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ESTONIA PROPERTY UPDATE

In the Q3 of 2011, worrying news has started to arrive from both USA and the Euro-zone, which have increased the uncertainty and put developers and investors to revise their plans.

In the Estonian residential property market, development activity has started to grow again in 2010, when a number of new projects were initiated. But continuous increase in construction prices combined with decline in purchasing power of the population has started to affect activity in this segment in a restrictive way. A growing uncertainty from the side of private consumption may calm down started positive processes in the retail property segment. Still, deficit of modern retail premises will persist in Tallinn. In the office segment, started decrease in vacancies and growth in rentals is jeopardized by possible weakening in financial position of the business companies. In the warehouse and industrial property segment, deficit appears in some property types, and rental rates are expected to start increase in the second half of 2011.

Revival in investment activity started in autumn 2010 and continued in the first half of 2011. Transactions amounts have increased. Transactions geography has expanded out of Tallinn. Investors’ attention was attracted the most by retail properties. Turbulence in the world economy, which became apparent in the Q3 of 2011, will most probably put further development of the investment market on hold.

Macroeconomic Forecast

As a result of 2010, Estonian GDP came over value of 2006, driven by an increase in export. In the Q3 of 2011, signs of uncertainty in both the Euro-zone and the world economy, have become obvious, which has cut world economy expectations. Due to reduced industrial orders in the Euro-zone, Estonian exports volume growth rate will turn to moderate, remaining still positive on year-of-year basis. Based on strong increase in exports volumes in the first half of the year, GDP growth in 2011 is expected at 7%. In 2012, GDP growth is forecasted to slow down to 3%.

The unemployment rate, which stopped growing in the end of 2010, remains on the same level and is expected to persist until the end of 2011 with no considerable improvement before 2013. High inflation, which has caused a decrease in average real wages for the 11thquarter in succession, is expected to go down to approx. 3% in 2012 (compared to the current 5%).

Interest rates

The economic situation in the Euro-zone becomes worrying. EURIBOR, which started to increase in the beginning of 2011, is not forecasted to go down. Estonian commercial banks’ margins continue moderate growth and most probably this tendency will persist in the short-term prospective.

Investment Market

The total value of transactions closed during first half of 2011 has increased to approx. 150 mln Euro, which is three times over the volume of total 2010. If the major part of property transactions was concluded in 2010 by local investors, then in the beginning of 2011, Scandinavian investors have returned to Estonian property market. After an active Q1, the volume of property transactions closed in the Q2 turned more modest, followed by a quiet Q3. Many investment decisions are postponed, partly due to uncertainty on the market, partly due to unmatched yield-expectations of potential sellers and buyers. The total amount of property investments in Estonia in 2011 will hardly come over 200 mln EUR.

Tallinn Office Market

Growing construction prices did not inspire developers to start new projects in the beginning of 2011; only few of them were started in spring. Despite descending vacancies and growing rental rates, continuous growth in construction prices (partly) caused by lack of working force in this sector, do not allow expecting revival in development activity in the second half of 2011. Further progress at the Tallinn office market will depend on the development of the overall economic situation.

Vacancy rate

Demand for office spaces started to increase in spring 2011 due to continuing positive development in the economic situation and the improved financial situation of the business companies. The average vacancy rate, having declined in 2010 from around 15% to 13%, continued to decrease in 2011, and reached below 10% in the end of the first half 2011. In quality well-located projects, only single spaces are available. As of autumn 2011, international companies have started cost-cutting, which will probably result in some calming of demand growth.

Rents

Rentals level started to increase in spring 2011 due to declining vacancies.

The market rent for prime office premises in Tallinn CBD is in the range of 105-130 EUR/sqm per year; top rent is 176 EUR/sqm per year. In other central locations the market rent is in the range of 76-93 EUR/sqm per year, with top rents up to 130 EUR/sqm. In the prime suburbs the market rent is in the range of 60-102 EUR/sqm.

Yields

The Investment market situation continued to improve in 2011, resulting in a decrease in yields for offices in prime CBD to the level of below 9%, being a few percentage points higher for secondary properties. The number of transactions with retail properties closed during first half of 2011 has increased compared to the same period of 2010. In the future, the yield development will be dependent on the dynamics of rents and vacancy rates and progress in lending situation.

Retail Turnover

The decrease in retail trade turnover stopped in the end of 2010, and the quarter-to quarter increase continues also in 2011. In August 2011, consumer confidence started to decrease, on the background of continuously complicated situation at labour market and overall economic uncertainty.

Supply

As of autumn 2011, the total modern retail stock in Tallinn makes up almost 470 000 sqm; the average shopping centre space per capita in Estonia has come over 300 m2per 1,000 inhabitants, being above the average European level.

The development activity in the retail segment is currently low; no large new projects are expected to be started during 2011 except for the on-going development of Tähesaju City shopping area in Tallinn, Lasnamäe (around 30 000 sqm). A considerable amount of new retail spaces is expected to be delivered in Tallinn starting from 2013.

Investment Market

In the first half of 2011 several retail property transactions were closed in Estonia with a total value of over 100 mln Euro. Those transactions were closed by both local and foreign (Scandinavian) investors.

The prime yields reached in the I HY of 2011 8,5%; further decline is expected by the end of 2012 to approximately 8%.

Rental Market

In the most successful shopping centres in Tallinn the vacancy is close to zero. None of the temporary retail facilities are suffering lack of tenants; small amortised soviet-age retail premises are the ones in trouble. Vacancy at street premises is being taking up, especially in Tallinn Old Town and the main shopping streets of City Center.

The prime rental level in Tallinn shopping centres is up to 230 EUR/sqm per year. Demand still exceeds supply, so tenants do not enjoy any discounts.

Comments, Questions, Additional Information:

Roul Tutt - Managing Director of Newsec Estonia+(372) 6645 090 r.tutt@newsec.ee www.newsec.ee

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Annika Wahlund Communication Manager