Growth ForecastG7 Countries (in % terms)

CAN DEU FRA GBR ITA JPN USA OECD

Investment Expected to Grow

Low investment levels in recent years have led to lagging productivity gains, and are due for an upgrade

OECD forecasts that investment will grow at a solid rate of around 3.2% for OECD countries

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Source: OECE Data, iGen Capital

Renewed investment should

provide support to the

global economy and result in

productivity gains to support

continued GDP growth.


Global Fiscal Easing

OECD forecasts that the fiscal stance “to ease in many OECD countries” between 2016 and 2019.

Fiscal easing measured as the change in underlying primary balance as percentage of potential GDP is in negative territory for most economies

38


Government interest payments have fallen despite rising debt levels in many OECD

countries. Governments are taking advantage of low interest rate environment to

borrow and ease fiscal policy. This provides further support in maintaining investor

risk appetite.


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