Spreading the wealth

With consumer spending on the rise across Poland, private equity firms are shunning the shiny shopping centers in Warsaw in favor of niche assets and mixed-use developments throughout the country. By Robin Marriott

On February 7, the doors to the Zlote Tarasy shopping center in Warsaw finally opened after years of delay and prevarication. The 2 million-square-foot development, the tallest mixeduse project in the Polish capital, was hampered for more than a decade by construction problems and negotiations between the developer and the local government.

However, the Zlote Tarasy now sits proudly in the middle of Warsaw's central business district, its vast undulating glass dome meant to evoke a canopy of trees. (Zlote Tarasy translates to “Golden Terraces.”) With more than 200,000 people reportedly attending the grand opening, the project is the latest and most dramatic signal of a new consumerist era in Poland.

The retail complex includes office buildings, a multiplex cinema and approximately 200 shops and restaurants, including a Hard Rock Café. A new five-star Intercontinental Hotel is located nearby. And just last month, Burger King, an icon of US commercial culture, chose Zlote Tarasy as the site for its first restaurant in Poland since exiting the market in 2001, another sign that the Poles are embracing Western life.

Yet even as local residents flock to Zlote Tarasy, not everyone is in love with the big shopping centers that have sprung up in Warsaw, namely private equity real estate firms. As the country enters a fresh phase of prosperity, foreign real estate investors have piled into Poland, keen to cash in on Central Europe's largest economy. In the retail sector, demand for Class-A properties in the capital has pushed yields down to around 5.75 percent. And that is driving high-yield property investors to a number of new strategies, including mixed-use developments and niche projects in secondary cities, all in an effort to penetrate Poland's growing retail market.

Ringing the tills
The strategies are various, but the fundamental starting premise is the same: an emerging middle class with a lot more zloty to spend. Last year, the country's GDP grew by 5.8 percent; in 2007, it is expected to grow between 5.5 and 6 percent. Combined with a large population of approximately 40 million people, the drivers in the Polish retail sector remain strong.

“The market is at a very good point in the cycle because 2007 is the first year that individual consumption has been growing significantly,” says Agieszka Kowalska, a principal at Polish buyout firm Enterprise Investors. “GDP is also growing. There is an expectation that this will continue for some time.”

Last month, Enterprise tied up a deal to buy Poland's largest carpet and flooring chain, Komfort, for €90 million ($117 million). It was the latest in a string of retail acquisitions for the private equity firm, each one predicated on the assumption that consumer spending will continue to increase.

With many investors focused on the same sector, however, much of the return has already been priced out of prime retail properties, particularly in Warsaw. Most US and European value-added and opportunity fund managers believe that yield compression is at an end, implying that investors can no longer rely on rising capital values to deliver 20 percent returns.

In addition to economic factors, there are also political issues that are limiting private equity real estate interest in large-scale retail developments in Warsaw. A new city council has been critical of some of the economic arrangements that its predecessor had negotiated, including the agreement with ING over the Zlote Tarasy project. The Warsaw government was originally scheduled to sell its shares in the retail complex back to ING upon completion, but it has since said it will auction off its ownership stake. That has forced ING to compensate its partner, Rodamco, which had agreed to acquire a 50 percent stake in the retail center, a number ING can no longer deliver due to the government's actions.

“It is really tough now to do big city-center developments,” says Guy Speir, director of leasing and marketing in Central and Eastern Europe for Quinlan Private Golub. “They are fraught with political issues.”

In Poland, developers used to have carte blanche when it came to retail projects. In 1994, the planning system was based on general master plans, which allowed for the construction of shopping centers on land that was not necessarily zoned for retail use. However, times have changed. Since 2003, the government has stipulated that shopping developments of a certain size need to already be included in the master plan. This brings Poland more into line with Western Europe, but it has also had a radical effect on Warsaw land prices.

“Today, if there is a plot designated for a shopping center, everybody fights for it,” says Marcin Jansky, a surveyor in the Warsaw office of Cushman & Wakefield. “Ten years ago, you could find a plot that nobody knew about somewhere in the city and get a shopping center built.”

Mixing it up
Given that the planning regime has tightened and that large-scale retail projects have already infiltrated many of Poland's more affluent cities, including Warsaw, Poznan and Gdansk, opportunistic firms are pursuing strategies of a different nature.

For example, Quinlan Private Golub, a joint venture between Derek Quinlan's real esate investment firm and Chicago-based developer Golub, is focusing its efforts on mixed-use projects in smaller cities around Poland. In the center of Gliwice, which is in the industrial region of Silesia near the border with the Czech Republic, the firm is developing a 46,000-square-meter retail and leisure mall in partnership with a Danish company. The €75 million investment is the first modern retail building of any scale in the city center, yet the surrounding region has a population of 4.5 million. French hypermarket Carrefour is one of the tenants alongside fashion retailer H&M. The project will include a 15-screen cinema and a Swedish-operated health and fitness center. Meanwhile, in Podlaska, which is located on the eastern side of the country, close to the Russian border, the firm is developing an 18,000-square-meter “convenience center.” Again Carrefour is a key tenant.

