Unicredit: Romania - Real Estate Market Overview

• Significant stabilization of macroeconomic environment stimulated by EU convergence process

On 1 January 2007 Romania officially joined the EU as a result of acknowledged structural reforms and progress undertaken in the last decade. Looking forward to further achievements, the Romanian government presented its convergence report with plans to enter ERM-II in 2012. To help integrate Romania further into the EU there will be support from the planned EUR 31 billion structural and cohesion fund. Particular focus will be oriented towards competition, energy, transport, telecommunication, agriculture and consumer and health protection. Though there are some concerns regarding the efficiency of using these funds, they do represent an incentive for both local governments and the business sector to increase investments further. The Commission will ensure that the funds are going to be properly managed through financial corrections that may materialize in delayed disbursements, a reduction of future payments or a recovery of funds.

Since 2000, Romania has ensured a significant macroeconomic stabilization with a strong rebound of economic activity, reaching its peak in 2004. UniCredit CEE Research currently projects real GDP growth of 6% for 2007 and expects it to stay above 5% in the following years. Robust private consumption spending (despite reducing its pace of expansion) and accelerating investments will continue to be the main engine of growth in the country. According to the World Bank "Doing Business 2007", conditions for investments improved significantly during the last year with institutional progress made in the field of building permits, labor regulation and trading across borders. The favorable business environment is also assured by the low corporate tax (16%), improving infrastructure and relatively high labor productivity adjusted for labor costs. Positive prospects are expected in the medium term on the back of EU accession and sustained inflows of FDI, which play a significant role in deepening industrial integration and influencing the trade structure.

• Positive 2006 growth on the back of EUmembership

Romanian GDP increased in 2006 by a real 7.7 % yoy to reach EUR 97.2 bn. Last year was characterized by persistently strong growth in private consumption, fuelled by wage increases and credit expansion. While private consumption contributed the most, with annualized growth of 12.6% (representing 79% of total GDP), the fastest growth was registered in investments, which expanded by a real 16.1% yoy, supported well by foreign capital inflows. A significant volume of investments was directed towards infrastructure projects and the construction sector, posting impressive 19% yoy growth. The strong domestic demand led to an increase in imports, which resulted in a further deterioration of net exports. Nevertheless, the increasing share of capital goods in total imports (30% yoy growth in 2006) provides an indication of some improvements in the structure of the trade deficit.

• Positive growth prospects fuelled by huge (re)construction activity

Short and medium-term prospects look bright and the current pace of expansion is expected to continue, albeit somewhat more slowly due to the slightly more subdued growth in consumption. Investment activity is expected to gain further ground sustained by new large infrastructure projects and continued high FDI inflow. Boosted by the mild winter, construction works went up by 28.3% yoy in the first two months of this year. Such figures signal that 2007 may be a record year for the construction sector, supported by high demand for both residential and nonresidential buildings. The contribution of net exports is expected to deteriorate on the back of cheaper and more easily accessible products imported from EU member countries. Overall, full-year real GDP growth of 6% yoy should be achievable.

• Euro adoption expected in 2014

The Romanian government presented its convergence report with plans to enter ERM-II in 2012. Romania currently fulfills three out of the five Maastricht conditions, with fiscal balance and public debt below the 3% and 60% thresholds and fluctuations in the exchange rate remaining within the +/- 15% band. Nevertheless, further efforts are needed in order to forge ahead with the disinflation process to help achieve fast convergence in interest rates in order to meet all Maastricht criteria as of Q4 2011 to be able to adopt the euro as of 1 January 2014. The medium-term goals of the government also include improvements in the predictability of fiscal policy, efficient use of EU funds, continuation and deepening of structural reforms, sustainability of public finance in the long term, improvements in the investment environment, harmonized regional development, work force flexibility and public administration reform.

