CEE Real Estate stocks with upside potential of 15%, profitability lags behind

Erste analysts forecast 4% ROE for real estate companies in 2012 and possible 15% upside potential for CEE real estate shares until the year's end, whereas profitability lags behind.

The recent fall in highly-rated government bond yields makes investment in real estate look more attractive in terms of relative pricing between asset classes.

“We are currently witnessing the highest yield gap since spring 2009. However, current ROE levels are still disappointingly low. Whereas rents have recovered from the crisis, savings in operating costs still have to be unlocked, especially as the development volumes and profits will not reach pre-crises levels anytime soon. Speaking in favour of real estate shares is the 50% discount to book value”, said Günther Artner, Co-Head CEE Equity Research.

In an international peer group comparison, CEE real estate stocks show clear discounts based on book values, but are traded in line with peers on cash flow-based multiples, highlighting the below-average profitability level.

The market turbulences since August this year pushed back the valuation of real estate stocks to 2009 levels, when trough valuations were just left behind. Given these low stock price valuation levels compared to book values, it is increasingly interesting to buy back shares or other outstanding financial instruments instead of direct property investments. This is already being used by conwert and Immofinanz, others may follow.

Investment volumes in the CEE property investment market reached EUR 6.9bn by mid-August 2011, which is 20% higher than the full-year figure of 2010, accounted for by roughly 120 transactions. The majority of investment turnover continued to be concentrated on the markets Poland and Russia, which account for more than 70% of total CEE investment.

Among the three segments (residential, retail and office), retail properties observed the strongest growth in 2Q11 with 0.8% q/q and 3.5% y/y. The fast growing economies like Germany, Russia, Poland and the Nordics have witnessed increased turnover in the retail segment, while Southern European countries have seen only limited activity.

Investors remain more cautious and are concerned about economic growth and the impact of austerity measures on consumer spending.