“Convenience malls are not seen as being as sexy as a 45,000-square-meter shopping center,” says Speir. “But supermarket operators will take a 2,500-square-meter unit in small projects, and there is enough tenant depth in Poland to make such a center work.”

The issue of supermarket competition is an important one for retail investors in Poland. The country has become a battleground for large foreign operators who are trying to outmaneuver one another in order to build their footprint in the largest economy in Central and Eastern Europe.

Carrefour and Tesco, the UK retailer, are at the forefront of that battle. Both have been particularly successful in expanding store numbers and have provided strong anchor tenants for private equity-backed developments in many smaller locations around the country. Though questions remain about the profitability of these Polish operations, the large retailers have been willing to overlook short-term losses in their efforts to establish a critical mass.

Up market
Just as importantly, the expansion of Carrefour and Tesco have forced Polish retail chains such as Alma, Bomi, and Piotr I Pawel to change their strategies in order to survive. Many of them have begun to move upmarket, creating a new breed of domestic high-end retailers that are also gaining ground in Poland.

Last year, for example, IXIS AEW Europe/Curzon acquired the Klif shopping center in Warsaw on behalf of its PBW Fund I, a private equity real estate vehicle focused on Prague, Budapest and Warsaw. Although a new 1 million-square-foot retail complex, anchored by a large Carrefour, was located just 500 meters away, the Klif enjoyed a loyal customer base, especially among females with significant spending power. With a popular food store generating strong foot traffic, the fund set about replacing many of the existing tenants with higher-end retailers.

“The customers like smaller shopping centers without a cinema, huge food courts and young people spending their days there,” says Artur Mokrzycki, managing director of Central and Eastern Europe at IXIS AEW Europe/Curzon. “The shoppers told us if we bring new unique fashion brands, they will continue to shop here. In addition, the small supermarket is a huge attraction because it offers speciality goods exactly for this kind of client. It sells the kind of things you will not find in a Carrefour or Tesco.”

In another strategy, the London-based private equity real estate firm Europa Capital Partners is concentrating on buying up a series of small shopping centers around Poland with a local partner called IF Group through their “Eagle” investment platform. The goal is to build up a large portfolio that can attract a premium upon exit versus the sale of individual assets. Paul Kuœmierz, the son of a national Polish boxing champion, is running the Eagle platform and acquiring properties in secondary and tertiary locations where yields for shopping centers are around 8 to 9 percent. Thus far, Europa has acquired around 15 properties with the intention of assembling a total portfolio of approximately 20 retail centers.

“The customers like smaller shopping centers without a cinema, huge food courts and young people spending their days there. In addition, the small supermarket is a huge attraction because it offers speciality goods exactly for this kind of client. It sells the kind of things you will not find in a Carrefour or Tesco.”

In addition to the private equity real estate firms already active in the Polish retail sector, a number of others are looking to enter the market. US firm Harbert Management, which runs a European real estate vehicle, has just appointed Adam Karasch, formerly with Central and Eastern European developer US Invest Commercial Enterprises, to kick start a Polish investment program that includes retail. It is understood that the firm is pursuing numerous strategies in secondary and tertiary markets where there is more development potential. Macquarie Global Property Advisors, which has been active in the country's residential and office markets, is now looking towards retail as well. The private equity real estate firm believes large-scale developments remain attractive, but not in the principal cities of Poland.

“We think there is less competition in secondary markets,” says Daniel Harris, head of the region for MGPA. “We are looking to invest in, and develop shopping centers in, secondary cities to capture the growth in retail spending that we see as the economy grows.”

Loose change
Despite the strong underlying fundamentals in the retail sector, there are a number of countervailing influences confronting investors in Poland.

The first is construction costs, which have risen sharply in the past two years, particularly wages, which have added dramatically to the cost of development. The second is demographics. Joining the European Union has given Poles the freedom to work in Western Europe and thousands have taken the opportunity to move to the UK, Ireland and elsewhere, which has affected not only the construction industry but also the retail and hospitality sectors. Even in the glitziest malls such as Arkadia in Warsaw, which easily matches Western standards, the same advertisements can be found in shop windows again and again: “zatrudnimy sprzedawce,” which translates to “sales assistant required.” Such is the scale of economic migration that there are real concerns over slipping standards as employers turn to university students to fill vacancies.

But the other side to that coin is that a labor shortage means wages are increasing for those left behind. And that is one of the fundamental reason why retailers want to be in Poland and firms want to invest in retail property. As the market continues to mature, private equity real estate firms will continue to explore a variety of strategies in retail developments throughout the country. For now, the shopping malls might not be easy to staff, but that is hardly going to stop investors from trying to buy them.