• Focus on disinflation with an eye on FX market development

In the early months of 2007 headline inflation slowed further to 3.7% in March. Lower food-prices, which account for more than 39% of the CPI basket and are quite volatile, kept price growth low. Also cheaper imported products on the back of the still strong appreciation in the RON and increased competition among retailers have helped. The highest price increases were registered in the services sector, reflecting some convergence towards the higher costs in the EU for medical, water and wastewater services. Despite the lower than expected inflation figures, demand-side inflationary pressure still seems to be present, as shown by the relatively high administered price inflation in the past months. Price pressures are expected to resume in the coming months on the back of fast wage growth, the still high domestic demand and loose fiscal policy.

Additional price pressure is also expected mainly due to a higher base effect induced by the decline in volatile food prices during Q3 last year. Further adjustments in administrative prices are also expected to exert a strong inflationary impact. Romania is gradually lifting energy prices as it has pledged to align tariffs for domestic gas prices to the EU level by 2009.

• First signals of a looser fiscal policy

The 2007 budget targets a public deficit of 2.8% of GDP. Most of the increase in government spending is needed to support infrastructure investment expenditure. Revenues are projected to increase up to 35.2% of GDP, mainly as a result of the increase in transfers from the EU, as well as from corporate and personal income taxes and the stepped-up enforcement of VAT that is anticipated. The boost in revenues is needed in order to offset the 2% decrease in the social security contribution rate. February figures already showed a 0.5% deficit after the 0.6% surplus realized in January. The budget balance of the first two months posted a surplus of only 0.1% of expected GDP. This in combination with the upside revision of the planned state securities issue are giving clear signs of a more expansionary fiscal policy, supporting a forecast for a full-year deficit of 2.3%.

• Despite good FDI coverage, the deteriorating current account remains an issue to monitor

The current account closed 2006 with a deficit of EUR 9.97 billion, or 10.3% of GDP. The trade deficit widened to EUR 14.9 billion. Current transfers, incl. wage remittances from Romanians working abroad and EU funds, covered about 40% of the trade gap. Imports surged by 25% yoy in 2006 sustained by imports of capital goods (machinery and equipment, up by 29.5% yoy) and transport equipment (up by 41.5 % yoy). The main export drivers were also machinery and equipments, which increased by 33% yoy last year and became the main items in total exports with a share of 20% (outpacing textile products whose share dropped to 16%). The most dynamic sub-sector in terms of exports was transport equipment (mainly in connection with the automotive sector) with an average growth rate of 44% for the whole year.

In the first two months of 2007, Romania"s trade deficit widened by 83% (FOB/CIF) yoy to reach EUR 2.6 billion. For the rest of the year, pressures on the external balance are expected to come mainly from the persistence of excess demand fuelled also by lower imports prices, robust investment growth and loose fiscal policy.

The current account deficit is expected to widen further to 11.5% of GDP this year. To restrict this expansion, policy tools have to be used (e.g. to depress loan expansion). Nevertheless, even if the deterioration of the current account gap slows in the medium term, its sustainability remains an issue to monitor.

• Foreign companies target Romania

Foreign investors are attracted by the potential offered by the Romanian market. Since 2004 Romania has become one of the most important beneficiaries of FDIs in the region, reaching a record FDI level of 9.3% of GDP in 2006, due to huge inflows connected to some very large privatizations in the oil, banking and energy sectors. Also greenfield investments have become increasingly relevant and are likely to offset the lower inflows from privatization. The improved business prospects based on EU membership and the appealing tax system create the prerequisites for a sustained inflow of FDI, expected to be around EUR 5.7 bn on average over the 2007-2009 period. Although large-scale privatisation is near completion, there is still a significant number of companies in the portfolio of the National Authority for State Assets Realization (AVAS). Beside the main power distributors in Romania (subsidiaries of Electrica), priority privatisations for 2007 include companies from a variety of industries such as "Antibiotice", one of the largest domestic pharmaceutical producers, the electrical equipment manufacturer "Electroputere" and the main research institutes. Overall, FDI attracted through privatizations is expected to reach around EUR 1.7 bn in 2007, unless the political turmoil makes the current privatization plans unfeasible.

