Stressful times in the real estate market; builders between the rock and a hard place

CEO of Capital Mill Kaarel Loigu predicts difficult times for the real estate market. Photo: Sander Ilvest

• The real estate portfolio of Capital Mill in Baltics amounts to more than 400 million euros.
• Rapid inflation gradually reaches the rents of commercial real estate.
• Besides rising prices of building material the wage pressure continues.

According to Kaarel Loigu, manager of the real estate development and management company Capital Mill, which is expanding its reach in the Baltic countries, the real estate market is currently undergoing rapid changes: loan interest rates are rising, construction is becoming more expensive, and wage pressure continues, while real estate prices, which have been moving vertically up until now, may soon start to fall.

If apartment rents have risen sharply in the last year, where is the rental price of commercial premises moving?

The rental price of commercial property is usually set for a long period of time. It is true that most of the time the price is adjusted according to inflation. The fact that inflation is particularly fast this year will surely gradually affect prices. Undoubtedly, it's an interesting time; we have to hold intense negotiations with customers, because you cannot raise the price by 20 percent in one fell swoop. Especially because, in case of stores, for instance, a steep increase in the rental price would mean that it would immediately be passed on to the consumer by increasing the price of the goods, and a snowball effect would be triggered.

A compromise must be found here, because the landlords also do not want to lose customers or have empty space in their buildings. But the fact is that prices are going up.

Real estate became more expensive both in Estonia and in other parts of the world during the pandemic. Several analysts believe that since the risk of economic recession is now high, the price of real estate will also fall, and the fall will be greater where the rise was faster. In Sweden, where the price increase was almost as fast as in Estonia, the price already fell steeply. What will happen to us at the end of the year?

The price increase was largely related to the fact that there was enough free money in the market, and in troubled times people have looked to real estate to preserve their purchasing power and diversify their investments.

Uncertain times are continuing, interest rates are rising and real returns decreasing. Prices will probably fall when the market cools down, but I do not believe the kind of fall as during the crisis that started in 2008, when prices fell by 30-50 percent in many asset classes.

The fact that the war is a stone's throw away from us certainly scares foreign investors, but it gives more opportunities to local ones. The yield in our region is still higher than in the more developed market.

You worked in banking for over 20 years, are there any signs that banks are starting to slow down lending?

They certainly aren’t pulling the plug as yet. At the same time, the euribor is rising rapidly and the banks have also already increased their margin, which expresses their assessment of the general market situation.

How will the cost of construction affect Capital Mill developments?

Fortunately, we were able to open the buildings which we had already completed without major problems, because the material had largely been bought out before the price rise that accelerated with the start of the war. At the same time, however, we put a couple of developments in Lithuania on hold indefinitely. On the other hand, we will make some announcements about new developments this year.

There is a lot of uncertainty in the construction market at the moment. I would not want to step into the shoes of a builder, because they still have very hard times. At the price agreed upon in the beginning of the year, developments may already be largely loss-making by now. In addition to the rising cost of building materials, wage pressure continues.

Here, too, the developer has to reach a compromise with the builder, because it is not possible to let the builder bear all the suddenly increased costs. As the state also reduces its orders, less money comes into the construction market. The situation will be very difficult for the next six months and the builders will be between a rock and a hard place. We live in interesting but stressful times.

Capital Mill can be translated into Estonian as money mill, and real estate has brought a lot of money to most investors in recent years. What exactly does the company do and for whom does it make money?

We have been engaged in real estate development and management in Estonia, Latvia and Lithuania for over 15 years. We have a few dozen investors whose entrusted money we have channeled mainly into commercial real estate. Today, our real estate portfolio in the Baltic countries totals more than 400 million euros. Almost 70 percent of our assets are located in Estonia, 20 percent in Lithuania and about a tenth in Latvia.

Both Estonian and foreign wealthy investors, who have entrusted us with choosing the projects, invest in the real estate market through Capital Mill. Investors include people with experience in the real estate sector, but also people from other walks of life. All of them choose for themselves which project to invest in and how much risk they are willing to take.

It is up to them to decide whether to join a new development project or to invest in a management project which has been working well for years and has a fairly solid established cash flow. The risk level gap is quite wide. Our main task is to find good projects and opportunities in the market and to make their pros and cons and risks clear to potential investors before making an investment decision.

You operate in all three Baltic countries, how do these markets differ from each other?

In Estonia and Lithuania, the real estate market is quite similar in terms of the level of development and administration. In Latvia, processing documents takes longer because there is more bureaucracy. In terms of state and local government organization, Latvia lags behind.

One difference in commercial real estate is certainly that, while Tallinn and Vilnius have developed a definite downtown business district, Riga essentially does not have one. If we have tall office buildings in the city center in a single area and close to each other, there is no such concentration in Riga. There are three or four attractive quarters in Riga, which are located a few kilometers outside the city center.

I like the Tallinn and Vilnius option better, because office buildings are primarily designed for comfortable work and people are probably more comfortable if the offices, government institutions and well-established infrastructure are located as close to each other as possible.

At the same time, I see the biggest potential in the Latvian market right now, because the market has to catch up some of the lag.

How did the pandemic and the accompanying movement of workers to home offices affect investing in commercial real estate?

The offices became deserted indeed but it has not affected our plans much in the long run. There is a lot of market for new environmentally friendly office buildings due to the energy crisis. Here, the emphasis is on green solutions, which help to significantly save on utility costs. For example, the analysis performed by the anchor tenant of the Skyon house we developed revealed that the savings after moving into this house was 34 percent for heating and 75 percent for electricity per square meter. At current energy prices, this is a big benefit.

The Skyon building, which was completed last summer, differs from the high-rise buildings next to it in that we have almost half as much glass surfaces. The facade of the building is covered by 898 colored glass panels, which may seem like a mere design element at first glance, but there are environmentally friendly smart solutions behind it. Thanks to them, we can offer people better working conditions, including better air quality, which, in my opinion, is one of the most important components in creating a good working environment.

Smaller glass surfaces provide significant energy savings in both cooling in summer and heating in winter. Thanks to the green solutions, we received the highest international certificate LEED Platinium for this high-rise building, which is issued by analyzing, for example, the building's water use efficiency, energy efficiency, and the quality of materials and the indoor environment. Today, these are increasingly important criteria for tenants when choosing where to set up their office.

So there is still plenty of market for new office space even in the changed situation.

In June, Capital Mill bought Rappel, the largest shopping center in Rapla county, and the Ahtme Maxima supermarket from Fausto Capital. By which criteria do you choose what to buy or build?

First we view whether the building matches our strategy. Commercial real estate, especially supermarket buildings, is one of our main directions. For example, our portfolio includes several Maxima store buildings, and we manage and maintain two of their large logistics centers in Lithuania. We also have several Rimi, Selver and Coop store buildings in our portfolio.

On the other hand, we do not currently deal with large shopping centers. Supermarkets, whose buildings usually only house a grocery and flower shop and maybe also a pharmacy, for example, survived very nicely during the pandemic.

Of course, before starting development or buying an already functioning building, we thoroughly analyze its yield and risk level.

Capital Mill OÜ

Founded in 2006.

Major owners are Igor Mölder and Marko Kull.

Sales revenue in 2020 nearly 4 million euros and in 2021 4.6 million euros.

Profit 1.37 million euros in 2020 and 3.5 million euros in 2021.

Number of employees 16