Traditionally, the most attractive sectors for foreign enterprises include those with a high incidence of labor cost and specialized in traditional and standardized production (i.e. textiles, clothing and leather). However, an increasing number of foreign investors are targeting Romania to capture the strong potential connected to the large local demand as well as the need for renovation and to build up local infrastructure. Many companies consider the Romanian market very appealing in view of its growth potential compared to much more saturated western markets, targeting it for the commercialization and production of cheap products with gradual widening of the product range as soon as demand evolves in the market. In some cases, the launch of big projects connected to the modernization of infrastructure and the possibility to benefit from EU cofinancing represented a strong incentive to move into the country. With a positive growth scenario and increasing demand for high-quality accommodation and retail outlets, as well as large infrastructure projects (roads, motorways and utilities), the construction sector is expected to be one of the most attractive sectors in the coming years, generating a positive spill-over effect to other sectors like other nonmetallic mineral products, wood and wood products. Romania represents an interesting market in terms of future development with a lot of potential by virtue of the increasing demand for new constructions and renovation of old buildings, residential and non-residential projects.

Real Estate Country Facts

• EU-Euphoria drives commercial real estate market

Romania benefited from growing foreign interest even prior to joining the EU on 1 January 2007. In 2006, the influx of foreign investment reached a record level, equalling over 9% of GDP and the country"s attractiveness for international investors is still high. Not only is the macroeconomic climate appealing, the administrative and legal environment should also improve further, as EU membership was achieved subject to the implementation of reform concentrated on fighting corruption and enhancing the legal system. These reform measures should also have a positive effect on the transparency of the real estate market in the future. In the annual real estate transparency index published by Jones Lang LaSalle, international markets are rated in five categories, i.e., high transparency, transparent, semi-transparency, low transparency and opaque. According to the 2006 index1), Romania still has a long way to go.

Although two ranks up, from 50 to 48, Romania has remained in the category of low transparency. There are no restrictions to the acquisition of real estate by legal persons under Romanian law (e.g. Romanian firms with foreign participation). Nevertheless, ownership can still be a delicate issue. Careful due diligence research is a must and may be quite time-consuming. Despite the lack of transparency, international interest in the Romanian real estate market is high and foreign capital contributes significantly to market development. In the office space sector, investment is strongly concentrated on Bucharest. Although in retail and logistics, regional development is more widely spread, Bucharest also holds a predominant position here in view of its above-average purchasing power and its position as an important traffic hub.

Over the last years real estate has become a wellestablished investment category. On the lookout for attractive yields in Europe, international investors have gradually moved further to the east, with the result that yields have already declined considerably. Also the Romanian investment market is characterized by yield compression, which in light of the EU euphoria has been extremely significant. Between 2004 and end 2006, yields fell from double digit levels to about 7% in the office and retail sectors, and to slightly above 8% in logistics. As the investment market is still under-developed and its transparency is rated low, the market risk for Romania is still considered high by ING Real Estate´s worldwide ranking. However, it can be assumed that Romanias risk position will improve as EU integration proceeds. Austrian and British investors are very active, yet demand from German, U.S. and Australian investors is increasing as well. Real estate transactions are typically denominated in EUR. There is a relative preponderance of office space transactions, yet, the most important deal in 2006 was in the retail business - the Shopping Center City Mall.

• Office market booming - Quality A catching-up

The office market is concentrated in the Greater Bucharest area (2.2 to 2.3 million inhabitants) and over recent years, its growth has been dynamic. Since 2003, the supply of modern office space has roughly doubled and now exceeds 700,000m2. There is no traditional central business district (CBD). Development in the center between Romana and Unirii Plaza suffers from heavy traffic and a lack of both of parking and developable space. Office building projects are therefore concentrated in the north of the city, relatively widely spread between Piata Victoriei and Baneasa. These areas are easily accessible by public transportation and/or cars and are well connected to the airport. Ministries and embassies are also located in the north of the city, which is a popular residential area as well. Demand has been high and the development of rentals for high-quality office space has been stable, with a current level of EUR 15-19/m2/month. Higher rents are occasionally reported for exceptional projects in the city or in prime locations in the north, however, in less attractive locations comparable quality is notably lower priced.

Retail - Aggressive expansion plans for shopping centers

Starting from a low basis, Romanian per capita income increased sharply between 2001 and 2006, to an estimated EUR 4,500. During the same period, Romania"s GDP measured by purchasing power parity has improved; compared to the EU-25 average = 100%, it went up from 26.2% to 35.8%. Increasing wealth and easier access to loans has helped Romanian households notably improve their consumption potential; however, retail sales are still low by international comparison. Shopping is concentrated in small, traditional shops, shopping centers, markets and department stores.

There is high growth potential for retail and the market is extremely attractive for international retail chains, such as Carrefour, Rewe (Penny and Billa), Tengelmann, Lidl, Cora, Auchan, IKEA and others which are already on the market.

Quality standards of shopping centers are gradually adjusting to western standards. Demand for modern retail areas is strong and there are practically no vacancies. Average rents in the newer shopping centers are around EUR 20 to 25/m2/month and substantially lower in the older ones, at around EUR 15/m2/month.

Purchasing power is highest in Bucharest: with a population share of 10.2%, Greater Bucharest accounts for 24.8% of GDP. The average household income is about EUR 460, which is about 60% above the national average. There is a wealth gradient, favoring the northern and western parts of the city.

There are currently five shopping centers in Bucharest: Unirea Shopping Center (built in 1990), Bucharest Mall (1999), Plaza Romania (2004), Jolie Ville (2004) and City Mall (2005) with a total retail area of 146,600 m2 (including planned expansions). At only 0.08m., shopping center space per capita is extremely low in Bucharest.

The number of new shopping center projects is enormous. According to plans, eight new projects will have been finished in Bucharest by the end of 2009, the largest one being Colosseum Shopping Center with a gross rentable area of over 100,000m2. If all projects are realized as planned, this will result in an almost five-fold increase in the supply of retail space. Yet, such a rise in the retail space ratio of 0.37m. per capita would still be acceptable by international standards. This is especially due to the fact that retail in Bucharest is concentrated in shopping centers asthere is a lack of significant pedestrian zones or famous shopping streets. Only Calea Victoriei and Blvd. Magheru N. Balcescu are central shopping streets. There, rentals are between EUR 100 and 125/m2 per month. The vacancy rate is a low 3%.

There is also a lot of activity outside Bucharest. There are shopping center projects in all Romanian cities with a population of over 200,000 and interest in developing shopping centers for the smaller cities has grown as well.

Logistics market benefits from infrastructural investments and dynamic retail sector The Romanian logistics market is still relatively underdeveloped. In the past, development was dampened by a lack of infrastructure and weak economic growth. The strong economic catch-up in recent years has led to increased demand for modern warehousing capacity. Bucharest is an important logistics center and benefits from the strong, above-average regional economic growth and good traffic connections.

Bucharest is well located on the crossroads of three future pan-European transport routes: the street-rail corridor from Alexandroupolis to Kiev, the street corridor from Dresden to Constanta and the Danube waterway as the most important transport route within Romania, with a length of 2,300km. Bucharests Otopeni International Airport handles all the freight. With EU support the underdeveloped infrastructure will be further modernized and expanded. The supply of modern warehouses in the Bucharest area is still relatively low and is estimated at over 275,000m2 for the end of 2006. This year, a further 200,000m2 shall be added. Demand comes primarily from international logistics companies or new retail firms and also arises in connection with relocations.

After rentals peaked in 2005, there was a slight decrease in prices, down to EUR 4.5m2 to 5.5m2 per month. The highest rents in Bucharest are charged near the Otopeni airport and in the western parts of the city. Further developments might cause additional, slight price decreases this year.

Similar to the office and retail segments, prices for land have also gone up notably, ranging between EUR 35m2 and 50m for areas with good traffic connections in the westof Bucharest. There has been interest by investors in the logistics market. Yields are coming down and are estimated at around 8% for the end of 2006. Due to the underdevelopment of the market and its low transparency, only limited information is available on transactions.